What Are Non-Borrowed Reserves?

Non-borrowed reserves are bank reserves—that is, the funds a financial institution holds in cash—that are its own, and not money on loan from a central bank.

Key Takeaways

  • Non-borrowed reserves are funds a financial institution holds in cash; the funds are its own, and not money on loan from a central bank.
  • In practice, the vast majority of reserves in the U.S. are non-borrowed; getting loans from the Federal Reserve is relatively expensive and carries a stigma.
  • A bank's non-borrowed reserves overlap with, but are not exactly the same as, its excess reserves or free reserves.

Understanding Non-Borrowed Reserves

Under the fractional reserve banking system, depository financial institutions (what most of us think of as banks) only hold a limited amount of their total funds in a liquid form at any given time. Instead, they invest or lend out most of the deposits they receive from customers.

However, in order to increase financial stability—discouraging bank runs, for example—central banks impose reserve requirements, forcing these institutions to keep a certain portion of their funds either as vault cash or on deposit in accounts at the central bank.

To satisfy these reserve requirements, banks can borrow from the central bank if they need a cash infusion. In the U.S., that central bank is the Federal Reserve. The Fed, or more precisely, one of the 12 Federal Reserve banks, makes overnight loans to commercial banks at a discount rate. The central bank lending facility meant to help commercial banks manage short-term liquidity needs is called the discount window.

Reserves that are the bank's own, and not on loan in this way, are non-borrowed reserves. Non-borrowed reserve funds are calculated each week.

In practice, the vast majority of reserves in the U.S. are non-borrowed since discount window borrowing is relatively expensive and carries a stigma. It implies the bank isn't managed well, letting itself get into a cash crunch.

Non-Borrowed Reserves vs. Excess Reserves vs. Free Reserves

A bank's non-borrowed reserves overlap with, but are not exactly the same as, its excess reserves or free reserves.

Excess reserves refer to any reserves a bank has that exceed the Fed's reserves requirements, whether they are borrowed or not. Subtracting borrowed reserves from excess reserves yields a bank's free reserves, which are available to be lent out (the reason they're called "free"). In other words, free reserves consist of the cash a bank holds in excess of required reserves, minus any money borrowed from the central bank.

Traditionally, bank reserves decrease during periods of economic expansion and increase during recessions.

Since the financial crisis of 2008–2009, the Fed has paid interest on excess reserves. Combined with a near-zero federal funds rate, that policy drove the level of excess reserves to unprecedented levels in the ensuing decade, meaning that few institutions had a need to borrow to make up a shortfall.

More free reserves mean more available bank credit, which in theory lowers the cost of borrowing and eventually leads to inflationary pressures. However, that has not happened this time, because of a prevailing deflationary environment.