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# Fractional-reserve banking

## From Wikipedia, the free encyclopedia

Fractional-reserve banking is the common practice by commercial banks of accepting deposits, and making loans or investments, while holding reserves at least equal to a fraction of the bank's deposit liabilities.[1] Reserves are held as currency in the bank, or as balances in the bank's accounts at the central bank. Fractional-reserve banking is the current form of banking practiced in most countries worldwide.[2]

Fractional-reserve banking allows banks to act as financial intermediaries between borrowers and savers, and to provide longer-term loans to borrowers while providing immediate liquidity to depositors (providing the function of maturity transformation). However, a bank can experience a bank run if depositors wish to withdraw more funds than the reserves that are held by the bank. To mitigate the risks of bank runs and systemic crises (when problems are extreme and widespread), governments of most countries regulate and oversee commercial banks, provide deposit insurance and act as lender of last resort to commercial banks.[1][3]

Because banks hold reserves in amounts that are less than the amounts of their deposit liabilities, and because the deposit liabilities are considered money in their own right, fractional-reserve banking permits the money supply to grow beyond the amount of the underlying base money originally created by the central bank.[1][3] In most countries, the central bank (or other monetary authority) regulates bank credit creation, imposing reserve requirements and capital adequacy ratios. This can limit the process of money creation that occurs in the commercial banking system, and helps to ensure that banks are solvent and have enough funds to meet demand for withdrawals.[3] However, rather than directly controlling the money supply, central banks usually pursue an interest rate target to adjust the rate of inflation and bank issuance of credit.[4]

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• ✪ Overview of fractional reserve banking | The monetary system | Macroeconomics | Khan Academy
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• ✪ How Banks Create Money and the Money Multiplier- Macro 4.8
• ✪ The Economics of Fractional Reserve Banking | Joseph T. Salerno

