Reserve Requirement

The reserve requirement (or cash reserve ratio) is a central bank regulation that sets the minimum reserves each commercial bank must hold (rather than lend out) of customer deposits and notes. These required reserves are normally in the form of cash stored physically in a bank vault (vault cash) or deposits made with a central bank.

The required reserve ratio is sometimes used as a tool in monetary policy, influencing the country's borrowing and interest rates by changing the amount of funds available for banks to make loans with. Western central banks rarely alter the reserve requirements because it would cause immediate liquidity problems for banks with low excess reserves; they generally prefer to use open market operations (buying and selling government-issued bonds) to implement their monetary policy. The People's Bank of China uses changes in reserve requirements as an inflation-fighting tool, and raised the reserve requirement ten times in 2007 and eleven times since the beginning of 2010. As of 2006 the required reserve ratio in the United States was 10% on transaction deposits and zero on time deposits and all other deposits.

An institution that holds reserves in excess of the required amount is said to hold excess reserves.