Bank reserves is the amount of cash which a bank has not yet advanced as loans or invested elsewhere. It equals the cash physically available with the bank plus the amount it has deposited with the central bank.
The amount of bank reserves relative to total deposits is a measure used to assess a bank's risk. The higher the bank reserves are, the less risk-taking a bank is and vice versa. Central banks (such as the Federal Reserve or the Fed in the US) requires banks to maintain a certain percentage of their total bank deposits as required reserves. The amount by which bank reserves exceeds required reserves is called excess reserves.
|Bank Reserves = Bank's Deposit at Central Bank + Vault Cash|
|Bank Reserves = Required Reserves + Excess Reserves|
Sevilla Bank is a commercial bank operating in Andalusia. The bank has received total deposits of 80 billion Euros out of which it has advanced loans of 60 billion Euros. It has a physical cash balance of 2 billion Euros plus it has deposited 18 billion Euros in its account at the central bank. The central bank has promulgated a required reserve ratio of 15%.
Sevilla Bank's total reserves equals its vault cash (which is 2 billion Euros) plus its deposit at the central bank (which is 18 billion Euros). These add up to 20 million Euros.
We can also find the total bank reserves by subtracting the loans advanced of 60 billion Euros from total deposits of 80 billion Euros. It equals 20 billion Euros.
With a required reserve ratio of 15%, required reserves are 12 billion Euros (15% of 80 billion Euros). This gives us excess reserves of 8 billion Euros (total bank reserves of 20 billion Euros minus required reserves of 12 billion Euros).
Written by Obaidullah Jan