A bank reserve is money a bank must keep on hand instead of lending out
When you deposit money in 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 to other customers, invest in securities, or hold as cash. A bank reserve is the portion of customer deposits that federal law requires the bank to keep available—either in its vault or at the Federal Reserve—rather than lend out or invest.
The Federal Reserve sets these reserve requirements, which vary based on the type of account and the size of the bank. The purpose is straightforward: reserves may support a bank can handle withdrawals when customers need their money, and they act as a financial cushion if the bank faces losses.
This is not the same as the bank's own capital or profit. Reserves are customer money that the bank holds in trust. The distinction matters because it shapes how much lending power a bank actually has and what happens when deposits flow in or out.
Key Takeaways
- Banks must keep a percentage of customer deposits as reserves, set by the Federal Reserve, rather than lending or investing that money.
- Reserve requirements differ based on account type and bank size, and the Federal Reserve can change these percentages to influence lending in the economy.
- Reserves sit in the bank's vault or at a Federal Reserve account, not in a separate account tied to your name.
- A bank's reserves are distinct from its own capital; reserves are customer money held in trust, while capital is the bank's own assets.
How the Federal Reserve sets reserve requirements
The Federal Reserve does not require all banks to hold the same percentage. The requirement depends on the size of the bank's deposits and the type of account. For most of the past decade, the Federal Reserve set reserve requirements at 10 percent for transaction accounts (checking accounts and money market accounts that allow unlimited transfers) and 0 percent for savings accounts and time deposits.
In March 2020, the Federal Reserve reduced reserve requirements to 0 percent across the board, a move designed to free up bank capital during the COVID-19 pandemic. That change remains in effect. Even with a 0 percent requirement, many banks still hold reserves above the minimum because doing so is safer and because regulators expect it.
The Federal Reserve can adjust these percentages to influence how much banks lend. Lowering the requirement lets banks lend more; raising it forces banks to hold more cash and lend less. This is one of the tools the Federal Reserve uses to manage inflation and economic growth.
Where reserves physically sit
Bank reserves are not stored in a separate vault labeled with customer names. Instead, reserves exist in two places: in the bank's own vault as physical cash, or in an account the bank holds at the Federal Reserve itself.
Most reserves sit at the Federal Reserve. When you deposit a check at your bank, the bank sends it through the clearing system, and the funds eventually land in the bank's Federal Reserve account. The bank then uses those funds to cover withdrawals, make loans, and pay its operating costs. The portion it must hold as a reserve stays in that Federal Reserve account and cannot be lent out.
A small amount of reserves—enough to cover daily cash withdrawals at ATMs and teller windows—stays in the bank's physical vault. The rest earns interest at the Federal Reserve, though the rate is typically very low or zero.
Why reserves matter when you withdraw money
Reserves are why you can walk into a bank and withdraw your money on the same day. The bank knows it must keep enough cash available to meet customer withdrawals, so it maintains reserves for exactly that purpose. If a bank did not hold reserves and all its deposits were lent out, it could not pay you when you asked.
During normal times, a bank's reserves far exceed the daily withdrawal requests it receives. But during a financial crisis or a bank run—when many customers try to withdraw at once—reserves become critical. A bank with strong reserves can meet those withdrawals. A bank without them may fail.
This is also why the Federal Reserve acts as a "lender of last resort." If a bank runs low on reserves during a crisis, it can borrow from the Federal Reserve at the discount window, using its loans or securities as collateral. That backstop exists to prevent a solvent bank from failing straightforward because it ran out of cash.
The difference between reserves and capital
Bank reserves and bank capital are often confused, but they are different things. Reserves are customer deposits the bank must hold and cannot lend out. Capital is the bank's own money—the shareholders' equity, retained earnings, and other assets the bank owns outright.
Capital serves a different purpose: it absorbs losses. If a bank makes bad loans and loses money, capital shrinks first. Regulators require banks to hold a minimum amount of capital relative to their assets, separate from reserve requirements. A bank can have plenty of reserves but weak capital, or strong capital but low reserves. Both matter, but for different reasons.
When you hear that a bank is "well-capitalized," that refers to capital, not reserves. When you hear that a bank "maintains strong reserves," that means it has plenty of customer deposits on hand to cover withdrawals.
How reserves affect the money supply and lending
Reserve requirements shape how much money banks can create through lending. When a customer deposits $1,000 and the reserve requirement is 10 percent, the bank must hold $100 as a reserve and can lend out $900. That $900 loan becomes a deposit in another account, and the bank holding that deposit must reserve 10 percent of it ($90) and can lend $810. This process repeats, creating a multiplier effect where the original $1,000 deposit eventually supports thousands of dollars in loans.
By lowering reserve requirements, the Federal Reserve increases the amount banks can lend, which puts more money into the economy. By raising requirements, it reduces lending and slows money growth. This is why the Federal Reserve's decision to lower reserve requirements to 0 percent in 2020 was significant—it removed a constraint on bank lending during a period when the economy needed credit to flow.
The relationship between reserves and lending is not automatic, though. A bank with low reserve requirements will only lend if borrowers want loans and meet the bank's credit standards. During a recession, even with low reserve requirements, banks may tighten lending because they fear defaults.
What happens to your deposits if a bank fails
Bank reserves do not directly protect your deposits if a bank fails. That protection comes from the Federal Deposit Insurance Corporation (FDIC), which insures deposits up to $250,000 per account holder per bank. If a bank fails, the FDIC steps in, takes over the bank's assets (including its reserves), and pays depositors from the insurance fund.
Reserves do matter indirectly: a bank with strong reserves is less likely to fail in the first place. Regulators monitor reserve levels and other metrics to catch problems early. But the FDIC insurance may provide is what actually protects your money if things go wrong.
Frequently Asked Questions
Do I earn interest on the portion of my deposit that becomes a reserve?
No. The interest you earn on your account is based on your full balance, not on the portion the bank holds as a reserve. The bank earns interest on reserves held at the Federal Reserve (though the rate is typically very low), but that interest does not flow to you.
Can a bank lend out all of its reserves?
No. The Federal Reserve requires banks to hold a minimum percentage of deposits as reserves. Currently that minimum is 0 percent, but even so, most banks hold reserves above the minimum because regulators expect it and because it is safer. Banks cannot legally lend out reserves that are required to be held.
What happens if a bank does not hold enough reserves?
The Federal Reserve can fine the bank, restrict its growth, or require it to raise capital. In extreme cases, the Federal Reserve can revoke the bank's charter. Banks that consistently fall short of reserve requirements face regulatory pressure and may lose the ability to operate.
Are reserves the same thing as the money the bank keeps in its vault?
Not exactly. Reserves include both the cash in the bank's vault and the bank's account at the Federal Reserve. Most reserves sit at the Federal Reserve, not in the physical vault. The vault holds only enough cash to cover daily ATM and teller withdrawals.
How do reserve requirements change?
The Federal Reserve's Board of Governors votes to change reserve requirements. Changes are rare and announced in advance. The last significant change was in March 2020, when the Federal Reserve lowered requirements to 0 percent. Before that, the previous change was in 1992.