State Reserve Requirements and Bank Cash Assets

Abstract

BANKS THAT ARE NOT MEMBERS of the Federal Reserve System are required to meet the reserve requirements set by the various states, rather than the requirements of the Federal Reserve. Across states, there are wide variations in the levels of state reserve requirements, the assets that can be used to meet the requirements, and the way the requirements are enforced. I Unlike Federal Reserve member banks, which are required to hold reserves in the form of deposits with Federal Reserve Banks or vault cash, nonmember banks may meet state reserve requirements with balances at other banks and, in many states, with various interestearning assets. However, the only state reserve requirements that are comparable to the requirements set by the Federal Reserve are those that must be met with cash assets i.e., with vault cash and deposits with other banks. It would appear that banks in states that require a high ratio of cash assets to deposits would be at a disadvantage relative to those in states with low required ratios of cash assets to deposits.2 However, this is not necessarily the case. It is possible that the level of cash assets dictated by state reserve requirements is so low as to make these requirements ineffective. That is, state reserve requirements may not induce banks to hold more cash that they would otherwise.