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Your Comprehensive Guide In Managing Family Finances

Managing family finances has all sorts of challenges — from budgeting to savings goals, loans, debt management, and more. However, with the right knowledge, you will surely get through it.

Guide in Managing Family Finances

According to a consumer survey conducted by the Certified Financial Planner Board of Standards, it was found that 59% of the 300 adult respondents (aged 35 to 65 years old) do not track their spending, while two out of five never had a budget.

Meanwhile, in a Gallup poll, it was found that only 32% of Americans maintain a household budget.

Furthermore, the same poll revealed that only 30% of Americans prepare a long-term financial plan outlining their savings and investment goals in detail, while the 2020 ‘Financial Planning’ Survey Data Released by First National Bank of Omaha reported that 49% of Americans expect to live paycheck to paycheck in 2020.

In another study by FINRA Investor Education Foundation entitled, “The 2018 National Financial Capability Study,” it was found that over 53% of American adults feel anxious thinking about their financial situation. Forty-four percent even find it stressful discussing their finances.

The above-mentioned surveys and studies are just some of the many that are available out there.

Unfortunately, all of these show how badly Americans (particularly adults) are when it comes to their personal finances, which, in effect also affects how they handle their family finances.

However, this does not mean American people cannot change when it comes to how they handle their money – be it their personal, business, or the family’s money.

We believe that while change does not happen overnight, it will, eventually, for as long as there is a will.

Also, apart from that, proper knowledge, understanding, and guidance by experts are also essential to there can be a shift in how the American people handle their money.

With that said, in the next few sections, we are going to share with you some of the most important information you need to know when it comes to handling family finances.

From personal finance management to savings goals, loans, debt management, etc. – we got you covered.

In particular, we are going to tackle the following:

  • About Banking
  • Mobile Banking
  • Online Trading
  • Life Insurance
  • Investment Platforms
  • Loans
  • Credit Monitoring
  • Online Fund Transfer
  • Personal Finance Management Tools

ABOUT BANKING

Generally, banking refers to the act of accepting as well as safeguarding money owned by individuals, group of people, or entities, and then lending it out to make a profit or to cover operating expenses.

Banking also refers to the industry that handles cash, credit, as well as other financial transactions.

Banks refers to the physical structure that provides a safe place to store both cash and credit.

Banks offer a number of products and services, which include savings accounts, checking accounts, and certificates of deposit. Some banks also offer loan products and services.

In the U.S. economy, banking plays a very important role. In fact, it is one of the key drivers that keep the economy going.

When it comes to handling your personal finances or family finances for that matter, it is important to know and understand what banking is all about, the available products and services offered, how banking actually works, and how it will help you in your financial journey.

Banking is basic yet the most essential aspect of your financial journey. Needless to say, it is the most convenient and most accessible way to keep your money.

To help you understand better what banking is all about, and it is important in your overall financial journey, here are some references that you may check out:

MOBILE BANKING

Investopedia defines mobile banking as “the act of making financial transactions on a mobile device (cell phone, tablet, etc.)”.

Banking has never been so easy, simple, convenient, and accessible with the rise of the mobile banking industry.

In today’s digital age, it is not surprising that more and more banks (both old and new) are offering online services. After all, the number of people using online or mobile banking is impressively increasing over time.

With mobile banking, you can deposit a check, pay for merchandise, as well as transfer funds to a family member or a friend anytime and anywhere for as long as there is a secure internet connection.

Indeed, mobile banking has changed the way banking works.

If you want to know more about what mobile banking is all about, check out the blog posts below:

Mobile Banks for Personal Use

There are a lot of mobile banks out there, and choosing one can get a little challenging especially if you are new to mobile banking.

To help you choose the one that fits your needs and preferences, you may check out these mobile bank reviews:

Mobile Banks for Students

Meanwhile, if you are a student who wants to start early when it comes to financial management, or you are a parent who wishes to teach your kid about financial management through banking, here are some blog references for you:

Mobile Banks for Businesses

Mobile banks are not only available for personal use. In fact, even businesses can take advantage of what mobile banks have to offer.

There are a few mobile banks for businesses out there, and NorthOne is one of them. Know more about this mobile bank and what it offers in the blog below:

ONLINE TRADING

NerdWallet defines trading as the act of buying and selling stocks regularly in an attempt to time the market.

