<p>This is meant to add to @BKay's answer. Here are some examples that might help to see what's happening when a bank makes a loan. </p>

<h2>A bank's balance sheet</h2>

<p>The image below is text taken from Greg Mankiw's textbook <em>Macroeconomics</em> (7th edition, p. 555). This is a simplified version of a typical bank's balance sheet. Notice that reserves, loans, and securities are considered assets and that deposits, debt, and equity are considered liabilities.</p>

<p><a href="https://i.sstatic.net/hqT6S.png" rel="nofollow noreferrer"><img src="https://i.sstatic.net/hqT6S.png" alt="*Macroeconomics* (Mankiw, 7th edition, p. 555)"></a></p>

<h2>What happens when I deposit money into a bank?</h2>

<p>Now, let's first consider what happens when someone deposits money into this bank. For example, suppose someone deposits \$10. The new money goes to the vault which may then be deposited in the bank's account at the Federal Reserve (the central bank). This is a new asset. At the same time, the new deposit is a new liability. All together, this will increase the reserves of the bank by \$10 and the deposits by \$10. Both the assets and liabilities of the bank increased by \$10.</p>

<h2>What happens when a bank makes a loan?</h2>

<p>Now, what happens when a bank makes a loan? Suppose a bank makes a loan to someone for \$10. In the picture, it's clear that this will increase the amount of loans from \$500 to \$510. Now, remember that loans are considered assets. That is, the borrower has an obligation to pay the bank back. </p>

<p>But, where will the money come from? A few things can happen. One example of what could happen is the following. The bank could use its reserves. In this case, reserves would drop from \$200 to \$190. However, in a fractional reserve system, banks have reserve requirements. The ratio of reserves to deposits must stay above a certain percentage. More realistically, loans might go up by \$11 (because of interest), reserves down by \$10, and owner's equity up by \$1.</p>

<p>(However, I believe that often times, a bank might issue the loan but immediately sell the new asset to another party, while taking only a small cut.)</p>

<h2>The benefits of fractional reserve banking</h2>

<p>Economists typically agree that the fractional reserve system adds some instability to the economy. However, it also adds many great benefits as well. There is a big literature about the trade-offs here and the many functions of (fractional reserve) banking, in general. (One of the most important economic functions is that it allows us to better smooth out liquidity shocks. See an important paper by Diamond and Dybvig).</p>

<p>There is simply too much to get into here. You might consider opening a new question that specifically asks for a list of the summarized benefits. Also, check out Mishkin's Money and Banking book (undergraduate level) or <em>Microeconomics of Banking</em> by Freixas and Rochet (graduate level, but still very accessible).</p>

CC BY-SA 3.0
2016-10-24T20:13:58.537Z
Why the down votes?
jmbejara
CC BY-SA 3.0
2016-10-26T17:49:35.573Z
Maybe something todo with this: http://www.fractionalreserves.com/?page_id=81
Mick
CC BY-SA 3.0
2015-09-23T22:16:18.693Z
2015-09-23T22:26:38.837Z
2015-09-23T22:26:38.837Z
jmbejara
<p>I recommend a careful read of <a href="https://en.wikipedia.org/wiki/Fractional-reserve_banking" rel="nofollow">the Wikipedia page for Fractional-reserve banking</a> because it seems you are confused about how fractional reserve banking works.<br>
Banks only lend out money they have under fractional reserve banking and, in fact, strictly less than they have. Those funds are a mix of deposits, funds from other debt issuance, and bank equity. They don't lend out funds they don't have and they don't simply credit accounts at will in the way you suggest. When they credit a borrower's account with funds, they have to debit those funds from elsewhere on their balance sheet. So, lend-able funds go down as borrower's funds go up, and then the resulting loan is a new asset of the firm. While they do create money this way, they do so at the expense of these lone-able funds so the loaning out doesn't create new assets for the bank.</p>

