Bank Reserve

What is Bank Reserve?

Bank Reserves refer to the minimum liquidity reserves that every bank is required to maintain to make sure they never run out of cash in case the customer demands the withdrawal of the deposits kept with the bank.

Classification

It can be classified into the required reserveRequired ReserveReserve Requirement is the minimum liquid cash amount in a proportion of its total deposit that is required to be kept either in the bank or deposited in the central bank, in such a way that the bank cannot access it for any business or economic activity.read more and the excess reserveExcess ReserveExcess reserves are kept or deposited with the central regulatory authority over and above the statutory requirements. If reserves are positive, the bank has held the amount in reserves more than the statutory requirement. In the case of zero value, there is no deficit or surplus reserves balance kept.read more.

Classification of Bank Reserve

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Source: Bank Reserve (wallstreetmojo.com)

#1 – Required Reserve

The required reserve is the minimum funds that banks must hold to meet their deposit liabilities. The Fed has the authority to make changes from time to time in the required reserve ratio percentage.

The Fed has updated its required reserve target ratio, which is applicable from the effective date January 17, 2019.  The updated limits are as follows:

1 Required Reserve

(Source: federalreserve.gov)

As per the latest requirements, all the banks having deposit liabilities valuing more than the US $ 16.30 million but less than the US $ 124.20 million must keep 3% of deposits as required reserve and the banks with deposit liabilities of more than the US $ 124.20 million must maintain a required reserve equal to 10% of deposit values.

Further, while calculating the amount of required reserve, the banks consider the net transaction accounts, that means they do not consider the funds due from other banks or transaction that are still outstanding.

#2 – Excess Reserve

The excess reserve is the cash required to keep in the vault over the minimum required reserve. Usually, the banks keep the excess reserve balance at lower levels and lend out the money instead of keeping it in vaults. This is mainly because banks can earn higher returns by lending the funds as compared to the rate of interest offered by the Fed. In the past, the incentives on maintaining the excess reserve balances were very low or near to zero. However, the excess reserve balance can pile up during the crisis scenarios.

Monetary Policy and Bank Reserves Requirements

Interest Rate on Bank Reserves

The interest rate on required reserves (IORR) and the Interest rate on Excess reserve (IOER) are determined by the Fed. These interest rate gets updated each business day at 4:30 pm EST with the interest rate for the next business day.

The latest published interest rate is as follows:

Interest Rate on Bank Reserve

(Source: federalreserve.gov)

Impact of Inflation

During Inflation, the demand for the goods and services surpass the available supply at current prices. This demand-supply gap leads to an increase in prices and causes inflation. In order to deal with the scenario, the Fed begins to pay higher interest on the excess reserve, which affects the lending growth as a guard against inflationary pressure.

When a Fed raises the interest rate on excess reserves, the banks become more willing to keep the cash in the vault instead of lending it out, which affects the purchasing power of the consumers and hence the recovery beings to establish equilibrium.

However, when the economy goes through the problem of deflationDeflationDeflation is a decrease in the prices of goods and services caused by negative inflation (below 0%). It usually results in increased consumer purchasing power, owing to a simple supply and demand rule in which excess supply leads to lower prices.read more (i.e., when the supply of the goods and services produced is higher than the demand), the fed reduces the interest rate almost to zero. This encourages the lending process resulting in an increase in the purchasing power of the end-users.

Conclusion

Bank reserves are the minimum amount of funds held by the banks in cash or vault to ensure regulatory compliance with the federal reserve bank. The key purpose is to regulate the banking procedure and to make sure that banks will not go short of funds if any demand liability arises.

This has been a guide to Bank Reserve and its definition. Here we discuss classification (Required Reserve and Excess Reserve) and the impact of inflation on bank reserves requirements. You can more about finance from the following articles –

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