Furthermore, the website explains that the goal of traders is to “capitalize on short-term market events to sell stocks for a profit, or buy stocks at a low. Some stock traders are day traders, which means they buy and sell several times throughout the day“.

Meanwhile, online trading refers to trading stocks using an online platform. Online trading has become increasingly popular among traders because it’s timely, convenient, and easy.

There are a lot of online trading platforms out there, and one of them is eToro. Know more about what this online trading platform has to offer in the blog post below:

LIFE INSURANCE

According to Forbes Advisor, life insurance refers to “a contract between you and an insurance company. Essentially, in exchange for your premium payments, the insurance company will pay a lump sum known as a death benefit to your beneficiaries after your death.”

Generally speaking, life insurance is essential especially if you have dependents (which normally refers to your spouse and child/children). It helps protect your dependents and allows you to leave them a non-taxable amount at the time of your death. Apart from that, life insurance can also be used to cover existing mortgages as well as personal loans.

There are a lot of life insurance companies out there to choose from. These days, life insurance companies can also be easily found online.

Over time, insurance companies have adapted to the changes brought by technology and the internet. So, yeah, if you are looking for life insurance company options, we recommend you check these blog posts below:

INVESTMENT PLATFORMS

Investing is an essential way to help keep your family finances on a positive note.

An investment platform refers to an online service that allows consumers to buy, sell, as well as hold funds.

Most investment platforms are on a non-advised basis, which allows you, the consumer to do everything on your own. However, there are also those that are on an advised basis wherein the consumer has the option to use a financial adviser who will invest on his or her behalf.

Online investment platforms have become very popular among consumers over recent years as it can be a tax-efficient way to hold investments.

With its gaining popularity comes a lot of choices. Yes, there are many online investment platforms out there for you to choose from.

To help you choose the right online investment platform, and to know more about investing, check these reviews and references:

LOANS

Investopedia refers to the term loan as “a type of credit vehicle in which a sum of money is lent to another party in exchange for future repayment of the value or principal amount”.

If you want to have a better understanding of what a loan is all about, we recommend you check these references:

There are different types of loan out there, but some of the most commonly offered by banks and lending companies are:

  • Auto Loan – Also known as a car loan, this allows you to acquire a vehicle. Normally, car loans or auto loans are collateral loans, which means the vehicle automatically serves as collateral in case the borrower fails to pay off the loan.
  • Business Loan – This type of loan is specifically intended for business purposes. You can use it to open a new business or for expansion of an existing one.
  • Home Loan/Mortgage – This allows the borrower to purchase his or her dream home. Home loans usually consist of an adjustable or fixed interest rate and payment terms.
  • Payday Loan – This refers to a short-term loan that can help cover your immediate need for cash. This usually comes with a higher interest rate.
  • Personal Loan – This is the most common type of loan out there. A personal loan can be used for almost any type of purchase — especially big ones. It usually comes with a lower interest rate as compared to credit cards.
  • Students Loan – This type of loan is specifically designed to help students pay for their education as well as other school fees and charges. It can also be used to pay for books and school supplies.

Know more about these types of loan in the blog posts below:

Personal Loan

Auto Loan

Business Loan

Home Loan/Mortgage

Student Loan

Payday Loan

Other Types of Loan

Apart from the above-mentioned loan types, there are less commonly known types of loans, which include:

Dental Loan

Emergency Loan

Point of Sale Financing

Tax Refund Advance Loan

Boat Financing

Loan Marketplaces

Loan marketplaces are online sites or platforms where you can easily find a lender for your loan needs.

While there are a lot of them out there, here are some of them:

CREDIT MONITORING

In this day and age, there are a lot of products and services that will help keep you on track of your family finances – one of them is credit monitoring.

According to an article published by CNBC, credit monitoring basically refers to what the name suggests — it monitors your credit.

These services help track your credit history as shown on your credit report and send alerts via email, SMS, or phone call in case changes transpire. This helps hinder potential fraud, should there be any.

Furthermore, the article says, “credit monitoring services provide an automated and faster way to track changes to your comprehensive credit file”.

There are a lot of credit monitoring services out there, and each of them has its respective list of activities. However, some of the common activities among them are as follows:

  • New accounts opened under your name
  • Hard inquiries on your credit report
  • Balances and payments
  • Name changes and/or new address
  • Public records like bankruptcies
  • Personal information like your social security number, email address, and password

While credit monitoring services are helpful in spotting potential signs of fraud, please note that it is not as comprehensive and does not provide a holistic approach to prevent identity theft or unauthorized transactions.

