Excess reserves

In banking, excess reserves are bank reserves in excess of a reserve requirement set by a central bank. In banking, excess reserves are bank reserves in excess of a reserve requirement set by a central bank. In the United States, bank reserves for a commercial bank are held in part as a credit balance in an account for the commercial bank at the applicable Federal Reserve bank (FRB). This credit balance is not separated into separate 'minimum reserves' and 'excess reserves' accounts. The total amount of FRB credits held in all FRB accounts for all commercial banks, together with all currency and vault cash, form the M0 monetary base. Holding excess reserves has an opportunity cost if higher risk-adjusted interest can be earned by putting the funds elsewhere. For banks in the U.S. Federal Reserve System, this earning process is accomplished by a given bank in the very short term by making short-term (usually overnight) loans on the federal funds market to another bank that may be short of its reserve requirements. Over longer periods, banks have the opportunity to choose how much to hold in excess reserves versus in loans to the non-bank public. Therefore, the amount of its assets that a bank chooses to hold as excess reserves is a decreasing function of the amount by which the market rate for loans to the non-bank public from banks exceeds the interest rate on excess reserves and of the amount by which the federal funds rate exceeds the interest rate on excess reserves. Even with a substantial opportunity cost, banks may choose to hold some excess reserves to facilitate upcoming transactions or to meet contractual clearing balance requirements.