What is meant by reserve requirement by the central bank?

The reserve requirement set by a central bank refers to the percentage of a bank's liabilities that must be maintained as deposits with the central bank. This requirement is a crucial tool for regulating the financial system and ensuring that banks have enough liquidity to meet customer withdrawals and other liabilities. By determining this percentage, the central bank influences the amount of money that banks can lend, impacting overall economic activity.

The reserve requirement serves several purposes, such as maintaining stability in the banking system, managing inflation, and controlling credit availability in the marketplace. By requiring banks to hold a certain amount of their deposits with the central bank, it also acts as a safeguard against bank runs, where many customers withdraw their funds simultaneously, potentially destabilizing the financial system.

Understanding the reserve requirement is essential for comprehending how central banks regulate the money supply and the broader economic implications of such regulations.