As earlier mentioned, there are a lot of existing credit monitoring tools out there, which include Credit Sesame and Credit Karma. Know more about these services in these blogs below:

ONLINE FUND TRANSFER

As obvious as it is, online fund transfer refers to the act of transferring funds through an online platform. Normally, freelance workers or work from home workers use online fund transfer platforms to receive payments from their clients.

However, over time, these platforms have also been used to transfer money within families – especially those who are far from one another.

While there are many available options out there, TransferWise and Xoom are some of the most popularly used online fund transfer platforms these days. Know more about them in the following reviews:

PERSONAL FINANCE MANAGEMENT

Personal finance management tools refer to a platform or software that helps individuals or families in handling their money.

A personal finance management tool is very helpful especially in handling family finances. This helps ensure that all funds are directed to where they should be.

There are a lot of personal finance management platforms out there, and to be honest, it’s just about choosing the one that suits your and your family’s needs.

To know more about what’s out there, check the blog posts below:

FINAL THOUGHTS ON FAMILY FINANCES

Handling family finances may be quite a challenge back in the days, but in this era, it is made easier. Thanks to technological advancements, today, there are various tools and platforms (mostly available online) that can help you in managing your personal, business, and most of all, your family’s money.

Are you now excited to manage your and your family’s money?

As mentioned, keep in mind that with existing finance tools and platforms, handling your family finances should be a breeze.

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Investment Apps and Websites

Your Guide On How To Get Started With Banking

Before opening a bank account, it is important to know and understand the basics, as well as how to get started with banking. That way, you can maximize what the bank has to offer, at the same time, take full advantage of the benefits of banking.

how to get started with banking

Let’s face it, all of us reach a certain point in our lives when we will have to manage our finances. As a kid, perhaps you have your parents to manage your money, but once you reach a certain age, you will have to do it on your own.

Financial management, though it sounds overwhelming, is actually simple and easy as long as you know how to work around it. You know the basics, you know where to put your money, etc.

One aspect that is always present when it comes to financial management in banking. People, regardless of age, deal with banks. Banks are like our safe-keepers. They keep our money, ensure that it’s safe and secure and that it is ready anytime we need it. More so, by keeping our money in the bank, we get to earn – maybe not that big, but still, our money earns.

Now, if you are a newbie in banking, it is important to understand how it actually works. More so, you need to know what you actually need, and what you are expecting from a financial institution. That way, it’s easier for you to weigh your banking options, and eventually, choose the perfect bank for you.

Just so you know, according to data published by Statista, currently, there are 4,708 FDIC-insured commercial banks in the United States. That’s a lot!

Now, you know what we mean, right? With so many options around, how then do you choose the perfect one for you?

Well, today, we are going to share with you some of the basics on Before opening a bank account, it is important to know and understand the basics, as well as how to get started with banking. The information we shall be sharing is essential especially to those who are new to the idea of banking.

In particular, we are going to share with you the following information:

  • Definition of Banking
  • Types of Banking Services
  • Account Types
  • Where to Open an Account
  • What to Look for in a Bank Account
  • What to Avoid in a Bank Account
  • Opening a Bank Account

DEFINITION OF BANKING

Before we proceed to the process of how to get started with banking, we got to first and foremost, define what banking is. We need to know and understand what banking is all about, and the concept of banking.

A bank refers to a financial institution that is licensed to accept deposits, as well as recurring accounts from the people. It also makes loans to those who need money for specific reasons.

Apart from that, most banks also provide financial services like wealth management, currency exchange, as well as safe deposit boxes.

Whenever we hear the word bank, we thought it refers to just one particular body. What most of us do not know is that there are actually different kinds of banks, which depend on the client they are servicing in. Three of the most common types of banks include retail banks, commercial or corporate banks, and investment banks.

In a lot of countries, banks are usually regulated by either the national government, or by the central bank.

Now, when we say banking, it basically refers to the industry that handles financial transactions such as cash, credit, and many more. Banking may also refer to the act of doing bank transactions or dealing with banks, and the like.

In the United States, banking is known as one of the major drivers of the economy.

