Finance and Economics Discussion Series

Lessons from the Historical Use of Reserve Requirements in the United States to Promote Bank Liquidity

Mark A. Carlson
2013-11

Abstract: Efforts in the United States to promote bank liquidity through reserve requirements, a minimum ratio of liquid assets relative to liabilities, extend at least as far back as the aftermath of the Panic of 1837. These requirements were quite important during the National Banking Era. Nevertheless, suspensions of deposit convertibility and liquidity shortfalls continued to occur during banking panics. Eventually, efforts to ensure that banks remained liquid resulted in a shift away from reserve requirements in favor of a central bank able to add liquidity to the financial system. This paper reviews the issues raised in the historical debates about reserve requirements along with some empirical evidence on banks' holdings of reserves, to provide some insights and lessons that are relevant today. A key lesson is that individual bank liquidity during stress periods is inherently and intricately tied to the liquidity policies of the central bank.

Keywords: Reserve requirements, bank liquidity, lender of last resort, banking panic