In addition to the funds required for meeting the demands of the depositors who wish to withdraw their deposits – fixed, current and saving, bankers have to keep funds for meeting the requirements of such customers, as may want accommodation in one form or another.
It is, therefore, necessary for a banker to keep both in his own vaults, as well as with his bank – generally the central bank of the country – such amounts as he may consider sufficient for his day-to-day requirements.
These funds are known as cash reserve and are regarded as his first line of defense in times of trouble. The main purpose of holding reserves is to avoid bank runs and generally appear solvent.
Habits of the customers and business conditions of the locality
The amount of reserve required by a bank depends on the habits of the customers and the business conditions of the locality, which the bank is serving.
Thus, in a manufacturing and commercial community, where exchanges are numerous and rapid, it might be necessary to maintain a relatively larger reserve than that in an agricultural community, among the members of which the exchanges are less frequent.
On the other hand in an agricultural country like Bangladesh the demand for funds during the busy season for financing certain crops may be so large as to require the maintenance of a larger reserve than at other times.
Use of check currency: Where the check currency is popular, the need for hand to hand currency is less and consequently smaller reserves will suffice, because payments for these checks will, to a large extent, be made by transfer entries in the books of the bank.
Bankers‘ clearing house
Another important factor which affects the reserve to be kept by a bank is, whether or not, there is a bankers’ clearing house in the locality where the bank is carrying on its business.
As in a city, which has a bankers’ clearing house, most of the checks pass through the clearing house, a banker is not required to find funds for all the checks drawn upon him and held by other bankers.
He has to provide only for the difference between the respective amounts of checks drawn upon him and those drawn upon other banks and held by him if the balance of the clearing happens to be against him.
Nature of accounts
If a large majority of the current accounts are of a fluctuating nature as is the case with the accounts of share-brokers, cotton merchants, and bullion dealers, the banker will require a comparatively larger cash reserve because there is the chance of most of them withdrawing the major portions of their balances at a time, when there are heavy fluctuations in the prices of shares, cotton and bullion.
Similarly, city banks, especially those which hold deposits and reserves of other banks should ordinarily maintain a larger percentage of reserve than small local banks.
Size of average deposits
A bank which has only a few large deposits has to keep a larger reserve than a bank with numerous small accounts because the larger the number of clients of a bank, the less is the likelihood of any concerted movement towards a withdrawal of deposits.
The nature of advances and amount of bills discounted
The reserve a banker should keep is also affected by the consideration of the amount of money invested by him in the discount of commercial paper.
If he uses a large portion of his surplus funds in discounting good bills he should be able to manage with a smaller cash reserve than another banker who invests his funds largely in the form of loans, because the former, on account of having utilized a large sum of money in discounting commercial paper, can, is case of need, easily convert some of the bills in his vaults into cash, by re-discounting them with the central bank.