Educate me about Fractional Reserve System

[J_White]

I am trying to understand the fractional reserve system.
This is one video which seems to depict it clearly.



So it basically means that banks are running at a profit of about 900+ % ?
At reserve rate of 10%, if they have assets or deposits of 1m, then they can lend out another 9m, just out of thin air and earn interest on all of it ?
I also read somewhere that since the reserve rate is even lower, say 3%, then the effect is much larger ?
why is this considered a fair system ? why not have higher reserve ratios ?

 

[ronpaulfollower999]

If you deposit $10,000 into a bank, they can loan out up to 90% of that...or $9,000, but they have to keep the other 10% of that ($1,000) on reserve at the bank. This is called the Reserve Ratio, and it is set by the Federal Reserve. The Fed rarely changes the Reserve Ratio requirement, and it currently sits at 10% for major financial institutions.

http://www.federalreserve.gov/monetarypolicy/reservereq.htm

 

[robert68]

..

 

[Athan]

If you deposit $10,000 into a bank, they can loan out up to 90% of that...or $9,000, but they have to keep the other 10% of that ($1,000) on reserve at the bank. This is called the Reserve Ratio, and it is set by the Federal Reserve. The Fed rarely changes the Reserve Ratio requirement, and it currently sits at 10% for major financial institutions.

http://www.federalreserve.gov/monetarypolicy/reservereq.htm

Yes that is the reserve ratio, but that is not fractional reserve banking. It means that once they loan out that 9,000 dollars from 10,000 they can report to have MORE in reserve than that 1,000 dollars. They can say they have actually 1,500 in reserve (they don't). That means they have a FRACTION of the reported reserve.

 

[ClydeCoulter]

Yes that is the reserve ratio, but that is not fractional reserve banking. It means that once they loan out that 9,000 dollars from 10,000 they can report to have MORE in reserve than that 1,000 dollars. They can say they have actually 1,500 in reserve (they don't). That means they have a FRACTION of the reported reserve.

And then, that 9,000 loaned out goes somewhere, maybe into a bank where they can loan out 90% of that...on & on...

 

[fisharmor]

why is this considered a fair system ?

Who said anything about fair?
I've never heard anyone claim this is morally correct. I've heard claims that this allows society to do things that otherwise wouldn't be possible (which is itself bullshit even on the surface), but I've never heard anyone claim it was right.

 

[FindLiberty]

Jump to 00:01:15 and then sit back for a scary ride:

 

[Zippyjuan]

Yes that is the reserve ratio, but that is not fractional reserve banking. It means that once they loan out that 9,000 dollars from 10,000 they can report to have MORE in reserve than that 1,000 dollars. They can say they have actually 1,500 in reserve (they don't). That means they have a FRACTION of the reported reserve.

Let's run through an example of what happens with money in a fractional reserve form of banking.

I earn or otherwise get $!0,000. I don't need to spend this money right now but may want it later so I loan it to the bank (open an account and deposit the money with them). The bank has a reserve requirement where they are requilred to keep ten percent of their deposits on hand- this is the "fractional reserve" they are required to keep and where the term comes from. That means they can loan out up to $9000 of that money. I had $10,000 but now have none. The bank has $10,000 and I have an IOU from the bank for that amount.

Bill decides he needs some money so he goes to the bank and asks them for a loan. He takes out $9000- the maximum the bank can currently loan out. Now the money is as follows:
I have no money but am owed $10,000.
The bank has $1000 but owes me $10,000.
Bill has $9000 and owes the bank $9,000. Money supply is still $10,000.

Bill decides to wait on his purchase so he puts the $9000 in the bank for a while. He has created a deposit for $9,000. The bank gives him an IOU for the amount. He is currently neutral- he owes the bank $9,000 but they also owe him $9,000. Now the bank can make a loan against that deposit. With a ten percent reserve requirement, they can now loan out an additional $8100- keeping $900 on reserve. Carl comes along and wants to borrow money so he takes out that $8100 in a loan. He takes the money and gives the bank an IOU.

This is the current money status:
I have no money but am owed $10,000.
Bill has no money but owes and is owed $9,000.
Carl has $8100 and the bank has $1,900. Total money is still $10,000. Debt has grown but the money supply hasn't.

