Zero Reserve Requirements, Real Reserve Needs: Why Banks Still Rely on Reserves

The Paradox Worth Explaining

In March 2020 the Federal Reserve set reserve requirements to zero. No bank in the United States is legally required to hold any reserves against deposits. And yet reserves remain one of the most closely watched numbers in the financial system, and the Fed still manages their supply with real care. If no rule demands them, why do they still matter?

The answer is that reserves were never really about a regulatory minimum. They are about settlement. A bank needs reserves not because a rule says so, but because reserves are the only asset it can use to pay another bank. Understanding that distinction clears up most of the confusion around bank reserves.

Two Different Ledgers, Two Different Kinds of Money

A bank deposit is an IOU. When a customer has $10,000 in a checking account, the bank owes that customer $10,000, payable on demand. It is an entry on the bank's ledger, part of what economists call broad money, and it is what people mean when they talk about "the money in my account."

A bank reserve is a different kind of instrument entirely. It is a balance held at the Federal Reserve, available only to banks and a small number of other institutions with Fed accounts. Reserves do not circulate among the public. A household cannot hold reserves, spend reserves, or ask for reserves instead of cash. Reserves live in a separate, closed ledger that only the Fed and its account holders can touch.

This is why reserves are never "lent out" to the public in the way many people imagine. When a bank makes a loan, it does not hand over reserves to the borrower. It simply credits the borrower's deposit account, creating a new liability on its own books matched by a new loan asset. The loan creates the deposit. Reserves only move when the bank needs to settle with another institution, for example when the borrower spends that new deposit and it needs to be paid out to a different bank.

Ample Versus Scarce: A Question About Settlement, Not Lending Capacity

Because reserves exist to settle payments between banks, the relevant question is never "do banks have enough reserves to lend" but "do banks have enough reserves to move money to each other smoothly, at any hour, without strain."

When reserves are scarce, meaning the total supply sitting at the Fed is low relative to the system's day-to-day settlement needs, banks that come up short on a given day have to scramble to borrow reserves from banks that have a surplus. That borrowing happens in the repo market and the fed funds market, and when reserves are genuinely tight, the rate on that borrowing can spike unpredictably. That is roughly what happened in September 2019, when a shortage of reserves collided with heavy Treasury settlements and pushed overnight repo rates far above the Fed's target range.

When reserves are ample, there is enough of a buffer sitting across the banking system that no single bank needs to bid aggressively for funds on a given day. Rates stay anchored near the level the Fed wants, currently steered primarily through interest on reserve balances (IORB), the rate the Fed pays banks on reserves parked at the Fed. Ample reserves are not about giving banks more fuel to lend. They are about making sure the payment system never seizes up over a temporary mismatch in who owes whom on a given afternoon.

The Valves That Move Reserves Around: TGA and ON RRP

The total quantity of reserves in the system is not fixed. It shifts constantly because of two accounts that sit alongside reserves on the Fed's balance sheet.

The Treasury General Account (TGA) is the federal government's checking account at the Fed. When the Treasury collects tax payments or issues new debt, cash flows out of private bank accounts and into the TGA, and reserves drain from the banking system because that cash effectively leaves commercial banks' Fed balances behind. When the Treasury spends that money, whether on payroll, contracts, or benefits, reserves flow back out of the TGA and into the banking system. A rebuilding TGA drains reserves; a falling TGA adds them back.

The overnight reverse repo facility (ON RRP) works differently. It lets money market funds and other eligible non-bank institutions park cash overnight at the Fed in exchange for Treasury securities, effectively lending to the Fed. Money sitting in the ON RRP is money that has left the reserve pool, because it belongs to institutions that do not hold reserve accounts. When ON RRP balances rise, reserves in the banking system fall by roughly the same amount. When balances there decline, that cash can flow back toward bank deposits and reserves.

Together, the TGA and the ON RRP act like valves on either side of the reserve pool. During quantitative tightening (QT), the period when the Fed lets its bond holdings shrink instead of reinvesting the proceeds, reserves fall through the main drain of a smaller Fed balance sheet, while shifts in the TGA and ON RRP determine the day-to-day and month-to-month bumps along that declining path.

How a Payment Actually Clears

Suppose a customer at Bank A wires $1 million to a supplier who banks at Bank B. Bank A's ledger shows the customer's deposit falling by $1 million. Bank B's ledger shows the supplier's deposit rising by $1 million. But that is only the deposit side. For the transaction to be real, Bank A must actually transfer value to Bank B, and the only asset both banks trust for that purpose is a balance at the Federal Reserve. Through the Fedwire system, $1 million in reserves moves from Bank A's account at the Fed to Bank B's account at the Fed, instantly and finally. No court, no counterparty risk, no dispute. The deposit changed on two separate private ledgers; the reserves settled the difference on the one ledger both banks share.

What to Take Away

Reserve requirements can be set to zero and reserves still remain essential, because their job was never to control lending. Their job is to let banks settle obligations to each other with an asset that carries the Fed's own credit behind it. Deposits are what the public holds and spends; reserves are what banks use behind the scenes to make those spends final. Whether reserves feel ample or scarce depends on how much of that settlement buffer exists relative to the system's needs, and that level moves constantly as the TGA and the ON RRP absorb and release cash. None of this is a forecast about interest rates or markets. It is simply how the payment system underneath the economy keeps working, day after day, without most people ever noticing.