Glossary term
Reserve Requirement
A reserve requirement is a rule that requires banks to hold a minimum amount of reserves against certain deposits or liabilities.
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What Is a Reserve Requirement?
A reserve requirement is a rule that requires banks to hold a minimum amount of reserves against certain deposits or liabilities. Reserves may include cash held by the bank or balances held at the central bank.
Reserve requirements are one tool that can influence banking-system liquidity and money creation. In the United States, reserve requirements have historically been part of monetary-policy implementation, although the Federal Reserve set reserve requirement ratios to zero percent in 2020.
Key Takeaways
- A reserve requirement sets a minimum reserve amount for certain bank liabilities.
- Reserves can include vault cash and balances held at a central bank.
- Reserve requirements can affect bank liquidity and lending capacity.
- The U.S. Federal Reserve currently has reserve requirement ratios set at zero percent.
- Reserve requirements are different from capital requirements, which focus on loss-absorbing equity and capital.
How Reserve Requirements Work
If a bank receives deposits subject to a reserve requirement, it must hold a required amount in reserve rather than using all of those funds for lending or investment. The required amount depends on the applicable rules and reserve ratio.
When reserve requirements are higher, banks may have less flexibility to lend from covered deposits. When requirements are lower, more deposits may be available for lending or investment, although other rules and risk controls still matter.
Reserve Requirement Versus Capital Requirement
Requirement | Main purpose |
|---|---|
Reserve requirement | Requires certain reserves against deposits or liabilities |
Capital requirement | Requires banks to maintain loss-absorbing capital |
Liquidity requirement | Focuses on ability to meet cash outflows |
These concepts are related to bank safety, but they are not interchangeable. A bank can meet one requirement and still need to manage the others carefully.
Why Reserve Requirements Matter
Reserve requirements can influence how much money banks must keep readily available and how much lending capacity they have. They also help explain how central banks have historically influenced the banking system alongside interest-rate policy and other tools.
For consumers, reserve requirements are mostly background plumbing. They do not replace deposit insurance, bank supervision, or personal cash-management decisions.
The Bottom Line
A reserve requirement is a rule requiring banks to hold minimum reserves against certain deposits or liabilities. It is a banking-system tool, not a consumer account feature, and in the United States current reserve requirement ratios are set at zero percent.