How Closely Do Banks Manage Vault Cash?

Beginning in 1959, Federal Reserve member banks were allowed to use both vault cash and deposits at Federal Reserve Banks to satisfy statutory reserve requirements. Prior to this time, member banks were restricted to satisfying required reserves solely with deposits at Federal Reserve Banks. Hence, member banks held currency in their vaults only to satisfy daily demands by depositors. Fluctuations in the levels of vault cash prior to 1959 therefore can be assumed to reflect changes in depositors’ demands for cash, or changes in the opportunity cost of vault cash (the cost of holding versus the cost of running out). Figure 1 shows the historical movement of vault cash as a percent of demand deposits at depository institutions from 1930 to 1997. During the 1930s, vault cash as a percent of demand deposits ranged between 4 and 5 percent, possibly reflecting higher public demand for currency or more conservative management by banks as a result of the banking crises of the early 1930s and the Great Depression. During the period from the mid-1940s to the late 1950s, vault cash was typically around 2.5 percent of demand deposits. After 1959, decisions on how much currency to hold in vaults became influenced by total reserve management decisions. Banks could choose the amount of their required reserves that they wanted to be satisfied by currency in the vaults and the amount they wanted to hold in their accounts at the Fed. The opportunity costs were reduced for holding vault cash in excess of that required for customer demand but less than required for reserves. Banks could hold more currency than they needed for customer transactions if this currency also satisfied a portion of required reserves. The result, as Figure 1 shows, was that vault cash as a percent of total demand deposits increased steadily from 1959.1 Depository institutions are currently in an era of relatively low reserve requirements, yet bank vault cash holdings have been increasing—both in magnitude and as a percent of net transaction deposits. Donald S. Allen is an economist at the Federal Reserve Bank of St. Louis. Thomas A. Pollmann provided research assistance.