Reserve Ratio

Written By
Paul Tracy
Updated November 4, 2020

What is the Reserve Ratio?

The reserve ratio is the percentage of deposits that the Federal Reserve requires a bank to keep on hand at a Federal Reserve Bank.

Reserve Ratio Example

For example, let's assume that Bank XYZ has $400 million in deposits. If the Federal Reserve's reserve ratio requirement is 10%, Bank XYZ must keep at least $40 million in an account at a Federal Reserve bank and may not use that cash for lending or any other purpose.

Reserve ratios are set by the Federal Reserve, the central bank of the U.S. It is a bank for banks. Its several branches around the U.S. hold deposits for and lend to banks. As a means of ensuring the safety of the nation's financial institutions, the Federal Reserve sets reserve ratios so that banks always have some money on hand to prevent a run (a mass withdrawal of deposits so large that the bank actually runs out of cash, panicking the rest of the depositors). If a bank is unable to meet its reserve ratio, it can borrow from the Federal Reserve to meet the requirement.

Why Reserve Ratios Matter

Reserve ratios are a key component of monetary policy. The Federal Reserve can lower the reserve ratio, for example, in order to enact expansionary monetary policy and encourage economic growth. The reduction makes banks free to lend more of their deposits to other bank customers and earn interest.

These customers in turn deposit the loan proceeds in their own bank accounts, and the process continues indefinitely. This increase in the supply of available funds lowers the price of those funds (i.e., the lending rate), making debt cheaper and more enticing to borrowers.

If the Federal Reserve increases the reserve ratio (which leaves less of a bank's deposits available for lending), the reverse happens and the Federal Reserve can slow down the economy.
 

Activate your free account to unlock our most valuable savings and money-making tips
  • 100% FREE
  • Exclusive money-making tips before we post them to the live site
  • Weekly insights and analysis from our financial experts
  • Free Report - 25 Ways to Save Hundreds on Your Monthly Expenses
  • Free Report - Eliminate Credit Card Debt with these 10 Simple Tricks
Ask an Expert
All of our content is verified for accuracy by Paul Tracy and our team of certified financial experts. We pride ourselves on quality, research, and transparency, and we value your feedback. Below you'll find answers to some of the most common reader questions about Reserve Ratio.
Be the first to ask a question

If you have a question about Reserve Ratio, then please ask Paul.

Ask a question

Paul has been a respected figure in the financial markets for more than two decades. Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 3 million monthly readers.

If you have a question about Reserve Ratio, then please ask Paul.

Ask a question Read more from Paul
Paul Tracy - profile
Ask an Expert about Reserve Ratio

By submitting this form you agree with our Privacy Policy

Don't Know a Financial Term?
Search our library of 4,000+ terms