Question

Please Explain and Discuss Fractional- Reserve Banking System

Answer 1

Fractional reserve banking is a type of banking system in which the deposits are accepted from the cuatomers and the loans are made to the borrowere by keeping a reserve amount which is equal to the fraction of banks deposit liabilities. The bank reserves are held as cash in the bank or with the central bank. The central bank decides the reserve limits of the bank and in case of any emergency situations wherein the deppsitors would withdraw the money in bulk quntities, the banks can borrow from othrr banks to overcome the situation and the central bank would act as a last resort in this scenario.

As the deposit liabilities are considered, this type of system would allow the money to grow beyond the amount of underlying base money that has been created by the central bank. Thus, here by imposing the reserve requirements and the capital adequacy ratio, the central bank is able to make sure that the banks would remain solvent in case of any failures. Also rather than directly controlling the money, the central bank would issue interest based targets so as to make sure that the inflation limits are maintained in the economy. The regulatory frameworks like centralised money creation, centralised clearing of payments, regulatory audit etc are practised in this type of framework.