What is fractional reserve banking? How banks lend more than they hold
By SendPay Business · · 2 min read
Fractional reserve banking is the system where banks keep only a fraction of their customers' deposits as ready cash and reserves, and use the rest to fund loans. It's how almost every commercial bank in the world works.
How lending creates money
When a bank makes a loan, it credits the borrower's account with new money. The Bank of England explained this in its 2014 paper 'Money creation in the modern economy': most money in the economy is bank deposits created by lending, not notes and coins.
What limits it today
- Capital rules: banks must hold enough of their own capital to absorb losses.
- Liquidity rules: banks must hold enough easy-to-sell assets to cover sudden withdrawals.
- Interest rates set by the central bank, which affect demand for loans.
- Whether the bank can find borrowers it trusts to repay.
Reserve requirements
Some countries set a minimum share of deposits that banks must hold as reserves. The UK doesn't set one, and the US Federal Reserve cut its requirement to zero in March 2020, relying on capital and liquidity rules instead.
E-money is different
E-money and payment firms can't lend out customer money. They must safeguard it in full, keeping it separate from their own funds.
Where SendPay fits
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This guide is general information, not legal or financial advice. SendPay Business is a technology company, not a bank, and does not take deposits; regulated services on the platforms are provided by licensed partners. PayPal, Patreon and Substack are named as reference points only and are not affiliated with SendPay Business.