Introduction to Finance

required reserves ratio
. 
When bank reserves diff er from required reserves, a depository institution has either excess 
reserves or defi cit reserves. 
Excess reserves
 
occur when the amount of a depository institu-
tion’s bank reserves exceed required reserves. If required reserves are larger than the bank 
reserves of an institution, the diff erence is called 
defi cit reserves
. The banking system will 
have excess reserves if the cumulative amount of bank reserves for all depository institutions 
exceeds the total required reserves amount.
Two kinds of factors aff ect total reserves: those that aff ect the currency holdings of the 
banking system and those that aff ect deposits at the Fed. Currency fl ows in response to changes 
in the demand for it by households and businesses. Reserve balances are aff ected by a variety 
of transactions involving the Fed and banks, and that may be initiated by the banking system or 
the Fed, the Treasury, or other factors. Although the Fed does not control all of the factors that 
aff ect the level of bank reserves, it does have the ability to off set increases and decreases. Thus, 
it has broad control over the total reserves available to the banking system. 
Figure 5.2
provides 
a summary of the transactions that aff ect bank reserves. Discussion of these transactions follows.
Changes in the Demand for Currency
Currency fl ows into and out of the banking system aff ect the level of reserves of the banks 
receiving the currency for deposit. Let’s assume that an individual or business fi nds they have 
bank reserves 
a depository 
institution’s vault cash and funds 
held at its regional Federal Reserve 
Bank
required reserves 
minimum 
amount of reserves that a 
depository institution must hold 
against its deposit liabilities