CC BY-SA 3.0
2015-12-20T15:42:21.693Z
The Wiki page is wrong.  Banks are not intermediaries.  They create their own liquidity by maturity mismatching.  Also banks do not "only lend out money they have", because otherwise M2 would never be greater than MB.  This is well known by Fed officials and not a conspiracy theory.  That a balance sheet is balanced by debt and assets is not relevant as the time values changed.  Balancing 100k in reserves to 100k in deposits is completely different from balancing 100k in tbills to 100k in deposits.  Not enough space to explain all...but the original poster is more correct than you imaged.
user2662680
CC BY-SA 3.0
2015-12-20T16:37:21.607Z
I don't follow but perhaps you could elaborate in your own answer
BKay
CC BY-SA 3.0
2016-05-16T16:45:36.983Z
I'm not trying to increase confusion, but from what I've read from bank of england publications, banks do indeed create money, but not without some limitation. 

http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf

http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneyintro.pdf
An old man in the sea.
CC BY-SA 3.0
2015-05-30T00:58:15.600Z
2016-10-23T18:49:37.377Z
2016-10-23T18:49:37.377Z
BKay
<p>Economics is inherently political, so political questions and thus political answers are very appropriate.  To pretend that economics is not political is to make it an end to itself and not a means.  </p>

<p>The realistic answer to your question is that fractional banking is allowed because of a combination of factors.  </p>

<ul>
<li>Public ignorance</li>
<li>Political power of the banking sector</li>
<li>Ignorance of banking concepts by academia</li>
<li>And the lack of imagination in coming up with alternatives</li>
</ul>

<p>A derivative question of yours that was implied and is appropriate to answer is if banking is good for the common welfare of a nation.  It is not.  You will see many complicated equations and examples that obfuscate this, but the concepts are simple.  Banks issue more promises for money then they have.  These promises are errantly accepted the same as real base money and this create inflation and volitionality.  It is a system in perpetual need of assistance from central banks and would quickly collapse in a liquidity fire without their assistance.</p>

<p>Another way of looking at banks is that they engage in maturity mismatching.  They buy long term assets and borrow short term to finance this.  This is very risky.  If my short term debt is no longer rolled over (and I lost trust from investors/depositors), the game is up.  </p>

<p>So what are the alternatives?  Allow the public to hold debt-free deposits directly at the central bank.  In the USA only private banks can hold Fed deposits.  But if we allowed the public to hold deposits (and checking accounts/debit cards) with the Fed, we wouldn't need fractional deposit banking, we wouldn't need to bail it out and we wouldn't have its inflation.  Here is a proposal of how such an idea could work: <a href="http://wfhummel.cnchost.com/nationaldepositorysystem.html" rel="nofollow">http://wfhummel.cnchost.com/nationaldepositorysystem.html</a></p>

CC BY-SA 3.0
2016-02-29T01:30:13.237Z
The fact that this is downvoted is proof that SE doesn't know what it's doing.
D J Sims
CC BY-SA 3.0
2016-02-29T01:38:58.437Z
@Mustang Criticisms like this, especially one so sweeping and vague, goes into the meta discussion, not as a comment to an answer please. Taking a screenshot of the question and this answer and making a post will probably allow you to elaborate more.
Kitsune Cavalry
CC BY-SA 3.0
2016-02-29T01:56:17.420Z
Maybe you feel that way, but at least they have some sort of argument. Your comment is literally just "this is bad". Ok, why? This answer is literally just saying that fractal reserve banking is harmful because of maturity mismatching, but generally FRB is about clearing the liquidity market. Some people who don't need the money right now give it to those who want to invest, but don't have the liquidity for it. There's only so much I can write in a comment, but if you feel differently about the answer make a case for it!
Kitsune Cavalry
CC BY-SA 3.0
2018-04-27T23:00:03.940Z
To say that FRB is mainly about liquidity is astoundingly inaccurate.  If the reserve requirement is 10%, a commercial bank can create 10 times the money they hold. This is how the money supply grows.
Jason Kelley
CC BY-SA 3.0
2015-12-20T15:31:20.150Z
2015-12-20T15:31:20.150Z
user2662680
<p>A simpler way to answer this question is to say that Fractional Banking allows currency to do more work.
If I stop stuffing my savings into my mattress and bank them instead, and then the bank lends it out, then that money is doing double work.
A central bank is there to make sure this process - the creation of credit - is orderly by essentially insuring private banks.
No modern system of production based on demand can exist without it.
Either mass poverty or forced labor and forced investment are the historic alternatives.</p>

