Excess Reserves

Reserves held by banks above the reserve requirement set by financial regulators.

Excess reserves can help the bank deal with sudden cash withdrawals and liqudity crises. However, in times of prosperity, banks usually hold little or none excess reserves and attempt to loan out as much money as possible, even using vehicles such as Special Purpose Entities to hold loans off the balance sheet. Since in times of prosperity defaults on loans and losses are low, it makes sense for the bank to lend out as much as possible to generate a higher return for shareholders.

Banks usually hold excess reserves when times are uncertain and banks are afraid to loan out money. An extreme example would the Great Depression, when the reserve requirement ratio was around 10% and banks held 20% of their assets in reserves.

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