In commercial banking, the reserves of a commercial bank consist of which items held as cash balances?

Introduction / Context:
In commercial banking and monetary economics, the term reserves has a very specific and technical meaning. It does not refer to profits, net worth or all liquid investments. Instead, bank reserves are the cash balances that a commercial bank holds either in its own vaults or on deposit with the central bank. These reserves play a central role in meeting withdrawal demands and in satisfying legal reserve requirements. This question tests whether you can distinguish true bank reserves from other financial assets and equity items that may appear on a bank balance sheet but are not counted as reserves in the monetary system.

Given Data / Assumptions:
- The subject is a commercial bank that operates under a central banking system. - We are asked what the reserves of this bank consist of. - Options mention net worth, money market funds, government securities and deposits at the Federal Reserve Bank with vault cash. - We assume the standard textbook definition of reserves used in macroeconomics and banking regulation.

Concept / Approach:
Reserves in banking are the portion of bank deposits that are kept as cash and are not lent out. These reserves can be held in two main forms. First, vault cash, which is the physical currency stored in the bank vault and teller drawers. Second, reserve balances, which are deposits that the commercial bank itself maintains at the central bank, such as the Federal Reserve Bank in the United States. Together, vault cash and central bank deposits constitute the bank reserves. Other assets such as government securities, money market funds or loans are part of the bank investment portfolio or earning assets, but they are not considered reserves for reserve requirement calculations.

Step-by-Step Solution:
Step 1: Recall the definition of required reserves as a percentage of checkable deposits that must be held as cash or central bank deposits. Step 2: Identify which options describe cash or central bank deposit balances. Option D explicitly mentions deposits at the Federal Reserve Bank and vault cash. Step 3: Notice that net worth in option A represents owners equity, not a cash balance that can be used to meet withdrawals. Step 4: Recognise that money market funds and government securities in options B and C are financial investments that can fluctuate in value and may need to be sold before becoming cash, so they are not counted as reserves in the strict sense.

Verification / Alternative check:
A simple way to verify the correct answer is to look at a central banking or money and banking textbook, where reserves are always defined as vault cash plus deposits at the central bank. These are the balances that are immediately available to satisfy customer withdrawals and interbank payments. Government securities are often called secondary reserves because they are highly liquid, but they still need to be sold or used as collateral before they become cash. This distinction confirms that only vault cash and central bank deposits qualify as reserves in the narrow technical sense.

Why Other Options Are Wrong:
Net worth and shareholders equity: This is the difference between total assets and total liabilities, representing the owners claim on the bank, not a pool of cash reserves. Money market mutual funds: These are investment instruments that may be liquid but are not classified as bank reserves for legal or regulatory purposes. Government securities: Although very safe and liquid, they are investment assets and secondary reserves, not primary reserves held as cash.

Common Pitfalls:
Students often confuse liquidity with reserves, assuming that any safe and easily sold asset is part of reserves. While government securities and money market funds are highly liquid, the legal and regulatory definition of reserves is narrower. Another common mistake is to think that a strong net worth automatically implies large reserves. A bank can be well capitalised but still hold low reserves if most assets are in loans and securities. For exam purposes, always link the word reserves to vault cash plus deposits at the central bank.

Final Answer:
The correct option is deposits at the Federal Reserve Bank together with vault cash held at the bank, because these items form the official reserves of a commercial bank that are used to meet withdrawal demands and reserve requirements.