<p>The only alternative I can see is for the gov't to take over the entire insurance industry.
This would be essentially a system of Social Security for companies.</p>

CC BY-SA 4.0
2019-05-28T20:10:13.420Z
2019-05-28T20:10:13.420Z
Ray
<p>Fractional reserve banking should not be allowed. When banks create money and lend it out for profit, that process is not benign. They are engaged in counterfeiting. And just as it would be criminal for me to create money and spend it, so it should be illegal for the bank to create money and lend it out.</p>

CC BY-SA 4.0
2024-11-22T03:22:43.303Z
2024-11-22T03:22:43.303Z
Zak Young
<p>I learned about banks' fractional reserves and that revolted me. How is that not considered to be fraud? </p>

<p>The idea doesn't seem too sophisticated, on the contrary, it sounds very simple: the bank just loans money they don't even have and charges an interest rate (which is not low at all) on that virtual money. When I go to a bank to take out a loan, they will just type the amount of money in my account (but the money does not exist) and I will introduce the money into the economy (when I use that money to buy something). </p>

<p>Why are fractional reserves not considered fraud?</p>

CC BY-SA 3.0
2015-09-24T08:38:25.710Z
@Mandrill - choose an answer?
Thorst
CC BY-SA 3.0
2015-05-30T12:22:04.143Z
-1 The question asks whether a certain value judgement should apply to FRB,, something ultimately not scientific.
Michael Greinecker
CC BY-SA 3.0
2015-05-30T15:23:15.217Z
Fractional reserves generates a legal Ponzi scheme in the economy. [look this](http://wiki.mises.org/wiki/Criticism_of_fractional_reserve_banking)
Mandrill
CC BY-SA 3.0
2015-05-30T16:05:24.240Z
So you have no real question and just want to make a political statement? I vote to close.
Michael Greinecker
CC BY-SA 3.0
2015-05-30T16:17:45.293Z
my real question is "Why fractional reserve banking is not considered fraud?". Do you know the answer? Thank you.
Mandrill
CC BY-SA 3.0
2015-05-30T16:35:16.540Z
Why should it? Btw: I'm an Austrian economicst. Much more Austrian than Rothbard.
Michael Greinecker
CC BY-SA 3.0
2015-05-30T18:18:47.540Z
It is not considered fraud because I do not consider it fraud. Mandrill, could you please be a little more specific in your question? E.g. "do fractional reserves cause inflation" or "do the social costs of allowing f.r. outweigh the social benefits" or "why are f.r. not against law number xxx/yyy"?
Giskard
CC BY-SA 3.0
2015-05-30T19:18:38.027Z
**This question is not off topic, nor should it be closed for being primarily  opinion based**. Guys, please read the labels: Primarily opinion based as reason for closing is w.r.t. the answers that you get. Yes, this question is opinion based, and some of the premises may be false. That doesn't necessarily make it a bad question. It is very possible to write a good and neutral answer to this, something along the comment that @denesp just made.
FooBar
CC BY-SA 3.0
2015-05-30T19:21:59.780Z
If this a genuine question, i'll put an answer up - the short answers are: pretty much every description you'll read of FRB is wrong to varying degrees, any description with the word ponzi in it is completely wrong, money is being created and destroyed by FRB, banks live off interest, and legacy system. Plus, it kinda sorta works - and we built an advanced technological and scientific civilisation with it in about 300 years, so unless you have any better ideas, we're stuck with it. Legacy systems. If you're a maintenance engineer I would imagine you know all about them :)
Lumi
CC BY-SA 3.0
2015-05-30T19:59:09.143Z
@FooBar If the question is on-topic, why did you change it to something that was clearly not the original question? Op restated in a comment that his question is why reserve banking is not considered fraud. Obviously, whether on considers it fraud or not is inherently opinion-based. Your new question might prompt a political economy explanation from a neo-Misesian.
Michael Greinecker
CC BY-SA 3.0
2015-05-31T17:33:24.697Z
@FooBar Even in the new form I don't know how to answer the question. Why would it be fraud?
Giskard
CC BY-SA 3.0
2015-05-31T17:37:51.223Z
@denesp I think OP's premise *the bank just loan money they don't even have and charges interest rate (which is not low at all) on that virtual money.* clearly implies a "fraudulent"/unethical situation. Challenging this premise or arguing what advantages of fractional reserve banking justify this situation should be key to answering/rectifying the question.
FooBar
CC BY-SA 3.0
2015-05-31T18:02:04.867Z
@FooBar I just don't see the effort on the OP's part. What exactly does he mean when says the bank loans money that it does not have? I don't think that is what is happening. Formulating the question in the right way would probably give him the answer.
Giskard
<money-supply><banking>
Why is fractional reserve banking allowed?
Mandrill
# Why is fractional reserve banking allowed?

