In order to satisfy demands for withdrawals, banks keep fractional reserves. This means that banks are required to hold only a fraction of customer deposits on hand, while the rest can be loaned out or invested. This system allows banks to continue operating smoothly by balancing the need to have enough cash on hand for withdrawals while also being able to generate revenue through loans and investments.
Here's how fractional reserves work:
1. When you deposit money in a bank, the bank is only required to keep a portion of that deposit as reserves, which is usually set by regulations from the central bank.
2. The remaining portion of the deposit can be used by the bank to lend to other customers or invest in various financial instruments.
3. This process helps stimulate economic activity by providing funds for businesses and individuals to borrow and spend.
4. However, banks must ensure that they always have enough reserves to meet withdrawal demands from depositors.
By maintaining fractional reserves, banks can effectively manage liquidity while also supporting economic growth through lending and investment activities.