#### Transcription

What I want to do in this video is give an overview of how money is created in most market based economies, and even a little bit of a discussion of what really is money. And we can go into much more depth in future videos. And I think in many videos I already have gone into a much more technical depth. In most market based economies right now there is a central bank, which is essentially the actor, they do many things. They often will be a regulatory agency as well. But their main role is to have the right to print money, and to put that money into circulation. And I'll rely heavily on the model of the US. That's hard to read. The central bank in some countries is formerly part of the government. In other countries, it's pseudo-independent. In the US. It's more of the pseudo-independent flavor of a central bank, although obviously closely connected with the government. The US Federal Reserve, a lot of the leaders are appointed by the government. It's excess profits go back to the government. And so obviously it has very close ties to the government. But when the central bank decides to print money, it literally can just create it. It could literally print physical money. Or it can create electronic money, which has the same exact effect. So let's say the central bank, it goes out there and it goes out there and it prints three-- and we'll just focus on the physical right now. It's a little bit easier to conceptualize. And it just goes out there and it prints three physical dollar bills. Now it has to figure out, how does it get it into circulation? How does it get it into the economy? And it does not just put it into a helicopter and drop it from that helicopter. Sometimes, in certain circumstances, it can lend to this directly to banks, certain types of banks, member banks. But the typical way that this enters circulation is that the central bank will use this newly created money, this newly created reserves I should say, to go out into the open market and buy securities. And they typically buy very safe securities, typically government debt. So they will go out there and they will put this into circulation. And in exchange they are buying securities from the open market. So then these securities from the open market will go to the central bank. So these are securities, or maybe we could call them bonds. And once they do that, then whoever had these before, whoever was the owner of the securities before, they just sold them. Now they have these dollar bills. And they could either directly spend those dollar bills or they could deposit those dollar bills in a bank. If they spend the dollar bills, then whoever they gave those dollar bills to at some point would want to deposit it in a bank. Some way, by buying these securities, someone now has these dollar bills. And they will deposit them in a private bank. So let's draw that. So right over here is a private bank. And now it has the dollar bills. It has these reserves now. It has the reserves. Now, that's not the end of the story. This money can now be lent. And this is key, because this is what's typical in most market economies where they have fractional reserve lending. So fractional reserve lending, which is a bit strange, because you are telling the person who just deposited this money right here, that you can go at any time and you can take this money out. We've got this money for you. You can trust us. You don't have to be paranoid about what's going on with this money. But the reality is that this bank is allowed to keep only a fraction of these reserves, and lend to the rest of it out. In order for this system to not be super fragile, the Central Bank then also insures these banks. But we'll talk about that into more depth. But here. I just want to show you how the money is created in this fractional reserve lending system. So this bank right over here says, well I have to keep a little bit of these reserves in case that guy comes. The probability of all my customers coming on the same day and asking for all of their money is low. I just have to keep a little bit for whoever does come. And then the rest of it I can lend out, even though I promised everyone that all of their money is available. And so they lend it out to whoever needs to borrow that money, who looks like a decent risk. And those people might not spend it immediately. And so they would deposit it into a bank. Or they might spend that money immediately. They by a factor, or they buy a car. They do something with it. And whoever they bought that new thing from, those people now have the money and they will deposit it into a bank. And so this newly lent money will then end up in perhaps another bank. It could even be the same bank. So that will also end up in a bank, right over here. And now this bank, it can also only keep a fraction of the reserves and lend out the rest. And for simplicity, in most banking systems, they only have to keep on the order of about 10% of the reserves in house, and the rest they could lend out. But over here. I'm keeping much larger reserves just for the sake of making it easy to draw this diagram. So this bank right over here, maybe it decides to keep this dollar bill, and it could lend this one right over here out. And once again, when it lands that dollar bill, it will end up somehow-- the person they lend it to might keep it in a bank temporarily. Or they might immediately buy something. And when they buy something, it will eventually end up in a bank because the person they bought something from will deposit that money. And so it could end up in another bank. And now this is interesting, and in future videos we'll go into more of the math of exactly how much money is being created. And it's an interesting mathematical problem. Actually, it's a sum of an infinite series, and all that. And you can look that up if you're interested in those ideas. But the basic idea here is even though the central bank printed three units of base money, $3.00 right over here, there's a lot more money in the system. You have this guy, who made this deposit, thinks he has$3.00. This person thinks they have $2.00. This person thinks they have one. So just in this example over here, we have one, two, three, four, five$6.00. So just right over here we have $6.00 in this system. And you might say, well, is this really money? This is deposited. This guy thinks he has it, but he's not using it. If he had to use it he would have to withdraw it, and then the bank wouldn't be able to do this. And this is where checking accounts are really important. I'm assuming that these were on demand checking accounts. So this guy, the reason why he's not going to withdraw this money, is he can still use it as money by writing checks. So if this guy, let's say this is all the money that he has, and he decides if he really needs to buy an apple. And that Apple costs$1.00. So this is my drawing of an apple right over here. He does not have to withdraw this $1.00 out of the bank. He can write a check. So right now he has claims to all three of these dollars. He can write a check to the apple vendor, so$1.00. He writes a check, gives it to the apple vendor, and now he'll get the apple, so this check is acting as money. And now the apple vendor will have the rights to one of these dollars right over here. And now the apple vendor could write a check. So this dollar never has to leave the banking system. But because of checks it is essentially enabling-- this check writing-- is enabling these transactions to occur. So it's still enabling, either you could view it as it's still acting in some forms of money because the rights to it can change, even though it's sitting out in here and it's been lent. Or you could say that it's enabling the writing of checks that are acting as some form of money. And the whole reason I want to do this, I'm going through this exercise, is to show you that the amount of money in circulation isn't really in the Central Banks, or not directly in the Central Bank's control. They can definitely decide, hey I'm going to print money, buy securities, put it into circulation. Or if they want to take money out of circulation, they can decide to sell these securities. And then when they sell the securities, maybe this guy will buy them, those dollars will go back to the Central Bank. And maybe they could put it out of commission. But you have this whole effect right over here. If you have more lending occurring, if the banks are feeling very confident, then more of this will happen. You will get more of this-- the multiplier effect of this lending. And if less lending is happening, then you could potentially see all of this contract.