(Asked by: username_0 on 2015-05-29)

I learned about banks' fractional reserves and that revolted me. How is that not considered to be fraud?

The idea doesn't seem too sophisticated, on the contrary, it sounds very simple: the bank just loans money they don't even have and charges an interest rate (which is not low at all) on that virtual money. When I go to a bank to take out a loan, they will just type the amount of money in my account (but the money does not exist) and I will introduce the money into the economy (when I use that money to buy something).

Why are fractional reserves not considered fraud?

**Tags:** money-supply, banking

> **Comments:**
> **username_2**: -1 The question asks whether a certain value judgement should apply to FRB,, something ultimately not scientific.  
> **username_0**: Fractional reserves generates a legal Ponzi scheme in the economy. [look this](http://wiki.mises.org/wiki/Criticism_of_fractional_reserve_banking)  
> **username_2**: So you have no real question and just want to make a political statement? I vote to close.  
> **username_0**: my real question is "Why fractional reserve banking is not considered fraud?". Do you know the answer? Thank you.  
> **username_2**: Why should it? Btw: I'm an Austrian economicst. Much more Austrian than Rothbard.  
> **username_3**: It is not considered fraud because I do not consider it fraud. username_0, could you please be a little more specific in your question? E.g. "do fractional reserves cause inflation" or "do the social costs of allowing f.r. outweigh the social benefits" or "why are f.r. not against law number xxx/yyy"?  
> **username_4**: **This question is not off topic, nor should it be closed for being primarily  opinion based**. Guys, please read the labels: Primarily opinion based as reason for closing is w.r.t. the answers that you get. Yes, this question is opinion based, and some of the premises may be false. That doesn't necessarily make it a bad question. It is very possible to write a good and neutral answer to this, something along the comment that @denesp just made.  
> **username_5**: If this a genuine question, i'll put an answer up - the short answers are: pretty much every description you'll read of FRB is wrong to varying degrees, any description with the word ponzi in it is completely wrong, money is being created and destroyed by FRB, banks live off interest, and legacy system. Plus, it kinda sorta works - and we built an advanced technological and scientific civilisation with it in about 300 years, so unless you have any better ideas, we're stuck with it. Legacy systems. If you're a maintenance engineer I would imagine you know all about them :)  
> **username_2**: @username_4 If the question is on-topic, why did you change it to something that was clearly not the original question? Op restated in a comment that his question is why reserve banking is not considered fraud. Obviously, whether on considers it fraud or not is inherently opinion-based. Your new question might prompt a political economy explanation from a neo-Misesian.  
> **username_3**: @username_4 Even in the new form I don't know how to answer the question. Why would it be fraud?  
> **username_4**: @denesp I think OP's premise *the bank just loan money they don't even have and charges interest rate (which is not low at all) on that virtual money.* clearly implies a "fraudulent"/unethical situation. Challenging this premise or arguing what advantages of fractional reserve banking justify this situation should be key to answering/rectifying the question.  
> **username_3**: @username_4 I just don't see the effort on the OP's part. What exactly does he mean when says the bank loans money that it does not have? I don't think that is what is happening. Formulating the question in the right way would probably give him the answer.  
> **username_1**: @username_0 - choose an answer?  

