Reserve requirements are rules made by the central bank (like the People’s Bank of China or the Federal Reserve in the U.S.). These rules tell commercial banks (like Bank of China, ICBC, or Wells Fargo) how much money they must keep in reserve and not use for lending.

Why Do Banks Need to Keep Money in Reserve?

When you deposit money into a bank, the bank doesn’t just lock it away. It uses most of that money to give loans to other people or businesses. But to make sure banks always have enough cash on hand (in case many people want to withdraw their money at the same time), the central bank sets a rule: you must keep a small part of your total deposits safe and ready.

This amount is called the reserve.

How Much Must They Keep?

The amount a bank must keep is usually a percentage of all the money people have deposited in the bank. This percentage is called the:

  • Cash Reserve Ratio (CRR) or just
  • Reserve Ratio

For example:

If the reserve ratio is 10%, and a bank has $100 million in customer deposits, it must keep at least $10 million in reserve.

Where Do Banks Keep These Reserves?

Banks hold reserves in two main ways:

  • Cash stored in the bank’s own vault – this is called vault cash.

  • Money kept in the bank’s account at the central bank – kind of like how you have a savings account, but this one is between the commercial bank and the central bank.

Can Banks Keep More Than Required?

Yes! If a bank wants to be extra careful, it can keep more money than the central bank requires. This extra money is called excess reserves.

Banks might do this:

  • When they are uncertain about the economy.
  • If they don’t see good opportunities to lend.
  • Or if they want to avoid any risk of being short on cash.##

Summary

  • Central banks make rules so commercial banks don’t lend out all their money.

  • A small percentage must be kept as reserves to ensure safety and stability.

  • Reserves are held in the bank’s vault or in their account at the central bank.

  • Any extra money kept beyond the requirement is called excess reserves.

5W2H Method

Using the 5W2H (Who, What, When, Where, Why, How, How much) method to describe reserve requirements:

Central banks (Who) set reserve requirements (What) to be followed at all times (When) by commercial banks (Where) in order to ensure banks have enough cash to meet withdrawals and protect financial stability (Why) by requiring them to keep a portion of customer deposits (How), usually as a fixed percentage like 5–10% of total deposits (How much).