Reserve Ratio
What is the reserve ratio? What is the reserve requirement? What is the Federal Reserve requirement? How does the reserve ratio work?
The reserve ratio, also called the reserve requirement or Federal Reserve requirement, is the mandated amount of money and liquid assets that Federal Reserve System member banks must have relative to their total deposits. The reserve ratio is designed to guard against a crippling run on the bank.
As of 2006, the Federal Reserve mandated a ratio of 10% for unrestricted deposits, called transaction deposits or time deposits, meaning that if you deposit $100 in your checking, your bank can only lend $90 of it (maintaining $10, or 10%, in reserve). The process is complicated because the $90 your bank lends can in turn be deposited into another bank which could lend $81 of it (keeping 10%, or $9, in reserve) and so forth until an initial $100 deposit turns into $900 through lending with a 10% reserve ratio.