Bank reserves are holdings of central-bank money available to banks for meeting cash withdrawals, settling payments, and satisfying any applicable reserve requirements. In a broad accounting definition, they include vault cash and balances held at a central bank; in discussions of monetary operations, “reserves” often refers specifically to those account balances. They provide liquidity to the banking system and are central to the implementation of monetary policy. They are distinct from customer deposits and from the capital that absorbs bank losses. (federalreserve.gov)
Composition and accounting
Vault cash consists of physical currency held by a bank. Reserve balances are electronic claims on the central bank, recorded as assets on the commercial bank’s balance sheet and liabilities on the central bank’s balance sheet. Access to reserve accounts depends on a jurisdiction’s institutional arrangements; ordinary households and businesses generally use commercial-bank accounts instead. (federalreserve.gov)
Reserves differ from deposit money, which is a liability of a commercial bank to its customers. Together with currency outside the central bank, reserve balances form part of the monetary base. Broader measures of the money supply include customer deposits rather than treating banks’ reserve holdings as money available for public spending. These distinctions separate money used between financial institutions from money used by their customers. (bankofengland.co.uk)
Payment settlement and reserve demand
When a customer transfers money to someone at another bank, the banks must settle the resulting obligation. In a simplified direct settlement, the central bank debits the sending bank’s reserve account and credits the receiving bank’s account. Customer deposit balances change at the commercial banks, while reserves move between their central-bank accounts. A payment between customers of the same bank can instead be recorded internally without an interbank reserve transfer. (bankofengland.co.uk)
Banks therefore demand reserves to meet payment outflows and manage uncertainty about incoming funds. A bank with insufficient balances can seek funding from other institutions or obtain central-bank credit under applicable conditions. Central-bank lending commonly requires eligible collateral. During financial stress, lending facilities can support the central bank’s lender of last resort function. Reserves also help banks meet internal liquidity policies and regulatory constraints, even where no minimum reserve ratio applies. (bankofengland.co.uk)
Required and excess reserves
Reserve requirements specify minimum holdings against defined liabilities, often particular categories of deposits. The requirement is commonly calculated by applying a reserve ratio to a specified reserve base. Rules differ over eligible assets, exemptions, calculation periods, and whether compliance is measured daily or as an average over a maintenance period. Averaging permits banks to accommodate temporary payment fluctuations without meeting exactly the same balance every day. (federalreserve.gov)
Excess reserves are holdings above the applicable minimum. “Excess” is a regulatory classification, not evidence that the balances have no economic purpose: banks may hold them for settlement, precautionary liquidity, or interest income. The distinction becomes less informative when statutory reserve requirements are zero. (federalreserve.gov)
The Federal Reserve reduced reserve requirement ratios to zero effective March 26, 2020, eliminating minimum reserve requirements for United States depository institutions. This did not eliminate their demand for reserves. In the euro area, minimum reserves are calculated at 1% of specified liabilities, mainly customer deposits and debt securities with maturities up to two years, and compliance is assessed through average holdings over a maintenance period. These arrangements illustrate why reserve requirements cannot be assumed to be uniform across banking systems. (federalreserve.gov)
Creation and changes in aggregate supply
A central bank can create reserves by purchasing assets or lending to eligible institutions, crediting reserve accounts while acquiring a corresponding asset. Open market operations therefore alter the supply of settlement balances. Large-scale asset purchases under quantitative easing can substantially expand reserves; asset sales and the repayment of central-bank loans can reduce them. (federalreserve.gov)
An individual bank can acquire reserves from another bank, but such a transfer does not increase the banking system’s aggregate holdings. Likewise, a bank’s payment normally redistributes reserves rather than extinguishing them. Aggregate balances depend on central-bank operations and changes in other central-bank liabilities. Consequently, a high system-wide total does not guarantee that every institution has sufficient balances at every moment. (bankofengland.co.uk)
Monetary policy implementation
In a scarce-reserves framework, central banks adjust reserve supply to influence the interest rate on overnight borrowing. When reserves become harder to obtain, their marginal value rises, affecting rates in the interbank market. Before the global financial crisis, the Federal Reserve used changes in reserve supply to keep the federal funds rate near its target. (federalreserve.gov)
In an ample-reserves framework, reserves are supplied sufficiently generously that modest quantity changes have little influence on overnight rates. Policy control relies primarily on administered rates, especially interest on reserve balances, supplemented by other facilities. The return on reserves affects their opportunity cost relative to alternative short-term investments. Thus, a large reserve stock can coexist with high policy rates; reserve quantity alone does not identify the stance of monetary policy. (federalreserve.gov)
Lending, capital, and prudential liquidity
Banks do not ordinarily lend reserve balances directly to households or businesses. A bank loan normally creates a matching customer deposit; subsequent spending may generate a reserve outflow to another bank. Lending decisions are constrained by profitability, funding costs, credit risk, regulation, and bank capital, rather than by a mechanical conversion of each reserve unit into a fixed amount of credit. The textbook money multiplier therefore does not generally describe modern lending operations. (bankofengland.co.uk)
Capital absorbs losses, whereas reserves provide liquid settlement assets. A bank can have substantial reserves yet insufficient capital, or adequate capital yet face liquidity pressure. Under the Basel Accords, the Liquidity Coverage Ratio requires sufficient high-quality liquid assets to cover stressed net cash outflows over 30 days. Eligible central-bank reserves can contribute to that buffer, but reserve requirements, capital requirements, and prudential liquidity requirements are separate regulatory instruments. (bankofengland.co.uk)