## History

Fractional-reserve banking predates the existence of governmental monetary authorities and originated many centuries ago in bankers' realization that generally not all depositors demand payment at the same time.[5][page needed]

In the past, savers looking to keep their coins and valuables in safekeeping depositories deposited gold and silver at goldsmiths, receiving in exchange a note for their deposit (see Bank of Amsterdam). These notes gained acceptance as a medium of exchange for commercial transactions and thus became an early form of circulating paper money.[6] As the notes were used directly in trade, the goldsmiths observed that people would not usually redeem all their notes at the same time, and they saw the opportunity to invest their coin reserves in interest-bearing loans and bills. This generated income for the goldsmiths but left them with more notes on issue than reserves with which to pay them. A process was started that altered the role of the goldsmiths from passive guardians of bullion, charging fees for safe storage, to interest-paying and interest-earning banks. Thus fractional-reserve banking was born.

If creditors (note holders of gold originally deposited) lost faith in the ability of a bank to pay their notes, however, many would try to redeem their notes at the same time. If, in response, a bank could not raise enough funds by calling in loans or selling bills, the bank would either go into insolvency or default on its notes. Such a situation is called a bank run and caused the demise of many early banks.[6]

The Swedish Riksbank was the world's first central bank, created in 1668. Many nations followed suit in the late 1600s to establish central banks which were given the legal power to set the reserve requirement, and to specify the form in which such assets (called the monetary base) are required to be held.[7] In order to mitigate the impact of bank failures and financial crises, central banks were also granted the authority to centralize banks' storage of precious metal reserves, thereby facilitating transfer of gold in the event of bank runs, to regulate commercial banks, impose reserve requirements, and to act as lender-of-last-resort if any bank faced a bank run. The emergence of central banks reduced the risk of bank runs which is inherent in fractional-reserve banking, and it allowed the practice to continue as it does today.[3]

During the twentieth century, the role of the central bank grew to include influencing or managing various macroeconomic policy variables, including measures of inflation, unemployment, and the international balance of payments. In the course of enacting such policy, central banks have from time to time attempted to manage interest rates, reserve requirements, and various measures of the money supply and monetary base.[8]

## Regulatory framework

In most legal systems, a bank deposit is not a bailment. In other words, the funds deposited are no longer the property of the customer. The funds become the property of the bank, and the customer in turn receives an asset called a deposit account (a checking or savings account). That deposit account is a liability on the balance sheet of the bank. Each bank is legally authorized to issue credit up to a specified multiple of its reserves, so reserves available to satisfy payment of deposit liabilities are less than the total amount which the bank is obligated to pay in satisfaction of demand deposits.

Fractional-reserve banking ordinarily functions smoothly. Relatively few depositors demand payment at any given time, and banks maintain a buffer of reserves to cover depositors' cash withdrawals and other demands for funds. However, during a bank run or a generalized financial crisis, demands for withdrawal can exceed the bank's funding buffer, and the bank will be forced to raise additional reserves to avoid defaulting on its obligations. A bank can raise funds from additional borrowings (e.g., by borrowing in the interbank lending market or from the central bank), by selling assets, or by calling in short-term loans. If creditors are afraid that the bank is running out of reserves or is insolvent, they have an incentive to redeem their deposits as soon as possible before other depositors access the remaining reserves. Thus the fear of a bank run can actually precipitate the crisis.[note 1]

Many of the practices of contemporary bank regulation and central banking, including centralized clearing of payments, central bank lending to member banks, regulatory auditing, and government-administered deposit insurance, are designed to prevent the occurrence of such bank runs.

## Economic function

Fractional-reserve banking allows banks to create credit in the form of bank deposits, which represent immediate liquidity to depositors. The banks also provide longer-term loans to borrowers, and act as financial intermediaries for those funds.[3][9] Less liquid forms of deposit (such as time deposits) or riskier classes of financial assets (such as equities or long-term bonds) may lock up a depositor's wealth for a period of time, making it unavailable for use on demand. This "borrowing short, lending long," or maturity transformation function of fractional-reserve banking is a role that many economists consider to be an important function of the commercial banking system.[10]

