Banking Practice Exam

Banks hold reserves primarily to satisfy legal requirements set by regulatory authorities. These legal requirements, often referred to as reserve requirements, mandate that banks maintain a certain percentage of their deposits in reserve, either in cash or as deposits with the central bank. This ensures that banks have enough liquidity to meet withdrawal demands from customers and contributes to overall financial stability in the banking system.

While earning interest is a potential aspect of holding reserves, such as interest earned on excess reserves or balances held at the central bank, the primary motive for maintaining reserves is not to earn income but to comply with regulatory mandates. Similarly, while banks do invest in securities and may use reserves to manage funding for new loans, these actions are secondary to the fundamental need to adhere to the statutory reserve requirements. Maintaining the required reserves protects both the bank and the broader financial system by ensuring that institutions are liquid and able to respond to customer needs effectively.