Reservable Deposit

Key Takeaways

• Reservable deposits are regulated by Federal Reserve reserve requirements.
• They include transaction, savings, and non-personal time deposits.
• A portion may be loaned out, while some must be retained for withdrawals.
• Reservable accounts may offer lower interest rates due to reserve holding.
• Sweep accounts are non-reservable and generally offer higher interest rates.

What Is a Reservable Deposit?

A reservable deposit is a bank deposit subject to reserve requirements set by the U.S. Federal Reserve, including transaction accounts, savings accounts, and non-personal time deposits. This means banks must hold part of these deposits in reserve while lending the rest through fractional-reserve banking. The goal is a cushion against bank runs, and it affects both lending capacity and financial stability.

Understanding Reservable Deposits

Reservable deposits include savings accounts and transaction accounts. Transaction accounts include deposits that are readily available to the account owner, such as a checking account or share draft account. These accounts may be accessed through cash withdrawals, the use of debit cards or checks, or electronic transfers. Transaction accounts are used by both individuals and institutions. Because a bank customer may withdraw at any time, the Fed requires that a certain percentage be kept on hand and not loaned out.

Non-personal time deposits are accounts owned by institutions, not an individual(s), that pay an interest rate and have a specified maturity date before which the depositor must pay a fee to withdraw funds. An example of a non-personal time deposit account is a certificate of deposit (CD) owned by a corporation.

How the Reserve Requirement Rate Works

The Federal Reserve Bank's Board of Governors determines the reserve requirement rate, which is imposed on the total value of a depository institution's reservable deposits. If account holders increase the amount of money held in their reservable deposit accounts, the depository institution's reserve requirement will increase. The amount of this reserve requirement must be held either as cash in an institution's own vault or as a deposit at the nearest Federal Reserve bank.1

This practice is known as fractional reserve banking because only a fraction of customer deposits are kept on hand for immediate withdrawal. The remaining value of customer deposits is loaned out so the bank can earn a return on it.

Fast Fact

As part of the COVID-19 pandemic, the Federal Reserve reduced its reserve requirement ratios to 0%. This was in light of attempting to stimulate the faltering economy.2

Drawbacks of Reservable Accounts

Though reservable accounts represent as a buffer against potential losses and bolster the stability of a financial system, these types of accounts are not without their limitations.

Because banks are required to hold these funds, the bank does not earn money on these accounts by loaning out the balances. Therefore, depositors may receive very low interest rates on these types of accounts. For instance, consider the difference between your checking account rate and the prevailing high-interest savings account. For this reasons, reservable deposits are often seen as having opportunity cost as these funds could have been used elsewhere to generate revenue.

Reservable accounts do place some burden on a financial institution. First, it requires persistent compliance with government regulation to ensure proper reserves relating to proper deposits are being held. Second, the bank has less opportunity to lend or invest these funds, limiting the upside profit potential of the operation.

Last, central banks can dictate reserve requirements to stimulate or cool the economy. Should a reservable deposit requirement be tightened, a bank will be forced to keep more capital on hand and issue less loans (making debt more expensive to obtain). Alternatively, loosening deposit requirements help stimulate the economy though at the risk of having less deposits kept on hand. Because of these changes, there may be volatility within the banking system as economies transition from one economic climate to another.

Important

Certain types of banking accounts are insured by the Federal government. As seen by the Silicon Valley Bank failure, all depositors were able to recoup their deposits.3

Exploring Non-Reservable Accounts

Many depository institutions make use of sweep accounts, which are non-reservable deposit accounts, such as money market funds, that generally earn a higher interest rate than reservable deposit accounts. Depository institutions may analyze reservable deposit accounts to determine if there are excess funds that can be moved out of the account, and will automatically transfer these funds, sometimes as often as daily, to a sweep account that is not subject to federal reserve requirements.

By utilizing sweep accounts, the depository institution lowers the amount of money it must hold in cash to meet reserve requirements, thereby increasing the amount of money it can lend out or invest to earn an interest rate or higher rate of return.

What Are the Advantages of Reservable Deposits?

Reservable deposits act as a buffer against potential losses and help to maintain stability in the financial system. Banks are required to hold reserve deposits on hand in the event that the depositor demands these funds.

Why Do Banks Hold Excess Reserves?

Banks hold excess reserves to meet unexpected cash demands from their customers. Banks are also required by law to hold a certain amount of reserves against their deposits to safeguard client funds. These two practices are in stark contrast of how banks typically make money (i.e. using excess capital and investing or loaning these funds).

Can a Bank Run Out of Reserves?

Yes, banks can run out of reserves. However, the Federal Reserve implements policies that encourage banks to be fiscally responsible and have enough capital on hand for normal operations. Though banks may not carry enough capital to handle very large bank runs, the Federal Deposit Insurance Corporation was established to protect depositor assets to invoke confidence that their funds (up to a certain amount) are insured by the government.