Additionally, according to macroeconomic theory, a well-regulated fractional-reserve bank system also benefits the economy by providing regulators with powerful tools for influencing the money supply and interest rates. Many economists believe that these should be adjusted by the government to promote macroeconomic stability.[11]

The process of fractional-reserve banking expands the money supply of the economy but also increases the risk that a bank cannot meet its depositor withdrawals. Modern central banking allows banks to practice fractional-reserve banking with inter-bank business transactions with a reduced risk of bankruptcy.[12][13]

## Types of money

There are two types of money in a fractional-reserve banking system operating with a central bank:[14][15][16]

1. Central bank money: money created or adopted by the central bank regardless of its form – precious metals, commodity certificates, banknotes, coins, electronic money loaned to commercial banks, or anything else the central bank chooses as its form of money.
2. Commercial bank money: demand deposits in the commercial banking system; also referred to as "chequebook money", "sight deposits" or simply "credit".

When a deposit of central bank money is made at a commercial bank, the central bank money is removed from circulation and added to the commercial banks' reserves (it is no longer counted as part of M1 money supply). Simultaneously, an equal amount of new commercial bank money is created in the form of bank deposits.

## Money creation process

At least one textbook states that when a loan is made by the commercial bank, the bank is keeping only a fraction of central bank money as reserves and the money supply expands by the size of the loan.[3] This process is called "deposit multiplication". However, as explained below, bank loans are only rarely made in this way.

The proceeds of most bank loans are not in the form of currency. Banks typically make loans by accepting promissory notes in exchange for credits they make to the borrowers' deposit accounts.[17][18] Deposits created in this way are sometimes called derivative deposits and are part of the process of creation of money by commercial banks.[19] Issuing loan proceeds in the form of paper currency and current coins is considered to be a weakness in internal control.[20]

The money creation process is also affected by the currency drain ratio (the propensity of the public to hold banknotes rather than deposit them with a commercial bank), and the safety reserve ratio (excess reserves beyond the legal requirement that commercial banks voluntarily hold – usually a small amount). Data for "excess" reserves and vault cash are published regularly by the Federal Reserve in the United States.[21]

