What Is The Legal Reserve Requirement Of Banks?

In modern banking, bank reserves are held either as cash on hand or as deposits with the central bank. A prudent banker, concerned only with assuring customers that the bank has enough cash for daily transactions, might choose to keep only 5 percent of the bank's checking deposits in reserves. In fact, banks today set aside about 10 percent of their checking deposits in reserves. These are held in cash or in deposits with our central bank, the Federal Reserve System, often called the Fed.

Reserves are so high because all financial institutions are required by law and Federal Reserve regulations to keep a fraction of their deposits as reserves. Reserve requirements apply to all types of checking and savings deposits. Independent of the actual need for cash on hand.

Bank reserves are kept above the prudent commercial level because of legal reserve requirements. The main function of legal reserve requirements is to enable the Federal Reserve to control the amount of checking deposits that banks can create. By imposing high fixed legal reserve requirements, the Fed can better control the money supply.