Fractional Reserve System used by Banks

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The best thing about banks are they can be the greatest allies or your worst enemies in the battle of FIRE and It is in your control how you want them to behave. The banks works on the principle of fractional reserve system. In this article we will learn how banks work so that we can know how to use them efficiently.

Fractional reserve system works best only if person like you and me trust the bank. RBI has right to print money from the air but banks have a magic wand called fractional reserve system. Let's see in detail by example how it works. Let's assume we as a saving bank account holder deposit 100 rs in the bank. By the rule set by RBI, CRR(Cash Reserve Ratio) should be atleast 3%. In simple words, bank can use 97 rupees of your money to borrowers without your consent or approval. Imagine the chaos, when 20% of the population wants to withdraw money from the banks(I let it to your imagination).

Above dooms day scenario will playout only when trust in banking system and country is lost. In india, we are well protected by the government. India has deposit insurance scheme by Deposit Insurance and Credit Guarantee Corporation(DICGC) which has 500000 deposit guarantee for Depositors.

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