## Money multiplier

The expansion of $100 through fractional-reserve banking with varying reserve requirements. Each curve approaches a limit. This limit is the value that the "money multiplier'" calculates. The money multiplier is a heuristic used to demonstrate the maximum amount of broad money that could be created by commercial banks for a given fixed amount of base money and reserve ratio. This theoretical maximum is never reached, because some eligible reserves are held as cash outside of banks.[22] Rather than holding the quantity of base money fixed, central banks have recently pursued an interest rate target to control bank issuance of credit indirectly so the ceiling implied by the money multiplier does not impose a limit on money creation in practice.[4] ### Formula The money multiplier, m, is the inverse of the reserve requirement, R:[23] ${\displaystyle m={\frac {1}{R}}}$ Example For example, with the reserve ratio of 20 percent, this reserve ratio, R, can also be expressed as a fraction: ${\displaystyle R={\tfrac {1}{5}}}$ So then the money multiplier, m, will be calculated as: ${\displaystyle m={\frac {1}{1/5}}=5}$ ## Money supplies around the world Components of US money supply (currency, M1, M2, and M3) since 1959. In January 2007, the amount of "central bank money" was$750.5 billion while the amount of "commercial bank money" (in the M2 supply) was $6.33 trillion. M1 is currency plus demand deposits; M2 is M1 plus time deposits, savings deposits, and some money-market funds; and M3 is M2 plus large time deposits and other forms of money. The M3 data ends in 2006 because the federal reserve ceased reporting it. Components of the euro money supply 1998–2007 In countries where fractional-reserve banking is prevalent, commercial bank money usually forms the majority of the money supply.[14] The acceptance and value of commercial bank money is based on the fact that it can be exchanged freely at a commercial bank for central bank money.[14][15] The actual increase in the money supply through this process may be lower, as (at each step) banks may choose to hold reserves in excess of the statutory minimum, borrowers may let some funds sit idle, and some members of the public may choose to hold cash, and there also may be delays or frictions in the lending process.[24] Government regulations may also be used to limit the money creation process by preventing banks from giving out loans even though the reserve requirements have been fulfilled.[25] ## Regulation Because the nature of fractional-reserve banking involves the possibility of bank runs, central banks have been created throughout the world to address these problems.[8][26] ### Central banks Government controls and bank regulations related to fractional-reserve banking have generally been used to impose restrictive requirements on note issue and deposit taking on the one hand, and to provide relief from bankruptcy and creditor claims, and/or protect creditors with government funds, when banks defaulted on the other hand. Such measures have included: 1. Minimum required reserve ratios (RRRs) 2. Minimum capital ratios 3. Government bond deposit requirements for note issue 4. 100% Marginal Reserve requirements for note issue, such as the Bank Charter Act 1844 (UK) 5. Sanction on bank defaults and protection from creditors for many months or even years, and 6. Central bank support for distressed banks, and government guarantee funds for notes and deposits, both to counteract bank runs and to protect bank creditors. ### Reserve requirements The currently prevailing view of reserve requirements is that they are intended to prevent banks from: 1. generating too much money by making too many loans against the narrow money deposit base; 2. having a shortage of cash when large deposits are withdrawn (although the reserve is thought to be a legal minimum, it is understood that in a crisis or bank run, reserves may be made available on a temporary basis). In some jurisdictions, (such as the United States and the European Union), the central bank does not require reserves to be held during the day. Reserve requirements are intended to ensure that the banks have sufficient supplies of highly liquid assets, so that the system operates in an orderly fashion and maintains public confidence. In addition to reserve requirements, there are other required financial ratios that affect the amount of loans that a bank can fund. The capital requirement ratio is perhaps the most important of these other required ratios. When there are no mandatory reserve requirements, which are considered by some economists to restrict lending, the capital requirement ratio acts to prevent an infinite amount of bank lending.[citation needed] ### Liquidity and capital management for a bank To avoid defaulting on its obligations, the bank must maintain a minimal reserve ratio that it fixes in accordance with, notably, regulations and its liabilities. In practice this means that the bank sets a reserve ratio target and responds when the actual ratio falls below the target. Such response can be, for instance: 1. Selling or redeeming other assets, or securitization of illiquid assets, 2. Restricting investment in new loans, 3. Borrowing funds (whether repayable on demand or at a fixed maturity), 4. Issuing additional capital instruments, or 5. Reducing dividends.[citation needed] Because different funding options have different costs, and differ in reliability, banks maintain a stock of low cost and reliable sources of liquidity such as: 1. Demand deposits with other banks 2. High quality marketable debt securities 3. Committed lines of credit with other banks[citation needed] As with reserves, other sources of liquidity are managed with targets. The ability of the bank to borrow money reliably and economically is crucial, which is why confidence in the bank's creditworthiness is important to its liquidity. This means that the bank needs to maintain adequate capitalisation and to effectively control its exposures to risk in order to continue its operations. If creditors doubt the bank's assets are worth more than its liabilities, all demand creditors have an incentive to demand payment immediately, causing a bank run to occur.[citation needed] Contemporary bank management methods for liquidity are based on maturity analysis of all the bank's assets and liabilities (off balance sheet exposures may also be included). Assets and liabilities are put into residual contractual maturity buckets such as 'on demand', 'less than 1 month', '2–3 months' etc. These residual contractual maturities may be adjusted to account for expected counter party behaviour such as early loan repayments due to borrowers refinancing and expected renewals of term deposits to give forecast cash flows. This analysis highlights any large future net outflows of cash and enables the bank to respond before they occur. Scenario analysis may also be conducted, depicting scenarios including stress scenarios such as a bank-specific crisis.[citation needed] ## Hypothetical example of a bank balance sheet and financial ratios An example of fractional-reserve banking, and the calculation of the "reserve ratio" is shown in the balance sheet below: Example 2: ANZ National Bank Limited Balance Sheet as of 30 September 2037 Assets NZ$m Liabilities NZ$m Cash 201 Demand deposits 25,482 Balance with Central Bank 2,809 Term deposits and other borrowings 35,231 Other liquid assets 1,797 Due to other financial institutions 3,170 Due from other financial institutions 3,563 Derivative financial instruments 4,924 Trading securities 1,887 Payables and other liabilities 1,351 Derivative financial instruments 4,771 Provisions 165 Available for sale assets 48 Bonds and notes 14,607 Net loans and advances 87,878 Related party funding 2,775 Shares in controlled entities 206 [subordinated] Loan capital 2,062 Current tax assets 112 Total Liabilities 99,084 Other assets 1,045 Share capital 5,943 Deferred tax assets 11 [revaluation] Reserves 83 Premises and equipment 232 Retained profits 2,667 Goodwill and other intangibles 3,297 Total Equity 8,703 Total Assets 107,787 Total Liabilities plus Net Worth 107,787 In this example the cash reserves held by the bank is NZ$3,010m (NZ$201m Cash + NZ$2,809m Balance at Central Bank) and the Demand Deposits (liabilities) of the bank are NZ$25,482m, for a cash reserve ratio of 11.81%. ### Other financial ratios The key financial ratio used to analyze fractional-reserve banks is the cash reserve ratio, which is the ratio of cash reserves to demand deposits. However, other important financial ratios are also used to analyze the bank's liquidity, financial strength, profitability etc. For example, the ANZ National Bank Limited balance sheet above gives the following financial ratios: 1. The cash reserve ratio is$3,010m/$25,482m, i.e. 11.81%. 2. The liquid assets reserve ratio is ($201m + $2,809m +$1,797m)/$25,482m, i.e. 18.86%. 3. The equity capital ratio is$8,703m/107,787m, i.e. 8.07%.
4. The tangible equity ratio is ($8,703m −$3,297m)/107,787m, i.e. 5.02%
5. The total capital ratio is ($8,703m +$2,062m)/\$107,787m, i.e. 9.99%.

