Question

What is true about banks in a fractional reserve banking system?

	a.	Banks face the risk of not having enough cash to meet withdrawal needs.
	b.	Banks have to purchase gold that has the value of the deposits received.
	c.	Banks have to deposit all cash from depositors in their own bank vault.
	d.	Banks can lend all of the deposits that are received.
	e.	Banks must deposit all cash from depositors with the Federal Reserve.

Answer 1

Answer-A

Fractional reserve banking system is the most common system through which banks work. There is a risk to banks of not having enough cash to meet withdrawal needs. As banks lend the depositis they get to earn interest, they cannot lend all the deposits they have. As that would lead to not having enough cash if the depositor asks to withdraw. In this case, banks keep a sufficient amount of deposits with themselves in form of securities, bonds, gold, vault cash. This amount is a fraction of the total amount of deposits. That is why this system is called fractional reserve banking system. Banks cannot keep all of the deposits as reserve as in that case banks would not be able to lend to earn interest and will run into losses as they have to pay interest to depositors. That eliminates all other options because all other options either lend all the amount or reserve all of the amount. The key point here is FRACTION of deposits to be kept as RESERVES.