So from what I understand, in Fractional Reserve Banking, whenever money is deposited into a bank, they keep a percentage of that money to give out as loans.
So since they are giving out the reserve, how exactly is the bank making money here?
And since people are able to withdraw their entire deposit…. How can that be the case when some of it is taken for the reserve?
In: Economics
Cash is fungible – they don’t put your cash in a specific box and remove part of it for loaning out. They make money off of loan interest. They lend money out, and are repaid more money over time.
If *everyone* wanted to withdraw everything, it would not be possible.
Thats what you call a bank run, when everyone pulls their money at once. The bank goes under, very few if any can survive a run, we saw it happen with that bank in Silicone valley a year or two back. It was pure fear that the bank was out of money and everyone freaked out pulling billions out over night, feds had to step in and basically liquidate their assets.
Banks make money by lending out your money and charging interest, which is agreed upon percentage of said loan. 100,000 loan at 7% means the borrower will pay back 107,000 over the next say 5 years
Banks do not operate on fractional reserve! This is a myth. Easiest explanation for how banks work is a Bank of England paper on money creation. PDF is public.
20 people each put 5 gold coins in the Bank of Bob. They each get a piece of paper that says “Bank of Bob – Account balance – 5 gold coins.” (Translation: IOU 5 gold coins – Bob.)
Bob then loans Harry Homebuyer 80 gold coins to buy a house from Sally Seller. Harry signs a piece of paper that says “Bank of Bob – Mortgage Loan Agreement – I will pay you 4 gold coins a year for the next 30 years. Signed, Harry Homebuyer” (Translation: IOU 120 gold coins – Harry.)
After this sequence of events, here are some facts:
– There are 20 gold coins in Bob’s vault.
– There are 80 gold coins in Sally’s purse.
– Bob’s vault also contains one piece of paper that says “IOU 120 gold coins – Harry.”
No new gold coins were created. There are still 100 of them.
But, when we can ask people how much money they have, here’s what they say:
– Sally says “I have 80 gold coins. They’re right here in my purse.”
– 20 people say “I have 5 gold coins on deposit at the Bank of Bob — I have a bank statement. Look, we can go down to the bank and I can get 5 gold coins right now.”
If more than 4 people ask for their gold back at the same time, Bob will be unable to service them and go out of business. Unless he manages to quickly sell Harry’s IOU to another banker for 80 gold coins.
Because when the bank loans out the money, it doesn’t count it as a deduction of the money the bank has on hand. For example, say that the bank has $100,000 in deposits, with a reserve rate of 10%. The bank is able to loan out 90%, or $90,000. Then, the person who took out the loan spends the money buying what they wanted to buy, and the person that they bought it from deposits it back in the bank. The bank now gets to claim that they have $190,000 in deposits on hand, which means that there’s now $90,000 of new money that has been added to the money supply.
in the simplest terms, if your money is in, part of it is being used as a loan the bank can use. If that loan is currently being used for somebody and you decide to take all your money out, well they have to give you back that money, but it’s obviously in use by somebody else, they will use the loan from other peoples balances to pay for it.
the issues happen when *everybody* tries to take out their balance, if they have your money on loan with somebody, but everyone else is also taking their money out, there is no one available to loan money from their balance to cover it.
If I remember correctly, if the bank has 100k in deposits, it’s not that they lend out 90k, it’s that they create 900k through loans.
Somebody has to borrow the money in order for it to be created. So they then have 900k in loans on 100k in deposits, son the reserve ratio is about 10%
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