Fractional reserve banking does not work like this.

You still need assets in fractional reserve banking. Those assets just don't need to be reserves.

Ie 90% of your assets could be diamonds in the vault, and 10% could be reserve cash in the vault. That would be fractional reserve banking, but you still have 100% assets. (In practice, you have more than 100% assets. The excess is your equity cushion.)

If your liabilities outstrip your assets, that's when you are bankrupt. Fractional reserve banking doesn't help you there.

The 90% is not diamonds, it's loans I've made.

I have two customers A & B. A has $1000 on deposit. B has $500 on deposit. I have $1500 in my safe. Assets = $1500, Liabilities = $1500.

B borrows $500, which for simplicity's sake he deposits in his account.

Now A has $1000 on deposit, B has $1000 on deposit. I have $1500 cash in my safe and a note from B for $500. Assets = $2000, Liabilities = $2000.

I just created $500. It's really that simple.

Yes, IOUs of credit worthy people can be part of your assets. But so can be diamonds or stocks.

> B borrows $500, which for simplicity's sake he deposits in his account.

If you stop there, your analysis is indeed correct. However, people don't typically take out loans to stuff the borrowed money into their accounts until the loan comes due.

They go out and buy stuff with the proceeds. So B withdraws the money.

So now you have:

- Assets: 1000$ cash in your safe plus an IOU of 500$ from B = 1500$.

- Liabilities: 1000$ deposit from A + 500$ deposit from B = 1500$.

So far so good.

You can repeat that game two more times, and then you run out of cash to withdraw.

So if you repeated it a third time, you'd need to sell the loan from B to a third party for cash, so you can fulfill B's withdrawal request.

If B is credit worthy, you will generally be able to make that sale. (But it takes time and hassle to organise.) Ie you have short term liquidity trouble, but you ain't insolvent.

If B is a deadbeat, you won't be able to sell that loan for enough to cover the withdrawal request, and now you are insolvent, and go into bankruptcy.

B is creditworthy. That’s why I leant it to him. If I have an issue with liquidity I go to the discount window of my central bank and they will lend me the money.

That’s why central banks typically make the rules about reserves, etc.

> B is creditworthy. That’s why I leant it to him. If I have an issue with liquidity I go to the discount window of my central bank and they will lend me the money.

Yes. But that means you got newly created base money from the central bank. Which sort of goes against the original claim.