The banking system of the United States is a fractional reserve system. What dangers does this pose for the safety of the banking system?

Question

What will be an ideal response?

Answer 1

Fractional reserve banking means that each individual bank only keeps a fraction of its deposit liabilities on hand as cash in the vault or easily accessible reserves. Therefore, every individual bank is vulnerable to a bank run, a situation where many depositors attempt to withdraw all of their deposits in cash at the same time. If the situation were to spread from bank to bank, the entire banking system could be subject to collapse. This possibility of bank runs means that bankers have to perform something of a balancing act in weighing the benefits to the bank of the profits from loans against the need for prudent levels of reserves to handle depositors’ withdrawal demands. In the United States today, the probability of bank runs has been substantially reduced by government regulation and supervision of banks along with the existence of federal deposit insurance.