What Are Reserves In Banking.Most of the liabilities of a banker are demand obligations. In order to meet the demand liabilities on deposits, he must keep with him sufficient amount of cash reserve. This is considered as first line of defence for a bank.
What Are Reserves In Banking.
In banking, reserves refer to funds that a bank holds either in its vaults or on deposit with a central bank. These reserves are maintained to ensure the stability and liquidity of the banking system and to meet the demands of depositors.
There are two types of reserves:
- Required Reserves: These are the minimum amount of funds that banks are legally required to hold by the central bank. The central bank sets the reserve requirement as a percentage of a bank’s deposits. Banks must keep these funds available for withdrawal by their customers or as a deposit with the central bank.
- Excess Reserves: These are reserves held by banks above the required minimum. Banks may hold excess reserves voluntarily to meet unexpected demands for cash withdrawals or as a precautionary measure against potential liquidity issues. Excess reserves also provide a buffer for banks to lend to other banks in the interbank market.
The central bank, such as the Federal Reserve in the United States, acts as the lender of last resort and sets the reserve requirements for banks. By adjusting the reserve requirements, the central bank can influence the lending capacity of commercial banks and control the money supply in the economy.
Reserves play a crucial role in maintaining the stability of the banking system. They ensure that banks can meet their obligations to depositors and provide a foundation for lending and economic activity. Additionally, reserves help central banks manage monetary policy and stabilize the financial system during times of economic stress.
What Are Reserves In Banking.
If the bank does not keep an adequate amount of cash reserve and at any time banker is not able to meet the demand obligations then the good will of the bank will be affected and faith of customers on the bank will be shaken which may lead the bank to bank-ruptcy.
On the other hand if more cash reserve is kept than the requirements then the profits of the bank will be affected so there is need for an adequate amount of cash reserve to be kept by the commercial bank.
FORMS OF CASH RESERVE
Cash reserve of a bank is in following three forms:
- Cash with central bank.
- Cash in hand in form of coins and currency.
- Balances with other banks.
DEFINITIONS:
- “The part of total capital of any trading bank, financial corporation or institution which is essential to deposit with central bank or to keep with it in cash form is called reserve”.
(D.G.Locket)
- It is that part of total assets or capital of a commercial bank or financial institution, which is necessary to keep with central bank or itself in form of cash is called cash reserve.
(Jhon Reed)
- The cash, which is possessed by any trading bank in order to meet the immediate demands of its customers, is termed as cash reserve.
(Comprehensively)
Main Points of Definition
- A part of capital or assets.
- Essential to keep with central bank.
- Possessed by a trading bank or financial institution.
- For meeting the demand of customers.
RATIO OF CASH RESERVE:
Cash reserve ratio means that particular part of total deposits which is essential to keep with the central bank. Central bank is authorized to bring change in the ratio of cash reserve according to the circumstances. The ratio of cash reserve, which a commercial bank keeps or requires for meeting the demand of its customers, is the discretionary power of the bank
FACTORS OF CASH RESERVE
The amount of cash reserve cannot be determined by the rule of thumb but it depends upon the following factors.
- Legal Requirements:
If the law requires that every bank must maintain a certain percentage of its deposits as cash reserve with the central bank of the country then the banks must maintain at-least that ratio as reserve. If reserve ratio is raised then more cash reserve is required, and if it is lowered down then less cash reserve may be required.
- Nature of Accounts:
If people deposit their money in cunent deposits, the bank keeps more money as cash reserve. Whereas; in case of fixed or term deposits bank does not need to keep heavy cash reserve.
- Use of Credit Instruments:
If payments in the locality are mostly made by cheques or drafts or hundies etc., so the amount of cash reserve would be smaller. On the other hand, if transactions are carried mostly on cash basis then a larger reserve will be necessary.
- Development of Investment Habit:
If the people of the place were in the habit of investing their savings in banks then a smaller cash reserve would be required and vice versa.
- Habit of Saving:
If the people in locality are in the habit of saving then the bank will require less cash and if there is less trend of saving then more cash reserve will be required.
