There are many claims on different sides of the debate over fractional reserve banking. Doing the debate justice would require a book. And even then...
We can, though, at least break ground on the topic. This opens up the opportunity to review claims on both sides of the debate. Only then would one be in position to look into the deeper implications. So, to start, in basics, what is fractional reserve banking?
The actual practice is not difficult to grasp, though, often, those unfamiliar with the idea sometimes have difficulty appreciating the implications. The practice can be stated in a couple sentences.
Depositors place their savings into an account with a bank. The bank then uses those deposits to make loans to others - who may or may not also be depositors. (If they are, semantically accurate description can create complications with diminishing returns in insight. So, for purposes here, we'll just talk as though depositors and borrowers were different people.)
In theory, this is good for everyone. The borrowers get the funds needed to start businesses or buy homes or otherwise improve their and their families' life prospects. The interest charged to the borrowers pays for the operations of the bank and allows them to also pay interest to the depositors, giving them a return on their savings and incentive to deposit, allowing the whole system to function.
You can see why defenders of fractional reserve banking depict this as a win-win-win arrangement. The critics, though, point out that the reality is a good deal messier than this win-win-win language suggests.
On the face of it, the banks seem to be putting themselves in a precarious situation. After all, the depositors are not investors. Most regard their money as merely being stored at the bank: a bit like renting a mini-storage unit to stash away those boxes of keepsakes they can't bring themselves to trash. They can go fetch those boxes, though, any time they want. So, most expect with their money deposited in the bank.
This perception is of course quite wrong. Obviously their money can't be in the bank if it's been loaned out. The fact of course is that most depositors, most of the time, have no reason to withdraw most of their money. Thus, the imminent disaster intrinsic to fractional reserve banking usually is averted.
To meet the demands of depositors who do want to withdraw some portion of money, banks reserve a fraction of total deposits. This is then the source of the term fractional reserve banking.
Usually, this system works efficiently enough. It is true that many depositors don't realize when creating accounts that the small print in their contracts deny them withdrawal on demand. Often they have to at least endure a waiting period for withdrawals beyond a certain size.
Furthermore, beyond a certain threshold, the bank may exercise a prerogative to interrogate them about the financial intentions behind their withdraw demands. These contractual instruments enable banks to avoid the dangers posed by withdrawal demands that put their reserves at risk.
Most of the time, though, there is no need to resort to such draconian measures. The banks do decent jobs of anticipating the level of reserves necessary to cover the withdrawals and everyone goes about their business more or less contently.
Does this mean though that fractional reserve banking is uncontroversial or unproblematic? Far from it, claims many critics. In fact, it presents a constant threat of catastrophe for the bank and, given the interconnection of today's globalized banking system, even for the world economy.
Even that though is not the end of the danger. Under its apparently serene surface, fractional reserve banking plays an even more insidious role through its contribution to the inflationary destruction of the money supply . And that naturally increases the likelihood of borrowers defaulting on repayment and putting the entire system at even greater risk.
With these basics under your belt, you might want to turn to this article on the pros and cons (and con jobs) of fractional reserve banking for a deeper understanding of what's at stake.
We can, though, at least break ground on the topic. This opens up the opportunity to review claims on both sides of the debate. Only then would one be in position to look into the deeper implications. So, to start, in basics, what is fractional reserve banking?
The actual practice is not difficult to grasp, though, often, those unfamiliar with the idea sometimes have difficulty appreciating the implications. The practice can be stated in a couple sentences.
Depositors place their savings into an account with a bank. The bank then uses those deposits to make loans to others - who may or may not also be depositors. (If they are, semantically accurate description can create complications with diminishing returns in insight. So, for purposes here, we'll just talk as though depositors and borrowers were different people.)
In theory, this is good for everyone. The borrowers get the funds needed to start businesses or buy homes or otherwise improve their and their families' life prospects. The interest charged to the borrowers pays for the operations of the bank and allows them to also pay interest to the depositors, giving them a return on their savings and incentive to deposit, allowing the whole system to function.
You can see why defenders of fractional reserve banking depict this as a win-win-win arrangement. The critics, though, point out that the reality is a good deal messier than this win-win-win language suggests.
On the face of it, the banks seem to be putting themselves in a precarious situation. After all, the depositors are not investors. Most regard their money as merely being stored at the bank: a bit like renting a mini-storage unit to stash away those boxes of keepsakes they can't bring themselves to trash. They can go fetch those boxes, though, any time they want. So, most expect with their money deposited in the bank.
This perception is of course quite wrong. Obviously their money can't be in the bank if it's been loaned out. The fact of course is that most depositors, most of the time, have no reason to withdraw most of their money. Thus, the imminent disaster intrinsic to fractional reserve banking usually is averted.
To meet the demands of depositors who do want to withdraw some portion of money, banks reserve a fraction of total deposits. This is then the source of the term fractional reserve banking.
Usually, this system works efficiently enough. It is true that many depositors don't realize when creating accounts that the small print in their contracts deny them withdrawal on demand. Often they have to at least endure a waiting period for withdrawals beyond a certain size.
Furthermore, beyond a certain threshold, the bank may exercise a prerogative to interrogate them about the financial intentions behind their withdraw demands. These contractual instruments enable banks to avoid the dangers posed by withdrawal demands that put their reserves at risk.
Most of the time, though, there is no need to resort to such draconian measures. The banks do decent jobs of anticipating the level of reserves necessary to cover the withdrawals and everyone goes about their business more or less contently.
Does this mean though that fractional reserve banking is uncontroversial or unproblematic? Far from it, claims many critics. In fact, it presents a constant threat of catastrophe for the bank and, given the interconnection of today's globalized banking system, even for the world economy.
Even that though is not the end of the danger. Under its apparently serene surface, fractional reserve banking plays an even more insidious role through its contribution to the inflationary destruction of the money supply . And that naturally increases the likelihood of borrowers defaulting on repayment and putting the entire system at even greater risk.
With these basics under your belt, you might want to turn to this article on the pros and cons (and con jobs) of fractional reserve banking for a deeper understanding of what's at stake.
About the Author:
Those who want to be well-informed about managing their money need to stay tuned to the Fractional Reserve Banking Review to keep tabs on all the ways, new and old, that the banking system erodes your wealth. Wallace Eddington has emerged as a major commentator on how to detect and beat the scams of the mainstream financial system. Check out his recent controversial article on a Free Market Economy in Money .
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