Reserve Requirement
A reserve requirement is the minimum fraction of deposits that a bank must hold as reserves rather than lending out, historically set by the Federal Reserve, which reduced the requirement to zero in March 2020.
Reserve requirements were for decades one of the Federal Reserve's three traditional monetary policy tools, alongside open market operations and the discount rate. By mandating that banks hold a specified percentage of their deposits as reserves — either in their vault or as deposits at a Federal Reserve Bank — the Fed could theoretically influence how much money the banking system could create through lending.
Before the 2020 change, the Fed required a 10% reserve ratio on transaction accounts (checking accounts) above a certain threshold, with no requirement on time and savings deposits. A bank that received a $1,000 demand deposit would be required to keep at least $100 in reserve, leaving $900 available to lend. If those loans circulated back into the banking system, the process would repeat, theoretically supporting up to $10,000 in total deposits (the money multiplier).
In practice, even before the 2020 elimination of requirements, reserve requirements had become a relatively blunt and less relevant tool. Since 2008, the Federal Reserve began paying interest on excess reserves (IOER) — balances banks voluntarily held above the regulatory minimum — giving banks an incentive to hold large excess reserve balances rather than lending them out. This policy effectively disconnected the old relationship between reserve balances and credit creation.
When the Fed set reserve requirements to zero in March 2020 as an emergency measure at the onset of the COVID-19 pandemic, it formalized a shift that was already underway. The Fed now primarily manages monetary conditions through the interest on reserve balances (IORB) rate and the overnight reverse repo rate, which together establish a corridor for the federal funds rate.
For those studying monetary economics, reserve requirements remain theoretically important as a conceptual framework for understanding money creation, even though their practical role in U.S. monetary policy has diminished considerably.