How money is being created: The Fractional Reserve Banking System
ON FRACTIONAL RESERVE BANKING SYSTEM
Fractional Reserve banking system is a system that is designed whereby every bank is expected to hold a small portion of your money in bank reserves while lending out the rest.
This system allows the bank to lend your money while still showing your funds sitting in the bank. Whenever you deposit funds in a bank, that money is available for withdrawal whenever you need it. But that doesn’t mean all of your cash is actually in the bank’s immediate possession. Hmm…
Are you surprised? Let’s continue.
It’s important to note that this system was created to ensure regular supply of money and to help grow the economy.
However, this system creates “double” money. What this means is for example. If I deposit 10,000naira in my bank. And Bank is allowed to keep only 10% as reserve this means they would lend out 90% of my money.
So what we have is my 10,000 deposit
Bank lend out 90% of my 10,000= #9000.
So in reality I am seeing a credit of #10,000 which is electronic figure whereas the bank has given out #9000 from my money as loan. So what I am just seeing is figures.
Now in the economy, what we have is my #10,000 and #9000 which is total of #19,000.
So new money have been created.
Then the cycle continues. So as we know, the bank will pay the #9000 into the borrower’s bank as loan.
Then the borrowers bank, lends 90% of #9000 = #8,100.
Now it is vital to note that in all this, you can still access your funds. Surprised?
So let’s see what we have now. We have my #10,000, #9000, #8100… and the circle continues.
Now, in United States, the Federal Reserve dropped the Cash Reserve Requirements to Zero in March 26, 2020.
What this means is that the moment you deposit your money, bank is allowed to give out everything as loan. So a lot of money is being created or like we say money is being printed out of thin air.
Now in Nigeria, CBN increased the cash reserve from 5% to 27.5%, while mandating banks to lend out 65% of all money deposited. Meanwhile this new development didn’t go down well with banks, however when banks fail to meet up, they pay huge charges.
LET’S TAKE A LOOK AT THE DANGERS OF THE FRACTIONAL RESERVE BANKING SYSTEM.
It’s important to note that the reason why this system has been successful is because we all don’t need access to our money at the same time. The day we will all do, we would realize how much debt our financial system is in. When a bank fails, what do you think will happen to your money since there is no cash reserve.