It is important how the term 'reserves' is defined for calculating the reserve ratio, as different definitions give different results. Other important financial ratios may require analysis of disclosures in other parts of the bank's financial statements. In particular, for liquidity risk, disclosures are incorporated into a note to the financial statements that provides maturity analysis of the bank's assets and liabilities and an explanation of how the bank manages its liquidity.

## Criticisms

### Criticisms of textbook descriptions of the monetary system

A paper published in the Bank of England's Quarterly Bulletin states "While the money multiplier theory can be a useful way of introducing money and banking in economic textbooks, it is not an accurate description of how money is created in reality."[27]

Glenn Stevens, governor of the Reserve Bank of Australia, said of the "money multiplier", "most practitioners find it to be a pretty unsatisfactory description of how the monetary and credit system actually works."[28]

Lord Adair Turner, formerly the UK's chief financial regulator, said "Banks do not, as too many textbooks still suggest, take deposits of existing money from savers and lend it out to borrowers: they create credit and money ex nihilo – extending a loan to the borrower and simultaneously crediting the borrower’s money account".[29]

Former Deputy Governor of the Bank of Canada William White said "Some decades ago, the academic literature would have emphasised the importance of the reserves supplied by the central bank to the banking system, and the implications (via the money multiplier) for the growth of money and credit. Today, it is more broadly understood that no industrial country conducts policy in this way under normal circumstances." [30]

A report from the German central bank explains that the money supply is not determined by the reserves of private banks, but by market factors and regulatory decisions.[31]

These criticisms are supported by studies made by professor of economics Richard Werner who finds that the creation of money as bank credit is limited by the demand for credit, not by the reserve requirement because private banks have usually been able to acquire sufficient reserves in various ways to meet the growing demands for credit.[32]

### Criticisms on the basis of instability

In 1935, economist Irving Fisher proposed a system of 100% reserve banking as a means of reversing the deflation of the Great Depression. He wrote: "100 per cent banking ... would give the Federal Reserve absolute control over the money supply. Recall that under the present fractional-reserve system of depository institutions, the money supply is determined in the short run by such non-policy variables as the currency/deposit ratio of the public and the excess reserve ratio of depository institutions."[33][page needed]

Today, monetary reformers point out that fractional reserve banking leads to unpayable debt, growing inequality, inevitable bankruptcies, and an imperative for perpetual and unsustainable economic growth.[34]

