Question

What is the federal reserves role in fractional reserve banking?

Answer 1

Fractional Reserve Banking is system where in Banks can not lend all the money, which investors has deposited, to other other customers. Banks need to keep some amount to money reserved with the Federal Bank and can loan out the remaining amount.

It works like this :

If a Bank has deposits of $100,000 and federal reserve requirements is 10%, then banks need to keep $10,000 with the Fed and can lend out remaining $90,000 to other customers. These customers can deposit some or all of this with other bank. So the other bank can loan out 90,000 * 0.9 = $81,000 again to other customers. So by this way, money supply has increased which will help the economy to expand

Federal reserves, as explained earlier, is the amount which banks has to keep with the Feds. They can not lend all the money. This is done to protect the depositors in case of Run on banks. If all the customers come at once and wants to withdraw their money, banks will not be able to do that. So to protect depositors interest upto some extent, federal reserve requirements are imposed