Free Reserves

From CEOpedia | Management online

Free reserves - are that reserves, which are amount to the borrowed reserves, but without surplus reserves. Banks keep usually that reserves contrary their deposits. These reserves are compound of essential reserves that are kept at the Federal Reserve(it has the form of the electronic notes) and surplus reserves. It is called like that because they are the total sum of reserves set aside and beyond needed reserves. By borrowing means at the Federal Reserve due to the discount window, banks have the possibility to plus to their reserves (R. W. Hafer 2005, p. 151).

Early conception of free reserves

During a some while, free reserves were considered to be a helpful scale for estimating the monetary policy. Some officials of Federal Reserve assumed that if banks make the attempt to stump up their accommodated reserves before that moment they made the loans or bought other securities, in that case free reserves could be an appropriate measure whether banks have the ability to enlarge their assets. Because of that, politics noted that free reserves were raising or dropping down in the banking system. In accordance, that helped to estimate whether monetary policy was "arduous" or "free"(R. W. Hafer 2005, p. 151).

The conception that was accepted by the late 1950s was that interest level was awaited to drop down (grow) and another money stock to expand (drop down), In the situation when free reserves are elevated (small). In spite of that fact that official controversy of free reserves, it included warning that considerable policy changeability usually is discussed during the meetings of the Federal Open Market Committee (FOMC). The situation looks like that not because they believed it was such criterion they were able to keep under the control, but as an estimator intension and ease of policy(R. W. Hafer 2005, p. 151).

Free reserves in the role of a guide

Free reserves are like an exponent of monetary tightness. In that case when the endogenous is changeable, free reserves depend on the rate of the deduction. If the level of the discount is decreased, banks decide to enlarge credit at the extension of their free reserves holding, because it is more profitable for them. That low level of free reserves will report monetary tightness in that situation when the decline in the discount level reports provisional monetary fluency( J. Handa 2000, p. 293).

We can imagine the situation when the bank kept $100 million of free reserve at the predominant scale of percentage. Presuming that the central bank evaluates it in the position of the exponent of monetary tightness and enhances the monetary foundation by $50 million across open market operations, making the effort to grow free reserves to a wishful level of $150 million. However, banks want to keep only $100 million of free reserves. They dispose of the overage by enhancing their debts, thus growing the money reserves. In case when the central bank pursues with that free market operations policy, the interest scale will sooner or later drop. That kind of fall will make credits less beneficial and implicate banks to maintain much more free reserves. Nevertheless, the wishful growth of free reserves was caused together with an distension in the money stock that may not have been wishful. Consequently, free reserves, in turning into a purpose of the company's policy in place of solely being a pointer of the circumstances of the market, reducing from the chasing of the money stock as an aim. Therefore, the monetarists dispute about whether the central bank must pay particular attention to the money supply straight or on the reserve apprehension which is intimately connected with the money stock. This puts forward for the consideration that it could be a sight better to make use of the monetary basis, the commercial banks and the private non-bank stocks are set as a goal (J. Handa 2000, p. 293).

In the situation of free reserves that is noticed we can make such statement: rates of the interest are equipoise rates so that alterations in them might display also changes in necessity or supply conditions or both. Thereof, a growth in the interest scale may be caused thanks to the expansion in the demand for a loanable funds or a drop in their stock, but the central bank can wish to get the recompense litigation in such situation (J. Handa 2000, p. 293).

Using of the free reserves

Bigger part of the banks shave to hold a constant deposits’ percentage with the Federal Reserve. Since that moment when banks make use of overage reserves (overall reserves not as much necessary reserves) for making investments , a disposable reserve stance ( wastage reserves not as much as accommodated reserves) often designates free money. Level of the free reserves has a big meaning in the market. For example, if the level of the free reserves is bigger than $200 million, the condition of the market is good. And if the level of free reserves of the market is under $180 million - the market has the significant economical problems (N. Davis 2014, p. 294).

