What is the Reserve Ratio
The reserve ratio is the portion of reservable liabilities that depository institutions must hold onto, rather than lend out or invest. This is a requirement determined by the country's central bank, which in the United States is the Federal Reserve. As a simplistic example, assume the Federal Reserve determined the reserve ratio to be 11%. This means if a bank has deposits of $1 billion, it is required to have $110 million on reserve.
BREAKING DOWN Reserve Ratio
Depository institutions in the United States are required to hold reserves against their total reservable liabilities, which cannot be lent out by the bank. Reservable liabilities include net transaction accounts, nonpersonal time deposits and Eurocurrency liabilities. The reserve amount is referred to as the reserve requirement, and is expressed as a percentage known as the reserve ratio. The reserve ratio is specified by the Federal Reserve Board’s Regulation D. Regulation D created a set of uniform reserve requirements for all depository institutions with transaction accounts, and requires banks to provide regular reports to the Federal Reserve.
Banks must hold reserves either as cash in their vaults or as deposits with a Federal Reserve Bank. On Oct. 1, 2008, the Federal Reserve began paying interest to banks on these reserves. This rate is referred to as the interest rate on required reserves (IORR). There is also an interest rate on excess reserves (IOER), which is paid on any funds a bank deposits with the Federal Reserve in excess of their reserve requirement.
Reserve Ratio Guidelines
Within limits specified by law, the Board of Governors of the Federal Reserve has the sole authority over changes in reserve requirements. In January 2018, the Fed updated its reserve requirements for depository institutions of different sizes. Banks with more than $122.3 million in net transaction accounts must maintain a reserve of 10% of net transaction accounts. Banks with $16 million to $122.3 million must reserve 3% of net transaction accounts. Banks with net transaction accounts of $16 million or less do not have a reserve requirement. The majority of banks in the United States fall into the first category. The Fed set a 0% requirement for nonpersonal time deposits and Eurocurrency liabilities.