When the Federal Reserve clears a check that is written against an account in bank A and deposited into an account in bank B, it transfers the claim on a corresponding amount of deposits held at the Fed from bank A to bank B.
Banks must hold an amount of physical currency equal to the portion of their checking deposits represented by the reserve ratio. In other words, if the reserve ratio is 10%, a bank must hold one tenth of its demand deposits in the form
of physical currency. But all of the reserve currency need not be held by the bank.
The physical currency held in reserve by a bank can either be in the bank's vault or held at the Federal Reserve. Holding a portion of a bank's reserves at the Fed allows the Fed to clear checks written against those reserves by simply transferring a portion of the claim on them to another bank.
