Fractional reserve banking

Question

Quizplus · Accepted Answer

Fractional reserve banking allows banks to create money by lending out more than they actually hold in reserve. This new money is created out of thin air and increases the money supply in the economy. However, the banks are only required to hold a fraction of the money they create in reserve, which means they can engage in more lending and money creation. This process does not necessarily destroy money, but it can lead to inflation if there is too much money creation without corresponding increases in the production of goods and services. Option B is incorrect because it suggests that banks are required to engage in 100 percent of total banking activities, which is not true. Option A is incorrect because while fractional reserve banking can lead to economic problems, it does not inherently destroy money.

Fractional Reserve Banking