The Federal Reserve Banking System requires banks to only keep a portion of its customer’s deposits on hand for withdrawals and it allows the remaining funds to be used as loans. When we deposit money into our savings or checking account, the bank doesn’t just keep it hidden in a vault somewhere, the bank actually lends the money out to other customers and companies as loans. The Fractional Reserve Banking System is broken down as follows. Banks accept deposits from individuals and companies providing them with savings and checking accounts in return. Banks then loan out a bulk of these deposits to other customers to buy things like homes, cars, or even open businesses. If a customer deposits $100,000 and the federal reserve is 5%, the bank then has the ability to loan out $95,000. The customers whom received the loans must pay the bank an interest fee on the amount borrowed. When customers borrow loans from the bank, they in turn deposit the funds into their own accounts which could be at a different bank. That new bank then has the ability to use those funds as loans to other customers. This method eventually causes the economy to expand.
When banks have the ability to lend out money, their actually creating money. The economic purpose of the Federal Reserve Banking system is to create a multiplier effect on the supply of funds deposited which helps with expanding our economy. When the Federal Reserve System sets a low reserve amount, banks are able to use more funds as loans. If the Federal Reserve System sets its reserve at 100 percent, banks would not be able to provide loans and it would be impossible for them to generate any kind of money which prevents the economy from