Understanding the Reserve Ratio: Definition, Calculation, and Impact

What Is the Reserve Ratio?

The reserve ratio, often referred to as the cash reserve ratio, is a critical component dictated by central banks to ensure economic stability. This percentage of deposits that banks must hold rather than lend is determined by the Federal Reserve in the U.S. It influences the money supply and can impact interest rates, lending practices, and overall economic growth.

The minimum reserves a bank must hold is called the reserve requirement. It's often used interchangeably with the reserve ratio. The reserve ratio is specified by the Federal Reserve Board’s Regulation D. Regulation D set uniform reserve requirements for all institutions with transaction accounts. It also requires banks to regularly report to the Federal Reserve.

How to Calculate the Reserve Ratio

 $\begin{aligned} &\text{Reserve Requirement} =\text{Deposits} \times \text{Reserve Ratio} \\ \end{aligned}$​Reserve Requirement=Deposits×Reserve Ratio​

As a simplistic example, assume the Federal Reserve determined the reserve ratio to be 11%. This means if a bank has deposits of $1 billion, it is required to have $110 million on reserve ($1 billion x .11 = $110 million).

Understanding the Impact of the Reserve Ratio

The Federal Reserve uses the reserve ratio as one of its key monetary policy tools. The Fed may choose to lower the reserve ratio to increase the money supply in the economy. A lower reserve ratio requirement gives banks more money to lend, at lower interest rates, which makes borrowing more attractive to customers.

Conversely, the Fed increases the reserve ratio requirement to reduce the amount of funds banks have to lend. The Fed uses this mechanism to reduce the supply of money in the economy and control inflation by slowing the economy down.

The Fed sets reserve ratios to ensure banks have cash available if many depositors want to withdraw funds at once. If a bank can't meet its reserve, it may borrow funds from the Fed to comply.

Banks must keep reserves as cash in vaults or as Federal Reserve Bank deposits. On Oct. 1, 2008, the Federal Reserve began paying interest to banks on these reserves. This rate was referred to as the interest rate on required reserves (IORR). There was also an interest rate on excess reserves (IOER), which is paid on any funds a bank deposits with the Federal Reserve in excess of their reserve requirement.

On July 19, 2021, the IORR and IOER were simplified to a new measure called the interest on reserve balances (IORB). As of Sept. 18, 2025, the IORB rate is 4.15%.

Current Reserve Ratio Regulations and Guidelines

The Board of Governors of the Federal Reserve has the sole authority over changes in reserve requirements within limits specified by law. As of January 2024, the reserve requirement for the exemption amount of $36.1 million to $644.1 million was set at 0%. That's when the board eliminated the reserve requirement due to the global financial crisis. This means that banks aren't required to keep deposits at their Reserve Bank. Instead, they can use the funds to lend to their customers.

The last time the Fed updated its reserve requirements for different depository institutions before the pandemic was in January 2019. Banks with over $124.2 million in net transaction accounts had to keep a 10% reserve of those accounts. Banks with more than $16.3 million to $124.2 million needed to reserve 3% of net transaction accounts. Banks with net transaction accounts of up to $16.3 million or less were not required to have a reserve requirement. The majority of banks in the United States fell into the first category.

The Fed set a 0% requirement for nonpersonal time deposits and Eurocurrency liabilities.

The Reserve Ratio's Role in Money Multiplication

In fractional reserve banking, the reserve ratio is key to understanding how much credit money banks can make by lending out deposits. If a bank had $500 million in deposits, it had to hold $50 million, or 10%, in reserve before the requirement was reduced to 0%. It could then lend out the remaining 90%, or $450 million, which would make its way back to the banking system as new deposits.

Banks could then lend out 90% of that amount, or $405 million, while retaining $45 million in reserves. The $405 million is then re-deposited and the cycle continues. That $500 million in deposits could ultimately turn into $5 billion in loans, where the 10% reserve requirement defines the so-called money multiplier as:

The Bottom Line

The reserve ratio is a critical tool used by the Federal Reserve to regulate the U.S. money supply and ensure economic stability. It mandates the percentage of deposits banks must retain rather than loan out or invest. In times of economic growth, a lower reserve ratio facilitates increased lending, stimulating the economy by putting more money in circulation.

Conversely, during inflationary periods, a higher reserve ratio helps reduce the money supply to stabilize prices. Understanding how the reserve ratio impacts lending and economic conditions empowers both banks and individuals to anticipate shifts in financial markets.