Glossary · Money and central banks
Fractional-reserve banking
Fractional-reserve banking means banks keep only a fraction of their deposits as cash and reserves and lend out the rest.
Also called: fractional reserve, reserve requirement, money multiplier
Currency in M2, Sep 2026. The rest are deposits and similar balances.
Sep 2026
In plain words
Picture a goldsmith in the 1600s who stores gold for townspeople and hands out paper receipts. He notices that on any day only a few customers come for their gold. So he lends some of the stored gold to others, at interest, keeping just enough to pay whoever shows up. He has invented fractional-reserve banking.
Banks today work the same way. Of every $100 you deposit, a bank keeps a fraction as cash and reserves at the central bank and lends the rest. The loan lands in someone else’s account as a new deposit, which can be lent again, so lending creates new money.
This makes banks useful, because savings finance homes and businesses, and fragile, because a bank cannot pay everyone back at once. If too many depositors ask, the result is a bank run.
Example
The textbook money multiplier at 10%
- You deposit $100. The bank keeps $10 and lends $90.
- The $90 is spent and deposited at a second bank, which keeps $9 and lends $81.
- Then $72.90, $65.61 and so on: each round is 90% of the one before.
- Add up all the deposits: $100 + $90 + $81 + … = $100 ÷ 10% = $1,000.
In theory $100 of reserves can support up to $1,000 of deposits. In practice banks lend when they find good borrowers and their capital allows, so the real multiplier is smaller and changes over time.
One level deeper
For about a century US banks had to hold a minimum share of their deposits in reserve, the reserve requirement, 10% for most checking accounts. In March 2020 the Fed cut it to zero. What limits banks now are capital rules (how much of their own money must stand behind their loans), liquidity rules (how many easy-to-sell assets they need to survive a month of stress) and simple demand for loans.
In the US cash is only about 10% of M2 (Sep 2026); nearly all the rest is bank deposits, money that exists as entries in banks’ books. Since 1959 the cash share has stayed between 7% and 11%.
Critics, from the economists behind the 1930s “Chicago Plan” to some modern fans of bitcoin, argue banks should keep 100% reserves so that runs become impossible. Defenders reply that lending out deposits is what makes banks useful, and that deposit insurance and central banks have made runs rare.
Cash as a share of US money since 1959
Paper money and coins as a percent of M2. The other nine dollars in ten or so are deposits and similar balances, created mostly when banks lend. The share has stayed between 7% and 11% since 1959.
The numbers behind the chart
| Date | Value |
|---|---|
| Jan 1959 | 9.9% |
| Dec 1960 | 9.2% |
| Dec 1970 | 7.8% |
| Dec 1980 | 7.2% |
| Dec 1990 | 7.5% |
| Dec 2000 | 10.8% |
| Dec 2010 | 10.4% |
| Dec 2020 | 10.3% |
| Dec 2022 | 10.4% |
| Dec 2023 | 10.8% |
| Dec 2024 | 10.6% |
| Dec 2025 | 10.5% |
| Sep 2026 | 10.2% |
Why it matters
It explains where most money comes from: bank lending, not printing presses.
It explains why banks can fail even when their loans are good: their cash is a fraction of what they owe depositors.
It is why bank rules, deposit insurance and central banks as lenders of last resort exist at all.
A common mistake
Myth: Banks lend out their depositors’ money one for one: they need a deposit before they can make a loan.
In fact: Mostly it works the other way round: when a bank makes a loan, it credits the borrower’s account, creating a new deposit. It then needs reserves to settle payments, which it can get from other banks or the central bank. The Bank of England explained this in a widely read paper in 2014.
Questions people ask
Is fractional-reserve banking still used?
Yes: every commercial bank lends out most of what is deposited with it. In the US the official reserve requirement has been zero since March 2020; capital and liquidity rules limit lending instead.
What is the reserve requirement?
A rule that banks must keep a minimum share of deposits as cash or as reserves at the central bank. The Fed used 10% for most checking deposits before 2020, the ECB requires 1% (as of 2026), and China’s central bank uses it actively as a policy tool.
What is the money multiplier?
The ratio of the money supply to the money the central bank creates. In the textbook it is 1 divided by the reserve ratio: 10 at 10%. In reality it is much lower and swings a lot; it collapsed after 2008, when banks held huge excess reserves.
Read more on BigCapital
About the numbers
- The numbers on this page are recalculated from the data every night; the sources are listed at the end of the page.
- M2 money stock: Board of Governors of the Federal Reserve System, H.6 Money Stock Measures, series M2SL; retrieved from FRED, Federal Reserve Bank of St. Louis.
- Currency component of M1 and M2: Board of Governors of the Federal Reserve System, H.6 Money Stock Measures, series CURRSL; retrieved from FRED, Federal Reserve Bank of St. Louis.
- US population (midperiod, BEA): U.S. Bureau of Economic Analysis, National Income and Product Accounts, Table 2.1, series B230RC0A052NBEA; retrieved from FRED, Federal Reserve Bank of St. Louis.
- This page explains a term. It is not investment advice.