Reserve Banking

By: EconomyWatch Content   Date: 1 February 2010

About The Author

EconomyWatch Content

Follow The Money

EconomyWatch, Content Team

 

  • Dot Div
  •      

 There are two types of reserve banking practices, full reserve banking and fractional reserve banking. Full reserve banking is a banking practice in which banks are not entitled to spend any fund that is deposited by its customers. All the funds are available in reserve, either as ready cash or as a highly liquid asset, and can be withdrawn whenever a depositor wants. This principle was practiced by several banks, such as the Bank of Amsterdam until 1800. Fractional reserve banking is the banking practice in which banks keep only a part of their deposits in reserves that can be easily liquidated. The remainder of the deposits can be used by the banks in high-return investments. The fraction of reserves that banks across the globe need to maintain is decided by the central bank of each country.  

Debate over Full Reserve Banking and Fractional Reserve Banking

The fractional reserve banking system replaced the full reserve banking practice across the world in 1800. However, after two centuries of successful implementation of the fractional reserve system, there have been proposals to restore full reserve banking. While renowned economists such as Laurence J Kotlikoff and Edward Leamer support the full reserve system,mainstream economists believe that the costs of such a change would outweigh any benefits.

Requirements for Reserve Banking

In the US, reserves are generally considered as the average of funds held by the bank over the 14 day period ending every second Wednesday. On any given day, banks require funds that are enough to cover withdrawals made by its customers. Banks hold these funds in any combination of vault cash and deposits at the Federal Reserve.

All depository institutions, whether commercial banks or thrifts, are required to adhere to certain reserve requirements for customer deposits. The reserve ratio is dependent on the amount of checkable deposits in a bank. While no reserves are required on the first $10.3 million deposits, banks carrying $10.3-$44.4 million deposits must have 3% of total deposits in reserves. Meanwhile, banks having more than $44.4 million of deposits are subject to a 10% reserve as of yearend 2008. These requirements are adjusted annually with growth in money supply. Banks are not required to create reserves for deposits in savings accounts.


  • Dot Div
  •      

Most Popular in High Finance

Related Links
blog comments powered by Disqus