Business Definition for: reserve requirements
reserve requirements
portion of their deposits banks and savings institutions are required to maintain as
legal reserves
for the protection of depositors. Reserve requirements also provide one of the monetary adjustment tools the Federal Reserve System employs to regulate the supply of credit in the banking system. By raising or lowering the amount of required reserves, the Federal Reserve can either stimulate or tighten available bank credit, and the ability of banks to lend-known as fractional reserve banking. The ratio of required reserves to deposits ranges from 3% to 12% for transaction accounts such as checking accounts and Negotiable Order of Withdrawal (NOW) accounts, and up to 3% for time deposits (certificates of deposit). The reserve requirement may be kept in a separate checking account or with the bank's own cash (
vault cash
). Commercial banks that are member banks in the Federal Reserve System are required to maintain their reserves in a checking account (
reserve account
) at the nearest Federal Reserve Bank. Other financial institutions have the option of holding reserves at a Federal Reserve Bank or in a checking account (called a
pass-through account
) at a correspondent bank.
See also
fractional reserves
,
nonborrowed reserves
,
total reserves
,
borrowed reserves
,
excess reserves
Related Terms:
proportion of bank deposits that must be kept as legal reserves. Bank reserves are a tool of central bank monetary policy; an increase in the ratio of required reserves to deposits indicates a tightening in credit policy by the Federal Reserve. Large banks are required to keep up to 12% of checking account deposits in a noninterest earning account at the Fed. Smaller banks have lower reserve requirements. The multiplier effect of money allows a bank to re-lend most (88 ¢ of $1 in deposits, at a 12% reserve requirement) of the funds in new deposits, in effect, creating new deposits. Because only a portion of deposits are backed by reserves, banks can suffer losses, or even fail, due to a sudden runoff of deposits, as in a bank run. This risk is known as liquidity risk.
measure of banking system reserves, consisting of total reserves (member bank deposits in Federal Reserve Banks, plus vault cash), less funds borrowed (borrowed reserves) at the Federal Reserve Discount Window. The amount of nonborrowed reserves is computed weekly by the Federal Reserve.
sum of the deposits that depository institutions may count toward their legalreserve requirements. Included in the calculation are reserve account balances on deposit with a reserve bank during the most recent week, currency and coin in a bank's vault, including cash in transit to or from reserve banks. The Monetary Control Act requires most depository institutions to keep reserve balances either directly or indirectly with the Federal Reserve.
funds borrowed by member banks from a federal reserve bank for the purpose of maintaining the required reserve ratios. Actually, the proper term is net borrowed reserves, since it refers to the difference between borrowed reserves and excess or free reserves. Such borrowings, usually in the form of advances secured by government securities or eligible paper, are kept on deposit at the Federal Reserve bank in the borrower's region. Net borrowed reserves are an indicator of heavy loan demand and potentially tight money.
money a bank holds over and above the reserve requirement. The money may be on deposit with the Federal Reserve System or with an approved depository bank, or it may be in the bank's possession. For instance, a bank with a reserve requirement of $5 million might have $4 million on deposit with the Fed and $1.5 million in its vaults and as till cash. The $500,000 in excess reserves is available for loans to other banks or customers or for other corporate uses.
Referring Terms:
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