The most important obligation which a bank assumes is the necessity of meeting its current liabilities, whether deposits or circulating notes. It is therefore essential for the bank to keep its general assets in liquid condition, and particularly to maintain a portion of its resources available at all times to meet these demand obligations. These special assets are known as the reserve. The nature of this reserve and the policies which a bank may follow in order to restore any depletion have been discussed in Chapter X; and an explanation of the redemption of bank notes will be deferred until Chapter XXIII. For the present, consideration will be given only to the methods by which public regulation seeks to enforce the upkeep of adequate reserves against deposit liabilities.

To attain this end the government insists that banks observe certain reserve requirements which are expressed as a percentage ratio between the amount of the bank's cash and available credit and the total of its deposits. How large a reserve will be needed to meet these liabilities depends to a considerable degree on the locality of the bank. If it is situated in a large money center where business men are continually drawing checks against their balances, obviously a higher ratio of reserves against deposits is necessary than in the case of a bank in a smaller city where accounts are less active.

The National Bank Act, therefore, divided the United States into three groups: (1) central reserve, (2) reserve, (3) nonreserve, or country districts. The first group includes New York City, Chicago, and St. Louis; the second covers about one hundred of the larger cities; and the third, the remainder of the country. Location was the only distinction which the National Bank Act drew in fixing the amount of the reserves. The Federal Reserve Act continued the above classification, but further graded these requirements by permitting banks to carry a lower reserve against time than against demand deposits. The division between these two classes of deposits has been arbitrarily set at thirty days, and all accounts which can be withdrawn within this period are regarded as demand deposits, while time deposits include those payable after thirty days.

Certificates of deposits, savings accounts payable after thirty days' notice, and postal savings are regarded as time deposits under the Federal Reserve Act.

As soon as a certificate of deposit attains a maturity of less than thirty days, or as soon as the holder of a savings account has notified the bank of his intention to withdraw his balance, these items then become demand deposits.

Based on the principle of the location of banks and the maturity of deposits, the Federal Reserve Act as amended in 1917 fixes the reserve requirements of member banks as indicated in the following table:

Against demand deposits, banks in the central reserve cities must maintain a reserve of 13 per cent; in reserve cities, 10 per cent; and in the remainder of the country, 7 per cent. No such distinction is drawn in computing the reserve against time deposits, of which only 3 per cent need be maintained by all banks, irrespective of their location.

The Federal Reserve Act effected two important changes in the system of reserves established by the National Bank Act. In the first place, the percentages of reserve requirements were considerably reduced. The National Bank Act permitted banks to carry a certain part of their reserves with other institutions, but the Federal Reserve Act as later amended compelled the transfer of all reserves to the Federal Reserve banks. All members of the Federal Reserve system, whether national or state institutions, must comply with the reserve requirements stated in the above table.