In a fractional reserve banking system, banks keep only a fraction of deposits in reserve, lending out the rest to earn interest and stimulate economic activity. This model has evolved over centuries, with regulations and safeguards ensuring banks hold enough in reserve to meet withdrawal demands. Yet, the balance between lending profits and deposit safety is delicate and constantly shaped by monetary policy, oversight, and the overall financial climate. --- **Three Key Points** 1. **Reserves vs. Lending** Banks do not hold all deposited funds in their vaults. They retain a specific percentage as reserves (the ‘fraction’) and lend out the remainder to businesses, home-buyers, or other borrowers, contributing to the money supply. 2. **Money Creation Effect** Each loan a bank makes is effectively creating new money in the economy. As borrowers deposit the funds into other accounts, banks can again lend a portion of those fresh deposits, further magnifying overall liquidity. 3. **Risk and Regulation** Because banks hold only a fraction of deposits on hand, there is always some risk of a ‘run on the bank’. Governments counter this risk by imposing reserve requirements, overseeing banks through central banking policies, and offering deposit insurance schemes, helping maintain public trust. --- **So What?** Fractional reserve banking has enabled vast economic growth by mobilising idle funds for lending and investment. However, the system’s reliance on confidence — both in individual banks and in the financial system at large — highlights why prudent management, regulatory checks, and stable monetary frameworks are vital. Understanding these fundamental mechanics helps us appreciate both the power and the fragility of modern banking.