Excess Reserves
Excess reserves are capital reserves held by a bank or financial institution above amounts required by regulators, creditors, or internal controls. For commercial banks, excess reserves are measured against standard reserve requirement ratios set by central banking authorities. These required reserve ratios set the minimum liquid deposits (such as cash) that must be in reserve at a bank; more is considered excess.Excess reserves may also be known as secondary reserves.
Definition: Excess reserves refer to the capital reserves held by banks or financial institutions that exceed the requirements set by regulatory authorities, creditors, or internal controls. For commercial banks, excess reserves are compared to the standard reserve requirements set by the central bank. These required reserve ratios determine the minimum liquid deposits (such as cash) that banks must hold. Excess reserves are also known as secondary reserves.
Origin: The concept of excess reserves originated in the early stages of banking when banks needed to ensure sufficient liquidity to meet customer withdrawal demands. As the financial system became more complex, regulatory authorities began setting minimum reserve requirements to ensure the stability and liquidity of banks. The concept of excess reserves evolved to represent the additional reserves held by banks after meeting the minimum reserve requirements.
Categories and Characteristics: Excess reserves can be divided into two categories: cash reserves and excess reserves held at the central bank. Cash reserves are the actual cash held by banks to meet daily withdrawal demands. Excess reserves held at the central bank are the additional funds deposited at the central bank after meeting the minimum reserve requirements. The main characteristic of excess reserves is high liquidity, allowing them to be quickly converted into cash to meet urgent needs.
Specific Cases: Case 1: During the 2008 financial crisis, many banks increased their excess reserves to ensure sufficient liquidity to cope with market uncertainties. Case 2: A commercial bank, after meeting the central bank's minimum reserve requirements, decides to deposit some funds at the central bank as excess reserves to earn interest paid by the central bank.
Common Questions: 1. Why do banks need to hold excess reserves? Banks hold excess reserves to ensure sufficient liquidity to meet customer withdrawal demands and market uncertainties. 2. Do excess reserves affect a bank's profitability? Holding excess reserves may reduce a bank's profitability because these funds are not used for loans or other investments.
