The Ins and Outs of Fractional Reserve Banking
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The Fractional Reserve Banking Process
Banks are not obliged to keep 100% of a depositor’s money if they don’t want to, but are allowed to lend up to 90% of deposits in the form of mortgages, personal loans and the like, because the reserve ratio set by the Federal Reserve is 10%, and this allows for fractional reserve banking. In doing this, banks create new money which has a multiplier effect, and causes inflation. When the reserve ratio is 10%, the multiplier effect is 10 times the original deposit, meaning that when a deposit is made in Bank 1 for $100,000, by the time the bank has lent out 90%, and this has been re-banked in Bank 2 which lends out another 90%, and the process continues, the ultimate effect is the creation of another $900,000; this cycle taking around 6-8 weeks to complete.
The process also creates debt, and everyone knows how indebted the United States is today. Most people have no idea how banks create money; their main concern being their pay check each week or fortnight, and what they will spend their money on. Little is known about how banks function, how changes in the reserves affect the money supply, and why a bank can be here today, but gone tomorrow; the main reason being they have little in reserves to pay depositors with if there is a run on the bank. It’s a risky business dealing with money in the manner banks do. Fractional reserve banking, while creating money and profits for the bank concerned, can also be its undoing.
Professor of Economics at Pace University, Joseph T. Salerno, presents a lecture on the economics of fractional reserve banking in the following documentary. For those without an understanding of the process the banks use to create money, lend it out, and earn their profits on, the lecture is most informative: