• Silicon Valley Bank recently suffered a $42 billion bank run, raising questions about the dangers of fractional-reserve banking.
• Fractional reserve banking is a system that only holds a fraction of deposits, with the remaining funds loaned out or invested.
• In the US, fractional-reserve banking has been linked to numerous financial crises and instability in the past century, culminating in the Great Depression.
What is Fractional Reserve Banking?
Fractional reserve banking (FRB) is a system of bank management that only holds a fraction of bank deposits, with the remaining funds invested or loaned out to borrowers. FRB operates in nearly every country worldwide and became widely prominent during the 19th century in America with the passage of the National Banking Act. There is debate on whether fractional lending occurs these days as some believe it is printed out of thin air.
History of FRB in USA
Prior to FRB becoming widely used, banks operated with full reserves meaning they held 100% of their depositors‘ funds in reserve. The practice spread significantly after 1863 when America’s banking charter system was created and later led to occasional bank failures and financial crises after World War I. To fix this issue, U.S. President Franklin D Roosevelt initiated the Banking Act 1933 to restore trust in the system resulting from multiple issues related to FRB prior to this time period.
Dangers Associated with Fractional Reserve Banking
The recent ordeal at Silicon Valley Bank (SVB) has brought renewed attention to risks associated with fractional-reserve banking such as economic instability and bank runs which were highlighted by popular movie „It’s A Wonderful Life“. Furthermore there are myths associated with modern banking based on a paper called „Money Creation in The Modern Economy“ written by Bank Of England which can be read here by economist Robert Murphy who also discussed these myths more broadly in his book “Understanding Money Mechanics” .
Conclusion
Fractional reserve banking continues to be used around the world but risks associated with it must not be underestimated as was seen recently at SVB where customers attempted to withdraw $42 billion from it causing significant panic among them leading many people realize how dangerous it can be for economy & financial stability if not managed properly & efficiently .
References
1) Murphy Robert: Understanding Money Mechanics 2) Money creation modern economy: Bank Of England