The good side of free reserves is:

  • they don't include in themselves that reserves that are not possible to use in any case
  • they don't include reserves that were borrowed and on which banks could to expand credit. Free reserves introduce the amount of the banks to expand the farther loan (J. Handa 2000, p. 293).

Examples of Free Reserves

  • Free reserves are the excess funds in a bank's reserves that are not required to meet the minimum requirements set forth by the Federal Reserve. These funds can be used by the bank for lending, investing, and other activities. An example of free reserves is the additional funds a bank may have beyond what is needed to meet the reserve requirement. The bank can then use these funds to invest in securities or make loans to customers.
  • Another example of free reserves is the excess funds in a company's accounts receivable. If a company has more money than necessary in their accounts receivable, this amount can be used for other investments or activities. Companies can also use these funds to pay down debt or purchase additional inventory.
  • A third example of free reserves is the excess funds in a company's cash and cash equivalents. If a company has more cash than necessary to cover their operating expenses, this amount can be used for investments, loan payments, or other activities. These funds can also be used to purchase additional assets such as real estate, equipment, or inventory.

Advantages of Free Reserves

Free reserves are reserves of funds that are available to a bank without any additional deposits or borrowings. There are several advantages to having free reserves, which include:

  • Having free reserves provides a bank with greater liquidity, which can be used to respond quickly to customer needs and make fast loans. This allows banks to meet the needs of their customers in a timely manner and potentially increase profits.
  • Free reserves can also be used to invest in other financial instruments, such as bonds, stocks, and derivatives, which can provide additional income to the bank. This helps to increase the bank's profitability and can also provide a buffer against losses in other investments.
  • Free reserves can also be used as a source of capital for new investments or to expand existing operations. This can help a bank to grow and increase its profitability.
  • Free reserves can provide a bank with a greater level of financial stability, since they can be used to provide a cushion against losses from bad loans or other investments. This can help a bank to remain solvent and able to meet its obligations.

Limitations of Free Reserves

Free reserves have several limitations that should be considered when assessing the overall financial health of a company. Specifically, the limitations of free reserves include:

  • The amount of free reserves available is limited by the amount of capital that has been borrowed. This means that the amount of free reserves available to the company is not able to increase without borrowing more capital.
  • Free reserves are also limited by the amount of capital that must be used to pay off debts and other liabilities. This means that the amount of free reserves available to the company is limited by any outstanding loans or other debts that must be paid off.
  • Free reserves are also limited by the amount of capital that is available to invest in new projects or initiatives. This means that the amount of free reserves available to the company is limited by the capital that can be used to fund new investments in the company.
  • Finally, free reserves are limited by the company's ability to generate income and profits. This means that the amount of free reserves available to the company is limited by the revenue and profits that the company can generate.

Other approaches related to Free Reserves

Free reserves refer to the level of reserves that a bank holds in excess of the level required by its regulators. Other approaches that are related to free reserves include:

  • The leverage ratio, which is the ratio of a bank's assets to its equity capital and is used by regulators to assess the riskiness of a bank.
  • The liquidity coverage ratio (LCR), which measures the ability of a bank to meet its short-term obligations.
  • The capital adequacy ratio (CAR), which measures the amount of capital a bank has relative to its risk-weighted assets.
  • The net stable funding ratio (NSFR), which measures the ability of a bank to meet its long-term funding needs.
  • The stress testing framework, which is used by regulators to assess the potential effects of extreme market conditions on a bank's financial position.

In summary, free reserves refer to the level of reserves that a bank holds in excess of the level required by its regulators, and other approaches related to free reserves include the leverage ratio, the liquidity coverage ratio, the capital adequacy ratio, the net stable funding ratio, and the stress testing framework.

Free Reservesrecommended articles
Reserve capitalLiquidity riskBorrowing capacityDebenture Redemption ReserveCapital bufferNon current liabilityCapital gearingDefensive strategyAssets funding strategy


Author: Diana Fandul