If you want to learn more about what banking is all about, you may refer to this video by Kurzgesagt – In a Nutshell:

TYPES OF BANKING SERVICES

Now, as part of the process on how to get started with banking, we also need to know the different types of banking services offered by banks. This will help us gauge the right service according to our preferences.

When we say banking services, it basically refers to everything — from savings accounts, to checking accounts, to loans, and more.

As a potential customer or client, it is best to decide which specific banking service or services is/are most important to you, and also, if you are or are not willing to pay for some of these services.

Here are some of the different banking services that banks offer:

SAVING AND STORING FUNDS

To be honest, we find banks as the safest place to store money. Instead of keeping your cash at home, putting it in a “piggy bank,” or carrying it with you, storing it in the bank helps ensure that your money is safe and secure. Don’t worry, keeping it in the bank does not mean you won’t have access to your money. Banks let you easily access your funds anytime (and anywhere) you need them through electronic banking or through an ATM.

Make sure though that you are keeping your money in an FDIC-insured bank or credit union so your money is protected by the U.S. government. So, if by chance the bank where you stored your money fails, your funds will not completely evaporate.

EARNING INTEREST

Some of us would want to use banks not just to keep our money, but also to be able to earn interest from it.

If that is your goal, then you got to find a bank that offers a service or services that could help you reach such a goal.

There are bank accounts out there that help you grow your money by paying interest.

In a certain period of time, compounding interest helps grow your original funds into a larger amount of money.

However, please take note that most banks do not pay as much as many investments do.

If your goal is to earn a larger amount of money from your account, then, you better check investment options instead (but that’s for another topic).

LOANS

Apart from storing and keeping their clients’ money safe and secure, banks are also into the business of lending money.

Banks provide a variety of lending options such as auto and home loans, credit cards, as well as lines of credit for starting a business.

MOVING MONEY AND MAKING PAYMENTS

Banks understand that people need easy access to their money. Thus, they provide products like checking accounts, which allows you to write checks against your money in the bank.

Also, banks provide several ways to make electronic payments wherein a lot of them use the Automated Clearing House (ACH) network or electronic funds transfer (EFT) system.

Specifically, banks offer the following features (Please note that features differ from one bank to another. That is why it’s always best to check with your preferred bank first before opening an account with them.):

  • Pay bills online
  • Use your debit card to make payments at retailers or online merchants
  • Move money from one account to another through the bank’s app or via an online banking service
  • Provide account information to companies to be able to pull funds from your account through automatic payments
  • Send money to family, friends, and businesses that you buy from via a third-party app or an online banking service

ACCOUNT TYPES

Most banks, if not all, offer a wide variety of account types that will suit customers with varying needs and preferences.

As a potential bank customer, it is important to be aware of the different account types that the bank offers. That way, it’s easy for you to detect if the bank is ideal (or not) based on your needs.

Here are some of the common types of accounts that banks offer:

SAVINGS ACCOUNTS

Savings accounts are the most basic type of bank account. You basically put money in, and then the bank pays you with a little interest, and then, if you need funds, you can withdraw cash or you can opt to transfer to another account.

The downside of a savings account, though, is that it is not ideal for everyday spending. That is because there is a limitation when it comes to how often you can make certain types of transfers or withdrawals.

CHECKING ACCOUNTS

Unlike savings accounts, checking accounts do not usually have withdrawal limits. Thus, making it ideal for those who need to access their money every time.

To use your funds in your checking account, you can do any of the following:

  • Write checks
  • Enter your card number online
  • Set up bill payments online
  • Swipe your debit card
  • Authorize billers to get the fund you owe

Meanwhile, the downside of checking accounts is that usually, they do not pay interest. Although, there are interest-bearing checking accounts, they do not pay more as compared to savings accounts.

CERTIFICATE OF DEPOSIT (CD)

Apart from savings accounts, certificates of deposit also earn interest. CDs are another good choice for those who want to put their money in the bank in order to earn interest.

However, unlike savings accounts, CDs are not easily accessible. Banks require that you leave your CD funds untouched for a particular period of time.

Should you intend to get your money ahead of its maturity date, the bank will have you pay a penalty.

With CDs, terms normally vary from six months to five years, and even longer. If you want to earn more, then go for a longer-term.

