ELI5 Fractional Reserves

Imagine a big cookie jar at a school. Every kid puts some cookies into the jar for safekeeping. The rule says the jar must always keep some cookies inside, just in case kids come back hungry. But it does not have to keep all of them. That is the basic idea behind fractional reserve banking.

When you put money in a bank, the bank does not lock your cash in a box with your name on it. Instead, it keeps only a fraction of it ready to use. This part is called the reserve. The rest can be lent out to other people. So if you deposit 100 dollars, the bank might keep 10 dollars in reserve. The other 90 dollars can be loaned to someone who wants to buy a car or start a business. That borrower spends the money. The person who receives it may then deposit it into their own bank. Now that bank keeps a small part and lends the rest again.

This process repeats many times.

Because of this, the banking system can turn a small amount of original money into a much larger amount of spending money. No new physical cash is printed. It is created through loans and deposits. This is why people say banks create money. This system works because not everyone asks for their money at the same time. Most people leave their money in the bank and only take out small amounts when they need it. The bank counts on this normal behavior.

If everyone tried to withdraw all their money at once, the bank would not have enough cash on hand. That situation is called a bank run. To reduce this risk, banks are regulated and must follow reserve rules. Governments also offer deposit insurance so people feel safe leaving money in the bank. Fractional reserve banking helps the economy grow. It makes it easier for people to borrow money. Businesses can expand. Homes can be built. Jobs can be created. Without it, banks could only lend out money they already fully had, which would slow everything down.

At the same time, it requires trust. Trust in banks. Trust in rules. Trust that people will not all panic at once. So in simple terms, fractional reserves mean this. Banks keep some of your money safe. They lend the rest to help the economy move. As long as people stay calm and the system is watched carefully, it works surprisingly well.