Question

What are the benefits and drawbacks of a fractional reserve banking system? If you were in charge of making policy on our financial system, what required reserve ratio would you set and why? Include a detailed and accurate application of one or more of the concepts: fractional reserve banking, required reserve ratio, bank runs (risk of fractional reserve banking).

Answer 1

The advantages of fractional reserve banking are:

• Fractional reserve banking allows banks to capitalize on the funds lying unused to generate substantial returns.

• When banks lend your money to a customer, it charges interest on the loan. You get part of this interest.

Fractional reserve banking practice extends the money supply beyond what it really is. Because banks around the globe use this principle, the wide money supply in most nations is greater than the base money generated by a particular multiple of the country's central bank, also called money multiplier.

Limits liquidity and generates the risk of running a bank. This is a situation where the bank does not have sufficient resources to meet the customer's requirement for their deposits to be withdrawn

I would maintain the CRR to 10% then a bank with net demand and time deposits of 1,00,000 will have to deposit 10,000 with the FED as liquid cash. This would be an effective tool for directly regulating the lending capacity of banks and controlling the money supply in the economy.