Definition
Fractional reserve banking is the dominant model of modern commercial banking, in which a bank keeps only a small fraction of its customers' deposits available as reserves and lends or invests the remainder. Because the lent funds are redeposited and lent again, the banking system as a whole creates new deposit money far in excess of the original base. The fraction a bank must retain is governed by the reserve requirement set by the central bank.
How money is created
When a bank issues a loan, it credits the borrower's account with a new deposit rather than handing over pre-existing cash. That deposit can be spent, redeposited elsewhere, and lent again, so a single unit of base money supports a multiple of bank deposits. Economists describe this with the money multiplier: a lower reserve ratio permits a larger expansion. In the United States the official reserve requirement was set to zero in March 2020, meaning bank lending is now constrained mainly by capital rules and liquidity rather than a fixed deposit fraction.
Why it matters for sovereignty
The model means most circulating money is a liability of private banks, not physical cash. Deposits represent a claim on the bank rather than money the bank is holding on your behalf, which is why simultaneous withdrawal demands can outstrip available reserves. This structural feature is one motivation cited by holders of self-custodied, supply-capped assets, where the unit you hold is not someone else's promise.
To explore related mechanisms, see our entries on the Bank Run and on Quantitative Easing.
In Simple Terms
Fractional reserve banking is the dominant model of modern commercial banking, in which a bank keeps only a small fraction of its customers’ deposits available…