EXCESS RESERVES Meaning and
Definition
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Excess reserves refer to the surplus funds that a commercial bank holds above and beyond the required reserve ratio set by the central bank. In other words, it represents the additional cash reserves that a bank retains voluntarily to meet unexpected withdrawals or to ensure financial stability.
When depositors make cash deposits into a bank, a portion of these funds must be held as reserves to fulfill the reserve requirement imposed by the central bank. The reserve requirement is a predetermined percentage of a bank's total deposits that must be kept in reserve either as vault cash or deposited with the central bank. If a bank holds more reserves than the required amount, the surplus is considered as excess reserves.
Commercial banks hold excess reserves as a precautionary measure against unforeseen financial events, such as significant deposit outflows or unexpected loan defaults. These reserves act as a cushion, allowing banks to quickly meet customer withdrawals without resorting to borrowing from other financial institutions or the central bank.
Excess reserves also contribute to maintaining stability within the banking sector as they provide a sense of security and confidence in the banking system. By holding surplus reserves, banks are better positioned to mitigate financial shocks, avoid liquidity shortages, and maintain the smooth functioning of interbank lending.
The central bank regulates excess reserves as it can influence the money supply and the economy. In times of economic distress or recession, the central bank may lower the required reserve ratio to encourage banks to release excess reserves into the financial system, promoting lending and stimulating economic activities. Conversely, during periods of inflation or excessive lending, the central bank may increase the reserve requirement to reduce the amount of lending and bring inflation under control.
Etymology of EXCESS RESERVES
The etymology of the term "excess reserves" can be broken down as follows:
1. Excess: The word "excess" derives from the Latin word "excessus", which means "a going beyond". It eventually made its way into Middle English and Old French with the same meaning, and today it refers to something that surpasses what is deemed necessary or expected.
2. Reserves: The word "reserves" has its roots in Latin as well, coming from the verb "reservare", meaning "to keep back" or "to save". It entered Middle English via Old French, and in the context of banking, it typically refers to funds or assets that are set aside or saved for future use or emergencies.
So, when combined, "excess reserves" refers to the surplus funds or financial resources that banks hold above the required reserve ratio mandated by central banks.
