Reserve requirements oblige banks to hold a certain minimum level of sight deposits on their account with the central bank and may apply to single day-ends, or to an average over e.g. a one-month period.
Current accounts, reserves, and central bank liquidity are used as synonyms for banks’ sight deposits with central banks in monetary policy implementation jargon.
The fulfillment of reserve requirements is measured only on the basis of end-of-day snapshots (i.e. intra-day levels of reserves are not relevant). The requirement may apply to single day-ends, or to an average over e.g. a one-month period.
The size of the reserve requirement of a specific bank is normally set as a function of specific items of its balance sheet which need to be reported on a monthly basis. For example, in the case of the European Central Bank, the requirement for each bank amounts to 1% of its liabilities to non-banks with a maturity below two years.
Within the set of indirect instruments, reserve requirements play an important role. In industrial countries, reserve requirements are mainly being used to facilitate interbank settlement and automatically smooth daily variations in short-term interest rates, but are not actively managed by the monetary authorities.
In developing countries and economies in transition, however, reserve requirements are still an important monetary instrument. Daniel C. Hardy Opens in new window examines the role and design of reserve requirements.
He notes that these requirements may help stabilize the demand for base money and thus facilitate the use of other instruments in the implementation of monetary policy. In the absence of more flexible instruments, reserve requirements may themselves be varied as a means of implementing monetary policy.