- Employment of Funds:
If commercial bank has employed its funds in such a way that at the time of need these can be called back at short notice then less cash reserve may be needed but if funds cannot be easily converted into cash in need then more cash reserve will be required.
- Clearing House System:
If the clearing-house system is well developed in the locality so that the mutual indebt ness of the banks are settled by cross payments, a smaller reserve would usually be kept by the banks.
FORMS OF CASH RESERVE
Cash reserve of a bank is in following three forms:
- Cash with central bank.
- Cash in hand in form of coins and currency.
- Balances with other banks.
DEFINITIONS:
- “The part of total capital of any trading bank, financial corporation or institution which is essential to deposit with central bank or to keep with it in cash form is called reserve”.
(D.G.Locket)
- It is that part of total assets or capital of a commercial bank or financial institution, which is necessary to keep with central bank or itself in form of cash is called cash reserve.
(Jhon Reed)
- The cash, which is possessed by any trading bank in order to meet the immediate demands of its customers, is termed as cash reserve.
(Comprehensively)
Main Points of Definition
- A part of capital or assets.
- Essential to keep with central bank.
- Possessed by a trading bank or financial institution.
- For meeting the demand of customers.
RATIO OF CASH RESERVE:
Cash reserve ratio means that particular part of total deposits which is essential to keep with the central bank. Central bank is authorized to bring change in the ratio of cash reserve according to the circumstances. The ratio of cash reserve, which a commercial bank keeps or requires for meeting the demand of its customers, is the discretionary power of the bank.
FACTORS OF CASH RESERVE
The amount of cash reserve cannot be determined by the rule of thumb but it depends upon the following factors.
- Legal Requirements:
If the law requires that every bank must maintain a certain percentage of its deposits as cash reserve with the central bank of the country then the banks must maintain at-least that ratio as reserve. If reserve ratio is raised then more cash reserve is required, and if it is lowered down then less cash reserve may be required.
- Nature of Accounts:
If people deposit their money in current deposits, the bank keeps more money as cash reserve. Whereas; in case of fixed or term deposits bank does not need to keep heavy cash reserve.
- Use of Credit Instruments:
If payments in the locality are mostly made by cheques or drafts or hundies etc., so the amount of cash reserve would be smaller. On the other hand, if transactions are carried mostly on cash basis then a larger reserve will be necessary.
- Development of Investment Habit:
If the people of the place were in the habit of investing their savings in banks then a smaller cash reserve would be required and vice versa.
- Habit of Saving:
If the people in locality are in the habit of saving then the bank will require less cash and if there is less trend of saving then more cash reserve will be required.
- Employment of Funds:
If commercial bank has employed its funds in such a way that at the time of need these can be called back at short notice then less cash reserve may be needed but if funds cannot be easily converted into cash in need then more cash reserve will be required.
- Clearing House System:
- If the clearing-house system is well developed in the locality so that the mutual indebt ness of the banks are settled by cross payments, a smaller reserve would usually be kept by the banks.Size of Deposits:
If the size of deposits is very large and belongs to a smaller number of people, then the cash reserve should be large enough to meet their heavy withdrawal now and then.
- Rediscounting Facilities:
If there is a central bank in the locality to provide rediscounting facilities to the member banks then the amount of cash reserve required would be smaller because the commercial banks can rediscount the bills with the central bank to get the funds.
- Nature of Depositors:
If the depositors are traders, businessmen, or industrialists then bank has to keep more cash reserve where as if the depositors do not belong to business community then there will be less need of cash reserve.
- Profit Ratio:
If the profit ratio of bank is high then people deposit their savings in abundance so the bank has to keep less amount of cash reserve. On the contrary, if the ratio of profit is lower then more cash reserve will be required.
- Location of Bank:
If a bank is located in industrial or commercial areas then it keeps much more cash reserve. While in case of agricultural and residential areas, bank needs less cash reserve.
- Trust in Bank:
If a bank has good repute in locality then the people do not withdraw their money rapidly, due to which bank does not keep large amount of cash reserve.
- Other Banks’ Reserve:
If the other banks of the locality keep large cash reserve to win public confidence, then the bank should also have a large reserve for inspiring public confidence and winning popularity.