MONEY MARKET ACCOUNTS

Money market accounts are like a mix of savings and checking accounts. Usually, money market accounts pay more interest as compared to savings accounts.

A money market account allows you to spend your money easily by either writing checks or by using a debit card.

The catch with money market accounts is that the government limits the number of withdrawals or transfers up to six per statement cycle only.

Money market accounts are ideal for emergency savings or for infrequent expenses.

WHERE TO OPEN AN ACCOUNT

The bank is normally used generically. If you do not know yet, there are actually different types of banks out there. But of course, big banks are typically the most popular option when in fact, local or regional banks, as well as credit unions, are actually better choices especially if it’s your first account.

Thanks to digital technology and the internet, online banks are booming and are becoming a popular option especially among the young ones.

For your reference, here are the different bank options where you can open an account:

BIG BANKS

You can usually find large banks as well as global banks advertised aggressively. Needless to say, since they are huge, they usually are present in numerous locations.

Big banks are often household names plus they normally offer a full range of products and services.

Furthermore, big banks have a global reach, a lot of ATMs to choose from, and their customer service is often available 24/7 through phone (or in some cases, through chat).

The downsides of using a big bank though are that since they are huge, you might find them complicated to navigate. Also, there’s a chance of paying more and higher fees as compared to smaller banks and credit unions out there.

REGIONAL AND COMMUNITY (OR LOCAL) BANKS

Unlike big banks, regional and community banks focus on smaller geographic areas. Normally, they would either serve customers in several states or in just a few towns.

Since they are on a smaller scale, these types of banks is usually more involved in communities. They help individuals, as well as businesses, operate locally. Technically, regional and community banks may play an important role in the local economy.

Now, since they have a more personal touch or personal approach, these banks are more likely to offer free checking accounts and loan approvals.

Unlike big banks though, since these are smaller banks, they typically offer limited options with regards to their products and services.

CREDIT UNIONS

Credit unions are very much similar to regional and community banks. What makes the difference is that credit unions are not-for-profit organizations that are owned by the members (which are also their customers). Banks are usually investor-owned.

In order to take advantage of the products and services offered by credit unions, you need to be a member first. By the way, being a member means becoming a partial owner of the credit union.

A lot of credit unions have eligibility requirements like belonging into employee groups, associations, or geographic areas.

Being part of a credit union means enjoying superb customer service, lower fees, and of course, access to a shared network of ATMs.

ONLINE BANKS

With the advent of digital technology and the internet, the banking industry adapted to it — thus the existence of online banks. Today, there are more online banks coming out, offering customers digital access.

Most online banks operate entirely online without brick-and-mortar branches. This type of bank is ideal for people who are tech-savvy.

What’s nice about online banks is they pay higher interest rates on savings accounts than traditional or brick-and-mortar banks, which we thought is the very reason why this is becoming the new norm in banking.

WHAT TO LOOK FOR IN A BANK ACCOUNT

When finding a bank where to keep your money into, make sure to look for one that offers the following:

  • Good Interest Rates – As much as possible, look for a bank that pays high-interest rates, but offers low rates on loans. Interest rates become more important as dollar amounts get bigger.
  • Minimal Fees – If you can find a bank that does not charge any fee, then that’s a good find. Otherwise, at least choose the one with minimal fees particularly on monthly service charges and low-balance fees. It’s non-sense keeping your money in the bank at the same time paying high fees. It defeats the purpose of saving.
  • Additional/Special Features – All banks offer almost the same types of products, but what makes one different from another? Usually, it’s the features that come with it. So, look into that, and see if it’s a good deal.

WHAT TO AVOID IN A BANK ACCOUNT

While there are certain factors that you should look into a bank, there are also things that you should avoid. This includes the following:

  • Limited Availability of Funds – Banks’ rules are different from one another. While some lets you access your money in just a day or two business days, some hold your deposits and would let you wait a week or so before you get to use your money.
  • Unnecessary Fees – As we have said, when looking for a bank, make sure to look for one with less or no fees at all. Also, make sure the bank does not charge unnecessary fees like low balance fees, inactivity fees, fees for bouncing checks, and many others.
  • Errors and Fraud – As a customer, it is important that you are confident with the bank where you store your hard-earned money into. Thus, make sure to look for a credible bank. A bank that has been there and get through the test of time.

OPENING A BANK ACCOUNT

How to get started with banking is pretty much easy, right? It actually is if you know the basic information. It should not cause any hassle at all.

