Fractional Reserve Banking

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Fractional Reserve Banking is a banking system in which banks maintain only a certain liquid-cash ratio of deposits to cover immediate demand from their clients. In most banking systems a minimum reserve ratio is required by law[1].

The sum of deposits then equals the amount of the reserves times the deposit multiplier[2].

The primary benefit of such as system is that it creates an opportunity for the bank to lend capital and earn interest on it while expanding the supply of money. That in turn increases the velocity of money and stimulates both spending and investment.

Detractors are typically 'hard money' or 'sound money' proponents, i.e., those who argue in favor of a gold standard, or silver standard, i.e. currencies exchangeable for a prescribed amount of physical materials, and against fiat currencies. Their primary criticism is that fractional reserve banking leads to an expansion of credit and inflation.

Murray N. Rothbard, a member of the Austrian School of Economics, goes further, characterizing the practice as "swindling or counterfeiting[3]."

Fractional reserve banking is the standard practice in the United States and all major global economies.


References

  1. Fractional reserve banking. Economics-Dictionary.com.
  2. Fractional reserve banking. Investorwords.com.
  3. Fractional Reserve Banking by Murray N. Rothbard. LewRockwell.com.