How to Calculate the Reserve Ratio

Save

Banks make a profit by taking the money that consumers invest and loaning it out at a higher rate. However, banks must also keep a certain amount of cash on hand to cover their liabilities and financial obligations. The ratio of cash that a bank must have in liquid form is referred to as the reserve ratio and is regulated by the U.S. Federal Reserve.

Calculating Cash Reserve

The cash reserve ratio is the amount of cash on hand relative to total assets. To calculate a reserve ratio, divide cash reserves by the bank's total deposits. For example, say that a bank has total deposits of $100,000 and has $10,000 in current cash reserves. Its reserve ratio is $10,000 divided by $100,000, or 10 percent. If the required reserve ratio is 12 percent and total deposits are $100,000, the bank must maintain $12,000 in cash reserves instead of $10,000.

Effects of the Ratio

A high cash reserve ratio means banks have a lower chance of becoming insolvent and are able to pay when depositors withdraw cash. After the financial crisis of 2008, the Federal Reserve worked to increase liquidity and cash reserve requirements in banks.

However, a high cash reserve ratio also limits the amount of money a bank can lend out. Since banks earn money by lending cash, a high reserve requirement could decrease a bank's profits or force it to charge higher interest rates to make the same amount of profit. Since the amount that a bank can lend is dictated by reserve ratio requirements, central banks such as the Federal Reserve can also use these requirements as a type of monetary policy to control the supply of money in circulation.

Promoted By Zergnet

Comments

You May Also Like

  • How to Calculate Ratios and Proportions in Math

    Ratios and proportions are related mathematical concepts. Ratios compare similar things, like distances or time. Proportions are two equivalent ratios, such as...

  • How to Calculate Ratios

    The ratio is an important mathematical concept that allows you to relate two or more quantities, often large, in a simplistic way....

  • How to Find Ratios

    A ratio is a way of comparing the quantity, amount or size of two or more things. Using the following information, you...

  • How to Calculate the Texas Ratio

    The so-called Texas Ratio measures the financial health of a bank, credit union or similar institution by comparing its potential losses from...

  • How to Calculate the Inspiratory & Expiratory Ratio

    Inspiratory and expiratory ratio is a figure that shows the relationship between a person's inspiratory time and his expiratory time. Typically, the...

Related Searches

Check It Out

Are You Really Getting A Deal From Discount Stores?

M
Is DIY in your DNA? Become part of our maker community.
Submit Your Work!