Anyway, now, we go into how to actually open an account — assuming by now you already have a specific bank in mind.

Generally, banks will ask you to provide the following information:

  • Personal Details – This includes your name, date of birth, and Social Security Number or something similar
  • Identification – Banks normally asks one or two identifying documents like a driver’s license, passport, or other government-issued ID.
  • Address – This refers to your physical address.

The above-mentioned information is actually required by the law.

Now, when opening an account, banks do have varying deposit requirements depending on the product that you are availing. Some may require at least $25, while others require at least $100. It’s best to check with the bank first regarding this.

FINAL THOUGHTS ON HOW TO GET STARTED WITH BANKING

Getting started with banking, as you can see, is actually not that complicated as long as you know the basics.

So, have you been enlightened on how to actually start with your banking experience?

Just keep in mind that to successfully get started with banking, you have to learn and understand the basics first.

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Investment Apps and Websites

A Guide On What Is Fractional Reserve Banking

Do you know what is fractional reserve banking? It’s basically putting your money on the bank not just for safekeeping, but also allowing the bank to hold a portion of your funds as reserves.

What is Fractional Reserve Banking

Sounds complicated? Well, that is precisely why we are here!

We are going to discuss what fractional reserve banking is all about for you to be able to understand, at the same time, appreciate the whole concept.

As a saver or a bank customer, it is a plus to learn about this process. This way you get to know how you can potentially earn more from your money.

While the term sounds complicated, it’s actually simple and easy to understand. We thought once you have read through everything, you’d have a better appreciation of what fractional reserve banking is all about.

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Here’s the thing, when a saver deposits his or her money in the bank, that money is usually available for withdrawal anytime he or she needs it, right? However, what savers do not know is that the bank does not keep all their cash on hand for safekeeping purposes. Instead, a fractional reserve banking system is practiced. This system basically allows the bank to invest the savers’ money, but, still showing the funds sitting in their accounts (otherwise, savers will surely freak out).

It’s like, making use of your money while you do not need it yet — but, in a legal way.

Yes, fractional reserve banking is legal. In fact, according to Encyclopedia.com, all banks in the United States operate under the said system, which means, “the law requires banks to keep a percentage of their deposits as reserves in the form of vault cash or as deposits with the nearest Federal Reserve Bank.”

But for you to fully understand the whole concept of fractional reserve banking, we are going to walk you through some of the most important information regarding this system. As a bank saver, it is your every right to know more about this so you get an idea about what exactly is happening with your money while in the bank.

To be specific, we are going to talk about the following:

  • What is fractional reserve banking?
  • How does fractional reserve banking work?
  • What does expanding money supply means?
  • What do bank runs mean?
  • What are the requirements for fractional reserve banking?
  • How do banks create money?
  • What does fractional reserve multiplier effect mean?
  • What is the importance of fractional reserve banking?
  • What are the disadvantages of fractional reserve banking?

WHAT IS FRACTIONAL RESERVE BANKING?

For us to fully understand what fractional reserve banking is all about, we need to first, define what is fractional reserve banking, and second, know its history.

As mentioned earlier, fractional reserve banking refers to a system wherein a fraction of your bank deposits is held in bank reserves. Banks are required to hold just a portion of the funds deposited with them as reserves.

Generally, banks use customer deposits in making new loans, as well as in awarding interest in the deposits made by their clients.

Meanwhile, reserves are held as balances in the bank’s account either at a central bank or as currency in the bank.

In the United States, the Federal Reserve has set a reserve requirement wherein banks are tasked to set aside a minimum portion of funds. For these funds, banks are expected to hold it as cash in vaults or as deposits with Federal Reserve Banks.

Just to give you an idea, for a financial institution that has over $124.2 million in liabilities, the reserve requirement at the moment is 10 percent. This basically means that banks can lend out $90 of every $100 their clients deposit.

As mentioned, apart from understanding and knowing the definition of what fractional reserve banking is, knowing the history is also important — equally important, if we may say.

So, the concept of fractional reserve baking happened during the gold trading era. The idea came to life after it was realized that not all people need their deposits all at the same time.

Back then, when people deposit their gold and silver coins at a goldsmith, they were, in return, handed a promissory note, which was later accepted as a means of exchange. The holders used them in commercial transactions.

