What are Secondary Reserves
Secondary reserves, also known as excess reserves, are bank assets invested in safe, short-term securities, including Treasury bills. Secondary reserves are a supplemental measure of low-risk liquidity, providing additional reserve capital if needed. These reserves earn interest and can be useful in boosting a bank's primary reserve total, should the bank experience loan losses or a surge in customer withdrawals. These reserves are those in excess of the reserve requirements as measured by the reserve ratio.
BREAKING DOWN Secondary Reserves
Secondary reserves are often deposited in short-term instruments that can be quickly converted to cash when additional liquidity is required. However, they are not listed separately on the balance sheet. Secondary reserves differ from legal reserves in their ability to earn interest.
Types of Secondary Reserves
Secondary reserves usually include Treasury bills, but also include other short-term government securities and bank acceptances. While primary bank reserves don’t earn interest, secondary reserves can, and act as additional liquidity for banks. That means when primary reserves are running low, secondary reserves can be used to boost the reserve position.
Cash and deposits not needed for loans can be used to invest as secondary reserves. Broadly speaking, any security purchased by a financial institution that’s low-risk can be considered a secondary reserve if it can be reasonably converted into cash. This includes municipal bonds from local and state governments and various federal bills and notes.
Primary Reserves and Secondary Reserves
Bank reserves, or primary reserves, don’t earn interest. This is capital kept in a bank vault or kept at the Central Bank. Banks must keep a minimum amount as reserves, additional money invested for the short-term that can be quickly used to boost its primary reserves is called secondary reserves.
History of Secondary Reserves
Prior to the Emergency Economic Stabilization Act of 2008 banks were not allowed to collect interest on secondary reserves. Holding reserves beyond the reserve requirement provides a safety net against loan losses, but secondary reserves can also play a role in boosting the credit rating of the financial institution.
After the ability to collect interest on secondary reserves came about during the financial crisis, banks naturally started holding more capital as secondary reserves. That is if the rate collected on loans is low enough, banks may choose to instead invest in secondary reserves. Or if the demand for loans is low, banks will choose to invest that money as secondary reserves to ensure they are collecting a return for unused money.