Fractional banking, also known as “reserve banking,” began with goldsmiths in Europe who built secure vaults for storing precious metals. When other people requested to store gold with the goldsmiths, they received certificates that represented their deposits that could be traded as though they were gold or used to reclaim their gold.
Since only a small percentage of depositors came to retrieve their gold at any given time, the goldsmiths realized they only needed to keep a fraction of this precious medal on hand as a “reserve”, to meet the needs of those who did. Recognizing this, the goldsmiths started issuing more gold certificates than the actual amount of gold they held. This practice allowed them to create certificates on gold they didn’t possess, effectively “making money out of nothing.” These certificates could be used to purchase tangible assets, or be loaned out with interest, offering a path to significant wealth for the bankers.
The Challenge of a “Bank Run”
Occasional suspicions arose that a bank might not possess as much gold as claimed. This led to a rush of people attempting to exchange their certificates for available gold before it depleted, commonly known as a “run on the bank.” In such situations, the banks would initially attempt to reassure the first depositors by promptly providing the precious metal in exchange for the certificates.
Nevertheless, if the “run” persisted, they could not sustain this pretense for long as the bank’s gold reserves would eventually be exhausted. In such cases, the only recourse was to “close their doors” in disgrace and cease their banking operations.
Can You Sell the Same Horse to Four Different Buyers?
Fractional banking could be likened to a farmer who sells the same horse to multiple buyers, each with different riding schedules. The farmer sells the horse again and again, thinking he can do so safely. The problem arises when all the buyers decide to ride their horse at the same time. This situation is comparable to a “run” on the bank, where multiple people demand their deposits at the same time, leading to potential trouble.
Banks and such are no longer required to reserve that 10%, therefore fractional banking per se has been done away with. Your institution gets into trouble, you have no reserve, what do you do…… you seize the accounts since once deposited all funds are the banks property…Sorry Charlie!