reserve

(noun)

Banks' holdings of deposits in accounts with their central bank.

Related Terms

Examples of reserve in the following topics:

  • The Fractional Reserve System

    • A fractional reserve system is one in which banks hold reserves whose value is less than the sum of claims outstanding on those reserves.
    • The fraction of deposits that a bank must hold as reserves rather than loan out is called the reserve ratio (or the reserve requirement) and is set by the Federal Reserve.
    • Any reserves beyond the required reserves are called excess reserves.
    • Excess reserves plus required reserves equal total reserves.
    • First, it can adjust the reserve ratio.

  • The Reserve Ratio

    • The reserve ratio is the percentage of deposits that a bank is required to hold in reserves, or funds that are not allowed to be loaned.
    • The required reserve ratio is a tool in monetary policy, given that changes in the reserve ratio directly impact the amount of loanable funds available .
    • Money growth in the economy can occur through the multiplier effect resulting from the reserve ratio.
    • For example, a reserve ratio of 20% will result in 80% of any given initial deposit being loaned out and if the process of loaning is assumed to continue, the maximum increase in money expansion specific to an initial deposit at a 20% reserve ratio will be equal to the reserve multiplier 1/(reserve ratio) x the initial deposit.
    • The Federal Reserve is charged with maintaining sustainable economic growth.

  • Structure of the Federal Reserve

    • The Federal Reserve (the Fed) was designed to be independent of the Congress and the government.
    • The Federal Open Market Committee (FOMC), composed of the seven members of the Federal Reserve Board and five of the 12 Federal Reserve Bank presidents, which oversees open market operations, the principal tool of U.S. monetary policy.
    • Twelve regional Federal Reserve Banks located in major cities throughout the nation, which divide the nation into twelve Federal Reserve districts.
    • The Federal Reserve Banks act as fiscal agents for the U.S.
    • Recall the structure of the Federal Reserve System of the United States

  • Example Transactions Showing How a Bank Can Create Money

    • When a bank's excess reserves equal zero, it is loaned up.
    • Anderson will loan out the maximum amount (90%) and hold the required 10% as reserves.
    • When banks in the economy have made the maximum legal amount of loans (zero excess reserves), the deposit multiplier is equal to the reciprocal of the required reserve ratio ($m=1/rr$).
    • Thus, with a required reserve ratio of 0.1, an increase in reserves of $1 can increase the money supply by up to $10 .
    • The graph shows the total amount of money that can be created with the addition of $100 in reserves, using different reserve requirements as examples.

  • The Money Multiplier in Theory

    • That is, in a fractional-reserve banking system, the total amount of loans that commercial banks are allowed to extend (the commercial bank money that they can legally create) is a multiple of reserves; this multiple is the reciprocal of the reserve ratio.
    • We can derive the money multiplier mathematically, writing M for commercial bank money (loans), R for reserves (central bank money), and RR for the reserve ratio.
    • We start with the reserve ratio requirement that the the fraction of deposits that a bank keeps as reserves is at least the reserve ratio:
    • In theory banks should always lend out the maximum allowed by their reserves, since they can receive a higher interest rate on loans than they can on money held in reserves.
    • A 10% reserve requirement creates a total money supply equal to 10 times the amount of reserves in the economy; a 20% reserve requirement creates a total money supply equal to five times the amount of reserves in the economy.

  • The Money Multiplier in Reality

    • First, some banks may choose to hold excess reserves.
    • During this time, the relationship between reserves, reserve requirements, and the money supply was relatively close to that predicted by economic theory.
    • The presence of these excess reserves suggests that the reserve requirement ratio is not exerting an influence on the money supply.
    • The monetary base is the sum of currency and reserves held in accounts at the central bank.
    • After the financial crisis the monetary base increased dramatically: the result of banks starting to hold excess reserves as well as the central bank increasing the supply of reserves.

  • Money in the U.S. Economy

    • "The Fed," as it is commonly known, includes 12 regional Federal Reserve Banks and 25 Federal Reserve Bank branches.
    • In general, a bank that is a member of the Federal Reserve System uses the Reserve Bank in its region in the same way that a person uses a bank in his or her community.
    • The Federal Reserve Board of Governors administers the Federal Reserve System.
    • The Fed also can control the money supply by specifying what reserves deposit-taking institutions must set aside either as currency in their vaults or as deposits at their regional Reserve Banks.
    • Banks often lend each other money over night to meet their reserve requirements.

  • Executing Expansionary Monetary Policy

    • Banks can keep these reserves as cash in their vaults or as deposits with the Federal Reserve (the Fed).
    • When a bank needs additional reserves on a short-term basis, it can borrow them from other banks that happen to have more reserves than they need.
    • It adjusts to balance the supply of and demand for reserves.
    • Payment for the bonds increases the bank's reserves.
    • As a result, the bank may have more reserves than required.

  • The Federal Funds Rate

    • The Federal Funds rate is the interest rate at which depository institutions actively trade balances held at the Federal Reserve.
    • In the US, banks are obligated to maintain certain levels of reserves, either in the form of reserves with the Fed or as vault cash.
    • These daily activities change their ratio of reserves to liabilities.
    • If, by the end of the day, the bank's reserve ratio has dropped below the legally required minimum, it must add to its reserves in order to remain compliant with the law.
    • Banks do this by borrowing reserves from other banks with excess reserves, and the weighted average of these interest rates paid by borrowing banks determines the federal funds rate.

  • The Creation of the Federal Reserve

    • The Federal Reserve was created to promote financial stability, provide regulation and banking services, and conduct monetary policy.
    • The US suffered through a number of financial crises that eventually drove Congress to create the US central bank, the Federal Reserve (the Fed), through the Federal Reserve Act of 1913.
    • Commercial banks are required to hold a certain proportion of their deposits in reserves and not lend them out.
    • This proportion is called the reserve requirement and is controlled by the Fed.
    • Commercial banks are required to have a certain amount of reserves on hand at the end of each day.