In Fractional Reserve Banking, how is the money supply increased considering reserves are given away? And how are people who deposit the money able to withdraw their entire deposit when some of it is kept to BE a reserve?

Question

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

Answer 1

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.