Reserve Ratio/Requirement
Definition
The reserve ratio, also known as the reserve requirement, refers to the percentage of deposits that banks are required to hold in reserves. It is set by the central bank and helps regulate the amount of money banks can lend out.
Analogy
Imagine you have a piggy bank where you keep your savings. Your parents tell you that you must always keep 20% of your savings in your piggy bank and can only spend the remaining 80%. This is similar to how banks have to keep a certain percentage of their deposits as reserves.
Related terms
Fractional Reserve Banking: This term refers to the banking system where banks are only required to hold a fraction of their deposits as reserves.
Excess Reserves: These are reserves held by banks above and beyond what is required by the reserve ratio.
Money Multiplier: The money multiplier represents how much new money can be created through the lending process based on changes in reserves.
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