- Discounting Bills:
If the bill market is in developed form and the people are in the habit of discounting bills at the time of need then the bank keeps large amount of cash reserve and vice versa.
- Availability of Capital:
If a bank expects the availability of capital from any other source or it can be managed easily then less cash reserve has to be kept.
- Nature of Securities:
If the securities are marketable then bank keeps less cash reserve and if the securities are not marketable then the bank keeps more cash reserve.
- Political Conditions:
If there is political stability leading to economic stability in the country, thCn banks keep less cash reserve and more cash reserve in case of economic instability.
- Seasonal Requirements:
While determining cash reserve, climate requirement are also kept in view (e.g.) farmers and traders need more cash at the time of cultivation and harvesting the crops.
- Initial and Last Dates of the Month:
Due to the needs of customers or account holders in the beginning and at the end of month, the bank needs more cash.
Reserves in Banking: Ensuring Stability and Security
Introduction
In the intricate world of banking, reserves play a crucial role in ensuring stability and security. These reserves act as a cushion, protecting financial institutions from unexpected shocks and ensuring the smooth functioning of the banking system. In this article, we will delve into the concept of reserves in banking, exploring their importance, types, and the role they play in maintaining the trust of customers and the overall economy.
The Importance of Reserves in Banking
What are Reserves?
Reserves can be defined as funds or assets set aside by banks to meet potential liabilities and obligations. These reserves act as a safety net, providing financial institutions with the confidence to cover unforeseen events and ensure the smooth operation of their daily activities.
Ensuring Stability
One of the primary functions of reserves is to ensure the stability of the banking system. By maintaining an adequate level of reserves, banks can protect themselves from liquidity crises and financial shocks. These reserves provide a buffer that allows banks to meet their obligations, even in times of economic downturns or sudden withdrawal demands from customers.
Mitigating Risks
Reserves serve as a safeguard against potential risks faced by banks. By setting aside a portion of their deposits as reserves, banks can protect themselves against defaults, bad loans, and other financial setbacks. This prudent approach lowers the risk of insolvency and ensures the solvency of banks, fostering confidence among depositors and investors.
Types of Reserves
Required Reserves
Required reserves are the minimum amount of funds that banks are obligated to hold by regulatory authorities. These reserves are set as a percentage of the bank’s deposits and are meant to ensure the stability of the banking system. By mandating a minimum reserve requirement, central banks can control the money supply and prevent excessive lending that may lead to inflation or financial instability.
Excess Reserves
Excess reserves are any reserves held by banks above the required minimum. These reserves are a result of a bank’s decision to hold additional funds in order to manage liquidity risks or as a strategic measure. Excess reserves provide an extra layer of protection, enabling banks to quickly respond to unexpected events or meet increased customer demands.
Capital Reserves
Capital reserves, also known as equity capital or capital adequacy, are funds held by banks to absorb potential losses or adverse situations. These reserves are designed to provide a cushion against unexpected shocks, ensuring that banks can maintain their solvency and continue their operations without relying solely on deposits. Capital reserves are a vital measure used by regulatory bodies to assess the financial strength and stability of banks.
Role of Reserves in Maintaining Trust and Stability
Customer Confidence
Reserves play a pivotal role in maintaining customer confidence in the banking system. When customers know that their deposits are protected by reserves, they are more likely to consider banks as secure, trustworthy institutions. Reserves give customers the peace of mind that their funds are safe and accessible, even during turbulent times.
Economic Stability
The presence of reserves in the banking system fosters economic stability at a broader level. By acting as a shock absorber, reserves cushion the impact of financial crises and help prevent severe disruptions that can harm the overall economy. Reserves ensure that banks can continue to lend and support businesses and individuals, preserving the flow of credit and encouraging economic growth.
Conclusion
Reserves in banking serve as the backbone of stability and security within the financial sector. By acting as a cushion against unexpected events, reserves ensure the smooth functioning of banks and maintain customer trust. The various types of reserves, including required reserves, excess reserves, and capital reserves, contribute to the overall resilience of banks and the stability of the economy. As the banking industry continues to evolve, reserves remain a vital component in safeguarding financial institutions and nurturing a robust and trustworthy banking system.
