Light

Reserve Requirement

Definition

The reserve requirement is the percentage of deposits that banks are required to hold as reserves, which cannot be loaned out. It is set by the central bank to control the amount of money in circulation.

Analogy

Imagine you have a piggy bank where you keep your savings. Your parents tell you that you must always keep 20% of your savings in the piggy bank and cannot spend it. This is similar to how banks must keep a certain percentage of their deposits as reserves.

Related terms

Money Multiplier: The money multiplier refers to the amount of money that can be created through the banking system based on changes in the reserve requirement.

Excess Reserves: Excess reserves are any reserves held by banks above and beyond what is required by the reserve requirement.

Fractional Reserve Banking: Fractional reserve banking is a system where banks only hold a fraction of their deposits as reserves and lend out the rest.