Federal law requires banks to hold a percentage of all deposits in the bank. Deposits include money in checking and savings accounts, which represent liabilities for banks. Because customers use these types of accounts heavily for transactions, the Federal Reserve Board regulates the required reserves of each bank to ensure that banks have sufficient cash to cover all customer withdrawals. The requirements vary depending on the amount of deposits the banks hold. Generally, banks with higher amounts of deposits are required to hold a higher percentage of cash reserves.
The Board of Governors of the Federal Reserve has the authority to set the reserve requirements within the limits set forth in the Monetary Control Act of 1980. In accordance with this legislation, reserves can be held in the form of cash in the depository institution's vault, or as a deposit or credit with a regional Federal Reserve Bank. This piece of legislation also grants the Federal Reserve the authority to set reserve requirements for all banks, whether or not banks are members of the Federal Reserve System.
The Monetary Control Act of 1980 grants the Federal Reserve the authority to impose reserve requirements on banks. This piece of legislation also empowers the Board of Governors of the Federal Reserve to apply reserve requirements ranging between eight and 14 percent on transaction deposits, including checking deposits. In addition, a reserve requirement of up to nine percent may be applied to non-personal time deposits, including investment accounts and Certificates of Deposit (CDs).
Three Percent Requirement
The Monetary Control Act of 1980 also provides for a low reserve requirement designed to ease the burden of required reserves on small banks. Since December 31, 2009 the Federal Reserve requires banks with deposit liabilities between $10.7 and $55.2 million to keep three percent in reserves. Legislation also provides for annual adjustments in the reserve amount each year by using a formula set forth in the Monetary Control Act.
Ten Percent Requirement
Any amount of a depository institution's transaction accounts in excess of the low-reserve tranche currently requires a reserve amount of 10 percent. As of December 31, 2009, banks holding deposit liabilities greater than $55.2 million are required to abide by the new reserve rate.
Although banks are required to hold a certain ratio of reserves, legislation and the Federal Reserve Board have established exemptions. For example, under the Garn-St. Germain Act of 1982, the first $2 million of a depository institution's liabilities are exempt from reserve requirements. Like the low-reserve tranche amount, the amount of the exemption changes from year-to-year in keeping with a formula included in the law. In addition, non-personal accounts such as CDs and investment accounts have been exempt from reserve requirements since December 27, 1990. The Federal Reserve also exempts banks with deposit liabilities under $10.7 million.