Definition of Fractional-Reserve Banking
What does the term "fractional-reserve banking" mean? What is meant by a "fractional-reserve banking system"?
Let's say that you currently have $52,000 deposited in a checking account at your local bank.
Does the bank have enough cash on hand to cover you if you walk in and ask to have your account closed? Most probably.
Does the bank have enough cash on hand if you and scores of other people ask for your money back on the same day? Probably not.
Under the "fractional-reserve" banking system, banks loan out most of the funds that they have received as deposits.
Deposits at a bank are actually considered (in most circumstances) to be loans.
Let's say that you have $52,000 deposited at your local bank and receive 2% interest per year.
The bank will lend out the majority of this money at a higher interest rate and pocket the difference.
If a bank has $1 billion in total deposits, then they certainly do not have a vault somewhere with $1 billion in cash sitting in it. This is not how it works.
Instead, banks will loan out the majority of the deposits, keeping a fraction of the deposits in "reserve" in order to properly handle withdrawal requests.
This is the basic definition of the "fractional-reserve banking system".
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