Reserve Ratio
The reserve ratio is the portion of reservable liabilities that commercial banks must hold onto, rather than lend out or invest. This is a requirement determined by the country's central bank, which in the United States is the Federal Reserve. It is also known as the cash reserve ratio.The minimum amount of reserves that a bank must hold on to is referred to as the reserve requirement, and is sometimes used synonymously with the reserve ratio. The reserve ratio is specified by the Federal Reserve Board’s Regulation D. Regulation D created a set of uniform reserve requirements for all depository institutions with transaction accounts, and requires banks to provide regular reports to the Federal Reserve.
Definition: The reserve ratio refers to the portion of depositors' balances that commercial banks must have on hand as cash. This requirement is set by the country's central bank and is also known as the cash reserve ratio. The minimum amount of reserves that banks must hold is called the reserve requirement, and it is sometimes used interchangeably with the reserve ratio.
Origin: The concept of the reserve ratio originated in the 19th century during the development of the banking industry. To prevent bank runs and ensure the stability of the financial system, countries gradually began to implement this system. The earliest reserve ratio systems can be traced back to banking regulations in the UK and the US.
Categories and Characteristics: The reserve ratio can be divided into statutory reserve ratio and excess reserve ratio.
- Statutory Reserve Ratio: This is the minimum reserve ratio set by the central bank, which banks must strictly adhere to.
- Excess Reserve Ratio: This is the additional reserve ratio that banks hold beyond the statutory reserve ratio. Excess reserves provide banks with an additional liquidity buffer.
- Regulating Money Supply: By adjusting the reserve ratio, the central bank can influence the lending capacity of banks, thereby regulating the money supply in the market.
- Ensuring Financial Stability: A high reserve ratio can enhance banks' risk resistance and reduce the instability of the financial system.
- Impacting Interest Rates: Changes in the reserve ratio affect the cost of funds for banks, indirectly influencing market interest rates.
Specific Cases:
- Case 1: During the 2008 financial crisis, the Federal Reserve significantly lowered the reserve ratio to increase bank liquidity, encourage lending, and help the economy recover.
- Case 2: The People's Bank of China lowered the reserve ratio multiple times during the COVID-19 pandemic in 2020 to support financing for small and medium-sized enterprises and stabilize economic growth.
Common Questions:
- Question 1: Why does the central bank adjust the reserve ratio?
Answer: The central bank adjusts the reserve ratio to regulate the money supply, influence interest rates, and ensure the stability of the financial system. - Question 2: What are the effects of a reserve ratio that is too high or too low?
Answer: A reserve ratio that is too high can limit banks' lending capacity, potentially slowing economic growth; a reserve ratio that is too low can increase the risk within the financial system.