---

## 5 answers

### Answer by username_8 on 2015-05-30. Score: 12

I recommend a careful read of [the Wikipedia page for Fractional-reserve banking](https://en.wikipedia.org/wiki/Fractional-reserve_banking) because it seems you are confused about how fractional reserve banking works.  
Banks only lend out money they have under fractional reserve banking and, in fact, strictly less than they have. Those funds are a mix of deposits, funds from other debt issuance, and bank equity. They don't lend out funds they don't have and they don't simply credit accounts at will in the way you suggest. When they credit a borrower's account with funds, they have to debit those funds from elsewhere on their balance sheet. So, lend-able funds go down as borrower's funds go up, and then the resulting loan is a new asset of the firm. While they do create money this way, they do so at the expense of these lone-able funds so the loaning out doesn't create new assets for the bank.

> **Comments:**
> **username_9**: The Wiki page is wrong.  Banks are not intermediaries.  They create their own liquidity by maturity mismatching.  Also banks do not "only lend out money they have", because otherwise M2 would never be greater than MB.  This is well known by Fed officials and not a conspiracy theory.  That a balance sheet is balanced by debt and assets is not relevant as the time values changed.  Balancing 100k in reserves to 100k in deposits is completely different from balancing 100k in tbills to 100k in deposits.  Not enough space to explain all...but the original poster is more correct than you imaged.  
> **username_8**: I don't follow but perhaps you could elaborate in your own answer  
> **username_10**: I'm not trying to increase confusion, but from what I've read from bank of england publications, banks do indeed create money, but not without some limitation.   http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf  http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneyintro.pdf  

---

### Answer by username_6 on 2015-09-23. Score: 6

This is meant to add to @username_8's answer. Here are some examples that might help to see what's happening when a bank makes a loan.

## A bank's balance sheet

The image below is text taken from Greg Mankiw's textbook *Macroeconomics* (7th edition, p. 555). This is a simplified version of a typical bank's balance sheet. Notice that reserves, loans, and securities are considered assets and that deposits, debt, and equity are considered liabilities.

[![*Macroeconomics* (Mankiw, 7th edition, p. 555)](https://i.sstatic.net/hqT6S.png)](https://i.sstatic.net/hqT6S.png)

## What happens when I deposit money into a bank?

Now, let's first consider what happens when someone deposits money into this bank. For example, suppose someone deposits \$10. The new money goes to the vault which may then be deposited in the bank's account at the Federal Reserve (the central bank). This is a new asset. At the same time, the new deposit is a new liability. All together, this will increase the reserves of the bank by \$10 and the deposits by \$10. Both the assets and liabilities of the bank increased by \$10.

## What happens when a bank makes a loan?

Now, what happens when a bank makes a loan? Suppose a bank makes a loan to someone for \$10. In the picture, it's clear that this will increase the amount of loans from \$500 to \$510. Now, remember that loans are considered assets. That is, the borrower has an obligation to pay the bank back.

But, where will the money come from? A few things can happen. One example of what could happen is the following. The bank could use its reserves. In this case, reserves would drop from \$200 to \$190. However, in a fractional reserve system, banks have reserve requirements. The ratio of reserves to deposits must stay above a certain percentage. More realistically, loans might go up by \$11 (because of interest), reserves down by \$10, and owner's equity up by \$1.

(However, I believe that often times, a bank might issue the loan but immediately sell the new asset to another party, while taking only a small cut.)

