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Link Between Required Reserves, Capital Levels and Profitability of a Bank

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Discuss the effect of required reserves and capital levels on a bank's profitability.

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The following posting discusses the effect of required reserves and capital levels on a bank's profitability.

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Impact on Required Reserves on Bank's Profitability

Banks play an important role in the economy to determine the supply of money and liquidity. The central bank has some guidelines on the banks for the capital level and reserve requirements. Reserve requirements can be defined as a fraction of customer deposits and notes, which commercial banks are required to hold as reserves. The required reserves have a negative impact on the profitability of a bank (Cardoso, 1998). It is because reserves increase the real interest rate and also the non-performing loans, which causes a decline in the profitability of the firm. At the same time, required reserves will also reduce the ability of bank to provide loans to the customers, which would cause a decline in the profitability of banks (International Monetary Fund, 2010).
The reserve requirements could have a positive impact on the bank's liquidity due to availability of funds to fulfil the demand of customers ...

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