Which banking system allows banks to hold only a fraction of deposits in reserve?

• A. Fully reserved banking
• B. Fractional reserve
• C. Central banking
• D. Cash reserve requirements

Answer: (B)

Fractional reserve banking is the practice in which banks keep only a portion of deposits as reserves and lend out the rest. This setup lets banks create more money through the lending process: when a loan is made, the borrower’s funds typically end up deposited somewhere else in the banking system, producing new deposits that can be loaned again, within reserve limits. The reserve portion acts as liquidity to meet withdrawals and is guided by policy rules and the central bank’s tools. If many people want cash at once, banks must rely on those reserves and, if needed, the central bank can lend them funds to prevent a panic. This approach is distinct from fully reserved banking, where all deposits are kept as reserves and no additional lending occurs, and from the broader roles of central banking or the specific policy of cash reserve requirements.