Things get messed up when somebody decides to take their money out of the bank. Bill decides to close out that deal on the car he wanted so he takes out his $9,000. But the bank doesn't have it. They can't make money out of nothing so they have to get it from someplace. That can be by borrowing money from another bank. Or attracting in another $9,000 in deposits. Or they can borrow money from the Federal Reserve. Or they can call in an outstanding loan. They bank will also have more out in loans than their deposits allow- they have gone below their reserve requirement. They cannot make any loans until that is fixed. Giving Bill his money temporariliy increases the money supply but the bank borrowing (or taking in more deposits which is also borrowing) shrinks it back down again.

 

[Zippyjuan]

What would be the alternatitves to a fractional reserve banking system? That would be either a no- reserve or a full- reserve banking system. In a no- reserve banking system, there would be no restrictions on how much a bank could loan out- up to 100% of all of their deposits. In a full- reserve banking system, a bank must keep 100% of all deposits on hand and will not be able to loan out any of them. Anything in between would be a form of fractional reserve banking.

 

[J_White]

Let's run through an example of what happens with money in a fractional reserve form of banking.

I earn or otherwise get $!0,000. I don't need to spend this money right now but may want it later so I loan it to the bank (open an account and deposit the money with them). The bank has a reserve requirement where they are requilred to keep ten percent of their deposits on hand- this is the "fractional reserve" they are required to keep and where the term comes from. That means they can loan out up to $9000 of that money. I had $10,000 but now have none. The bank has $10,000 and I have an IOU from the bank for that amount.

Bill decides he needs some money so he goes to the bank and asks them for a loan. He takes out $9000- the maximum the bank can currently loan out. Now the money is as follows:
I have no money but am owed $10,000.
The bank has $1000 but owes me $10,000.
Bill has $9000 and owes the bank $9,000. Money supply is still $10,000.

Bill decides to wait on his purchase so he puts the $9000 in the bank for a while. He has created a deposit for $9,000. The bank gives him an IOU for the amount. He is currently neutral- he owes the bank $9,000 but they also owe him $9,000. Now the bank can make a loan against that deposit. With a ten percent reserve requirement, they can now loan out an additional $8100- keeping $900 on reserve. Carl comes along and wants to borrow money so he takes out that $8100 in a loan. He takes the money and gives the bank an IOU.

This is the current money status:
I have no money but am owed $10,000.
Bill has no money but owes and is owed $9,000.
Carl has $8100 and the bank has $1,900. Total money is still $10,000. Debt has grown but the money supply hasn't.

Things get messed up when somebody decides to take their money out of the bank. Bill decides to close out that deal on the car he wanted so he takes out his $9,000. But the bank doesn't have it. They can't make money out of nothing so they have to get it from someplace. That can be by borrowing money from another bank. Or attracting in another $9,000 in deposits. Or they can borrow money from the Federal Reserve. Or they can call in an outstanding loan. They bank will also have more out in loans than their deposits allow- they have gone below their reserve requirement. They cannot make any loans until that is fixed. Giving Bill his money temporariliy increases the money supply but the bank borrowing (or taking in more deposits which is also borrowing) shrinks it back down again.

your explanation makes sense, but then in that video, why does Gamble say that now the money supply has increased about 9 times ?
I don't understand that.
or maybe only the debt has increased, but the money supply remains the same.

On the other hand, lets say the bank claims to have deposits and assets of about 1 million, in that case can it give out loans of 1+9 million ?

What is the harm in full reserve banking ? in a way it limits the debt that the banks can create.

 

[Crystallas]

Delete me. Double post

 

[Crystallas]

If you deposit $10,000 into a bank, they can loan out up to 90% of that...or $9,000, but they have to keep the other 10% of that ($1,000) on reserve at the bank. This is called the Reserve Ratio, and it is set by the Federal Reserve. The Fed rarely changes the Reserve Ratio requirement, and it currently sits at 10% for major financial institutions.

http://www.federalreserve.gov/monetarypolicy/reservereq.htm

This.

Our federal reserve policies add more layers to the fractional reserve banking system, thus making it more confusing. It's important to keep these issues separated, as one major fallacy is that fractional reserved banking is strictly regulated by a central bank, however it does not have to be in theory. It's important to note that reserve concepts are strictly tied to banks, where some of what the fed does uses this very same policy outside of simply banking(yay, corruption of the fed, but hey, we all know that.)

 

[Crystallas]

What is the harm in full reserve banking ? in a way it limits the debt that the banks can create.

