Benefits of fractional reserve banking

Benefits of fractional reserve banking

According to the United States' Federal Reserve, fractional reserve banking provides benefits to the economy and the banking system:[4]

The fact that banks are required to keep on hand only a fraction of the funds deposited with them is a function of the banking business. Banks borrow funds from their depositors (those with savings) and in turn lend those funds to the banks’ borrowers (those in need of funds). Banks make money by charging borrowers more for a loan (a higher percentage interest rate) than is paid to depositors for use of their money. If banks did not lend out their available funds after meeting their reserve requirements, depositors might have to pay banks to provide safekeeping services for their money. For the economy and the banking system as a whole, the practice of keeping only a fraction of deposits on hand has an important cumulative effect. Referred to as the fractional reserve system, it permits the banking system to create money.

Thus, fractional reserves are a necessary consequence of bank lending. The fractional reserve system allows banks to act as financial intermediaries – facilitating the movement of funds from savers to investors in a society.[5]

According to many economists, fractional reserve banking benefits the economy by providing regulators with powerful tools for manipulating the money supply and interest rates, which many see as essential to a healthy economy. Additionally, fractional reserve banking provides an easy way for the government to finance its debt, as government debt has historically made up most of the commercial banks' reserves (e.g. in U.S. national and state banks).