Fractional-reserve banking is the banking practice in which a bank lends out most of the funds deposited and keeps the remaining fraction in reserve (as cash and other highly liquid assets), while simultaneously maintaining the obligation to redeem all deposits upon demand.[1][2] Fractional reserve banking necessarily occurs when banks lend out funds received from deposit accounts, and is practiced by all modern commercial banks.
The practice of fractional reserve banking expands the money supply (cash and demand deposits) beyond what it would otherwise be. Due to the prevalence of fractional reserve banking, the broad money supply of most countries is a multiple larger than the amount of base money created by the country's central bank. That multiple (called the money multiplier) is determined by the reserve requirement or other financial ratio requirements imposed by financial regulators, and by the excess reserves kept by commercial banks.
Criticisms of fractional-reserve banking have been put forward from a variety of perspectives. Critics have included mainstream economists such as Irving Fisher,[1] Frank Knight[2] and Milton Friedman.[3] However, few if any mainstream economists now endorse such views.[citation needed] Within the economics profession, most criticisms are based upon non-mainstream economic theories such as those of the Austrian School.[4] There are also critics from outside the economics profession, such as Frederick Soddy,[5] who have advocated for a full reserve banking system.
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