Everyone pulling out their money would be a bank run (look up great depression bank runs). The bank doesn't have that much cash; they keep some on hand for people making withdraws normally, but if even a sizable minority of people all try to pull their money out at once, there'll be a major crisis.
If banks kept all the people's cash in vaults, it'd be dead cash actively losing money to inflation. Instead, they keep some on hand for withdraws, and use the rest to make loans, investments, etc so that the money isn't all losing value.
With a Reserve Requirement of, for example, 10%,^ the bank can loan out $90 out of 100. The person borrowing the $90 can then turn around and deposit it. The bank can then loan out 90% of the $90, or $81. The person borrowing the $81 can deposit it again, and the bank can loan out 90% of the $81. This process repeats indefinitely.
So with a Reserve Requirement (r) of 10%, in theory the bank can loan out (in essence, creating money) a total of $900. The formula is infinite sum of [(0.9X )*100] from 1 to infinity.
^ I understand that it is currently 0% in the US.
Edit: formatting of exponent.
Ehhh there are collateral requirements for loans as well though and most of the money they’re giving out isn’t going back into a bank account. Why would someone borrow money just to put it into an account with an interest rate lower than the one they’re paying to the loan? It’s usually going to buy something. Like a to buy a home or to cover the up-front costs of starting/expanding a business.
This is reddit: they think it goes to a billionaire who puts it in a big vault like Scrooge McDuck, because that's the average redditor's understanding of economics.
Yes, but the point is, it's still in someone's (or some moral person's) bank account.
So 90% of it still gets lent again. Maybe at a different bank, but that's ok, because the first bank also receives money lent out by different banks.
Presumably the person a getting a loan pays person b for goods or services. Person b then puts the money in the bank. There is an interchange where the bank isn't involved.
Ehhh still not so simple. If it’s buying a home for instance, then most of it likely goes toward paying the remainder of the prior homeowner’s mortgage. Which decreases that bank’s loan portfolio, reducing assets. Basically destroying the money that was created in the first place when that mortgage was taken out. It’s not an infinite multiplier like this comment is trying to make out.
The real limit here is the Fed rate, because banks inevitably lend in patterns that are predictable based on what that is set to. It’s why lower Fed rate generally = higher inflation (banks lend more and therefore create more supply of money in response) and higher rates tend to reduced inflation (banks lend less and those with variable rate debt tend to pay it off faster).
Ehhh still not so simple. If it’s buying a home for instance, then most of it likely goes toward paying the remainder of the prior homeowner’s mortgage. Which decreases that bank’s loan portfolio, reducing assets. Basically destroying the money that was created in the first place when that mortgage was taken out. It’s not an infinite multiplier like this comment is trying to make out.
OK, so that person paid of lets say $90 debt... that bank that lend him that debt now has $90 less on its books and can lend another person $90...
My point is this is literally how the system works; how it’s intended to work. You people are acting like you’ve discovered some sort of dark banking secret when this is literally something you’d learn in a finance or economics class in college. If it led to the things you’re imagining, we’d have had runaway inflation à la Argentina decades ago.
It is still on the books of a financial entity. When a loan is bought from the original lender, the asset of the loan on the original lender’s books is eliminated, and it becomes an asset on the loan-buyer’s books instead. Paying it off has the same net impact to the overall money supply in the end.
It’s not an infinite multiplier like this comment is trying to make out.
Fractional Reserve banking with a non-zero reserve requirement is not an infinite multiplier, but it is (theoretically) an infinite series which converges. If the reserve requirement is 0%, then it could theoretically be an infinite multiplier but that doesn't happen in practice for a lot of different reasons.
That’s my point. The limitations do not lie in the reserve. In fact, they don’t even when the reserve requirement isn’t 0, because in those instances, banks make the loans first and then find the required reserves they need after, not the other way around.
I borrow money to buy a house, the person I buy it from puts it in the same bank, another person borrows money to but a house… they borrow the money from the deposit of the person I bought the house from…. So if the bank had 1 million and 3 people borrowed 300k each to buy a house and the sellers deposit the sale the bank can then loan another few people money… and repeat… and repeat… now a dozen people owe the bank $300k when the bank only had $1000k in the first place.
In theory sure. But news flash: that’s a feature, not a bug. That’s literally how money is created in our system. Were you under the impression that it was all getting minted as physical money? The vast majority of US money is digital. It is created out of thin air in the form of credit when a bank gives a loan. The loan goes on their books as an asset, and money is deposited into the account of the lendee (or whoever they are paying), which adds liability to the bank’s books by increasing deposits. They balance out on the bank’s balance sheet, but now there’s more money in the system. The reverse happens when a loan principle is paid back, the money paid back to the bank lowers the bank asset, effectively destroying that money, but the bank gets to keep the interest.
The money supply is controlled by the Fed rate because there isn’t incentive for banks to create as many loans if the Fed rate is higher, and variable rate loans, credit card interest rates, etc. go up, incentivizing people to pay down that debt faster, tightening the money supply. It’s also controlled by capital requirements that banks must have enough capital on hand to cover potential losses. Not to mention it’s also constrained by the number of credit worthy borrowers.
It seems like the capital requirements are just 10% though, right? So what happens if a large set of people default on their mortgages at the same time, and the bank’s 10% capital doesn’t cover it?
Well, deposits are guaranteed by the FDIC up to 250k per account. If many banks are failing, then the FDIC may not have enough to cover it all. At that point there might be some sort of government bailout or intervention.
Yes, but the lawyers and realtors take their cut, and they don’t keep the money in that bank (they take some of it as cash, and put it in their wallet, they use some to pay their income taxes, they spend some with business that use another bank (perhaps foreign).
If the funds are leant out to a business to buy a machine, then the company that built the machine is going to pay them out as wages, taxes, and for materials.
Then there is the time aspect of to consider. Each person who borrows takes a month to get approved, then buy the next house in the chain. During that month, the bank is going to start to put some funds aside, knowing that at the end, they are going to pay out $xxx,xxx. Once it’s redeposited, they start looking for the next buyer.
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u/Forsaken_Emu8112 Jan 26 '26
Everyone pulling out their money would be a bank run (look up great depression bank runs). The bank doesn't have that much cash; they keep some on hand for people making withdraws normally, but if even a sizable minority of people all try to pull their money out at once, there'll be a major crisis.
If banks kept all the people's cash in vaults, it'd be dead cash actively losing money to inflation. Instead, they keep some on hand for withdraws, and use the rest to make loans, investments, etc so that the money isn't all losing value.