What is Fractional Reserve Banking?

in #banking4 years ago

Fractional Reserve Banking (FRB) is a banking concept which is employed to create new money. This activity is a key aspect of how money is created and how money supply is managed in a modern economy. 

Initially banks started off as a repository of metal coins. On depositing their worth with the government approved bank merchants used to be issue a paper bank note as a receipt of deposit. Paper bank note was easier to carry and store. From here the concept of paper money developed further. In this way the banks became the reserve of assets. 

With passage of time as paper money became more popular bank reserves kept souring. At some point of time banks decided to lend these reserves to businesses at a premium. Hence paving the way for the concept of Fractional Reserve. Banks now hold only a fraction of assets while lends the rest in the market. This way banks generate revenue for itself. Value and services generated by business is converted to money in this fashion. 

One of the earliest public bank to be established in 1609 was Bank of Amsterdam. It initially operated on a deposit-only basis, but by 1657 it was  allowing depositors to overdraw their accounts, and lending large sums  to the Municipality of Amsterdam and the Dutch East India Company. Unfortunately, the Dutch East India Company fell on progressively harder times and eventually defaulted to the Bank of Amsterdam. So, the Bank of Amsterdam become an early victim of overly optimistic lending.

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