Final answer:
The Federal Reserve requires banks to hold a percentage of deposits as reserves to ensure sufficient liquidity, regulate the money supply, and protect against bank runs, thus stabilizing the banking system.
Step-by-step explanation:
The Federal Reserve imposes a reserve requirement on banks, compelling them to keep a certain percentage of depositors' funds on reserve, ensuring banks maintain sufficient liquidity to meet potential withdrawal demands. This requirement is a vital monetary policy tool to regulate the money supply and stabilize the banking system. Prior to the pandemic-induced recession in March 2020, these requirements were set at specific percentages based on the amount of deposits held by a bank. It is also a protective measure against bank runs, where many depositors withdraw their money at once, which could destabilize the banking institution and the financial system at large.