It is a banking system where only a fraction of the bank deposits are backed by cash at hand and are also available for withdrawal. The rest of the money is used by the bank as loans creating new money in the economy. The commercial banks are given the power to affect money flow with some banks being in charge of money supply in the economy. All this is done to expand the country’s economy by freeing capital to be loaned out to other people.

How does fractional reserve banking work?

As explained above, banks are required by the federal reserve to keep a particular amount of cash deposited in hand for withdrawal purposes. This means if someone banks a million dollars, the bank can’t lend out the whole amount. However, the bank is also not required to keep the whole amount either. Most of the banks are required to keep 10 per cent of the deposits as reserves. The reserves requirement is set by the Federal Reserve and it’s one of the tools that the Feds use to implement their numerous money policies. If the Feds increase the reserve requirement for the banks, they take out money from the economy while decreasing pumps money into the economy.

What are the fractional reserve requirements?

There are banks exempt from holding reserves but all banks are paid a percentage of interest on their reserves. The interest rates on reserve act as an incentive for banks to keep excess reserves and earn more. If a bank in the US has less than 15.2 million dollars in assets, it isn’t required to keep reserves. The banks with assets worth less than 110.2 million dollars but more than 15.2 million dollars must have a 3 per cent reserve and those with more than 110.2 million dollars are required to have a 10 per cent requirement.

Fractional reserve banking and cryptocurrency

The dynamics of fractional reserve banking and the role of a central bank like the Federal Reserve doesn’t fully apply to crypto. First, because cryptoassets are self-managed and decentralized and they don’t require a central bank to govern them. Second, there is no need for a centralized institution to act as an intermediate or facilitate transactions in the cryptoassets world. Lastly, in cryptoassets, you don’t need a deposit. Your digital assets security measures are enough to secure large or small amounts making the bank security unnecessary.