What is Reserve Ratio?

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The reserve ratio is the portion of reservable liabilities that commercial banks 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. It is also known as the cash reserve ratio.The minimum amount of reserves that a bank must hold on to is referred to as the reserve requirement, and is sometimes used synonymously with 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.

Definition

The reserve ratio refers to the portion of depositors' balances that commercial banks must have on hand as cash. This requirement is set by the country's central bank and is also known as the cash reserve ratio. The minimum amount of reserves that banks must hold is called the reserve requirement, which is sometimes used synonymously with the reserve ratio.

Origin

The concept of the reserve ratio originated in the early stages of banking development when banks needed to ensure sufficient cash to meet customer withdrawal demands. As modern banking systems evolved, central banks began using reserve ratio adjustments to regulate money supply and economic activity.

Categories and Features

The reserve ratio can be divided into statutory reserve ratio and excess reserve ratio. The statutory reserve ratio is the minimum requirement set by the central bank, while the excess reserve ratio is the portion that banks voluntarily hold above the statutory requirement. Adjusting the statutory reserve ratio can affect banks' lending capacity, thereby influencing economic activity. The excess reserve ratio reflects banks' risk management strategies.

Case Studies

During the 2008 financial crisis, the Federal Reserve lowered the reserve ratio to increase bank liquidity and help stabilize financial markets. Another example is the People's Bank of China, which adjusted the reserve ratio multiple times in 2018 to support economic growth and alleviate credit tightening.

Common Issues

Investors might misunderstand the impact of reserve ratio adjustments on banks' profitability. Typically, lowering the reserve ratio can increase banks' available funds for lending but may also increase risk. Conversely, raising the reserve ratio may limit banks' lending capacity but helps enhance financial stability.

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