Fractional Reserve Banking

Fractional Reserve Banking

Fractional-reserve banking is the practice whereby banks retain only a portion of their customers' deposits as readily available reserves (currency or deposits at the central bank) from which to satisfy demands for payment. The remainder of customer-deposited funds are used to fund investments or loans the bank makes to other customers. Most of these funds are later redeposited into banks, allowing further lending. Thus, fractional-reserve banking permits the money supply to grow to a multiple of the underlying reserves of base money originally created by the central bank.

Central banks and other monetary authorities often regulate bank credit creation, imposing reserve requirements and other capital adequacy ratios. This limits the amount of money creation that occurs in the commercial banking system, and ensures that banks have enough funds to meet the demand for withdrawals. To mitigate the risks of bank runs (when a large proportion of depositors seek withdrawal of their demand deposits at the same time) or, when problems are extreme and widespread, systemic crises, the governments of most countries regulate and oversee commercial banks, provide deposit insurance and act as lender of last resort to commercial banks.

Fractional-reserve banking is the current form of banking in all countries worldwide.