reserve requirement

Example

“The Federal Reserve reduced reserve requirements to zero in 2020, giving banks maximum flexibility during the COVID crisis.”

Memory Tip

RESERVE REQUIREMENT = minimum % of deposits banks must keep. Limits how much they can lend.

Why It Matters

Reserve requirements affect how much money banks can lend to consumers and businesses. When the central bank lowers reserve requirements, banks have more money available to lend, which can make it easier and cheaper for you to get mortgages, car loans, and business credit. Understanding this helps you anticipate changes in borrowing costs and availability.

Common Misconception

Many people think reserve requirements mean banks keep customer deposits in a vault somewhere safe. In reality, banks use most deposits to make loans and investments, keeping only the required percentage in reserves. The reserves are held electronically at the central bank, not as physical cash.

In Practice

If a bank has 100 million dollars in deposits and the reserve requirement is 10 percent, the bank must hold 10 million dollars in reserves and can lend out up to 90 million dollars. If the central bank reduces the requirement to 8 percent, the same bank now only needs to hold 8 million dollars in reserves, freeing up 2 million dollars in additional lending capacity.

Etymology

RESERVE (kept back, held) REQUIREMENT (mandatory minimum). The REQUIRED RESERVE a bank must HOLD.

Common Misspellings

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