A reserve requirement is the minimum fraction of deposits that banks must hold as reserves. They cannot lend it out. The requirement is set by the central bank and applies to transaction accounts, like checking accounts. If the requirement is 10 percent and a bank has $100 million in deposits, it must hold $10 million in reserves and can lend the other $90 million.

The reserve requirement is a monetary policy tool. Raising it reduces the amount banks can lend, which tightens credit. Lowering it increases lending capacity. In practice, central banks rarely change it because the effects are blunt and hard to predict. Open market operations and interest rate policy are preferred tools.

The United States reduced its reserve requirement to zero in March 2020. The Federal Reserve argued that reserves were abundant and that capital and liquidity rules were sufficient to control risk. Other countries still use reserve requirements. China adjusts them frequently to manage credit growth. Brazil uses them to discourage short-term capital inflows.

Reserve requirements are not the same as capital requirements. Reserves are cash or deposits at the central bank, held to meet withdrawals. Capital is the difference between assets and liabilities, held to absorb losses. Both matter, but they serve different purposes. A bank can meet its reserve requirement and still fail if it lacks capital.