Let's Break It Down - Fractional Reserve Banking

Introduction

When you deposit $100 in a bank, you might think it just sits in a vault. In reality, the bank lends most of it to other people. This system is called fractional reserve banking, and it plays a big role in how money is created.

How It Works

Under fractional reserve banking, banks keep only a fraction of deposits as reserves and lend out the rest. If you deposit $100 and the bank keeps $10, it can lend $90 to someone else. That person spends it, and the money is deposited in another bank, which can lend out a portion again.

Creating Money

Through this process of lending and re-depositing, the banking system expands the money supply. The original $100 deposit can support several hundred dollars in total deposits across the system. This is why economists say banks create money when they make loans.

Risks and Safeguards

Because banks do not keep all deposits on hand, a bank run, where many customers try to withdraw at once, can cause trouble. This happened to Silicon Valley Bank in 2023. To protect depositors, the FDIC insures deposits up to $250,000, and regulators require banks to hold enough capital and liquid assets.

Conclusion

Fractional reserve banking is the engine that powers lending and economic growth. Understanding it helps you see how money really moves through the economy!