Fractional banking is a banking system in which banks keep only a fraction of their customers' deposits on hand as reserves and lend out the rest. This means that if a bank has $100 in deposits from customers, it may keep $10 in reserve and lend out $90 to borrowers. This system allows banks to create money through lending and can increase the supply of money in the economy.
In fractional banking, banks are required to hold a minimum percentage of their deposits as reserves, which is set by the central bank or regulatory authority in the country. This reserve requirement is designed to ensure that banks have enough funds on hand to meet withdrawal requests from customers.
The practice of fractional banking can be beneficial for both banks and borrowers. Banks can earn interest on the money they lend out, while borrowers can access the funds they need to invest in projects or purchase goods and services. However, fractional banking also carries risks, as banks may not have enough reserves to cover a sudden increase in withdrawals or a default by borrowers. In such cases, banks may need to borrow from other institutions or the central bank to meet their obligations.
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