The currency-deposit ratio refers to the relationship between the amount of cash a person holds and the amount of money she maintains in readily accessible bank accounts, such as checking accounts. The formula for the currency-deposit ratio is cr = C/D.
The Ratio in Practice
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Say you have $62 on your nightstand and $1,872 in a checking account. You write your currency-deposit ratio as cr= 62 / 1872 or 0.033. The more cash you keep on hand compared with your total deposits, the higher your currency-deposit ratio. For example, if you keep $800 in cash and $800 in a checking account, your currency-deposit ratio rises to 1.00.
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Relevance to Banking
The Federal Reserve requires banks to keep a percentage of all deposits in reserve. The bank cannot loan or invest its reserve funds. If the average currency-deposit ratio increases, meaning that everyone keeps more cash on hand, banks' ability to lend decreases. The decrease in available money to lend makes every loan a bigger risk for the bank. The increased risk drives up interest rates. This combination of factors, if left unchecked, can stifle economic growth and job creation.
Influencing the Economy
During economic slowdowns, when the currency-deposit ratio tends to rise, the Fed encourages lending by lowering the federal funds rate. The federal fund rate refers to the amount of interest banks charge to lend money to each other to, for example, cover minimum reserve requirements. Reducing this rate typically leads to reductions in interest rates for businesses and consumers and can help spur growth.