Reserve Ratio

See: Reserve Requirements.

One of the ways banks make money is by lending it out. Wait, lending out what money? Deposits. That’s right. The money is being lent back to you with that loan you took out from the same bank. But hey, they’re paying you a tiny bit of interest as a way of saying “thanks.”

Since banks make the big bucks by lending out deposits, in their ideal world, they’d lend out most (all) of it. That way, all those deposits are working to make money for them. Yet they can’t lend out all of it...you wouldn’t be able to pay your bills and go to the ATM if they lent out all their moolah. And if there was a bank run, where everyone’s trying to take out their deposits at the same time, then they’d be really screwed (well, the people and the bank).

That’s why the federal government created the central bank (“the Fed” in the U.S.) The Fed made a rule: banks have to keep a certain percentage of deposits on hand at their banks, in liquid (cash) form. This is the reserve ratio...the ratio of “reserves” they gotta keep on hand to be legal.

For instance, a 10% reserve ratio would mean the bank is allowed to lend out 90% of their deposits. Your $2,000 check you just deposited? $1,800 is lent out, and they keep $200 on hand.

The Fed wants to make sure you don’t have too many reservations about banks. It’s best for them if you keep the money in the bank rather than under your mattress. And probably in your best interest too, given that inflation erodes your money away. Hopefully your bank account’s interest rate is close-ish to inflation.