Fractional Reserve Banking
How banks multiply money through lending and why it creates both opportunity and risk
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0 / 5 completedThe Banking Multiplier Effect
When you deposit $1,000 in a bank, you might assume the bank stores that exact cash in a vault. In reality, banks keep only a small fraction as reserves and lend out the rest. This system—fractional reserve banking—is how modern banking multiplies money throughout the economy.
With a 10% reserve requirement, your $1,000 deposit can generate $10,000 in total money supply. Banks earn profits on loans, depositors keep access to funds, and the economy gets credit to grow. But this magic has a dark side: the system is inherently fragile.
The Core Mechanism
You deposit $1,000 cash in Bank A
Bank keeps $100 (10% reserves), lends $900
$900 gets deposited elsewhere, cycle continues
Banks don't lend out depositors' money—they create new money when they make loans. Your deposit becomes the "reserve" backing multiple loans. This is why the money supply is much larger than physical currency.
Interactive: System Comparison
Compare fractional reserve banking to alternative systems and see how money creation differs.
✓ Banks multiply deposits 10x or more
✓ Credit available for business growth
✓ Economy expands with money supply
✗ Vulnerable to bank runs
✗ Requires deposit insurance
✗ Can amplify boom-bust cycles