What is the concept of fractional reserve banking?

Fractional reserve banking is a system that allows banks to hold only a fraction of their depositors' money in reserve while using the majority of those deposits to provide loans to other customers. This practice is fundamental to the banking system because it enables banks to create credit, thus facilitating economic activity and growth. By retaining only a portion of deposits as reserves, usually determined by a specific reserve requirement established by regulators, banks can generate income through interest on loans, which benefits both the bank and the economy.

The process relies on the understanding that not all depositors will withdraw their funds simultaneously, allowing banks to operate effectively while maintaining liquidity. This system promotes lending, which stimulates investment and consumption in the economy. The concept of fractional reserve banking is crucial for understanding how modern banking functions and how money supply in the economy can be expanded or contracted.

In contrast, the other options illustrate different concepts: one suggests that banks maintain all deposits as reserves, which would not allow for lending; another discusses investing in stocks and bonds, which refers to asset management rather than banking operations; and the last relates to restrictive lending practices that do not align with the essence of fractional reserve banking, which is fundamentally about managing deposits and creating loans.