Fractional Reserve Banking

About Fractional Reserve Banking

Fractional reserve banking is the system where banks keep only a fraction of deposits as reserves, lending out the rest. This system creates money, as deposited funds are lent and re deposited. The money multiplier effect means that 100 deposited can support hundreds in loans. Fractional reserve banking has existed since the earliest banks. The system allows banks to pay interest on deposits and earn profits on loans. However, it creates the risk of bank runs, as banks cannot repay all depositors simultaneously. Central banks and deposit insurance were created to manage this risk. Critics argue that fractional reserve banking is inherently unstable and contributes to credit cycles. Some propose 100 percent reserve banking as an alternative.