See: Reserve Requirements.
One of the ways banks make money is by lending it out. Wait, lending out what money? Deposits. That’s right. The money is being lent back to you with that loan you took out from the same bank. But hey, they’re paying you a tiny bit of interest as a way of saying “thanks.”
Since banks make the big bucks by lending out deposits, in their ideal world, they’d lend out most (all) of it. That way, all those deposits are working to make money for them. Yet they can’t lend out all of it...you wouldn’t be able to pay your bills and go to the ATM if they lent out all their moolah. And if there was a bank run, where everyone’s trying to take out their deposits at the same time, then they’d be really screwed (well, the people and the bank).
That’s why the federal government created the central bank (“the Fed” in the U.S.) The Fed made a rule: banks have to keep a certain percentage of deposits on hand at their banks, in liquid (cash) form. This is the reserve ratio...the ratio of “reserves” they gotta keep on hand to be legal.
For instance, a 10% reserve ratio would mean the bank is allowed to lend out 90% of their deposits. Your $2,000 check you just deposited? $1,800 is lent out, and they keep $200 on hand.
The Fed wants to make sure you don’t have too many reservations about banks. It’s best for them if you keep the money in the bank rather than under your mattress. And probably in your best interest too, given that inflation erodes your money away. Hopefully your bank account’s interest rate is close-ish to inflation.
Related or Semi-related Video
Finance: What is the 1913 Federal Reserv...3 Views
Finance Allah Shmoop What is the nineteen thirteen Federal Reserve
Act Well for starters it created the Federal Reserve Thank
you Woody Wou okay So the Federal Reserve Act think
reserve of cash and or gold and or other securities
and assets that would serve to buffer volatile financial times
is the US grew to become a dominant global power
Will the Federal Reserve is essentially the mothership of banks
or central bank as it is called in other countries
which is kind of the water spigot in the price
and velocity at which it loans money to sub distributors
of loans A US banking system Will the act divvied
up the country into twelve regions right here twelve each
with its own board of directors And then the Federal
Reserve itself has seven board members purposely an odd number
two Both reflect the personalities of the people and the
need for tiebreaking facility Well they are the FOMC or
funk or Federal Reserve's Open Market Committee who live under
strict rules regarding meetings held discussions had And what kind
of bagels tohave on the conference room table for Friday
morning meetings Remember that the country only fifty years ago
before this act was almost split in half with the
you know their existing a Yankee currency more or less
And a Confederate currency and then other regional currencies kind
of popped up around the edges and there was gold
and there was always that nerdy whole wanted to pay
in bitcoin So the Federal Reserve act unified the country's
currencies into one common currency the US dollar And under
that massive scale tons of efficiency in managing and leveraging
that money could be had And in doing so the
US dollar became almighty It was the global standard currency
of choice And it also let banks catalyzed the American
dream at least in America by virtue of their ability
to grant mortgages right like most of the wealth in
this country is stored in homes people own So yeah
it's all powerful stuff in a world where the common
man you know for Millennia before had never dreamed of
actually owning his own castle no matter how small it
wass Well one tool that the Fed then used was
to basically say to banks We literally give you a
license to print money and it's okay Hey that you
make a profit but you have to live by our
rules But if you do you you know make bank
Yeah well that's probably where the term came from Well
it was that ability to print money that became the
central weapon the U S government then used to manage
the economy I'ii stimulate her giggity when she was cold
and cool her off when she was you know inflation
e Well the Fed created what is called a discount
window where banks line up to buy discounted money or
credit They mark it up and then resell it Tio
cash thirsty Joe six packs all around the country so
inside of each of the twelve regions of a bank
wanted to be a federal bank I live under the
rules of the Fed so that they got cheap U
S dollar backed loans from the Fed which they would
then mark up and sell Joe Consumer who wanted to
buy a home or a mule or a butter churn
or two thousand Well then they had to have skin
in the game That is the regional banks had to
go raise their own capital like you know asking grandmama
for money or raising it from a consortium of shareholders
who would then buy in or invest that capital as
part of their commitment to the long from establishment of
credible banks in the region That investment wasn't sellable or
transferable and the cash they invested well paid no interest
That quote gift unquote of no interest was kind of
a sign that well of their you know financial commitment
to the partnership would grow and do well is an
asset Our investors would lose everything and note the word
incredible Here It means believable trustworthy honest Well it doesn't
take much letter tweaking to make that word credit Credit
tha bull and yeah that's where all these turns to
write So who made all this happen Who made it
up Who implemented Well if you ever get a chance
to see Hamilton Hamilton the stage play not the TV
commercial for bulk pig meat see it You may have
to take out a bank loan You know just buying
but cheap tickets here That's what we're hoping for Yeah
