What are Excess Reserves?

Sometimes it is seen that the regulating bank pays interest on the amount extra deposited in the reserve account to encourage the banks to deposit their extra cash balance in the reserve account as it is very necessary for the overall growth of the economy to maintain the cash and funds of the economy properly.

Excess Reserves Formula

Excess Reserves Formula = Legal Reserves (Amount Deposited) – Reserves Required

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  • Calculate the amount required to be maintained per statutory requirements (reserves required). To calculate the minimum required to be maintained, the use of the below-given formula gives us the required results: Minimum Requirement = Rate of Minimum Requirement * Total amount on which the rate applies Identify the amount kept or maintained by the bank in the reserves account with statutory authority (legal reserve). Take a total of all amounts deposited during the year in the reserve account maintained with the regulatory authority. Calculate the difference between legal reserves calculated in step 2 above and reserves required computed in step 1 above. Mathematically represented as: Excess Reserves = Legal Reserves (Amount Deposited) u2013 Reserves Required

Minimum Requirement = Rate of Minimum Requirement * Total amount on which the rate applies

Excess Reserves = Legal Reserves (Amount Deposited) u2013 Reserves Required

Examples

Example #1

The statutory guidelines for the bank are: Bank should maintain a minimum of 20(twenty) percent of their demand deposits with central regulating authority (let us say ABC Bank). Now, Bank P has demand deposits of $50,000,000 and has maintained $11,000,000 with ABC Bank. Now, by applying the above steps, we can compute Excess Reserves as follows:

Solution

Given:

  • Legal Reserves = $11,000,000Minimum reserve percentage = 20% of demand depositsDemand DepositsDemand DepositsMoney deposited with a bank or financial institution that can be withdrawn without notice is known as a demand deposit. Due to the shorter lock-in time, it does not pay any interest or a nominal amount of interest.read more = $50,000,000

Calculation of Reserves Required

Statutory RequirementStatutory RequirementA statutory reserve is the minimum limit of funds, net profits, readily marketable securities and other assets that the insurance companies need to keep aside as specified under the state insurance regulations for maintaining liquidity and settling the insurance claims.read more (Reserves Required) = Demand Deposits * 20%

  • =50000000*20%Reserves Required =10000000

Calculation of the excess reserves can be done as follow –

  • =11000000 – 10000000

Example #2

Bank PQR has deposited $35000 in reserves account and has total deposits of $75000. The reserves bank should maintain 150 percent of its deposits all the time. The rate of interest given by the regulatory bank on extra deposits is 3% per annum. We have to find out from the below-given options which option is the correct one regarding interest earned on excess reserves: a) $470 b) $675  c) $815  d) $715.

  • Legal Reserves = $1000Minimum reserve percentage = 150% of depositsDeposits = $500

Statutory Requirement (Reserves Required) = Demand Deposits * 20%

  • =500*150%= 750

  • =1000 – 750

Example #3

  • Legal Reserves = $75000Minimum reserve percentage = 150% of depositsDeposits = $35000

  • = $3500*150%= $52500

  • = $75000 – $52500

Interest Income on Extra Deposits

Interest Income on Extra Deposits = Excess Reserves * Rate of Interest.

  • = $22500*3%= $675

Relevance and Use

  • Those banks who have maintained excess reserves are more secure in sudden loss or a situation of heavy cash demand.They resolve the liquidityLiquidityLiquidity is the ease of converting assets or securities into cash.read more issues of the bank in the situation when there is a shortage in the supply of cash.If the bank has a lot of cash balance with themselves, they may deposit the same with the regulatory bank and can earn interest thereupon if the same is above the minimum requirement. For example, if Bank A must maintain $500 as minimum reserves and has deposited $750 in the reserve account, the statutory bank pays them interest over $250 for the period they were deposited.

This article has been a guide to Excess Reserves and their definition. Here we discuss how to calculate excess reserves and its formula, examples, and downloadable excel template. You can learn more from the following articles –

  • Reserves and Surplus MeaningTypes of Demand DepositsStatutory Reserve MeaningA Budget Surplus