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OMO: The abbreviation for open market operations, which is the Federal Reserve System's buying and selling of government securities in an effort to alter bank reserves and subsequently the nation's money supply. These actions, under the direction of the Federal Open Market Committee, are the Fed's number one, most effective, most often used tool of monetary policy. If, for example, the Fed wants to increase the money supply (termed easy money) it buy's government securities. If the Fed chooses to reduce the money supply (called tight money) it sells some government securities.

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BANK RESERVES:

Assets used by banks to back up deposits and to conduct daily transactions, including withdrawing funds, "cashing" checks, and transferring funds between banks to "clear" checks. Reserves, also termed bank reserves or legal reserves, includes two types of assets: vault cash and Federal Reserve deposits. These legal reserves are then divided between require reserves and excess reserves. Required reserves are used to back up deposits and excess reserves are used for loans.
Banks in the modern economy practice fractional-reserve banking. They keep a portion of deposits in reserve, usually less than five percent, to facilitate daily business transactions (cashing checks and the like) then use the rest for loans. The two types of assets that are legally used to back up deposits include vault cash and Federal Reserve deposits. Any legal reserves held by banks over and over government requirements are termed excess reserves, which are then used for loans.

Two Assets

While banks have a number of different assets that could, in principle, be used to as reserves to back bank deposits, two particular assets stand out: vault cash and Federal Reserve deposits.
  • Vault Cash: This is the paper bills and metal coins that is kept in the bank, that is, in the vault. This cash is used, quite literally, to "cash" checks and otherwise to satisfy currency withdrawal demands of depositors. Note that vault cash is not part of the official M1 money supply because it is held by banks (not the nonbank public) and thus it is not in circulation.

  • Federal Reserve Deposits: This is deposits that banks keep with the Federal Reserve System to clear checks and assist in other banking activities. The Federal Reserve System provides banks with a range of banking services, including loans and deposits. Banks are not only required to keep deposits as a means of joining the Federal Reserve System, these deposits are used to process checks through the banking system.

Three Categories

The vault cash and Federal Reserve deposits are often divided into three categories: legal, required, and excess.
  • Legal Reserves: Legal reserves are the TOTAL of vault cash and Federal Reserve deposits. These two assets are the only two assets that satisfy the legal reserve requirements handed down by regulators. And the reason these assets are used to satisfy legal reserve requires is that these are the two assets banks use for daily operations--such as cashing or processing checks or generally satisfying deposit withdrawals. Legal reserves can also be thought of as total reserves.

  • Required Reserves: Required reserves are the amount of reserves--vault cash and Federal Reserve deposits--that regulators require banks to keep for daily transactions. Required reserves are specified as a fraction of outstanding deposits--usually about 1 to 3 percent.

  • Excess Reserves: Any legal (or total) reserves over and above those required by regulators are excess reserves. These excess reserves are used for loans, which makes them exceedingly important to the banking industry. Because reserves, unlike loans, do not generate interest, add to revenue, or enhance profit, banks are prone to hold as few reserves as possible. Banks hold enough reserves to satisfy reserve requirements, because they are required by law. But they try NOT to hold excess reserves. Holding excess reserves means lost interest revenue.

Loans and More

Banks tend to do one of two things with these excess reserves.
  • First, and most important for the study of money and banking, banks use excess reserves for loans. If someone needs a car loan, has good credit, and their local banks has excess reserves, then a little lending business is very likely.

  • Second, banks might decide to direct excess reserves into investment securities, like U.S. Treasury securities or Federal Funds. A bank might do this for the liquidity not found with household or business loans, while earning interest that is not possible with reserves.

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Recommended Citation:

BANK RESERVES, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2020. [Accessed: April 6, 2020].


Check Out These Related Terms...

     | legal reserves | required reserves | excess reserves | fractional-reserve banking | full-reserve banking | no-reserve banking | vault cash | Federal Reserve deposits |


Or For A Little Background...

     | banks | banking | traditional banks | savings and loan associations | credit unions | mutual savings banks | thrift institutions | money | M1 | monetary economics | government functions | financial markets | liquidity |


And For Further Study...

     | money creation | Federal Reserve System | Federal Deposit Insurance Corporation | Comptroller of the Currency | central bank | monetary policy | bank panic | monetary aggregates | barter |


Related Websites (Will Open in New Window)...

     | Federal Reserve System | Federal Deposit Insurance Corporation |


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