Reserve requirement

A reserve requirement (or reserve ratio or liquidity ratio) is a central bank regulation that sets the minimum amount that a commercial bank must hold in liquid assets in reserve. The minimum reserve is generally determined by the central bank to be a specified proportion of deposit liabilities of the commercial bank. The commercial bank's reserves normally consist of cash owned by the bank and stored physically in the bank vault (vault cash), plus the amount of the commercial bank's balance in that bank's account with the central bank. A bank is at liberty to hold in reserve sums in addition to this minimum requirement, commonly referred to as excess reserves.

The reserve ratio is sometimes used by a country’s monetary authority as a tool in monetary policy, to influence the country's money supply by limiting the amount of lending by the banks.[1] Monetary authorities increase the reserve requirement only after careful consideration because an abrupt change may cause liquidity problems for banks with low excess reserves; they generally prefer to use open market operations (buying and selling government-issued bonds) to implement their monetary policy. In the United States and many other countries (except Brazil, China, India, Russia), reserve requirements are generally not altered frequently in implementing a country's monetary policy because of the short-term disruptive effect on financial markets.