4 replies to this topic

[Murphy]

What is fractional reserve banking?

[Murphy]

Mart Grams, on Aug 5 2008, 07:22 PM, said:

Fraction reserve banking is when the bank does not keep all the money deposited by depositors, but rather uses some of those deposits (excess reserves) to create loans or to use that money to purchase securities, stocks, etc with another's money. This is consisered okay as long as not everyone asks for full redemption. However, if allowed to get out-of-hand runs on the bank can soon bankrupt it. However, recently, through law and pressure most depositors find they cannot get control through runs...especially if the bank is large "too big to fail!"

Well, I'm not sure what you mean by the last part. People can withdraw their money if they want; the FDIC ultimately guarantees it (up to $100,000 per checking account). But you're right, the effect of these laws is to discourage people from running on their banks, which in turn removes the key thing keeping banks from being too risky.

[Murphy]

Mart Grams, on Nov 8 2008, 11:00 AM, said:

What I meant was that if we can withdraw and bankrupt it, but the Fed bails them out by replacing the withdrawn deposits, doesn't that keep banks from being too risky?

It allows the banks to be riskier than they otherwise would be. I think that's what you're saying, but you wrote the opposite.