Bank Reserve - Explained
What is a Bank Reserve?
Written by Jason Gordon
Updated at March 29th, 2023
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What is a Bank Reserve?
A bank reserve refers to a portion of currency or bank deposits that a bank is required to have as its holdings. This portion is not lent out as loans, instead, they are put aside in a liquid account to guarantee the solvency of the bank. Usually, bank reserves are held physically by a commercial bank, either in a vault or locked in a liquid account It is a small portion of the total currency deposits made to the bank. A bank reserve is part of the regulations of central banks to ensure that a commercial bank has enough holdings to settle client transactions.
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How Does a Bank Reserve Work?
Generally, commercial banks holding accounts with the central bank are required to have a minimum amount in this account as a bank reserve. Funds separated as reserves are not available to be used for loans or paid as interests to customers. This reserve is to ensure that commercial banks are protected against significant risks such as insufficient cash to execute customer's requests. Typically, the central bank sets the minimum capital that banks must hold in their reserve, this is known as required reserve. When a bank, however, has more reserve than what the central bank requires, it is known as excess reserve.
Special Considerations
Bank Reserve is a regulation of the Federal Reserve Board in the United States, this board states the minimum amount a bank must have in its holdings to protect it from certain liabilities. The amount allowable in the reserve is also determined by the reserve ratio derived from the accumulated amount recorded in the net accounts of commercial banks. There are two types of bank reserve, the required reserve and the excess reserve. Through the required reserve ratio, central banks formulate monetary policies. Oftentimes, banks do not hold excess reserves, given that no interest is earned on excess reserves. There are several factors that affect bank reserve. As it has been generally noticed, banks have more reserves during recessions and in times of economic growth and expansion, there is a decrease in bank reserve. Key Takeaways The importation points to note about a bank reserve include the following;
- A bank reserve is a portion of currency deposits that a commercial bank is required to have in a holding account.
- Bank reserves are not lent out to clients or used in paying interests.
- A bank reserve is physically held by a bank in a vault or kept in an account with the central bank.
- There are two types of reserves, the required reserve and the excess reserve. The minimum amount that a bank must hold as stipulated by the central bank is the required reserve while any amount more than the required reserve is known as an excess reserve.
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