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Risks associated with fractional reserve banking (bank runs)

What is fractional reserve banking?

  • "Fractional reserve banking is a system in which only a fraction of bank deposits are required to be available for withdrawal. Banks only need to keep a specific amount of cash on hand and can create loans from the money you deposit. Fractional reserves work to expand the economy by freeing capital for lending. Today, most economies' financial systems use fractional reserve banking.

    When you create an account at a bank, in the contract, you agree to allow that bank to use a percentage of your deposits as loans to other bank customers. This doesn't mean you don't have access to the money you deposited; it only means that if you want to remove more than the percentage a bank keeps on hand, such as the entire balance, from the account, the bank will need to access funds from somewhere else to give you your balance.

    When you deposit money in your savings account, your bank can use an amount specified as capital to fund loans and pay you for using your money. For instance, say you deposited $2,000 in a savings account. Savings accounts pay interest—generally between 0.5% and 2%—so you receive an interest payment on your money, and the bank can use part of it in a loan. In turn, the bank might want to access 80% of your money to use as loans to other customers."

    Source: Investopedia, December 2022