Reserve Requirement
AdvancedA reserve requirement is a rule set by a central bank requiring banks to hold a minimum percentage of their customers' deposits as reserves, either as cash in their vaults or on deposit with the central bank.
Reserve requirements were traditionally used to ensure banks kept enough liquid funds to meet withdrawals and as a tool of monetary policy. Raising the requirement reduces the amount banks can lend, while lowering it allows more lending.
For example, with a 10% reserve requirement, a bank receiving 1,000 in deposits must hold at least 100 in reserves and can lend or invest the rest.
Many central banks now rely more on interest rates, and on capital and liquidity regulations, than on reserve requirements. The US Federal Reserve reduced its reserve requirement to zero in March 2020. Some countries, such as the United Kingdom and Canada, have no reserve requirements at all.
Others, including China and India, still use reserve requirements actively as a policy tool. For example, the People's Bank of China adjusts its reserve requirement ratio to influence lending. The role of reserve requirements has also changed as banks' liquidity is now governed by international standards such as the liquidity coverage ratio.
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