Fractional-reserve banking is a type of banking whereby the bank only retains a fraction of the customer’s deposits as reserves. This means that cash and coin in the bank’s vaults (also called bank reserves) are only a fraction (called the reserve ratio) of the quantity of deposits at the bank. As most bank deposits are treated as money in their own right, fractional reserve banking increases the money supply, and banks are said to create money.
Bank runs (or when problems are widespread, a systemic crisis) can occur in fractional-reserve banking systems. To mitigate this risk, the governments of most countries (usually acting through thecentral bank) regulate and oversee commercial banks, provide deposit insurance and act as lender of last resort to commercial banks.
Fractional-reserve banking is the most common form of banking and is practiced in almost all countries. Although Islamic banking prohibits the making of profit from interest on debt, a form of fractional-reserve banking is still evident in most Islamic countries.