### Criticisms on the basis of legitimacy

Austrian School economists such as Jesús Huerta de Soto and Murray Rothbard have also strongly criticized fractional-reserve banking, calling for it to be outlawed and criminalized. According to them, not only does money creation cause macroeconomic instability (based on the Austrian Business Cycle Theory), but it is a form of embezzlement or financial fraud, legalized only due to the influence of powerful rich bankers on corrupt governments around the world.[35][36] Politician Ron Paul has also criticized fractional reserve banking based on Austrian School arguments.[37]

## References

1. ^ a b c Abel, Andrew; Bernanke, Ben (2005). "14". Macroeconomics (5th ed.). Pearson. pp. 522–532.
2. ^ Frederic S. Mishkin, Economics of Money, Banking and Financial Markets, 10th Edition. Prentice Hall 2012
3. Mankiw, N. Gregory (2002). "18". Macroeconomics (5th ed.). Worth. pp. 482–489.
4. ^ a b Hubbard and Obrien. Economics. Chapter 25: Monetary Policy, p. 943.
5. ^ Carl Menger (1950) Principles of Economics, Free Press, Glencoe, IL OCLC 168839
6. ^ a b United States. Congress. House. Banking and Currency Committee. (1964). Money facts; 169 questions and answers on money – a supplement to A Primer on Money, with index, Subcommittee on Domestic Finance ... 1964 (PDF). Washington D.C.
7. ^ Charles P. Kindleberger, A Financial History of Western Europe. Routledge 2007
8. ^ a b The Federal Reserve in Plain English – An easy-to-read guide to the structure and functions of the Federal Reserve System (See page 5 of the document for the purposes and functions)
9. ^ Abel, Andrew; Bernanke, Ben (2005). "7". Macroeconomics (5th ed.). Pearson. pp. 266–269.
10. ^ Maturity Transformation Brad DeLong
11. ^ Mankiw, N. Gregory (2002). "9". Macroeconomics (5th ed.). Worth. pp. 238–255.
12. ^ Page 57 of 'The FED today', a publication on an educational site affiliated with the Federal Reserve Bank of Kansas City, designed to educate people on the history and purpose of the United States Federal Reserve system. The FED today Lesson 6
13. ^ "Mervyn King, Finance: A Return from Risk" (PDF). Bank of England.  Banks are dangerous institutions. They borrow short and lend long. They create liabilities which promise to be liquid and hold few liquid assets themselves. That though is hugely valuable for the rest of the economy. Household savings can be channelled to finance illiquid investment projects while providing access to liquidity for those savers who may need it.... If a large number of depositors want liquidity at the same time, banks are forced into early liquidation of assets – lowering their value ...'
14. ^ a b c Bank for International Settlements – The Role of Central Bank Money in Payment Systems. See page 9, titled, "The coexistence of central and commercial bank monies: multiple issuers, one currency": [1] A quick quotation in reference to the 2 different types of money is listed on page 3. It is the first sentence of the document:
"Contemporary monetary systems are based on the mutually reinforcing roles of central bank money and commercial bank monies."
15. ^ a b European Central Bank – Domestic payments in Euroland: commercial and central bank money: One quotation from the article referencing the two types of money:
"At the beginning of the 20th almost the totality of retail payments were made in central bank money. Over time, this monopoly came to be shared with commercial banks, when deposits and their transfer via cheques and giros became widely accepted. Banknotes and commercial bank money became fully interchangeable payment media that customers could use according to their needs. While transaction costs in commercial bank money were shrinking, cashless payment instruments became increasingly used, at the expense of banknotes"
16. ^ Macmillan report 1931 account of how fractional banking works
17. ^ Federal Reserve Bank of Chicago, Modern Money Mechanics, pp. 3–13 (May 1961), reprinted in Money and Banking: Theory, Analysis, and Policy, p. 59, ed. by S. Mittra (Random House, New York 1970).
18. ^ Eric N. Compton, Principles of Banking, p. 150, American Bankers Ass'n (1979).
