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In Fractional reserve banking, which is the common practice these days in most (?) states in the world, a bank is required to limit its loans to a certain multiple of its reserves.

I know that central banks typically set the multiple (i.e. the required reserve fraction). But - who decides on what constitutes reserve? And how reserve is counted? Supposedly, in the olden days of the Amsterdam goldsmiths, the notes were, say, for X amount of gold (or some other precious material) so the reserves were gold, and it all went by weight. But now we have physical currency, and balances with the central bank, and maybe precious materials, and maybe a whole bunch of other assets which a bank may hold. Who decides how they're counted/combined in the evaluation of the reserve?

This question is mostly about the larger economies, but actually I'm more interested in examples of how this gets decided (or if there's some universally-accepted rule, then in that).

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In the United States, the Federal Reserve (central bank) publishes the reserve requirements.

Reserve requirements must be satisfied by holding vault cash and, if vault cash is insufficient, also by a deposit maintained with a Federal Reserve Bank. An institution may hold that deposit directly with a Reserve Bank or with another institution in a pass-through relationship.

So the bank must hold physical currency, deposits with the Federal Reserve, or deposits with another bank that total 10% of the total cash deposited with it (for banks with $115.1 million or more in deposits, as of 2017). Note that if one bank has reserves held by another bank, the bank holding the reserves has to hold its 10% plus whatever it is holding for the other bank.

The $115.1 million number is set by statute and is adjusted annually. The types of valid reserves would also be set by statute, possibly subject to regulatory interpretation.

When you hear about the Fed setting interest rates, the most important is the federal funds rate target. This is the target for the average rate at which banks lend reserves to each other. So if Bank A loans bank B enough to increase B's reserves from 9.9% of deposits to 10%, then it reports the amount and the interest to the Fed. The weighted (by amount) average of all those rates is the federal funds rate. If it is below target, then the Fed sells bonds to soak up cash. If it is above, the Fed buys bonds to add cash to the system. When buying, the Fed is effectively printing money, although it only deals in accounting itself (it transfers money between accounts rather than shipping actual cash).

  • But who adopted the paragraph you quoted? Is it the US Federal Reserve itself or some branch of the federal government? Or is it legislated? – einpoklum May 30 '17 at 7:25
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    @einpoklum The decision was made by the Federal Reserve itself pursuant to authority granted to it by Congress pursuant to the law creating the Federal Reserve. The Federal Reserve could change that requirement if it wished to do so. Congress could also, via a duly enacted law, set the requirement itself or change how that decision is made. – ohwilleke May 31 '17 at 1:43

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