A bank reserve is money a bank keeps on hand instead of lending out or investing

When you deposit money at a bank, the bank does not lock it in a vault with your name on it. Instead, the bank uses your deposit to make loans, buy securities, or fund other operations. A bank reserve is the portion of customer deposits and other funds that a bank holds back and does not put to work. This money sits in the bank's own accounts at the Federal Reserve or in its vaults, ready to be withdrawn by customers or to cover unexpected losses.

Banks are required to hold a minimum amount in reserve. The Federal Reserve—the central bank of the United States—sets these minimum requirements, though the rules have changed in recent years. The reserve requirement exists to ensure that banks can always meet customer withdrawal requests and stay solvent even if loans go bad or markets move against them.

Key Takeaways

  • Banks must hold a percentage of customer deposits in reserve rather than lending or investing all of it.
  • The Federal Reserve sets the minimum reserve requirement, which varies depending on the type of deposit and the bank's size.
  • Reserves protect you by ensuring the bank can pay out your deposits even if loans default or the bank faces sudden losses.
  • Banks earn less profit when reserve requirements are high, because money in reserve generates no interest income.

How the Federal Reserve sets reserve requirements

The Federal Reserve requires banks to hold reserves based on the amount of customer deposits they hold. For most of the past 40 years, the requirement was 10 percent of checking and savings deposits above a certain threshold. In March 2020, during the COVID-19 pandemic, the Federal Reserve reduced the reserve requirement to zero percent, and it has remained at zero since then.

Even though the legal requirement is now zero, most large banks still hold substantial reserves voluntarily. They do this because regulators expect it, because holding reserves reduces the risk of a bank run, and because the cost of borrowing money in an emergency is higher than the cost of holding it in reserve. Smaller banks may hold less, depending on their business model and risk tolerance.

The reserve requirement applies differently to different types of deposits. Checking accounts and money market accounts count toward the requirement. Savings accounts and certificates of deposit (CDs) typically do not, though the rules vary by bank and have shifted over time.

Why banks hold reserves beyond the legal minimum

Even when the law does not require it, banks hold extra reserves for practical reasons. If many customers withdraw money at once—a situation called a bank run—the bank needs cash on hand to pay them. If a bank has lent out nearly every dollar it received, it cannot meet a sudden surge in withdrawals without borrowing money at an expensive rate or selling assets quickly at a loss.

Regulators also monitor how much capital and liquid reserves banks hold. The Federal Reserve and the Office of the Comptroller of the Currency (OCC) conduct stress tests on large banks to see whether they could survive a severe economic downturn. Banks that fail these tests face restrictions on dividends and share buybacks. This regulatory pressure pushes banks to hold more reserves than the legal minimum.

Banks also hold reserves to cover unexpected loan losses. When borrowers default, the bank's profit shrinks. A reserve of capital absorbs these losses without forcing the bank to cut lending or ask depositors for their money back.

The trade-off between reserves and lending

Money held in reserve does not earn the bank much income. A dollar in reserve earns little or nothing; a dollar lent out at 5 or 6 percent earns the bank that interest. This creates a tension: the more a bank reserves, the safer it is, but the less profit it makes. Banks try to find a balance that keeps regulators and depositors satisfied while still generating returns for shareholders.

When the Federal Reserve lowers interest rates, banks earn even less on their reserves, so they have more incentive to lend. When rates are high, holding reserves is less costly in terms of foregone profit. This is one reason why the Fed uses reserve requirements and interest rates as tools to influence how much banks lend to the economy.

How reserves protect your deposits

Your deposits are also protected by the Federal Deposit Insurance Corporation (FDIC), which insures deposits up to $250,000 per depositor per bank. The FDIC insurance exists separately from bank reserves. However, reserves are the first line of defense: if a bank has enough reserves and capital, it will never need to tap FDIC insurance because it can pay depositors directly.

If a bank fails and does not have enough reserves to cover deposits, the FDIC steps in, uses its own fund to pay insured depositors, and then tries to recover money by selling the bank's assets. This process can take weeks or months, but your money is protected up to the insurance limit.

What happens when a bank does not hold enough reserves

If a bank lends out too much and holds too little in reserve, it becomes vulnerable to a bank run. During the 2008 financial crisis, several large banks faced this problem: they had invested heavily in mortgage-backed securities that lost value, and they did not have enough liquid reserves to cover withdrawals. The government had to step in with emergency loans and guarantees to prevent total collapse.

More recently, in March 2023, Silicon Valley Bank failed because it held most of its deposits in long-term bonds that lost value when interest rates rose. The bank did not have enough liquid reserves to cover the sudden wave of withdrawals. The FDIC took over, and depositors above the $250,000 insurance limit lost money, though the FDIC later recovered some of it by selling the bank's assets.

These failures show why reserves matter: they are the difference between a bank that can weather a crisis and one that cannot.

Frequently Asked Questions

Do I need to worry about my bank's reserves?

Not directly. The FDIC insures your deposits up to $250,000 regardless of how much your bank holds in reserve. However, banks with strong reserves are generally safer and less likely to fail. You can check a bank's financial health through the FDIC's website or financial databases that publish bank balance sheets.

Can a bank use my deposit as its reserve?

No. Your deposit is a liability to the bank—money it owes you. The bank's reserve is money it holds separately to cover that liability and others. When you deposit $1,000, the bank records it as owing you $1,000, and it must hold some portion of its total deposits in reserve to ensure it can pay you back.

What does it mean when the Fed "raises" or "lowers" reserves?

The Federal Reserve does not directly raise or lower reserves. Instead, it changes the reserve requirement (the percentage banks must hold) or adjusts interest rates, which makes holding reserves more or less attractive. When the Fed wants banks to lend more, it lowers the reserve requirement or lowers interest rates, making reserves less profitable to hold.

Are online banks required to hold reserves?

Yes. Online banks are subject to the same Federal Reserve rules as traditional banks. They must hold reserves based on their deposits, though the current requirement is zero percent. Online banks typically hold reserves at the Federal Reserve or at correspondent banks that have Federal Reserve accounts.