Excess Reserves

As the term suggests Excess Reserves are those reserves which are more than the required standard reserves in any financial institutions like banks etc.  The standard reserve ratio is fixed by the Central bank which is mandatory for the banks to keep that ratio.

Beyond that ratio, anything that is in excess is called as Excess Reserve. However, banks do prefer excess reserve because they are not yielding anything to the institution. They are cash and are of not any use.

It is more advisable to make those reserves fruitful by investing them in either short term loans or may be secured loans.

Advantages

The advantages of Excess Reserves are as follows:

  1. Banks will have more cash in their hand
  2. Liquidity rate is high
  3. Creditworthiness increases of the bank
  4. Investors get attracted
  5. It can also improve the Credit Rating of the bank
  6. Acts a safety measure in times of sudden requirement of cash

Thus the above advantages make banks create more and more excess reserve and increase their liquidity ratio.

Disadvantages

The following are the disadvantages that Excess Reserves can create:

  1. The excess funds are idle funds
  2. They

    are supposeto be invested in

    short termearnings

  3. More than the required amount means hard cash is not being used properly
  4. It is also considered as a costly affair as the cash has to be maintained

Thus if it has advantages then it also has disadvantages. The best way to is to have minimal and as per required Excess Reserves neither beyond that nor less than that.

Calculation of Excess Reserve

Suppose in a bank there are:

Assets Rs. 500,000

Creditors Rs. 300,000

Loans  Rs. 150,000 then the Excess Reserves can be calculated by:

Excess Reserves (if any) = Assets – Liabilities (Creditors + Loans)

Excess Reserves = 500,000 – (300,000 + 150,000)

Excess Reserves = 50,000

Thus Excess Reserves is a double edged sword which has advantages as well disadvantages. However, it is recommended to keep it minimal if the cash is not invested properly in the business. Thus bank authorities should always keep a vigilant eye on the Excess Reserves that the institution has.

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