Central Idea

Full-reserve banking, also known as 100% reserve banking, and fractional-reserve banking are two different systems of banking that determine how banks handle customer deposits and lending practices.
This article discusses the key differences between these two banking systems and the arguments put forth by proponents of each approach.

What is Full-Reserve Banking?

Custodian Role: In a full-reserve banking system, banks hold all money received as demand deposits from customers in their vaults, acting as safekeepers of depositors’ funds.
Limited Lending: Banks can only lend money from time deposits, which customers can withdraw after an agreed-upon period.
Preventing Bank Runs: The full reserve ensures banks can meet depositor demands even if all customers seek to withdraw their money simultaneously, reducing the risk of a bank run.
Restricted Money Supply: Banks cannot create money through loans, limiting their influence on the economy’s money supply and potentially preventing artificial booms and busts.

Lending with Electronic Money: Banks in a fractional-reserve system predominantly lend in the form of electronic money, allowing them to lend more than the physical cash they have in vaults.
Risk of Bank Runs: Although electronic money minimizes cash withdrawals, excessive loans can lead to a bank run if depositors demand cash that exceeds the actual cash reserves.
Supporting Economic Growth: Proponents argue that fractional-reserve banking fuels investment and economic growth by allowing banks to create loans without relying solely on customer savings.

Fractional-Reserve Banking: Supporters believe fractional-reserve banking frees the economy from the constraints of real savings, stimulating investment and growth.
Full-Reserve Banking: Supporters argue that full-reserve banking is more natural, prevents bank runs, and limits banks’ ability to create money, which could prevent economic instability.