What are reserves and excess reserves?

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

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Reserves are money that a bank keeps in its vaults, so to speak, while excess reserves are one part of that money.

When a bank takes in money in the form of deposits, it keeps some of that money while lending the rest of the money out.  The money that it keeps and does not lend is called reserves.

The federal government requires the banks to keep a certain percentage of its deposits as reserves.  They are required to do so to make it less likely that they will fail.  This percentage is known as the required reserve ratio.

Banks sometimes keep more reserves than are required by the government.  When they do so, those reserves are called excess reserves.  Thus, reserves are the money kept in the bank and excess reserves are the reserves that the bank keeps over and above what it is required to keep by law.