DEFINITION of Lagged Reserves

Lagged Reserves is a method of bank reserve calculation whereby the financial institution is required to keep a certain level of reserves with a Federal Reserve bank. The amount of reserves required is based on the value of all outstanding deposits in the bank's demand deposit accounts from two weeks prior.

BREAKING DOWN Lagged Reserves

Lagged reserve calculation was used from the late 1960s until 1984, when contemporaneous calculations were implemented. But the Fed decided to revert back to the lagged calculation in 1998 in order to obtain more accurate data. This type of reserve calculation is still being used today.

How Lagged Reserves Work

Reserve requirements are the amount of cash that banks must have, in their vaults or at the closest Federal Reserve bank, in line with deposits made by their customers. Set by the Fed's board of governors, reserve requirements are one of the three main tools of monetary policy — the other two tools are open market operations and the discount rate.

The system of lagged reserves requires a bank's currency reserves held with the Federal Reserve to be tied to value of its demand deposit (checking) accounts 14 days earlier. If all of a bank's demand deposits were $500 million on a given date, and its reserve requirement was 10%, its currency reserves two weeks later would need to equal $50 million.

As of Jan. 1, 2018, banks with deposits less than $16 million have no reserve requirement. Banks with between $16 million and $122.3 million in deposits have a reserve requirement of 3%, and banks with over $122.3 million in deposits have a reserve requirement of 10%. Non-personal time deposits and eurocurrency liabilities have had a reserve ratio of zero since December 1990.

Reserves are counted against total transaction accounts, which consists of demand deposits, automatic transfer service (ATS) accounts, NOW accounts, share draft accounts, telephone or preauthorized transfer accounts, ineligible bankers acceptances, and obligations issued by affiliates maturing in seven days or less. Net transaction accounts are total transaction accounts less amounts due from other depository institutions and less cash items in the process of collection. 

No bank would have enough cash on hand of a significant percentage of its depositors wanted their money at the same time. That's because most of the money is lent out to other customers. The Federal Reserve, however, maintains a Discount Window where financial institutions can get additional cash on demand at any time to meet their requirements.