Bank reserves are the total amount of a bank’s holdings on deposit at a central bank, plus any currency in its vaults. They are important for the stability of banking institutions and can be classified into primary, loan loss, and secondary reserves.
Bank reserves are the total amount of a bank’s holdings currently on deposit at a central bank, plus any currency the bank currently has in its vaults. All banks maintain some form of reserves, even in countries where there is no minimum reserve requirement set by the national government. While these types of resources are generally called reserves in most nations, there are some exceptions. It should be noted that bank reserves are generally referred to as Bank of England remnants.
The presence of bank reserves is important for the stability of the banking institution. In countries where a central agency or bank sets minimum reserve requirements, the idea is to create a balance between the resources that the bank can draw on and the lending that the bank can safely carry out without creating undue risk for depositors. Even in countries where a minimum reserve is not required, banks often view holding some reserves as a sound fiscal strategy. In situations where there is no reserve requirement, the funds held in the check by the bank are called desired reserves.
There are other benefits to bank reserves in countries where a minimum amount of reserves is required to continue operating. In the United States, funds held by a bank in a Federal Reserve Bank account are known as legal reserves. These deposit holdings allow the bank to always maintain sufficient reserves to comply with current regulations, and also prevent the possibility of overextending loans and placing the bank in a precarious financial position.
Within the US banking system, there are also other categories of bank reserves that are used to classify different types of financial instruments. Primary reserves include the balance of checking accounts on deposit at a Federal Reserve Bank, plus any checks currently being processed. Money kept in the bank’s vault, both currency and currency, is also considered primary bank reserves.
Loan loss reserves are funds set aside to offset losses on loans that are past due or declared bad debts. Reserves can be used once loan payments have not been received for at least ninety days, or any time the bank deems the loan is no longer an income-producing asset. Secondary bank reserves are short-term securities that can be easily converted to cash if necessary, US Treasury bills being a good example. Reserves of this type are essentially back-up reserves to primary reserves and make it possible for the bank to remain fiscally sound, even in the face of highly unlikely situations that threaten to drain all of the bank’s assets.
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