19. ^ Paul M. Horvitz, Monetary Policy and the Financial System, pp. 56–57, Prentice-Hall, 3rd ed. (1974).
20. ^ See, generally, Industry Audit Guide: Audits of Banks, p. 56, Banking Committee, American Institute of Certified Public Accountants (1983).
21. ^
22. ^ "Managing the central bank's balance sheet: where monetary policy meets financial stability" (PDF). Bank of England.
23. ^ McGraw Hill Higher Education Archived 5 December 2007 at the Wayback Machine
24. ^ William MacEachern (2014) Macroeconomics: A Contemporary Introduction, p. 295, University of Connecticut, ISBN 978-1-13318-923-7
25. ^ The Federal Reserve – Purposes and Functions (See pages 13 and 14 of the pdf version for information on government regulations and supervision over banks)
26. ^ Reserve Bank of India – Report on Currency and Finance 2004–05 (See page 71 of the full report or just download the section Functional Evolution of Central Banking): The monopoly power to issue currency is delegated to a central bank in full or sometimes in part. The practice regarding the currency issue is governed more by convention than by any particular theory. It is well known that the basic concept of currency evolved in order to facilitate exchange. The primitive currency note was in reality a promissory note to pay back to its bearer the original precious metals. With greater acceptability of these promissory notes, these began to move across the country and the banks that issued the promissory notes soon learnt that they could issue more receipts than the gold reserves held by them. This led to the evolution of the fractional-reserve system. It also led to repeated bank failures and brought forth the need to have an independent authority to act as lender-of-the-last-resort. Even after the emergence of central banks, the concerned governments continued to decide asset backing for issue of coins and notes. The asset backing took various forms including gold coins, bullion, foreign exchange reserves and foreign securities. With the emergence of a fractional-reserve system, this reserve backing (gold, currency assets, etc.) came down to a fraction of total currency put in circulation.
27. ^ McLeay, Michael. "Money creation in the modern economy" (PDF). Bank of England.
28. ^ Stevens, Glen. "The Australian Economy: Then and Now". Reserve Bank of Australia.
29. ^
30. ^ White, William. "Changing views on how best to conduct monetary policy: the last fifty years". Bank for International Settlements.
31. ^ Deutsche Bundesbank (April 2017). "Die Rolle von Banken, Nichtbanken Und Zentralbank Im Geldschöpfungsprozess". Monatsbericht. Deutsche Bundesbank (15).
32. ^ Werner, Richard A. (2016). "A Lost Century in Economics: Three Theories of Banking and the Conclusive Evidence". International Review of Financial Analysis. 46 (July): 361–79. doi:10.1016/j.irfa.2015.08.014.
33. ^ Fisher, Irving (1997). 100% Money. Pickering & Chatto Ltd. ISBN 978-1-85196-236-5.
34. ^ Jackson, Andrew; Dyson, Ben (2012). Modernizing Money. Why our Monetary System is Broken and how it can be Fixed. Positive Money. ISBN 978-0-9574448-0-5.
35. ^ Rothbard, Murray (1983). The Mystery of Banking. ISBN 9780943940045.
36. ^ Jesús Huerta de Soto (2012). Money, Bank Credit, and Economic Cycles (3d ed.). Auburn, AL: Ludwig von Mises Institute. p. 881. ISBN 9781610161893. OCLC 807678778. (with Melinda A. Stroup, translator) Also available as a PDF here
37. ^ Paul, Ron (2009). "2 The Origin and Nature of the Fed". End the Fed. New York: Grand Central Pub. ISBN 978-0-446-54919-6.

## Further reading

• Crick, W.F. (1927), The genesis of bank deposits, Economica, vol 7, 1927, pp 191–202.
• Friedman, Milton (1960), A Program for Monetary Stability, New York, Fordham University Press.
• Meigs, A.J. (1962), Free reserves and the money supply, Chicago, University of Chicago, 1962.
• Philips, C.A. (1921), Bank Credit, New York, Macmillan, chapters 1–4, 1921,
• Thomson, P. (1956), Variations on a theme by Philips, American Economic Review vol 46, December 1956, pp. 965–970.
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