The Banking system of the United States is referred to as a fractional system because the banks are only required to keep a fraction of the money put on deposit with them. Because the banks only keep a fraction of the money depositors are owed in reserve, the Federal Reserve System created the Federal Deposit Insurance Corp (FDIC). It is this Insurance that will pay people the total amounts of their deposits (up to $250,000 per depositor, per type of account) in the even that a bank fails.
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Fractional Reserve Banking
Fractional Reserve Banking is a banking system where banks are required to hold a fraction of the deposits from customers as reserves. This allows banks to lend out most of the money to earn interest. This also allows banks to pay interest to savings accounts. This system frees up more funds and creates a multiplier effect where more money is available in the banking system. This system is used in many countries. The required reserve amount is set by the central bank and is one of the many monetary policy tools at their disposal.
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fromChapter 19 / Lesson 13
What is the FDIC and when was it created? In this lesson, learn what FDIC stands for and why the FDIC was created. Learn about the FDIC's purpose, function, and history.