1. Fractional Reserve Banking D. E. Weir Lawrence Central High School

2. What is Fractional Reserve Banking Fractional Reserve Banking is the ability of the banking system to make the nation’s money supply grow larger or small. Banks do this by changing how much money they loan out to customers.

3. Overview What is Fiat Money? Why is Fiat Money Important? How do Banks Work? What is Fractional Reserve Banking?

4. What is Fiat Money Items that the government declares to be money. The actual item used as money has no value outside of its use as money.

5. Remember – Fiat money is any object that the government declares to be money. This means that you can make more “money” when ever you need more. With “commodity money” you have to to have more gold, silver, or other valuable objects!

6. Why is Fiat Money Important? You can expand and shrink the money supply to meet economic needs. $ Q 0 $ Q 0 $ Q 0

7. How Do Banks Work? They pay people a small amount of money when they deposit money into their savings accounts. They loan out the money in the savings accounts at a higher rate to people who need to take out loans.

8. $80 $100 $20 Money customer doesn’t usually take out of bank Money customer usually takes out and replaces This money can be used to make loans

9. A “run on a bank” is when a lot of customers show up to demand their money. The Bank may not have enough money to give each customer their money

11. Reserve Ratio or Reserve Requirements: The percentage of each deposit the bank cannot loan out. $80 $20 Money customer usually takes out and replaces= Reserve Ratio or Reserve Requirement This money can be used to make loans

12. Deposit = $100 Reserve Ratio = 10%

13. What is Fractional Reserve Banking? Keeping a fraction of the deposit in the bank (the reserve ratio or reserve requirement) and loaning out the remainder.

14. Formula Deposit = 100 Reserve Requirements = 20% Take the reserve ratio and make it into a fraction 20% = 20 / 100

15. 2.Reduce your fraction 20 / 100 = 2/10 = 1/5 3.Take the reciprocal 1/5 = 5/1 = 5 5 = Deposit Multiplier

16. The Deposit is multiplied by the Deposit Multiplier $100 (Deposit) X 5 (Deposit Multiplier) = $500 When you deposit $100, Fractional Reserve Banking allows $500 in loans to be made!

17. Try Another Problem Deposit = $100 Reserve Ratio = 10% 1.10% = 10/100 = 1/10 2.Reciprocal 1/10 = 10/1 = 10 3.10 = Deposit Multiplier 4.10 X $100 = $1000

18. Let’s think for a minute… A deposit of $100 … A Reserve Ratio of 10% = $1,000 in “new” money… A Reserve Ratio of 20% = $500 in “new” money… What is occurring when you increase the Reserve Ratio?

19. Why is Fractional Reserve Banking Important? It allows the banking system to expand and contract the money supply to meet the money needs of the economy! When you need more money, reduce the Reserve Ratio. When you need less money, increase the Reserve Ratio.