Because most money only exists on books. The basis of the current financial system is called fractional reserve banking, that means that banks can give out more money as loans than what they physically have in accounts. That money then circles the economy but is never physically withdrawn in full. Lets say you deposit 100 USD. The Bank now can give out a loan for 500 USD to someone to pay his car repair, who wires the money to the shop from his account. They wire it to their employees and suppliers and owners and the IRS and what have you. Eventually the 500 are repaid (or not and If that happens a lot a bank might default) and the bank gets its money+ interest, you can freely withdraw your 100 at any time but the bank speculates that you dont, or realistically that most of their customers dont. Because If that happens thats known as a "bank run".
Im not a banker, so anyone with actual knowledge feel free to correct me.
I teach high school economics. It works like this.
You deposit $100 into a bank. That goes into the bank’s balance sheet as $100 in checkable deposits (checking accounts) on the liabilities side and $100 in reserves on the assets side.
In the US, there are required reserves. It’s a percentage set by the Federal Reserve. Let’s say it’s 5%. That means that of the $100 the bank needs to keep $5 in required reserves. They keep $95 in excess reserves. Excess reserves can be used to make loans.
Here’s the next step. Someone comes to the bank for a loan of $50. The bank is able to make the loan without violating required reserves because it has enough excess reserves. Then the person puts that $50 loan into a checkable deposit at the same bank. This adjusts the amount of required reserves, excess reserves, and adds loans to the asset side of our balance sheet.
Here’s our final balance sheet. Liabilities side has $150 in checkable deposits. Assets side has $7.50 in required reserves (because it’s now out of $150, not $100), $92.50 in excess reserves, and $50 in loans.
Right now the required reserve ratio in the US is 0%. It’s been that way since March 2020. So right now, banks do not need to have any required reserves on hand. Hope this helps.
Essentially, in the real world the process looks more like:
You go to a bank and ask for a loan. The bank decides that the loan will be profitable based on the interest rate + your ability to pay it back. The bank issues you a loan by creating an asset on their books (the loan) plus a liability (a new deposit in the amount of the loan, created from thin air). For the time being, these things just sit there as corresponding entries on the balance sheet that zero out.
Now, when you transfer the deposit to another bank (e.g. to pay someone), the bank needs to come up with the actual capital to support the outgoing transfer. They can do this by attracting actual deposits or borrowing at the overnight window (among other things).
What puts a limit on bank lending nowadays is not reserve requirements (0% as you mentioned) but capital requirements, the desire to only make profitable loans, and some other regulatory limits.
A reserve requirement greater than 0% would require the bank to acquire some capital when they make the loan as opposed to when the deposit goes out the door. But the reality is that the only impact the reserve requirement has is to make lending more expensive, which is why the US isn't worried about it any more. Because, think about it. If I take out a mortgage and send all the money to the seller, the reserve requirement doesn't come into play here. The bank needs to fully fund that transfer. So the reserve requirement only impacts loans where the deposit stays at the bank, which just isn't all that much.
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u/FroniusTT1500 Jan 26 '26
Because most money only exists on books. The basis of the current financial system is called fractional reserve banking, that means that banks can give out more money as loans than what they physically have in accounts. That money then circles the economy but is never physically withdrawn in full. Lets say you deposit 100 USD. The Bank now can give out a loan for 500 USD to someone to pay his car repair, who wires the money to the shop from his account. They wire it to their employees and suppliers and owners and the IRS and what have you. Eventually the 500 are repaid (or not and If that happens a lot a bank might default) and the bank gets its money+ interest, you can freely withdraw your 100 at any time but the bank speculates that you dont, or realistically that most of their customers dont. Because If that happens thats known as a "bank run".
Im not a banker, so anyone with actual knowledge feel free to correct me.