Reserve Ratio

The reserve ratio is like a rule that tells banks how much money they need to keep on hand compared to what they’ve got in deposits. It’s a percentage that shows the portion of deposits banks have to hold as cash and not lend out. Yes, when you put your money in a bank, they're out spreading it around to other people. Unfortunately.

For example, if the reserve ratio is set at 10%, and you deposit $1,000 into your account, the bank has to keep $100 of that in reserve and can only lend out $900. This ensures that banks have enough cash to handle withdrawals and avoid running into trouble if a lot of people want to take out their money at once (i.e bank runs).

The reserve ratio helps keep the banking system stable by making sure banks don’t lend out all the money they receive. If the ratio is higher, banks keep more money in reserve and have less to lend, which can slow down the economy. If it’s lower, they can lend out more, which might boost economic activity but also carries more risk. So, the reserve ratio is a key tool for managing how much banks can safely lend and how much they need to keep available.