Could someone please explain in simple language what the 'fractional reserve banking

[Mind_your_head]

system is all about"?

TIA,
M_Y_H :hi:

[Mind_your_head]

1. The' Sound of Silence'

Hello, Silence my old "friend"

[RoyGBiv]

2. In the simplest terms ...

Person A, B, C, D, and E deposit $100 in a bank, totaling $500 in deposits.

The bank issues loans totaling $400, for which it charges interest.

It then has a "fractional reserve" of total deposits of $100.

At any given time, any of the depositors may demand the total amount of their deposit. With the fractional system, only one of the five depositors could withdraw all of their deposit at any given time. Or, all five could withdraw up to $20 at once, or two could withdraw $50, etc.

When a bank does not have enough fractional reserve to cover demanded withdraws, they are suffering a liquidity crisis and use various methods to increase their reserve to meet demands, e.g. by borrowing from another bank. When banks cannot borrow money to increase their reserves, such as during a panic or "bank run" that is broad in scope, they tend to sell assets. If they do not have enough assets to meet demands, they are in default and fail.

As I said, this is very simplistic.

Ever seen _It's a Wonderful Life_? The nominal purpose of maintaining a fractional reserve system is to allow for economic growth or money creation. In the bank run scene, George Baily explains fractional reserve system in an more personal and equally simplistic way. Yes, your $100 is yours, and you can demand it at any time, but it's not all *here*. It's in the house Mr. Martini built or in the business that so-and-so started, etc.

[lurky]

3. OK,

Banks are required by law to keep a certain fraction of their deposits on hand in cash at all times, rather than loan it out. This is a safety thing, to protect depositors. They keep this reserve money at the Federal Reserve bank (hence the name). Because these amounts change every day, banks lend each other cash overnight to make sure that they have the right amount to satisfy the Fed. When you hear about federal interbank loan rates, this is what they are talking about.

Hope that helped.