# How to calculate Excess reserves, Required reserves and required reserve ratio

When analysing problems of such nature, it is good to distinguish between the two types of banks:

Central bank - The Central bank control the money supply within the economy.

Commercial banks - They provide facilities for customers to lend and save money.

First, we will outline some definitions and then go over some examples to solidify the concepts.

Required reserves - The amount of cash deposits that the bank must keep on the premises.

Required reserve ratio - This is the ratio of required reserves to total deposits and is defined

$\text{Required reserve ratio} = \frac{\text{Required reserves}}{\text{Total Deposits}}$

The required reserve ratio is typically set by the central bank of a country and is put in place so that banks will have enough money if people wish to withdraw their deposits.

Excess reserves - Excess reserves are reserves held in addition to required reserves.

Example 1 - Calculate the required reserves

Suppose that the central bank has stipulated that the required reserve ratio is 10% and a commercial bank has $1,000 deposited in it by its customers. Calculate the Required reserves. This is telling us that the commercial bank needs to keep 10% of its deposits as required reserves, therefore: $\text{Required reserves} = 0.1*1000 = 100$ The required reserves in this case are$100 and the bank is able to lend out the remaining $900. Example 2 - Calculate the excess reserves Suppose in the previous example that the bank decided to keep$200 of the deposits as reserves. How much would the Excess reserves be? We have

$\text{Excess reserves = Total reserves - required reserves}$

We know from the previous example that the required reserves are $100, so we have $\text{Excess reserves} = 200 - 100 = 100$ Example 3 - Calculate the required reserve ratio Suppose that a bank is not holding onto any excess reserves and they currently have a total of$10,000 deposits and have \$400 as reserves. What is their reserve ratio?

$\text{Required Reserve ratio} = \frac{400}{10,000} = 0.04$

Therefore, the required reserve ratio is 4%.