How does the fractional-reserve banking system work?

A fractional-reserve banking system is like a toy box where you can take out more toys than are actually inside, but only for a little while.

Imagine you have a piggy bank with 10 coins in it. That’s your reserve. Now, imagine you’re at the bank, and you ask to borrow 5 coins. The bank gives you 5 coins, even though they only had 10 coins total. They keep 5 coins as their reserve, just in case you come back later asking for more.

That’s how fractional-reserve banking works, banks only need to keep a part of the money people deposit with them, and they can lend out the rest.

Let’s say your friend goes to the same bank and also asks to borrow 5 coins. The bank gives them 5 coins too, now it has lent out 10 coins total, but only kept 5 as its reserve.

If everyone keeps asking for loans, the bank might need more coins to keep up. But until then, they can make more money by lending out what people deposit with them.

So even though there aren’t enough coins in the piggy bank at first, the bank acts like it has a lot more, and that’s how banks help grow money!