No more harm than exists today, just an adjustment period, and ideally it would be a big step to keeping money honest(oxymoron, yes). A market approach would be even better. Financial institutions can offer holding of funds based on their abilities, and customers can use the correct account contracts for their needs. You could have a parallel system in place that allows banks to act within a text-book fractional reserve system(not the kind that is pretty much cooking the books to help out the great money monopoly of the state) along with varying reserve rates, as well as a full reserve system. Then the consumer decides on the level of risk, banks can offer inviting rates to suit their needs(ie: full reserve bank may have overfilled vaults, and the bank may want to prevent such by offering greater incentives. Bank needs more in reserve, so it offers better incentives to have more in reserve, ect.) Banks act in their interest, where a small part of that now is focused on the customer. With a market approach, the bank would have far more interest in making the best decisions, or they lose customers and investments.

 

[J_White]

No more harm than exists today, just an adjustment period, and ideally it would be a big step to keeping money honest(oxymoron, yes). A market approach would be even better. Financial institutions can offer holding of funds based on their abilities, and customers can use the correct account contracts for their needs. You could have a parallel system in place that allows banks to act within a text-book fractional reserve system(not the kind that is pretty much cooking the books to help out the great money monopoly of the state) along with varying reserve rates, as well as a full reserve system. Then the consumer decides on the level of risk, banks can offer inviting rates to suit their needs(ie: full reserve bank may have overfilled vaults, and the bank may want to prevent such by offering greater incentives. Bank needs more in reserve, so it offers better incentives to have more in reserve, ect.) Banks act in their interest, where a small part of that now is focused on the customer. With a market approach, the bank would have far more interest in making the best decisions, or they lose customers and investments.

free market approach and even competing currencies would be good. but then those could also be biased by the big players.

if the money supply remains the same with the fractional reserve system, then does that mean that banks are not really creating all that money, just giving out 90% of what they have in deposits as loans - which may or may not be risky.

does this mean that the increase int he money supply us coming when the Govt borrows from the Fed by giving out bonds ?
i remember there was some report that the Fed gave Euro banks 15 billion or trillion $$ when they were in crisis - what did it get in return - since it must not have got US Govt bonds ?

 

[Crystallas]

free market approach and even competing currencies would be good. but then those could also be biased by the big players.

if the money supply remains the same with the fractional reserve system, then does that mean that banks are not really creating all that money, just giving out 90% of what they have in deposits as loans - which may or may not be risky.

does this mean that the increase int he money supply us coming when the Govt borrows from the Fed by giving out bonds ?
i remember there was some report that the Fed gave Euro banks 15 billion or trillion $$ when they were in crisis - what did it get in return - since it must not have got US Govt bonds ?

Well, corruption is corruption, and it's not tied to any of these systems in the purest form. That's why it's important to note what is attached to our banking policies, and how much power has been taken from the people. Full Reserve could have an extra check in the system to delay the corruption(if we are as complacent as we are today in our failures to maintain the power struggle), or maybe it would just open different doors and methods for corruption. The devil is in the details. Like fisharmor pointed out, none of this is a moral system. That is a different universe of discourse, and mixing them up makes everything more confusing than it needs to be.

Banking would be different if the institution stopped creating money. Therefore the business models would change. Some banks might do 50% if they felt fractional reserve was best. It's all a matter of risk and customer demand. Like I said before, since decentralized methods of fractional reserve are merely theoretical, each method would have to be broken down to take a best guess at what could happen and there is no reason to assume the supply is or isn't controlled by that very institution.

Yes and no to the third question. Neither are mutual to each other in concept, but it depends on which bond, and how the FED uses them. When the FED has the power to print, and can not/does not want to cover costs out of an actual "reserve", then of course, it increases the money supply. That is part of the scam, and we have a pretty good reason to believe the bonds and loans are an elaborate paper-game to do what most of us suspect, double-dip.

 

[Zippyjuan]

your explanation makes sense, but then in that video, why does Gamble say that now the money supply has increased about 9 times ?
I don't understand that.
or maybe only the debt has increased, but the money supply remains the same.

On the other hand, lets say the bank claims to have deposits and assets of about 1 million, in that case can it give out loans of 1+9 million ?

What is the harm in full reserve banking ? in a way it limits the debt that the banks can create.

If a bank has $1 million in deposits, they can give out loans of $900,000, not 1+9 million.

The money supply remains the same-debt is what is growing. Actually, the more the money gets "recycled" by borrowing and re-depositing, the amount actually available to spend is decreasing from the original sum because the bank takes another (smaller) slice off it for each new deposit. If I didn't deposit my money in the bank at all but instead spent it, I could have spent $10,000. By the time it gets to Carl, he can only spend $8,100 of it so real money is shrinking. The bank has the rest (and everybody has their IOUs).

