📚 Topic Summary
Fractional reserve banking is the most common form of banking practiced worldwide. It works by banks holding only a fraction of their deposits in reserve and lending out the remainder. This system allows banks to create credit and expand the economy, but it also carries risks if too many depositors try to withdraw their money simultaneously. The reserve requirement is the percentage of deposits a bank must keep in its vault or at the central bank.
🧠 Part A: Vocabulary
Match each term with its correct definition:
| Term |
Definition |
| 1. Reserve Requirement |
A. The interest rate at which commercial banks can borrow money directly from the central bank. |
| 2. Money Multiplier |
B. The process by which the money supply is increased as commercial banks lend money. |
| 3. Discount Rate |
C. The fraction of deposits banks are required to keep in reserve. |
| 4. Excess Reserves |
D. The amount of reserves banks hold above the required amount. |
| 5. Money Creation |
E. The ratio of the increase in the money supply to the increase in the monetary base. |
✍️ Part B: Fill in the Blanks
Fill in the missing words in the paragraph below:
Fractional reserve banking relies on banks holding only a ________ of their ________ in reserve. This allows banks to ________ out the remaining funds as ________, stimulating economic ________. The ________ ________ is the percentage of deposits that banks must hold in reserve.
🤔 Part C: Critical Thinking
Explain in your own words how fractional reserve banking can both stimulate economic growth and pose a risk to the financial system. Give a real-world example to support your answer.