A bank's required reserve ratio is the percentage of customer deposits that the bank must hold in cash rather than lend out
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 to other customers — that is how banks make money. But the bank cannot lend out every dollar you deposit. A required reserve ratio is a rule set by the Federal Reserve (the central bank of the United States) that says a bank must keep a certain percentage of deposits on hand, in cash or in an account at the Federal Reserve itself, ready to give back to customers who want to withdraw.
Think of it this way: if you and 99 other people each deposit $1,000, the bank has $100,000. If the required reserve ratio is 10 percent, the bank must keep $10,000 in reserve and can lend out the other $90,000. That reserve sits there so that if 15 people come in on the same day asking for their money, the bank can hand it over without delay.
Key Takeaways
- The Federal Reserve sets the required reserve ratio, which is a percentage of total customer deposits that banks must keep in cash or at the Federal Reserve.
- Banks calculate their reserve requirement by multiplying the total deposits they hold by the reserve ratio percentage set by the Federal Reserve.
- The reserve ratio changed in 2020 — the Federal Reserve lowered it to zero percent for most banks, meaning banks no longer have a minimum reserve requirement.
- A lower reserve ratio allows banks to lend out more money, which can increase the money available in the economy; a higher ratio keeps more cash in the banking system.
- The reserve requirement does not affect how much money you can withdraw from your own account — it is a rule about how much the bank must hold in total.
How the Federal Reserve sets the reserve ratio
The Federal Reserve, which is the central banking system of the United States, decides what the reserve ratio will be. The Federal Reserve Board of Governors meets regularly and can raise or lower this ratio as a tool to manage the economy. When the economy is weak and the Federal Reserve wants to encourage lending, it may lower the reserve ratio, freeing up more money for banks to lend. When inflation is a concern and the Federal Reserve wants to tighten the money supply, it may raise the ratio.
As of 2020, the Federal Reserve set the reserve ratio to zero percent for most banks. This means banks are no longer required to hold a specific percentage of deposits in reserve. However, banks still hold reserves for practical reasons — they need cash on hand to process withdrawals and handle daily operations. The zero percent requirement straightforward removed the legal minimum.
How banks calculate their reserve requirement
A bank calculates its reserve requirement by taking the total amount of deposits it holds and multiplying that by the reserve ratio. For example, if a bank holds $500 million in deposits and the reserve ratio is 10 percent, the bank's reserve requirement is $50 million.
Banks track this calculation regularly because the amount of deposits changes every day as customers deposit and withdraw money. If a bank falls below its required reserve, it must borrow money from other banks or from the Federal Reserve's "discount window" — a lending service for banks that need short-term cash. Borrowing this way costs the bank money in interest, so banks work to stay above their requirement.
Why the reserve ratio matters to you as a customer
The reserve ratio does not directly limit how much money you can withdraw from your account. You can withdraw your full balance whenever you want (during business hours, or through an ATM). The reserve ratio is a rule about the bank's total holdings, not about individual accounts.
What the reserve ratio does affect is how much money banks have available to lend to other customers. A lower reserve ratio means banks can lend more, which can make it easier for people to get loans and mortgages. A higher reserve ratio means banks lend less, which can make credit harder to find. Over time, this affects the whole economy — more lending can boost growth, while less lending can slow it down.
The difference between reserve ratio and reserve requirement
These terms are often used interchangeably, but there is a small difference. The reserve ratio is the percentage itself — for example, 10 percent. The reserve requirement is the actual dollar amount a bank must hold, calculated by explore that ratio to the bank's deposits. If the ratio is 10 percent and the bank has $500 million in deposits, the reserve requirement is $50 million.
Understanding this distinction helps you read banking news more clearly. When you see a headline saying "the Federal Reserve lowered the reserve ratio," it means the percentage went down, which automatically lowers the dollar amount each bank must hold in reserve. Both terms describe the same system, just from different angles.
How reserve requirements changed during the pandemic
In March 2020, as the COVID-19 pandemic began, the Federal Reserve lowered the reserve ratio to zero percent. The goal was to free up cash for banks to lend to businesses and individuals who were struggling. Before this change, banks had been required to hold reserves based on the type of deposit and the amount held. After the change, banks no longer had a legal minimum, though they continued to hold reserves for operational reasons.
This change was meant to be temporary, but as of now it remains in effect. The Federal Reserve has not announced plans to raise the reserve ratio again, so most banks continue to operate without a specific reserve requirement set by the Federal Reserve. This is a significant shift from decades of banking practice, though it has not changed how you interact with your own account.
Frequently Asked Questions
Can a bank run out of reserves and not be able to give me my money?
No. Banks are required to have enough cash available to meet customer withdrawals, and the Federal Deposit Insurance Corporation (FDIC) insures deposits up to $250,000 per account. If a bank truly cannot pay, the FDIC steps in and covers your deposit. The reserve requirement exists partly to prevent this situation.
Does the reserve ratio change based on the type of account I have?
The reserve ratio is set by the Federal Reserve and applies to the bank as a whole, not to individual accounts. Your savings account, checking account, and money market account are all part of the bank's total deposits when calculating reserves. You cannot see which deposits are "reserved" — it is a bank-wide calculation.
If the reserve ratio is zero percent now, why do banks still hold cash?
Banks hold reserves for practical reasons even without a legal requirement. They need cash to process customer withdrawals, pay employees, and handle daily operations. They also hold reserves to stay safe and stable — a bank with no cash on hand would be risky. The zero percent requirement just means the Federal Reserve is not forcing a minimum anymore.
How does the reserve ratio affect interest rates on my savings account?
A lower reserve ratio allows banks to lend more, which can increase competition for deposits and potentially raise the interest rates banks offer on savings accounts. A higher reserve ratio restricts lending and can lower rates. The connection is indirect — many factors affect interest rates — but reserve policy is one tool the Federal Reserve uses to influence the broader economy.