Financial institutions must keep legal reserves to meet obligations from deposits and premium payments. The reserve requirement is set by the central bank or government and ensures institutions can pay claims in dire situations. The reserve requirement can also affect a nation’s economy. Insurance companies have complex reserve calculations based on each policy issued.
A legal reserve is an amount of cash that a financial institution, such as a bank, credit union, or insurance company, must keep on hand to meet obligations incurred by accepting deposits and premium payments. Legal reserves required by banks and credit unions are generally set by the nation’s central bank, and those required by insurance companies are set by law or regulation by the national, state or provincial government or regulatory authority. Calculated in various ways, legal reserves are required to ensure that financial institutions are able to pay claims even in a dire situation.
Financial institutions such as banks, credit unions, and insurance companies make their profits from the loans and investments they make with the funds that have been deposited with them. Other financial institutions, such as stockbrokers, make their profits by charging their clients commissions on each transaction, and generally do not have access to their clients’ funds for loans or investments, and therefore are generally not subject to requirements. backup.
Banks, credit unions, and insurance companies, therefore, must balance their obligation to their shareholders to maximize profits by investing and lending their assets, deposits, and premiums they have accepted, and their obligation to its depositors and customers to maintain sufficient liquidity to meet any demand that may arise. In the United States, the Federal Reserve Bank determines the legal reserve requirements for banks; The National Credit Union Association (NCUA) makes the determination of nationally chartered credit unions. In general, the legal reserve requirement for banks and credit unions in the United States is 10% of deposits; that is, if a bank has $100,000,000 United States Dollars (USD) in customer deposits, it can lend up to $90,000,000 USD and must keep $10,000,000 USD in cash in its own vault or on deposit at the Federal Reserve Bank or another member bank.
The reserve requirement not only addresses liquidity problems and improves the perception of stability for a nation’s banking industry, but can also have a moderating effect on a nation’s economy. If the reserve requirement is increased, the amount of money available for borrowing is automatically reduced, effectively slowing down economic activity. Similarly, a reduction in the reserve requirement can potentially increase the amount of money available for borrowing. While reserve requirements remain fairly stable in most countries, some nations, including the United Kingdom, Germany, Turkey, and the United States, lowered their reserve requirements in the second half of the 20th century, in some cases significantly. dramatic.
Legal reserve calculations for insurance companies in the United States, on the other hand, are highly complex and are based on each insurance policy issued by the company. The requirements are set by each state in which a company does business. The most widely used formula to establish the reserve is the Commissioner’s Reserve Valuation Method, a complex formula based on a number of factors including the age and sex of the policyholder, the type of policy in force, and the table of Mortality used to calculate present policy values. Therefore, in meeting its statutory reserve requirements, an insurance company must use values derived from a complex formula applied to each policy issued in a state, and reserve a liquid reserve for the sum of the required reserves for all policies. You must do this for each state in which you operate, and regularly certify to each state that the reserves you hold meet the legal requirement.
Smart Asset.
Protect your devices with Threat Protection by NordVPN
