Mindestreserve

What Is Mindestreserve?

The Mindestreserve, or minimum reserve, is the fraction of customer deposit liabilities that a commercial bank is legally required to hold as reserves, rather than lending out. It is a key instrument of monetary policy used by a central bank to influence the availability of credit and the overall money supply within an economy. By adjusting the Mindestreserve requirement, central banks can affect the amount of funds banks have available for lending, thereby impacting economic activity and interest rates.

History and Origin

The practice of requiring banks to hold reserves dates back to the 19th century, with initial aims often centered on ensuring bank liquidity and safeguarding against bank runs. In the United States, national reserve requirements were first established with the passage of the National Bank Act in 1863. This act mandated that banks operating under a federal charter hold 25% reserves against both their notes and deposits.¹⁴, ¹⁵ Prior to the establishment of the Federal Reserve System, these requirements were intended to provide a measure of stability in the nascent financial system.¹³

Over time, the rationale for reserve requirements shifted from primarily ensuring individual bank liquidity to serving as a tool for broader monetary control. The Federal Reserve, upon its creation in 1913, inherited the authority to set reserve requirements, which became one of its instruments to manage credit conditions.¹² For decades, the Federal Reserve adjusted these ratios, using them alongside open market operations and the discount rate to implement monetary policy. However, the significance of the Mindestreserve as an active policy tool waned, especially after the global financial crisis of 2008 and the expansion of central bank balance sheets through measures like quantitative easing.

In a significant move, the Federal Reserve reduced its reserve requirement ratios to zero percent, effective March 26, 2020, effectively eliminating them for all depository institutions.¹⁰, ¹¹ This action was taken in response to the COVID-19 pandemic to bolster the economy by encouraging banks to lend more. In contrast, the Eurosystem, overseen by the European Central Bank (ECB), continues to maintain minimum reserve requirements, though the uniform reserve ratio has been relatively low, standing at 1% since January 2012.⁸, ⁹

Key Takeaways

• The Mindestreserve refers to the mandatory percentage of customer deposits that commercial banks must hold in reserve, either as vault cash or deposits with the central bank.
• Historically, it served as a prudential measure for bank liquidity and later evolved into a tool for monetary policy to control the money supply.
• Many central banks, including the U.S. Federal Reserve, have reduced their minimum reserve requirements to zero, diminishing their direct role in monetary policy.
• In regions like the Eurozone, a positive Mindestreserve ratio is still in place and plays a role in the central bank's operational framework.
• Changes in the Mindestreserve directly impact the funds available for banks to lend, influencing credit conditions and interest rates.

Formula and Calculation

The Mindestreserve for a bank is calculated by multiplying its total reservable deposit liabilities by the prescribed reserve ratio.

Where:

• Mindestreserve: The minimum amount of funds a bank must hold in reserve.
• Deposit Liabilities: The total amount of funds deposited by customers in various accounts (e.g., checking accounts, savings accounts).
• Reserve Ratio: The percentage set by the central bank that dictates the portion of deposit liabilities that must be held as reserves.

Interpreting the Mindestreserve

The Mindestreserve primarily acts as a lever for central banks to manage the overall liquidity in the banking system. When a central bank raises the Mindestreserve ratio, banks are required to hold more funds, reducing the amount they can lend out. This tightens credit conditions, potentially leading to higher interest rates and a contraction in the money supply. Conversely, lowering the Mindestreserve frees up funds, increasing bank liquidity and potentially encouraging credit expansion, which can stimulate economic growth.

In modern monetary policy frameworks, particularly in economies with abundant reserves, the Mindestreserve's role as a direct liquidity management tool has diminished. However, it still influences banks' funding strategies and their behavior in interbank markets.

Hypothetical Example

Consider a hypothetical commercial bank, "DiversiBank," operating in a country where the central bank has set a Mindestreserve ratio of 5%. If DiversiBank has total customer deposit liabilities of €500 million, its Mindestreserve requirement would be:

This means DiversiBank must hold €25 million in reserve, either as cash in its vault or as a balance with the central bank. The remaining €475 million (€500 million - €25 million) is available for lending, investments, or other operations, impacting the bank's balance sheet. If the central bank were to lower the Mindestreserve to 3%, DiversiBank's required reserves would drop to €15 million, freeing up an additional €10 million for lending.

Practical Applications

Historically, the Mindestreserve was a primary tool for monetary policy, influencing the amount of funds available for lending within the financial system. Central banks would adjust the reserve ratio to expand or contract the money supply. For instance, raising the requirement would reduce the funds banks had to lend, thereby tightening credit.

While its direct use as a frequently adjusted policy lever has decreased in some major economies, it still holds relevance. In the Eurosystem, minimum reserves continue to be a component of the operational framework, helping to stabilize money market rates and create demand for central bank money. Other central ban⁶, ⁷ks, particularly in emerging markets, still actively use reserve requirements for prudential purposes, such as imposing liquidity buffers on financial institutions to enhance systemic resilience. The International⁵ Monetary Fund (IMF) notes that many central banks globally still employ some form of reserve requirements, confirming their appeal as a broadly used instrument to influence the demand for bank reserves and support financial stability.

Limitations a⁴nd Criticisms

While the Mindestreserve has served as a monetary policy tool, it has faced criticisms and exhibits limitations. One major drawback is that abrupt changes to the Mindestreserve can cause significant liquidity problems for banks, especially those already operating with low excess reserves. This can lead to market disruptions and unintended consequences.

Furthermore, in a globalized financial landscape, stringent reserve requirements in one country can sometimes lead to disintermediation, where banking activities shift to less regulated entities or jurisdictions. Some critics argue that reserve requirements are a blunt instrument compared to more flexible tools like open market operations or adjustments to the federal funds rate target. The notion that reserve requirements effectively ensure bank liquidity has also been questioned, particularly since the advent of central banks acting as the lender of last resort. The Federal Reser², ³ve's decision to set the reserve requirement ratio to zero in March 2020 highlighted this diminishing utility in a financial system where reserves are already abundant.

Mindestreserv¹e vs. Excess Reserves

The distinction between Mindestreserve (minimum reserve) and excess reserves lies in their nature and purpose. Mindestreserve refers to the mandated amount of funds that a commercial bank is legally required to hold, as set by the central bank. This portion of a bank's total reserves cannot be lent out and serves a regulatory function, even if its role in monetary policy has evolved.

In contrast, excess reserves are any funds that a bank holds beyond the Mindestreserve requirement. These are voluntary holdings that banks may keep for various reasons, such as managing daily liquidity needs, preparing for unexpected withdrawals, or simply because they have more reserves than required and find it prudent or profitable to hold them at the central bank, particularly if interest is paid on those balances. While minimum reserves are a floor, excess reserves represent the additional cushions a bank chooses to maintain.

FAQs

Q: What is the primary purpose of the Mindestreserve?
A: Historically, the primary purpose was to ensure bank liquidity and prevent bank runs. Over time, it evolved into a tool for the central bank to influence the money supply and credit conditions in the economy.

Q: Do all central banks still use a Mindestreserve?
A: No. While many central banks, like the European Central Bank, still maintain a positive reserve ratio, others, such as the U.S. Federal Reserve, have reduced their minimum reserve requirements to zero. The use and importance of the Mindestreserve vary globally.

Q: How does the Mindestreserve affect the economy?
A: By changing the Mindestreserve, a central bank can influence the amount of money banks have available to lend. A higher requirement can reduce lending and slow economic growth, while a lower requirement can encourage lending and stimulate the economy.