# Bank Reserves **The model:** The cash that banks hold against their deposit liabilities — physically in vaults, but mostly as deposits at the central bank. Reserves serve two functions: (1) ensure banks can meet routine withdrawal demands, and (2) serve as the base layer of the [[Fractional Lending]] money-creation system. The amount of reserves banks must hold is set by central-bank regulation; the amount they choose to hold beyond the requirement is a banking-sector decision affected by the cost of holding reserves and the risk of insufficient reserves. The political importance is mostly indirect: bank-reserve policy is a key tool of monetary policy, and reserve dynamics affect financial-system stability. The 2008 financial crisis was partly a reserves-and-liquidity crisis; the post-crisis Basel III regulations dramatically raised reserve requirements globally; the 2023 regional-bank crisis (SVB, First Republic, Signature) exposed gaps in those requirements. ## The Mechanism **Required vs. excess reserves.** Banks must hold reserves equal to a regulator-set fraction of deposits (the "reserve requirement"). Reserves above this minimum are "excess reserves." The U.S. eliminated reserve requirements in March 2020 (in response to COVID disruption), so the formal reserve requirement is currently zero — banks hold reserves voluntarily based on liquidity needs and central-bank incentives. **Interest on reserves (IOR).** Since 2008, the Federal Reserve has paid interest on reserves held at the Fed. This converted reserves from a return-free asset banks tried to minimize into an interest-bearing asset banks may want to hold for yield. The IOR rate is now a primary tool of monetary policy: the Fed sets the rate, which sets the floor for short-term interest rates throughout the economy. **Reserves and bank runs.** A bank's reserves are its first line of defense against a run. If depositors demand cash faster than the bank can liquidate other assets, reserves provide the buffer. The 2023 Silicon Valley Bank failure was partly a reserves crisis: the bank's deposit base was unusually concentrated and unusually run-prone, while its reserves were inadequate to handle the speed and scale of the run that materialized. **Reserves are not money in circulation.** A common misconception: reserves held at the central bank are not part of M1 or M2 money supply that the public uses. They're an inter-bank settlement asset. Quantitative easing — the Fed's bond-buying programs since 2008 — increased reserves dramatically without producing the money-supply growth that some critics predicted, partly because the new reserves stayed parked at the Fed rather than entering circulation through new lending. ## KB Applications ### The 2008 Crisis and Why Reserves Mattered A central element of the 2008 crisis was that major banks held insufficient reserves and other liquid assets relative to the run-risk on their funding. When confidence in mortgage-backed securities collapsed, banks couldn't liquidate fast enough to meet redemption demands, triggering the cascading failures that required massive Fed intervention. Post-crisis Basel III rules dramatically raised liquidity requirements; the 2023 regional-bank crisis showed that the new rules covered the largest banks well but had gaps for mid-sized banks with concentrated deposit bases. ### Reserves and the Quantitative Easing Debate The Fed's post-2008 quantitative easing programs created an enormous expansion of bank reserves — from under $50 billion in 2007 to over $4 trillion at peak. Right-wing critics predicted runaway inflation as the new reserves entered circulation; the inflation didn't materialize because the reserves stayed at the Fed (the IOR rate was higher than market alternatives). The episode became an empirical refutation of strong-form Austrian-school predictions about money-supply expansion always producing inflation. Reserve dynamics are more complicated than the standard right-wing monetary frame allows. ### Bank-Reserve Policy and Political Pressure The Fed's reserve and IOR-rate decisions are among the most consequential financial-policy actions in the U.S. economy. They are made by an independent body insulated from political pressure — a structure that the Trump administration has periodically attacked. Politicizing reserve and IOR-rate decisions would be a significant change to U.S. monetary architecture, with predictable consequences for inflation expectations and currency stability. ## See Also - [[Fractional Lending]] — what bank reserves are the base layer of - [[Inflation]] — what reserve and monetary policy targets - [[Negative Interest Rates]] — the unconventional monetary tool that interacts with reserves - [[Credit Theory of Money]] — why reserves price lending rather than fund it