--- title: “Fractional Reserve Banking” description: “The systemic risk of banks lending out more money than they actually hold.” tags:
- banking
- economics
- risk
Fractional Reserve Banking
TL;DR
Fractional Reserve Banking is a system where banks keep only a small fraction of their deposits in reserve and lend out the rest, creating systemic instability.
What Is It?
When you “deposit” money in a bank, the bank doesn’t keep it in a safe. It treats your money as an unsecured loan. They keep a tiny portion (the reserve) and lend out the rest to earn interest.
Why It Matters
- Bank Runs: If too many people want their money back at once, the bank fails because the “cars” (money) are already rented out.
- Inflation: This process effectively creates “new” money in the form of credit, diluting the purchasing power of the existing currency.
- Insolvency: The entire system relies on the assumption that everyone won’t need their money at the same time.
Analogy: The Parking Lot
Imagine a parking lot that has 100 spaces but sells 1,000 “monthly parking” passes. As long as only 100 cars show up at a time, the system works. But if there is an event and 200 cars show up, the system collapses, and 100 people are stuck without their property.