The reserve requirementThe reserve requirement (also known as the cash reserve ra... More (also known as the cash reserve ratio) is the minimum amount of that must hold in reserve, usually given as a percentage of customer deposits. The cash is normally stored in a vault at the bank or with a and cannot be invested or loaned out to businesses or individuals.
The requirement is set by each country’s central bankWhat is a central bank? A central bank is an institution r... More and raising or lowering the reserve requirement will subsequently influence the moneyMoney is a generally accepted medium of exchange to buy and... More supply in the economy.
How does adjusting the cash reserve ratio affect money supply?
If the reserve requirement is raised, banks will have less money to loan out and this effectively reduces the amount of capital in the economy, therefore lowering the money supply. It will mean less money for and spending, and would stunt the growth of the economy. It would also mean that banks earn less interestWhat is interest? In finance and trading, interest is a fe... More and could see their share prices fall.
Lowering the reserve requirement will have the opposite effect; banks will be able to lend more which would increase money supply and stimulate economic growth.
How can adjusting the reserve requirement affect currency value?
Raising reserve requirements can cause an increase in value because when banks are restricted in the amount that they can lend out, they may charge borrowers a higher rate of interest. This is bad news for borrowers, but good news for savers who can benefit from a higher rate of return on their savings. If more capital enters the economy to benefit from those higher interest rates, the value of the currencyWhat is currency? Currencies are the generally accepted medi... More is likely to increase.
The opposite is true if reserve requirements are lowered. Banks will be able to lend more and so may offer lower interest rates, which can in turn cause the value of a currency to decrease.
To learn more about the impact of government and central bank policies, read our lesson:
