What is Bank Reserve?
691 reads · Last updated: December 5, 2024
Bank reserves are the cash minimums that financial institutions must have on hand in order to meet central bank requirements. This is real paper money that must be kept by the bank in a vault on-site or held in its account at the central bank. Cash reserves requirements are intended to ensure that every bank can meet any large and unexpected demand for withdrawals.Historically, the reserve ratio has ranged from zero to 10% of bank deposits.
Definition
Bank reserves are the minimum cash reserves that financial institutions must hold to meet the requirements set by the central bank. This is actual currency that banks must keep in their own vaults or hold in an account at the central bank. The cash reserve requirement is designed to ensure that each bank can handle any large and unexpected withdrawal demands.
Origin
The concept of bank reserves originated in the early stages of banking development when banks needed to ensure sufficient cash to meet customer withdrawal demands. As the banking system became more complex, central banks began to set reserve requirements to maintain financial stability. Historically, reserve ratios have varied between 0% and 10% of bank deposits.
Categories and Features
Bank reserves can be divided into required reserves and excess reserves. Required reserves are the minimum set by the central bank, while excess reserves are the additional reserves held by banks beyond the required amount. The main feature of required reserves is their mandatory and stable nature, whereas excess reserves provide banks with flexibility in liquidity management.
Case Studies
During the 2008 financial crisis, the Federal Reserve adjusted reserve requirements to influence bank liquidity. For example, lowering the reserve ratio can free up more funds for banks to lend, thereby stimulating the economy. Another example is the People's Bank of China adjusting reserve ratios during different economic cycles to control money supply and inflation.
Common Issues
Investors might misunderstand the impact of reserve ratio adjustments on bank profitability. Lowering the reserve ratio is often seen as beneficial for bank profitability because it allows banks to lend more funds. However, too low a reserve ratio can increase the risk within the banking system.
