The Federal Reserve announced they were reducing the reserve requirement ratio to zero percent across all deposit tiers as of March 26, 2020. This comes as the COVID-19 pandemic continues to impact much of the way financial institutions both operate and serve their customers.
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What Is the Reserve Requirement?
The Federal Reserve’s Regulation D has been around for years and requires depository institutions to keep enough cash reserves available to meet the immediate withdrawal requests of their net transaction accounts. The term used to describe these cash reserves is the reserve requirement.
Historically, the reserve requirement has been calculated by applying a predetermined tiered percentage (called the reserve requirement ratio) to the institution’s net transaction account balance. One way the calculated total can be satisfied is by having enough vault cash on hand. If the vault cash balance is insufficient, the institution is required to hold the additional funds in an interest-bearing account at a Reserve Bank. Historically, the reserve requirement ratios ranged from zero to 10 percent, based on the dollar amount of net transaction accounts held on deposit at the institution.
Why the Reserve Requirement is Important?
The Federal Reserve’s Reserve Requirement is essential for the stability of our economy as well as the financial security of individuals, families, businesses and financial institutions. Requiring banks to have a reserve requirement serves to protect them and their customers from a bank run. When the Fed adjusts the reserve requirement, it allows banks to charge lower interest rates, which in turn creates more appealing lending opportunities for those who need to borrow money—people who are financially impacted by the pandemic, business owners, homebuyers, college students, etc.
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What Does This Change Mean?
Depository institutions that were required to maintain deposits in a Reserve Bank account to satisfy reserve requirements will no longer be required to do so and can use the additional liquidity to lend to individuals and businesses.
According to the Federal Reserve website, there are currently no plans to reinstate the reserve requirement. However, they leave open the possibility of adjusting reserve requirement ratios if conditions warrant.
Some of the compliance and operational results of the change to reserve requirements include:
“Given the condition of the economy, in the early stages of the crisis it seemed plausible that, with a rapid, forceful, and sustained policy response, many sectors of the economy would be able to bounce back strongly once the virus was under control. That response would need to come from actions across all levels of government, from health and fiscal authorities, and from the Federal Reserve.”
- Chair Jerome H. Powell | Speech at the National Association for Business Economics Virtual Annual Meeting, October 06, 2020
The Importance of Compliance During COVID-19
While COVID-19 is impacting the way financial institutions operate, it is still important to maintain compliance. As guidance is issued and requirements are changed such as the reserve requirement, it’s important to understand what this means, not only for your financial institution, but for your customers. Take a look at the Federal Reserve Maintenance Manual.