Fractional Reserve Banking

Fractional reserve banking is the system in which banks hold only a fraction of customer deposits in reserve and lend out the remainder. The lending multiplies the money supply, since deposits are created faster than base money. Since March 2020 the US has set formal reserve requirements at zero, relying on capital and liquidity rules instead.

Why it matters

Fractional reserves are why bank deposits are not money in a vault but claims on a portfolio of loans. The system funds mortgages and businesses efficiently, but it is inherently exposed to runs: if enough depositors demand cash at once, no fractional reserve bank can pay, however sound its loans. That fragility produced recurring panics, and the modern responses to it, deposit insurance and central bank lending of last resort, socialize the risk rather than remove it, as the March 2023 failure of Silicon Valley Bank demonstrated when uninsured depositors fled in hours. Understanding the mechanism explains both the elasticity of modern money and its recurring crises.

In the gold vs bitcoin debate

Historically, fractional reserves were built on top of gold: banks issued more notes than they held metal, and runs revealed the gap. Bitcoin's design is a direct response, since self-custodied coins are a bearer asset with no issuer to run on, and the phrase not your keys, not your coins warns against recreating fractional claims on exchanges. Gold and bitcoin share this critique of banking; they differ on whether the escape hatch should be physical or digital. Full-reserve custody, whether of metal or of coins, is the alternative both communities practice.