Bank Reserve – Definition

Cite this article as:"Bank Reserve – Definition," in The Business Professor, updated January 24, 2020, last accessed October 20, 2020, https://thebusinessprofessor.com/lesson/bank-reserve-definition/.

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Bank Reserve Definition Definition

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.

A Little More on What is a Bank Reserve

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.

Reference for ‚ÄúBank Reserve‚ÄĚ

https://en.wikipedia.org/wiki/Bank_reserves

https://www.investopedia.com ‚Äļ Personal Finance ‚Äļ Banking

https://investinganswers.com/financial-dictionary/economics/bank-reserve-5735

www.businessdictionary.com/definition/bank-reserve.html

https://www.encyclopedia.com/finance/encyclopedias-almanacs…and…/bank-reserves

Academics research on ‚ÄúBank Reserve‚ÄĚ

Commercial bank reserve management in a stochastic model: implications for monetary policy, Poole, W. (1968). Commercial bank reserve management in a stochastic model: implications for monetary policy. The Journal of finance, 23(5), 769-791.

Commercial paper,¬†bank reserve¬†requirements, and the informational role of loan commitments, Kanatas, G. (1987). Commercial paper, bank reserve requirements, and the informational role of loan commitments.¬†Journal of Banking & Finance,¬†11(3), 425-448. An explanation is provided of the often-observed purchase of ‚Äėback-up‚Äô bank loan commitments by corporations immediately preceding their sale of dealer-placed commercial paper. Since loan commitments are typically viewed as hedging instruments, our paper explains why a risk-neutral corporation would purchase this type of instrument and how it is priced. It is assumed that while firms know their own credit risks, neither banks nor the paper market can distinguish between some credit applicants. We show that the purchase of a commitment can identify these Firms to the market. The equilibrium is partially revealing; of the firms with unobservable quality, those with higher quality identify themselves by purchasing commitments while those with lower quality sell unbacked paper and are ‚Äėpooled‚Äô together. Unbacked paper is sold also by firms whose quality is observable. Unidentified firms in the lowest quality range do not sell commercial paper.

Stochastic reserve losses and expansion of bank credit, Orr, D., & Mellon, W. G. (1961). Stochastic reserve losses and expansion of bank credit. The American Economic Review, 51(4), 614-623.

The effects of shifts in monetary policy and reserve accounting regimes on¬†bank reserve¬†management behavior in the federal funds market, Saunders, A., & Urich, T. (1988). The effects of shifts in monetary policy and reserve accounting regimes on bank reserve management behavior in the federal funds market.¬†Journal of Banking & Finance,¬†12(4), 523-535. This paper looks at the effects on Fed fund rates and Fed fund purchasing behavior of large banks resulting from (i) the 1982 regime switch from non-borrowed to borrowed reserve targeting by the Fed and (ii) the 1984 switch from lagged to¬†almost¬†contemporaneous reserve accounting (CRA). Whether we analyse changes in the interest-rate or quantity dimensions, the shift in monetary policy targets appeared to have had a more profound effect on the market for bank reserves than the shift in reserve accounting regime. These results, therefore, tend to support the contention that a shift to CRA by itself will have little effect on bank reserve management behavior unless combined with its logical counterpart ‚ÄĒ a¬†total¬†reserves target.

Bank reserve¬†requirements and monetary aggregates, Kanatas, G., & Greenbaum, S. I. (1982). Bank reserve requirements and monetary aggregates.¬†Journal of Banking & Finance,¬†6(4), 507-520. The paper criticizes the traditional belief in the usefulness of reserve requirements for the control of monetary aggregates. It is shown that the efficacy of this policy tool is maintained only if the incentive it provides for financial innovations is ignored. If the relevant monetary aggregate is broader than that which is reserve-constrained, we show that reserve requirements may be counter-productive. An alternative policy involving the payment of interest on voluntarily held reserves is proposed and analyzed. It is shown that this approach has the stabilization effects attributed to reserve requirements but without any of the latter’s adverse incentives.

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