fractional reserve banking

Fractional reserve banking

A right given by the government for banks to issue out credit to borrowers using their depositor's money while setting aside only a fraction of the total deposits in cold hard cash to use as payments when depositors demanded their deposits. This activity increases the money supply and provides relief at times when liquidity is drying up. Let's say there is only a single $1 bill in the room and you are playing as the banker and you lend your sister $1. That $1 is your asset loaned out to your sister, but then your sister exchanged that $1 bill for a carrot your brother grew in the backyard. Your brother deposited that $1 bill to the banker which is you. You now have $2 in assets even if there is only a single $1 bill in the room you guys were playing. Now your sister borrowed another dollar from you so she could buy more carrots. You gave her the only physical dollar bill in the room but at the same time your brother demanded his $1 bill. You would suffer a shortage if you don't print out that extra dollar bill since the only physical cash is in the hands of your sister. There is another player in the room which is your cousin who plays as the monetary authority where you could get a newly printed dollar bill. Your cousin injected that extra bill in your game which is either your reserves or the central bank somehow "created" new cash to provide liquidity, so there are now 2, $1 bills in circulation which totaled to the exact amount of your assets at $2. This goes on forever until money is multiplied several times requiring you to inject more printed bills which only started with $1.

Back to our banking activities, You used that money you borrowed from the bank to fund your business. The merchant who receives the money deposits it to another bank. The bank received 80 million in new deposits, that new deposit acts as both asset and liability.

Fractional reserve banking

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