In a full reserve bank, the bank is unable to make money from lending since they are required to keep 100% of all deposits on hand so they will have to find other ways to earn income and pay for their operating expenses. Likely they will charge you to keep your money there instead of paying you interest on deposits, lending it out at a higher rate than they pay you and keep the difference. Being unable to borrow, businesses would have a harder time expanding so the economy would grow much more slowly as well.

 

[cubical]

What would be the alternatitves to a fractional reserve banking system? That would be either a no- reserve or a full- reserve banking system. In a no- reserve banking system, there would be no restrictions on how much a bank could loan out- up to 100% of all of their deposits. In a full- reserve banking system, a bank must keep 100% of all deposits on hand and will not be able to loan out any of them. Anything in between would be a form of fractional reserve banking.

Yes, but in a free market, the assets the banks have as loans, couldn't be used to get more money via the fed.

 

[TaftFan]

Larry White.

 

[J_White]

If a bank has $1 million in deposits, they can give out loans of $900,000, not 1+9 million.

In this video too, at around 04:15, the narrator is saying that out of 10billion, 1 billion is kept as reserve and 9 billion is given out as loan,
when that 9b is deposited in someone's account - 900k reserve is kept and 8.1 billion "new money" is created ?
why call it new money, since it is already there - left from the original 9b ?
that is confusing.
and then he says around 05:04, that from the original 10B, from this deposit-money creation-debt cycle - new 90B has been created ?
explain this plz !

 

[Zippyjuan]

The video isn't accurate. It has many problems.

First is how government debt works. They don't go to the Fed to raise money. If the government is spending more money than they are taking in in taxes, they are running a deficit. They need to get more money from someplace to keep paying the bills. They notify the US Treasury how much money they need to raise - it is their job to try to get it. So the Treasury decides how many and what length of term of Treasury notes they are going to issue to raise the required funds. They issue a notice of how much worth of Treasuries they are going to issue and request bids from would-be buyers. These can be large financial institutions, foreign governments, retirement funds, etc. Each make an offer of how many notes they would like to buy and what price they are willing to pay for them- an auction process. The Treasury takes in all of the bids and sorts them by offer price. The higher prices get listed first and on down to the lowest bid.

Then they start at the top of the list and start adding up how many notes each wants to buy. They stop when they reach a bid which allows them to sell the final note they want to get rid of. This bid determines the actual selling price- it is the highest price that allows them to sell the entire allotment. It will be lower than the highest bid but all bidders who offered that rate or higher are allowed to buy the securities- even if they offered to bid more. Those who offered a lower price don't get a chance to buy in this auction but may participate in future auctions. The more interest in an auction (the more bidders) the higher the final price usually is.

A Treasury has a face value- usually $10,000. A bid will be less than $10,000 (but in rare cases could actually be higher). A buyer pays the bid price and later gets the full face value- the difference is calculated as a percent which is the "yield" of the bond. If they got it at $9,000, the yield would be 10%.

One very important thing besides how the process works is that THE FED DOES NOT PARTICIPATE.

SO how does the Fed get all those bonds they have been buying? Excellent question. They buy their bonds from a list of authorized dealers who did take part in the Treasury auctions. The Fed uses the same process the Treasury does- it announces how many bonds they want to buy and the dealers bid against each other for the abilty to sell to the Fed. Since they are the buyer and not the seller like the Treasury, they buy at the lowest price which lets them purchase the amount they want- not the highest price. Again, all sellers get the same price.

If you would like to read the pamphlet the video cites here is a PDF link: http://www.rayservers.com/images/ModernMoneyMechanics.pdf

Simplest answer to your question- bank deposits can multiply by that amount- the actual money supply doesn't.

From the pamphlet:

These operating needs influence the minimum amount of reserves an individual bank will hold voluntarily. However, as long as this minimum amount is less than what is legally required, operating needs are of relatively minor importance as a restraint on aggregate deposit expansion in the banking system. Such expansion cannot continue beyond the point where the amount of reserves that all banks have is just sufficient to satisfy legal requirements under our "fractional reserve" system. For example, if reserves of 20 percent were required, deposits could expand only until they were five times as large as reserves. Reserves of $10 million could support deposits of $50 million. The lower the percentage requirement, the greater the deposit expansion that can be supported by each additional reserve dollar.

Money is only really money when it is out being spent. In order for the deposits to grow by multiples, the money must be re-deposited at the bank and not spent. If any person along the line of borrowing and depositing money actually spends his money, the multiplication stops. It is a THEORETICAL maximum of deposit multiplication.