[0:01]
anonymous asks what are some common confusions about fractional reserve banking and what's the right way to think about it and he links an austrian video so i was curious about this issue and i looked into it and i talked to some people and i read some things and i people and i read some things and i found what people say about it is really unclear and confusing but the actual issues i don't think are all that hard 
[0:33]
so here's roughly what should happen you lend your money to a bank you put it in an account that pays interest and the bank is going to lend it out to people if the bank was not lending it out to people they would not pay you interest they would charge you money for holding their onto your money for you like a storage fee it wouldn't be very large but there would be like a small storage fee to have a bank account if the bank was just going to keep your money keep 100 of your money and then 
[1:04]
give it back whenever you want it that is not the type of account most people want most people want the bank to lend out their money and pay some lend out their money and pay some interest they want to they want to [Music] use the bank to outsource lending because like they don't want to figure out who to lend money to themselves that's hard and that's risky they might lend it to and that's risky they might lend it to someone who never pays them back so you give your money to the bank who are like expert lenders and they have a large portfolio they lend to a lot of people 
[1:35]
portfolio they lend to a lot of people so if one in a thousand people don't pay the money back the bank still makes money on lending overall so everyone gets paid interest because the risk is shared between all the depositors whereas if you were doing lending yourself and one in a thousand people didn't pay the money back you might get unlucky and lose a bunch of money so there's the the risk splitting up too so anyways we want to deposit money in a bank and get some interest bank and get some interest and 
[2:07]
the basic fact is if the bank lends out the money then not all of the money can be then not all of the money can be withdrawn so fractional reserve banking means the bank lends out some of the money rather than being storage for example the bank could lend out 80 percent of the money and they could keep 20 as a reserve so that there's some money that you can withdraw if you need spending you can withdraw if you need spending money but 80 of the money has been lent out so for simplicity let's say that all loans are for one let's say that all loans are for one year 
[2:38]
that would mean that the bank could not guarantee giving you back 100 of your money unless you're willing to wait a full year that would be the maximum amount of time it would take for the bank to get all of its loans paid back and then pay out all its depositors the full amount so if the maximum duration of loan the bank uses is a year and you deposit in that bank in return for the interest you have to be willing to potentially wait to get all of your money back you can get some of it back money back you can get some of it back sooner 
[3:09]
but you might have to wait a significant amount of time to get all of your money back so there's nothing wrong with that there's nothing bad about it there's there's nothing bad about it there's nothing uh there's no like economic argument that there's something wrong with that uh you just have to have a clear contract with the bank you have to deposit your money in the bank the bank says we're going to give you this much interest we keep this much reserve if you want to withdraw money we will try to give you all of your money right away 
[3:39]
and we expect we can usually be able to do that but if a lot of people want to withdraw a lot of money then there will be withdrawal delays up to potentially for some of your money the maximum amount of time that we've made a loan for and all you have to do is say okay sure and then you sign the contract and then it's that's basically what banks are like today because they do lend out money and they therefore cannot pay back all the money immediately um there are some 
[4:09]
complications so in order to pay back money sooner a bank could potentially take a loan out the bank could say okay well we have this outstanding loan we're going to get paid back a million dollars one year from today and then they go to a different bank and say well you loan us the million dollars now so we can give it to our depositors now so we can give it to our depositors so uh there are ways to pay people back sooner if necessary you don't necessarily have to wait for the loan to come due like you can sell 
[4:41]
the loan to a different bank and get most of the money back right away if depositors are willing to take like a small loss to have their money sooner then that works too or it's not necessarily a loss like if it's a if the loan is done well then on average it should uh retain its full value like if you're gonna get paid 1.1 million dollars in a year 
[5:11]
uh maybe you can sell that for the full million dollars today like the amount of interest should cover the delay the delay so uh if if nothing's gone wrong with the loans then you can sell them to another bank and all you're going to lose is the transaction costs of having to put effort into making a business deal and you might even gain money if the uh if the loans are a better deal than what you can get on the market today 
[5:44]
like the market situation can change so the value of the loans goes up or down but supposing it stays the same then you can sell the loans to another bank or borrow against them and you're just losing a small amount of transaction cost and then you can pay your borrowers back sooner so why do people hate fractional reserve banking well they think that the banks are writing the contracts incorrectly and not informing customers of what's going on so what they see is customer puts money in a checking account 
[6:15]
puts money in a checking account um and the customer believes i have full access to 100 of my money the instant i want it i can write a check for the full amount on the account and the bank the actual situation is not all the customers can do that so the contract really needs to say you know we'll try to honor your checks for the full amount in your account we have a reserve that we think will be adequate based on expected withdrawal demand but we cannot expected withdrawal demand but we cannot guarantee that in full and there could potentially be a weight so anyways the basic 
[6:47]
complaint is that banks don't tell people that's the contract that's the thing going on and that they're therefore committing fraud that they're lying about the situation but there's nothing wrong with that type of contract the only actual criticism of it the only actual criticism of it is if the banks are fraudulent about it if they lie to customers about what the situation is if they mislead customers if they false advertise etc i haven't carefully looked into the uh the contracts that banks 
[7:18]
offer you know like reading out the fine offer you know like reading out the fine print um but i think people people who care know what's going on that the bank is lending out the money and if the money is being lent out then the bank doesn't have all of it and therefore if everyone wanted their money back there would have to be a delay like i think it's not hard to find that out so i don't know if the banks are doing something wrong or not but as a customer i don't think it's a big deal you should know what's going on i mean it could be a big deal if uh 
[7:51]
if there's a run on the bank and all the other customers were getting mad and then the bank like lost bunch of money in the chaos because everyone was hating on them and uh pressuring them to return the money immediately and so on so like there's there's some risk there so like there's there's some risk there of a bunch of confusion rather than an orderly withdrawal over time like what should happen in a run on the bank is the bank says okay our reserves are getting low we're putting withdrawal limits you can only withdraw a little bit of money 
[8:22]
because we don't have enough for everyone to withdraw everything and then we'll quickly start calling in some loans when we can selling off some of our loans and we'll try to get most people most of their money back quickly people most of their money back quickly and uh but you're gonna have to wait a while to get all of it because we're not going to be able to get all of the loans undone quickly without losing money and we don't want to lose money so there's going to be some waiting they will also um the bank could just very reasonably say 
[8:53]
to people look if you want to withdraw like a lot of money today we'll be happy to do it if you will take uh 90 cents on the dollar you know they're like you know you can withdraw this much of your money for the full amount if you want more uh we'll give you 90 of the withdrawal uh we'll give you 90 of the withdrawal amount so you'll lose a little money or maybe it'll be 95 or 98 so they can offer if you want all your money back now you just have to take a small discount to make up for us calling 
[9:24]
in the loans something like that anyway so there's there's no like real theory problem here there's just people writing about it in ways where they're like fractional reserve banking is evil and the other side is like oh there's no problem at all and i don't know i don't think the issue is very complicated i just think everything everyone writes about it seems to be really confused confusing unclear and uh yelling at each other