Digital Industrial Park

The bank on your corner is an interesting place. They employ a system called Fractional Reserve Banking which, to a reasonably honest person, seems dishonest but is entirely legal.

This crafty system, first devised by seventeenth century goldsmiths who discovered that only about 10% of the population actually asked for their money at any given time, allows banks to lend $1000 for every $100 on deposit (a 9-1 ratio).

It gets interesting from time of deposit so follow closely; a bank receives a deposit of $100 and can loan out $90 of that deposit. If the borrower writes a check for $90 to someone who deposits it, the bank receiving it can now lend out $81. As the process continues, the banking system can expand the initial deposit of $100 into a maximum of $1000.

But don’t these funds belong to the people who deposited the money and expect it to be available at all times? Yes. The loan money, you could say, is counterfeited. Or you could say that’s just the way it works.

If you are baffled by this, you may want to read through the Chicago Federal Reserve’s, “Modern Money Mechanics“.

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Musings banking, fractional reserve, lending