Fractional Banking

What is Fractional Banking?

Fractional banking is a type of banking commonly used throughout the Western world. It describes a bank which only holds a fraction of its assets as deposits. For example, if a bank has $10,000,000 worth of customer deposits yet has $1,000,000,000 in assets and loans then this bank would be acting fractionally.

The reasoning behind using fractional banking is that at any given time only a small percentage of customers actually need access to their money, so the bank is free to loan out and invest the rest. The problem is when a greater-than-expected number of customers attempt to withdraw their cash and the bank cannot pay them. This is called a bank run.

Almost all commercial banks nowadays run a fractional banking system, albeit heavily monitored and regulated.

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