Fractional reserve banking (FRB) is fraudulent. It should be prosecuted as a crime rather than accepted as normal practice under current banking laws. Any society that respects property rights and the rule of law would not allow it. For those unfamiliar with the term fractional reserve banking or not quite confident of its complete meaning, let’s cover some basics.
What Is Fractional Reserve Banking?
All financial transactions must be settled ultimately by an exchange of standard money, otherwise known as “reserves”. Reserves in the US are composed of federal reserve notes (good old paper money in your wallet, piggy bank, retailers’ cash register tills, or bank vaults) plus reserve account balances held by banks at their local Federal Reserve Bank that may be exchanged for federal reserve notes on demand. The important point is that reserves are not the same thing as the money supply. The money supply is composed of cash outside bank vaults plus demand (checking) accounts at banks. A financial transaction is not complete until reserves are exchanged. For example, accepting a check from your neighbor for selling him your used car is not final settlement, because reserves have not yet been exchanged. The check might bounce. Or the bank upon which the check is drawn might become insolvent ; i.e., it does not have and cannot raise the reserves with which to pay you, the check’s payee, even though the bank balance of the payor, your neighbor, was at least as large as the check.
Most people assume that their money held at banks can always be exchanged for reserves, but such is not the case. Under a fractional reserve banking system banks are not required to keep one hundred percent reserves.
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