How do banks create money and what is the fractional reserve system?

Banks can create money like a cookie factory, by making more cookies from just one batch.

Imagine you have a piggy bank that’s half full. That’s like a fractional reserve system, where the bank keeps only part of your money and lends out the rest.

Let’s say you put $100 in the bank. The bank doesn’t keep all $100; it keeps just $20 (that’s its reserve) and lends out the other $80 to someone else. That person now has $80, which they might spend at a store or save again.

Now that money is in another piggy bank, and the process repeats! The next bank keeps $20 of that new $80 and loans out $60. It’s like making more cookies from just one batch, you keep some for yourself and give the rest to others, who then make even more cookies!

It’s when banks only keep a fraction (a part) of your money in reserve and lend out the rest. This system lets banks create more money than they originally had, like turning one cookie into many by sharing it around.

So, from $100, you can end up with way more money just because of this fun, everyday system!