Bank reserves are money that banks hold in their vaults or at the Federal Reserve instead of lending it out to customers

When you deposit money in a bank, the bank does not keep all of it sitting idle. It lends most of it out as mortgages, car loans, business loans, and credit lines. But banks are required to keep a portion of customer deposits on hand—these holdings are called reserves. Reserves serve two purposes: they let banks handle daily customer withdrawals without delay, and they act as a financial cushion if loans go bad or depositors withdraw large sums at once.

The amount of reserves a bank must hold is set by the Federal Reserve, the central banking system of the United States. The Federal Reserve changed its reserve requirements in 2020, and most banks now face no specific minimum reserve requirement, though they still hold reserves for practical and regulatory reasons. Banks that do face requirements typically must keep between 0% and 10% of certain customer deposits in reserve, depending on the size and type of deposit account.

Key Takeaways

  • Banks keep reserves to cover daily customer withdrawals and to protect themselves if loans default or unexpected financial stress occurs.
  • The Federal Reserve sets reserve requirements, though most banks now have no legally mandated minimum as of 2020.
  • Reserves are held either in the bank's vault or deposited at a Federal Reserve bank, not invested in stocks or other assets.
  • When banks hold more reserves than required, they earn less interest income because that money is not being lent out at a profit.
  • During financial crises or economic uncertainty, banks tend to hold larger reserves to reduce their risk.

Where banks physically keep their reserves

Reserves exist in two locations. Some are held in the bank's own vault as cash and coin. The rest are held in an account at a regional Federal Reserve bank. When you withdraw cash from an ATM or the teller window, the bank draws from its vault reserves. When banks need to settle transactions with other banks—such as when a check clears or a wire transfer moves between institutions—they use their Federal Reserve account.

A bank's vault reserves are insured and guarded, but they earn no interest. Money held at the Federal Reserve also earns little to no interest in most cases, though the Federal Reserve does pay interest on reserve balances during certain economic conditions. This is one reason banks prefer to lend money out: loans generate interest income, while reserves generate almost nothing.

How reserve requirements work

Before 2020, the Federal Reserve set a tiered reserve requirement based on the size of a bank's deposits. Large banks with over $127 million in certain deposits had to hold 10% in reserve. Smaller banks held 3% or less. In March 2020, the Federal Reserve reduced all reserve requirements to zero, a move designed to free up cash for banks to lend during the COVID-19 pandemic. That zero requirement remains in place today.

Even though the legal requirement is now zero for most banks, many still hold reserves voluntarily. Banks do this because regulators expect it, because it protects against unexpected withdrawals, and because it helps them meet other regulatory standards like the Liquidity Coverage Ratio, which requires banks to hold enough liquid assets to survive a 30-day stress scenario. The amount a bank chooses to hold is often higher than any legal minimum would have been.

Why banks hold more reserves than they have to

A bank's decision to hold extra reserves beyond any legal requirement depends on its size, its customer base, and the economic climate. Large banks with many business customers face bigger, less predictable withdrawal demands than small community banks. Banks also hold extra reserves when they are uncertain about the economy or when they expect loan defaults to rise. During the 2008 financial crisis and again during the 2020 pandemic, banks held significantly more reserves than usual because the future was unclear.

Holding excess reserves costs a bank money in foregone interest income. If a bank has $100 million in reserves earning 0.1% interest, it earns $100,000 per year. If it lent that $100 million at 5%, it would earn $5 million. The difference is substantial, so banks balance safety against profit. A bank that holds too little risks being unable to meet withdrawal demands or failing regulatory stress tests. A bank that holds too much sacrifices earnings and may struggle to compete with banks that lend more aggressively.

How reserves protect you as a depositor

Bank reserves are one layer of protection for your money, though they are not the only one. The Federal Deposit Insurance Corporation (FDIC) insures deposits up to $250,000 per depositor, per bank, per account type. This insurance exists because banks can fail—and when they do, the FDIC steps in to pay depositors from its own fund, not from the bank's reserves.

Reserves matter to you indirectly. If a bank does not hold enough reserves and faces a sudden crisis, it may not be able to pay you when you withdraw money, even if the FDIC insurance eventually covers you. A bank with healthy reserves can weather short-term problems without triggering a failure. Regulators monitor bank reserves closely and can force a bank to hold more if they see risk. This supervision is meant to catch problems before they become crises.

The difference between reserves and capital

Reserves and capital are often confused because both protect a bank, but they work differently. Reserves are customer deposits and borrowed money that the bank holds in liquid form—cash or accounts at the Federal Reserve. Capital is the bank's own money: shareholder equity, retained earnings, and other assets the owners have invested. When a bank makes a bad loan and loses money, capital absorbs the loss first. Reserves are there to handle daily operations and unexpected withdrawals.

Regulators require banks to hold both. The Federal Reserve sets capital requirements separately from reserve requirements, and capital requirements have actually become stricter since 2008. A bank can have plenty of reserves but weak capital, or vice versa. Both matter for the bank's stability and for your safety as a depositor.

What happens to reserves during economic stress

When the economy weakens or financial markets become unstable, banks typically hold more reserves and lend less. This is called a "flight to safety." During the 2008 financial crisis, banks stopped lending and hoarded cash because they did not know which loans would fail. The same pattern appeared in 2020 when the pandemic hit. Banks held record levels of reserves because the future was uncertain.

This behavior can slow economic growth because businesses and consumers have a harder time borrowing. To counteract this, the Federal Reserve sometimes lowers interest rates or injects money into the banking system to encourage banks to lend. The goal is to balance safety—making sure banks do not fail—with growth, making sure credit flows to the real economy.

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 many reserves your bank holds. Regulators monitor bank reserves and capital constantly. If a bank becomes weak, regulators can force it to hold more reserves or merge it with a stronger bank before it fails.

Can a bank run out of reserves and fail?

Yes, though it is rare in modern banking. If a bank faces sudden, massive withdrawals and does not have enough reserves or access to emergency borrowing, it can fail. This happened to some regional banks in 2023. The FDIC takes over failed banks and pays insured deposits, but uninsured deposits above $250,000 may not be fully recovered.

Why do banks earn so little interest on reserves?

The Federal Reserve sets the interest rate it pays on reserves, and that rate is typically very low—often near zero. This is intentional: the Fed wants to encourage banks to lend money into the economy rather than park it at the central bank. When the Fed raises rates, it sometimes increases the interest on reserves to give banks an incentive to hold more cash during inflationary periods.

Are my deposits actually held in reserve?

Not all of them. If you deposit $10,000, the bank keeps only a small fraction in reserve and lends the rest out. Your $10,000 is recorded as a liability on the bank's balance sheet—the bank owes you that money. The FDIC insurance covers your claim, not the physical dollars. When you withdraw, the bank pays you from its reserves or from money it collects on loans.

What changed when the Federal Reserve eliminated reserve requirements?

Banks are no longer legally required to hold a minimum percentage of deposits in reserve. However, they still hold reserves for practical reasons and because other regulations require it. The change gave banks more flexibility to lend, but it did not eliminate the need for reserves—it just made the amount a choice rather than a mandate.