Fractionnal Reserve Banking

March 21, 2010

The practice of such kind of banking in which only a portion of the deposits are being kept by the banks in reserve while they lend out the remaining portion of their deposit, but with the option of upholding such a kind of compulsion by which they would be able to redeem the entire money that is being deposited when they demand for it, is known as fractional-reserve banking. The deposits that are kept by the bank are reserved in the form of cash as well as in the form of assets that are highly liquid in nature. Situations for a fractional-reserve banking takes place in those conditions when banks specializes in lending out some portion of their funds that they were able to receive from those accounts that are being deposited. The practice of fractional-reserve banking has been found out to be a worldwide process in the field of modern day banking system. Fractional-reserve banking is just a distinct type of banking system as compared to the system of full-reserve banking which have expired out for more than two centuries now.


The amount of money supply which includes both cash as well as the cash that is in demand and is also deposited is being augmented by the process of fractional-reserve banking. The broad money supply of almost all the countries is much greater than the total sum of base money that has been created by the central bank of a country because of the pervasiveness of fractional-reserve banking. The cash that multiplies to form a great amount of money is better known as the money multiplier.

And this multiplication of the cash to form this greater amount is actually decided by the necessity of a reserve or other kind of necessities of finance in regard to ratio that is being imposed by the regulators of finance and also by those reserves that are kept in excess by some commercial banks.


The permission for the necessary requirements of reserve is being normally done by the central bank. And for this it becomes essential for the banks to maintain a bare minimum portion of their stipulated deposits in the form of such reserves that are of cash nature. As a result of this it confines the quantity of creation of money that takes place in such a system of banking which is of commercial nature. So this will ensure that the bank have a good amount of money ready with them so that they could meet the general demands when the chance of withdrawal rises up. There are times when a big number of depositors might decide to withdraw the amount of money that they have deposited and in such a condition the real problem crops up. With the turn of such a condition the bank can still function in a good manner. And in other conditions when the problems are of grave and extensive nature it can lead to a complete disaster of the bank. The central bank and in some other cases those institutions that are being controlled by the governments would normally control as well as supervise the banks which are of commercial type so that they could easily lessen up such problems. So these banks would actually function as being the last alternative for lending out money to the commercial banks. At the same time the banks would also act upon insuring the deposits of those customers who have deposited their money in the commercial bank.

No tags for this post.

Written by Uncle Sam · Filed Under Economics 

Comments

Got something to say?