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Full-Reserve Banking Versus Fractional-Reserve Banking

Full-Reserve Banking Versus Fractional-Reserve Banking:

Economists are engaged in a debate regarding Full-Reserve Banking (100% reserve banking) versus Fractional-Reserve Banking.

  • While both systems have their proponents and critics, understanding the key differences between them is crucial in assessing their potential impact on economic growth and financial stability.

Full-Reserve Banking:

  • Under full-reserve banking, banks are strictly prohibited from lending out demand deposits received from customers reducing the risk of bank runs.
  • Instead, they must always hold 100% of these deposits in their vaults, acting merely as custodians.
  • Banks serve as safekeepers of depositors’ money, charging fees for this service.
  • Banks can only lend money received as time deposits.

Fractional-reserve banking

  • This system, currently in practice, allows banks to lend more money than the cash they hold in their vaults.
  • This system relies heavily on electronic money for lending.
  • Bank runs are a potential risk if many depositors simultaneously demand cash.
  • However, central banks can provide emergency cash to avert immediate crises.