Regulatory liquidity is the legal reserve that must be maintained in compliance with Regulations D and M of the Federal Reserve System. These regulations establish the minimum reserve requirements on domestic deposits and transactions undertaken by foreign branches with member banks and other United States residents. There are three types of legal reserve available to institutions: vault cash, balances at the Federal Reserve banks and pass-through accounts. Pass-through accounts are balances maintained by depository institutions that are not member banks in one of the following: an institution that maintains required reserves at a Federal Reserve Bank; a Federal Home Loan Bank; the National Credit Union Administration Central Liquidity Facility; an institution authorized by the Federal Reserve Board to pass through required reserves.
Reserve requirements are based on net transaction amounts, gross nonpersonal time deposits and Eurocurrency liabilities. Net transaction amounts are defined as gross transaction accounts minus the sum of cash items in the process of collection and balances subject to immediate withdrawal due from other depository institutions located in the United States. These subtractions prevent the double counting of balances between depository institutions.
As of 1990, most depository institutions were required to maintain reserves of three percent on the first $40.5 million in transaction accounts, and 12 percent on balances in excess of $40.5 million. The Federal Reserve Board (Fed) has the power to adjust reserve percentages within a range of 8 to 14 percent on the portion of transaction accounts that exceed $40.5 million. The Fed can also institute a supplementary reserve requirement not to exceed four percent of total transaction accounts. Such an action requires an affirmative vote of at least five members of the Fed. Supplementary reserves also earn interest at a rate not to exceed the return o...