Reserve Requirement
Quick Definition
The minimum percentage of deposits that a bank must hold as reserves rather than lending out, set by the central bank.
Key Takeaways
- Minimum percentage of deposits banks must hold rather than lend
- Historically a key monetary policy tool, now largely phased out in advanced economies
- The Fed set U.S. reserve requirements to 0% in March 2020
- Still actively used by some central banks, notably China
What Is Reserve Requirement?
The reserve requirement (or reserve ratio) is a central bank regulation that mandates the minimum fraction of customer deposits that commercial banks must hold in reserve — either as vault cash or on deposit at the central bank — rather than lending out. Historically, reserve requirements were a primary tool of monetary policy: raising the ratio constrained bank lending and tightened the money supply, while lowering it expanded credit availability. However, most advanced economies have moved away from active use of reserve requirements. The Federal Reserve reduced the reserve requirement to 0% in March 2020, relying instead on interest rate adjustments and balance sheet operations for policy. Many countries, including Canada, the UK, Australia, and New Zealand, have had zero reserve requirements for years, using other mechanisms to manage monetary conditions.
Reserve Requirement Example
- 1The Fed reduced reserve requirements to 0% in March 2020, effectively ending mandatory reserves for U.S. banks.
- 2China actively uses reserve requirement ratios (currently around 7-10%) as a key monetary policy tool.
- 3Under a 10% reserve requirement, a $1,000 deposit allows the bank to lend out up to $900.
Related Terms
Monetary Base
The total amount of currency in circulation plus reserves held by commercial banks at the central bank — the foundation of the money supply.
Money Supply
The total amount of money available in an economy at a given time, measured in categories like M1 (cash and checking) and M2 (M1 plus savings and time deposits).
Central Bank
A national institution responsible for managing a country's monetary policy, regulating banks, maintaining financial stability, and issuing currency.
Monetary Policy
Actions by a central bank to manage the money supply and interest rates to achieve macroeconomic objectives like stable prices and full employment.
Open Market Operations
The buying and selling of government securities by a central bank to control the money supply and influence interest rates.
GDP (Gross Domestic Product)
The total monetary value of all finished goods and services produced within a country's borders in a specific time period.
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