reserve requirement

Examples of reserve requirement in the following topics:

• The Reserve Requirement

  • The Federal Reserve is in charge of setting reserve requirements for all depository institutions in the country.
  • Reserve requirements have long been a part of the United States banking history.
  • The Federal Reserve can adjust reserve requirements by changing required reserve ratios, the liabilities to which the ratios apply, or both.
  • Changes in reserve requirements can have profound effects on the money stock and on the cost to banks of extending credit and are also costly to administer; therefore, reserve requirements are not adjusted frequently.
  • Discuss what happens when the Fed increases or decreases the reserve requirement

• Reserve Requirement

  • Fed can use reserve requirements as a monetary tool.
  • The Fed rarely changes the reserve requirements because changes in the reserve requirements have a significant and disruptive impact on the banking system.
  • The Fed can use reserve requirements to alter the money supply.
  • Consequently, the Fed can increase the reserve requirement ratio, switching some excess reserves to required reserves.
  • Required reserves impose a cost to the banks because they cannot lend these reserves to borrowers, and therefore, do not earn interest income on required reserves.

• The Fractional Reserve System

  • The fraction of deposits that a bank must hold as reserves rather than loan out is called the reserve ratio (or the reserve requirement) and is set by the Federal Reserve.
  • If, for example, the reserve requirement is 1%, then a bank must hold reserves equal to 1% of their total customer deposits.
  • Banks can also choose to hold reserves in excess of the required level.
  • Any reserves beyond the required reserves are called excess reserves.
  • Excess reserves plus required reserves equal total reserves.

• Example Transactions Showing How a Bank Can Create Money

  • Assume that all banks are required to hold reserves equal to 10% of their customer deposits.
  • Anderson and Brentwood both operate in a financial system with a 10% reserve requirement.
  • Anderson will loan out the maximum amount (90%) and hold the required 10% as reserves.
  • Thus, with a required reserve ratio of 0.1, an increase in reserves of $1 can increase the money supply by up to $10 .
  • The graph shows the total amount of money that can be created with the addition of $100 in reserves, using different reserve requirements as examples.

• The Reserve Ratio

  • The reserve ratio is the percentage of deposits that a bank is required to hold in reserves, or funds that are not allowed to be loaned.
  • The ratio is a set percentage of customer deposits that a bank is required to hold in reserves, or funds that are not allowed to be loaned.
  • 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 a tool in monetary policy, given that changes in the reserve ratio directly impact the amount of loanable funds available .
  • The conventional view in economic theory is that a reserve requirement can act as a tool of monetary policy.

• The Money Multiplier in Theory

  • That is, in a fractional-reserve banking system, the total amount of loans that commercial banks are allowed to extend (the commercial bank money that they can legally create) is a multiple of reserves; this multiple is the reciprocal of the reserve ratio.
  • We start with the reserve ratio requirement that the the fraction of deposits that a bank keeps as reserves is at least the reserve ratio:
  • Theoretically, then, a central bank can change the money supply in an economy by changing the reserve requirements.
  • A 10% reserve requirement creates a total money supply equal to 10 times the amount of reserves in the economy; a 20% reserve requirement creates a total money supply equal to five times the amount of reserves in the economy.
  • The graph shows the theoretical amount of money that can be created with different reserve requirements.

• Chapter Questions

  • Required reserve ratio equals 5%; the banks hold zero excess reserves, and the public does not withdraw money out of their currency accounts.
  • Required reserve ratio equals 20%; the banks hold zero excess reserves, and the public does not withdraw money out of their currency accounts.
  • Required reserve ratio equals 10%, and the banks hold zero excess reserves.
  • Required reserve ratio equals 10%, and the banks hold zero excess reserves.
  • Why do excess reserves present a problem for the Fed?

• Multiple Deposit Expansion and Contraction

  • Bank must hold 10% of its deposits as required reserves.
  • Bank must hold 10% of its deposits as required reserves.
  • Second equation calculates required reserves.
  • If the required reserve ratio equals 10%, then we substitute this into Equation 7.
  • Bank pays your $200 from required reserves.

• Adjusting for LIFO Reserve

  • The difference between the cost of an inventory calculated under the FIFO and LIFO methods is called the LIFO reserve.
  • The difference between the cost of an inventory calculated under the FIFO and LIFO methods is called the LIFO reserve.
  • This reserve is essentially the amount by which an entity's taxable income has been deferred by using the LIFO method.
  • The SEC requires that all registered companies that use LIFO report their LIFO reserves for the start and end of the year.
  • Explain how the LIFO reserve is calculated and how to report it on the financial statements

• Structure of the Federal Reserve

  • The Federal Reserve (the Fed) was designed to be independent of the Congress and the government.
  • Twelve regional Federal Reserve Banks located in major cities throughout the nation, which divide the nation into twelve Federal Reserve districts.
  • The Federal Reserve Banks act as fiscal agents for the U.S.
  • Numerous other private U.S. member banks, which own required amounts of non-transferable stock in their regional Federal Reserve Banks.
  • Recall the structure of the Federal Reserve System of the United States