Federal Reserve Ratio
What federal reserve ratio? Why important?
The Federal Reserve ratio refers to the funds banking or depository institutions are mandated by law to hold against their deposit liabilities. This fund is a proportion of the amounts of money banking or depository institutions hold in form of net transactions accounts and deposits that make up the institution's liability to its customers. This proportion is a predetermined ratio arrived at through policy reforms targeting to safe guard the interests of its citizenry and controls the volume of money supply in an economy (Rose & Sylvia, 2010).
The sets to enforce a legal safe guard measure to serve the interests of economy's depositors with the banking industry (Rose & Sylvia, 2010). In this perspective, if a federal reserve is set as 11% of the banks liability, the banks are expected to deposit with the central bank/reserve bank an amount equal to the proportion. If for example a bank's customer deposit is 1 billion U.S. dollars it is expected to have a deposit with the reserve bank of $110 million.
Importance of Federal Reserve Ratio
Since the commercial bank core interest is to earn interest from the deposits made with by customers, the Federal Reserve ratio ensure that banking institutions do not lend out the entire deposited fund for the sake of earning interest. This safe guards the interest of banking customers by ensuring that their funds are not lost through losses accruing from bad investment decisions. This importance of the Federal Reserve ratio serves the interest of improving the consumer confidence through safe guarding their interest and controlling the banking institutions activities in handling customer deposits (Rose & Sylvia, 2010).
Federal Reserve deposits ensure that banking institutions are under check in their leading activity. The ratio is a regulatory measure that facilitates in wiping out excessive money supply in the economy. In the event there is excessive money supply in the economy the federal bank has the authority to increase its requirement for reserve ratio in accordance to its mandate as a control authority. By increasing its Federal Reserve requirement ratio, the federal banks increases the cost of money borrowed from banks through the market force (demand and supply). The customers to these banks will also be attracted to the higher saving earnings from deposits as opposed to the steeper cost of borrowing funds from banks. The Federal Reserve ratio facilitates in moping out excessive money supply and a stabilizer tool to the money market (Rose & Sylvia, 2010).
You’re 71% through this paper. Sign up to read the full paper.
Sign Up Now — Instant Access Already a member? Log inAlways verify citation format against your institution’s current style guide requirements.