Fractional-reserve banking is a type of banking where banks keep a fraction of their deposits in reserve. It means that banks can lend out a certain amount of money based on the amount they have on deposit. The fraction held in reserve varies from bank to bank, but it is typically around 10%.
The fractional-reserve banking system was created to allow banks to lend out more money than they have on deposit. That helps to stimulate the economy by making more money available for lending and investment. However, there are also risks associated with fractional-reserve banking. For example, if too many depositors try to withdraw their money simultaneously, the bank may not have enough money to meet all of the demand, which could lead to a run on the bank.
Despite the risks, many banks still use fractional-reserve banking today because it can help to spur economic growth. However, it is essential to note that this system is not foolproof, and one must consider potential risks.
Are There Better Alternatives?
Systems that may be better than fractional-reserve banking include full-reserve banking, Islamic banking, and commodity money.
Full-reserve banking is when banks hold 100% of customer deposits in reserve so that one can never use them for lending or other purposes. This system eliminates the risk of bank runs, as customers can always withdraw their deposited funds. However, it also means that banks can never create new money and thus may not be able to finance economic growth.
Islamic banking is based on the principles of Sharia law and prohibits charging interest (riba). This system encourages profit-sharing and risk-sharing arrangements between lenders and borrowers, designed to promote economic stability and growth.
Commodity money is a system in which money is based on a commodity such as gold or silver. This system provides more stability than fiat money systems, as the value of the money is directly linked to the underlying commodity. However, it can be challenging to transport and store large amounts of commodities, and their value can fluctuate depending on market conditions.
Will Fractional-reserve Banking Stay Popular?
The future outlook on fractional-reserve banking is bullish. It allows banks to expand the money supply, stimulating economic growth.
Additionally, this form of banking is less risky than full reserve banking since banks can use their reserves to cover any unexpected withdrawals.
Finally, the global economy is expected to grow further in the coming years, benefiting banks that engage in fractional-reserve banking.