Ask Dr. Econ

Do all banks hold reserves, and, if so, where do they hold them? (11/2001)

All depository institutions (commercial banks, savings institutions, credit unions, and foreign banking entities) are required to hold reserves against certain types of deposits that they report as liabilities on their balance sheets. The function of reserve requirements is described in the Federal Reserve publication, Purposes and Functions:1

At present, reserve requirements aid in the conduct of open market operations2 by helping to ensure a stable, predictable demand for reserves; they thereby increase the Federal Reserve's control over short-term interest rates.

In what forms may depository institutions hold their reserves?

Depository institutions may hold their required reserves as:

• Vault cash
• Deposits at their regional Federal Reserve Bank

Depository institutions normally keep a certain level of vault cash on hand to meet the operating needs of their offices and branches. Required reserves above the amount of vault cash are met by holding reserve balances with Federal Reserve Banks. Most institutions hold their reserves directly with their Federal Reserve Bank.3 Depository institutions prefer to minimize the amount of reserves they hold, because neither vault cash nor Reserves at the Fed generate interest income for the institution.

How large are total reserve requirements for all depository institutions?

As of November 2001, aggregate required reserves of depository institutions were $39.1 billion, according to the Federal Reserve Board's H.3 Statistical Release.4 Vault cash used to satisfy required reserves was $31.2 billion; reserve balances with Federal Reserve Banks were $8.9 billion.

What are 2001 reserve requirements against deposits?

Effective December 28, 2000, depository institutions were required to hold a reserve requirement of 3 percent against their first $42.8 million in net transaction accounts (demand and other checkable deposits). They were required to hold a 10 percent reserve against their net transaction accounts above $42.8 million. At present, there is no reserve requirement on time and savings deposits.

Endnotes

[1] Purposes and Functions, December 1994, Board of Governors of the Federal Reserve System, page 53.

[2] Open market operations are the purchase and sale of securities by the Federal Reserve. These transactions can add (purchases) or subtract (sales) reserves from the depository system and influence the interest rate on federal funds.

[3] Some smaller institutions may hold their reserves with larger correspondent banks that pass the smaller institution's reserves through to the Fed.

[4] Aggregate Reserves of Depository Institutions and the Monetary Base (Federal Reserve Statistical Release H.3), December 27, 2001. (as of 1-21-2002; http://www.federalreserve.gov/releases/H3/20011227/)