Fractional Reserve Banking in 2022, Is Your Money Safe?
What is Fractional Reserve Banking
This should be a familiar scenario: you go to your bank to make a deposit, hand the cash over to the teller and walk out thinking that your money is safe in the building. But actually, not all your money goes straight into a secure vault, not even half. If you didn’t know this, you’re not the only one. A study found that 26 percent of people believe banks are required to hold 100 percent of customer deposits in reserves. So, where does it go, and why? What are the risks involved? Here’s what you need to know about fractional reserve banking.
Fractional reserve banking is a banking system in which banks only hold a fraction of the money deposited as reserves. This means only a fraction of the bank deposits are backed by actual cash on hand and are available for withdrawal. With this system, the portion of money not considered as reserves can then loaned out by banks to other parties.
The reserve ratio is often determined and regulated by the government and/or bank policies. So for example, if you deposit $100 to your bank and it is required to keep 10 percent of your deposit as a reserve, then the bank can use $90 to make loans.
What’s interesting is that under this premise, banks can create new money out of base deposits through debt. Taking the example above, when the bank loans out the remaining $90 from your initial deposit then it adds $90 to the money supply.
When the borrower deposits the $90 to the bank, the same process will apply. The bank can keep $9 and the remaining $81 can be loaned out once again and is added into the money supply. This can happen several times and is called the multiplier effect.
The Problem with Fractional Reserve Banking
The existing bank system, fractional reserve, is inherently risky because it involves accepting deposits while lending out about as much money as has been deposited, and telling depositors their money is safe, which it quite clearly is not and for the simple reason that if a bank makes silly loans, it cannot repay depositors.
That problem is currently dealt with via taxpayer backed deposit insurance and billion dollar bail outs for banks. But that state support for banks amounts to preferential treatment for banks relative to other lenders, of which there are several: e.g. peer to peer lenders and trade credit lenders to name just two. That preferential treatment for one type of lender is a misallocation of resources. Second, having a bank lend on your money is just as much a commercial transaction as having a stockbroker lend on or invest your money. It is not to job of taxpayers to shield those involved in commerce from loss, unless there is an extremely good reason for doing so. Which in this case there is not.
As for the idea which has become popular of late, namely that commercial banks create the money they lend on rather than intermediate between lenders and borrowers, that is not entirely true as was explained in a Bank of England article (McLeay, 2014). The best solution to the above two flaws in fractional reserve is to abandon all state support for banks while letting those who want their money to be totally safe deposit it with the state, something the people in several countries have actually been free to do for a long time anyway. And that arrangement equals full reserve banking.
Perhaps the main drawback of fractional reserve banking is the multiplier effect. While it increases the money supply, it does not necessarily increase the wealth of the economy. This is because while borrowers get more money, they are also taking in more debt meaning they are not richer than they were before. Apart from this, the multiplier effect also causes a massive increase in inflation. When the money supply in an economy goes up, prices rise as well which affects financial stability.
What’s more, the fractional reserve system puts banks at a constant risk of bank runs since they only keep 10 percent of the money people have deposited. Once depositors wish to withdraw funds that are greater than the reserves held at the bank, these financial institutions can collapse.
The Morality of Fractional Reserve Banking
One of American Economists’, Murray Rothbard’s doctrines is that fractional reserve banking (i.e. virtually all banking with which First World consumers have any direct experience) is inherently fraudulent and should therefore be illegal. As he puts it in The Mystery of Banking, It should be clear that modern fractional reserve banking is a shell game, a Ponzi scheme, a fraud in which fake warehouse receipts are issued and circulate as equivalent to the cash supposedly represented by the receipts.
If “the bank can lend out your money to other people” is not part of the “common definition” of a bank account, what is? Almost no banking institution offer what is called the 100% reserve option – called safe deposit boxes.
Safe Deposit Boxes Can Guard Your Wealth
Now the question for most people is that under the system of fractional reserve banking, is your money safe in commercial banks? The quick answer is it’s not always safe. The current system is open to risks of varying degrees. There are mild risks like loans not getting paid back or banks going under but there are also severe risks like currency collapse, banking crises, or even civil war.
To prevent the modern banking system from jeopardizing your wealth, it’s important to diversify your assets. Apart from investing in stocks and bonds, you may also invest in commodities like gold, silver, and precious gems. If you’re worried about keeping these physical assets safe from theft, natural disasters, and damage, then the best option for you are safe deposit boxes.
Service providers like Private Vaults Australia are an independent safe deposit box facility that offers complete discretion, unparalleled security, and absolute peace of mind to its clients. Conveniently located Unit 3, 73 Redcliffe Parade and Baker Street, Redcliffe Old 4020, it offers a wide range of services for people who are in need of vault storage options in Australia.
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2 Months Free, No long term commitment necessary.* Limited spots available.