What a required reserve ratio actually is
A bank's required reserve ratio is the percentage of customer deposits that the bank must hold in reserve and cannot lend out. The Federal Reserve sets this ratio, and it applies to all banks that hold deposits. If a bank has $1 million in customer deposits and the required reserve ratio is 10%, that bank must keep $100,000 in reserve at all times.
The reserve itself sits in one of two places: in the bank's vault as physical cash, or in an account the bank holds at its regional Federal Reserve bank. Banks cannot use this money to make loans, invest, or pay dividends. It has to stay there, untouched, to cover withdrawals if many customers ask for their money at once.
The Federal Reserve changed the required reserve ratio to zero percent in March 2020 during the pandemic and has kept it there since. This means banks are no longer legally required to hold reserves based on deposit size. However, banks still hold reserves voluntarily because regulators expect it and because it is safer business practice.
Key Takeaways
- The Federal Reserve sets the required reserve ratio, which tells banks what percentage of deposits they must keep in reserve rather than lend out.
- Reserves are held either as cash in the bank's vault or in an account at the Federal Reserve bank, and cannot be used for loans or investments.
- The required reserve ratio has been zero percent since March 2020, so banks are no longer legally required to hold reserves based on deposit amounts.
- Banks still maintain reserves voluntarily because regulators monitor reserve levels and because holding reserves reduces the risk of a bank run.
How the Federal Reserve uses the reserve ratio as a tool
When the Federal Reserve wants to control how much money is circulating in the economy, it can raise or lower the required reserve ratio. Lowering the ratio means banks have to hold less in reserve, so they can lend out more money. Raising the ratio means banks have to hold more in reserve, so they lend out less. This is one of the Fed's main levers for managing inflation and economic growth.
The Fed also uses the reserve ratio to influence interest rates. When banks have more money available to lend (because the reserve requirement is lower), they compete more aggressively for borrowers and may lower interest rates. When banks have less to lend, they raise rates. This ripples through the entire economy because mortgage rates, car loan rates, and credit card rates all move in response.
Why banks hold reserves even when not required to
Since the requirement dropped to zero, banks are not forced to hold reserves by law. But they do anyway, and regulators watch how much they hold. The Federal Reserve and the Office of the Comptroller of the Currency (OCC) both monitor reserve levels as part of their regular bank examinations. A bank that holds too little is seen as riskier and may face pressure to increase reserves or face restrictions on lending and dividends.
Banks also hold reserves for their own protection. If a large number of customers withdraw money at once—what is called a bank run—the bank needs cash on hand to pay them. Holding reserves reduces the chance that a bank will run out of cash and have to borrow money at high rates or fail entirely. During the 2008 financial crisis and again during the pandemic, banks that held larger reserves weathered the crisis better than those that did not.
The difference between required reserves and excess reserves
Required reserves are the minimum amount a bank must hold based on the ratio set by the Federal Reserve. Excess reserves are anything the bank holds above that minimum. Before 2020, when the required ratio was typically 10% for large banks, a bank with $1 million in deposits had to hold $100,000 in required reserves. If it held $150,000, the extra $50,000 was excess reserves.
Banks can use excess reserves more flexibly. They can lend them out, invest them, or hold them as a safety cushion. The amount of excess reserves in the banking system is a signal of how much lending capacity banks have. When excess reserves are high, banks have room to lend more. When they are low, banks are already lending most of what they can.
How reserve requirements differ by bank size
The Federal Reserve applies different rules to different types of banks. Large banks—those with more than $128.5 million in transaction accounts—historically faced higher reserve requirements than smaller banks. Community banks and credit unions often had lower requirements or none at all. These thresholds change annually based on inflation.
Now that the requirement is zero across the board, size matters less for reserve calculations. However, larger banks still face stricter oversight from regulators. The Fed requires large banks to maintain what is called a "liquidity coverage ratio," which is a different measure of how much liquid cash a bank needs to survive a crisis. This is more stringent than the old reserve ratio and applies only to banks above a certain size.
What happens if a bank falls below its reserve requirement
When the requirement was in effect, banks that fell below it faced penalties from the Federal Reserve. The Fed could fine the bank, restrict its ability to pay dividends, or require it to raise capital. In extreme cases, the Fed could recommend that banking regulators take action against the bank, including forcing it to merge with another bank or shutting it down.
Today, with the requirement at zero, a bank cannot technically violate it. But regulators still watch reserve levels closely. A bank that holds almost no reserves and then faces a sudden wave of withdrawals may not have enough cash to meet demand. Regulators can and do force banks to hold more reserves if they believe the bank is taking on too much risk.
Frequently Asked Questions
Does the reserve requirement affect the interest rate I earn on my savings account?
Indirectly, yes. When the Fed lowers the reserve requirement, banks can lend more money, which increases competition for borrowers and can lower interest rates across the economy. This includes the rates banks offer on savings accounts. When the requirement rises, the opposite happens. However, your specific savings rate depends on your bank's policies and the current market, not just the reserve ratio.
Can a bank lend out the money it holds in reserve?
No. Money held to meet the reserve requirement cannot be lent out. However, banks can lend out excess reserves—anything they hold above the minimum. Since the requirement is now zero, banks technically can lend out all their reserves if they choose to, but regulators expect them to maintain some level of reserves for safety.
What is the reserve requirement right now?
The Federal Reserve set the required reserve ratio to zero percent in March 2020 and has maintained it since. This means banks are not legally required to hold any reserves based on the size of their deposits. Banks still hold reserves voluntarily because regulators monitor them and because it is safer to do so.
How does the reserve requirement affect inflation?
When the Fed lowers the reserve requirement, banks can lend more money into the economy, which increases the money supply and can push inflation up. When the Fed raises the requirement, banks lend less, the money supply shrinks, and inflation pressure eases. This is why the Fed uses the reserve ratio as one tool to manage inflation, though it is not the only tool available.