What is the reserve requirement in banking?

The reserve requirement in banking refers to the percentage of deposits that banks are required to hold as cash on hand. This regulation is set by the central bank and ensures that banks maintain a minimum amount of liquid cash available to meet withdrawal demands from depositors. Maintaining reserves helps to promote stability in the banking system by preventing banks from overextending their lending capabilities, which could lead to liquidity crises.

When a bank receives deposits, it can only lend out a portion of that money, while the remaining must be kept in reserve. This ensures that the bank has enough funds available to meet the needs of its customers while also generating income through lending activities. Understanding the reserve requirement is crucial for comprehending how monetary policy influences lending practices and the overall economy.