Banks have a constantly changing amount of money, and a bank’s free reserves represent how much money a bank has that can be used to give to customers or to pay bills. A major factor that determines a bank's free reserves is the fractional reserve system (FRS), which is a percentage of how much money a bank must have available. This available money can be given out as loans so the bank can make more money. If the bank needs more available money, although it technically is borrowed money, it can get a loan from the government that will function as free reserve money.
There are several factors that go into determining a bank's readily available free reserves, but the two main factors are excess money and borrowed money. Excess money is the amount of money the bank has above the FRS, while borrowed money is any money the bank is currently borrowing from other banks or entities. The two are subtracted, and the number left indicates how much available money the bank has at that moment.
Excess money is how much money the bank has above the FRS. This is a figure that many countries or regions use to legally force a bank to hold a certain amount of money, typically from 10 percent to 20 percent. This is because the bank needs money to pay customer withdrawals and other interactions that involve the bank giving out money. FRS may change according to economic factors in the region or country, but it usually remains fairly stable.
Free reserves can be used for a number of purposes, but they typically are used to give customers loans or to extend credit to more customers. These actions allow the bank to make money from the interest rates, which is why a bank usually prefers using free reserves for this purpose. The money also can be used to pay back borrowed money or to pay other bills.
A bank with a low level of free reserves may find it difficult to make a profit, because there may not be enough money to give out as loans. To get more free reserves, a bank usually can borrow from the government. While this technically is borrowed money and it usually will have to be paid back, this money can be used in place of free reserves funds if necessary.