## The benefits of fractional reserve banking

Economists typically agree that the fractional reserve system adds some instability to the economy. However, it also adds many great benefits as well. There is a big literature about the trade-offs here and the many functions of (fractional reserve) banking, in general. (One of the most important economic functions is that it allows us to better smooth out liquidity shocks. See an important paper by Diamond and Dybvig).

There is simply too much to get into here. You might consider opening a new question that specifically asks for a list of the summarized benefits. Also, check out Mishkin's Money and Banking book (undergraduate level) or *Microeconomics of Banking* by Freixas and Rochet (graduate level, but still very accessible).

> **Comments:**
> **username_6**: Why the down votes?  
> **username_7**: Maybe something todo with this: http://www.fractionalreserves.com/?page_id=81  

---

### Answer by username_9 on 2015-12-20. Score: 2

Economics is inherently political, so political questions and thus political answers are very appropriate. To pretend that economics is not political is to make it an end to itself and not a means.

The realistic answer to your question is that fractional banking is allowed because of a combination of factors.

* Public ignorance
* Political power of the banking sector
* Ignorance of banking concepts by academia
* And the lack of imagination in coming up with alternatives

A derivative question of yours that was implied and is appropriate to answer is if banking is good for the common welfare of a nation. It is not. You will see many complicated equations and examples that obfuscate this, but the concepts are simple. Banks issue more promises for money then they have. These promises are errantly accepted the same as real base money and this create inflation and volitionality. It is a system in perpetual need of assistance from central banks and would quickly collapse in a liquidity fire without their assistance.

Another way of looking at banks is that they engage in maturity mismatching. They buy long term assets and borrow short term to finance this. This is very risky. If my short term debt is no longer rolled over (and I lost trust from investors/depositors), the game is up.

So what are the alternatives? Allow the public to hold debt-free deposits directly at the central bank. In the USA only private banks can hold Fed deposits. But if we allowed the public to hold deposits (and checking accounts/debit cards) with the Fed, we wouldn't need fractional deposit banking, we wouldn't need to bail it out and we wouldn't have its inflation. Here is a proposal of how such an idea could work: <http://wfhummel.cnchost.com/nationaldepositorysystem.html>

> **Comments:**
> **username_11**: The fact that this is downvoted is proof that SE doesn't know what it's doing.  
> **username_12**: @Mustang Criticisms like this, especially one so sweeping and vague, goes into the meta discussion, not as a comment to an answer please. Taking a screenshot of the question and this answer and making a post will probably allow you to elaborate more.  
> **username_12**: Maybe you feel that way, but at least they have some sort of argument. Your comment is literally just "this is bad". Ok, why? This answer is literally just saying that fractal reserve banking is harmful because of maturity mismatching, but generally FRB is about clearing the liquidity market. Some people who don't need the money right now give it to those who want to invest, but don't have the liquidity for it. There's only so much I can write in a comment, but if you feel differently about the answer make a case for it!  
> **username_13**: To say that FRB is mainly about liquidity is astoundingly inaccurate.  If the reserve requirement is 10%, a commercial bank can create 10 times the money they hold. This is how the money supply grows.  

---

### Answer by username_14 on 2019-05-28. Score: 2

A simpler way to answer this question is to say that Fractional Banking allows currency to do more work.
If I stop stuffing my savings into my mattress and bank them instead, and then the bank lends it out, then that money is doing double work.
A central bank is there to make sure this process - the creation of credit - is orderly by essentially insuring private banks.
No modern system of production based on demand can exist without it.
Either mass poverty or forced labor and forced investment are the historic alternatives.

The only alternative I can see is for the gov't to take over the entire insurance industry.
This would be essentially a system of Social Security for companies.


---

### Answer by username_15 on 2024-11-22. Score: 0

Fractional reserve banking should not be allowed. When banks create money and lend it out for profit, that process is not benign. They are engaged in counterfeiting. And just as it would be criminal for me to create money and spend it, so it should be illegal for the bank to create money and lend it out.


---

