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.
![What is Fractional Reserve Banking?](https://www.davemanuel.com/images/def_fractional_reserve_banking.gif)
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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