The notes were used straight in trade, which eventually made goldsmiths realize that apparently, not all savers withdraw their money at the same time.

With that realization, they began using the deposits to issue loans as well as bills at high interest. That is in addition to the storage fee that is charged to the deposits.

With that, the goldsmiths transitioned from being safe keepers of valuables to interest-paying, as well as interest-earning banks.

Since then, this system, now called fractional reserve banking, was carried over up until this day, and as mentioned, it is in fact a requirement to every bank out there.

If you want to know more about what is fractional reserve banking, here’s a very informative video by Khan Academy. Watch it by clicking the play button below:

HOW DOES FRACTIONAL RESERVE BANKING WORK?

Apart from understanding what a fractional reserve banking is, it is also key to understand how the system actually works.  

Now, when putting your money in a bank, the bank is required to keep a fraction of it or a certain percentage of the total deposits on reserve at the bank.

For example, you deposited $100,000 at the bank, and based on the bank’s assets, it has a reserve requirement of 10 percent. Having said that, the bank has to keep $10,000 of your total money on reserve, while the remaining $90,000 can be lent out.

Essentially, the bank has taken $100,000 and turned your money into $190,000 by providing you a $100,000 credit on your deposits, and then lending the additional $90,000 to other customers.

Using the above example, the initial deposited amount, which is $100,000 can eventually grow into $1,000,000 with a 10 percent reserve requirement.

Now, if you are interested in finding out how much money the fractional reserve banking system can theoretically create with your initial deposited amount, you may use below money multiplier equation (which we are going to discuss further later on):

Total Money Created = Initial Deposit x (1 / Reserve Requirement)

WHAT DOES EXPANDING MONEY SUPPLY MEANS?

If you have been using banks to save your money or to save funds, perhaps in one way or another (especially if you are not that familiar with how banking works), you wondered how does the bank earn from keeping other people’s funds, right?

Basically, the supply of money in a bank grows when it shows money as deposits, at the same time, lending the funds out as loans to other people or clients.

When a saver like you (and me) deposits your money into your bank account, when you do a balance check, the bank will show 100 percent of your account balance.

But in reality, the bank is allowed to lend 90 percent of your deposited funds to other customers or clients, which in return help double (almost) the amount of money in the economy.

If we may just add, by following this kind of system, banks earn, and you as a saver earns as well. How? Well, it’s through interest. The bank won’t be able to grow your money and give you an annual interest if it’s just sitting there and they do nothing about it.

So, the more clients, borrowers they have, it’s actually better. It also helps strengthen the financial stability of a bank.

WHAT DO BANK RUNS MEAN?

If you come to think about it, and also basing on the history of fractional reserve banking, you will get to realize that this kind of system works because true enough, people do not need to access all their money all at the same time. It’s unlikely for someone, or for an account holder to withdraw all the money in his or her account at the same time. Now if you do, for instance, the reserve form other customer accounts should be enough to cover what you need.

But what if everyone in the system actually withdraws their money all at the same time? What happens, then?

Well, this circumstance is actually referred to as a “bank run.”

A bank run usually happens when customers feel or fear that the financial institution is in trouble. When customers lose faith and trust with the bank, withdrawal demands transpire.

In this kind of situation, there is a great chance that money will not be enough to satisfy all customer requests. When that happens, the bank becomes insolvent.

While in some cases bank runs are justified, at other times, it happens as a result of panic, which unfortunately causes a bank to fail.

Bank failures are catastrophic. Thus, the Banking Act of 1933 established the Federal Deposit Insurance Corp. Its primary job is to protect deposits in participating banks up to specified limits.

FDIC is like a security blanket. It provides a government guarantee that bank customers will get their money should something unlikely happens to their bank of choice. The same goes for credit unions. However, it’s the National Credit Union Share Insurance Fund that takes care of it.

WHAT ARE THE REQUIREMENTS FOR FRACTIONAL RESERVE BANKING?

Reserve requirements refer to central bank regulations regarding the minimum amount of reserves that a bank should hold.

Banking institutions are required to report their transaction accounts, as well as time and savings deposits, vault cash, and other obligations that need a reserve to the Fed on a weekly or quarterly basis.

While there are some banks that are exempted from holding reserves, all banks are paid a rate of interest on reserves, which is called the “interest rate on reserves” (IOR) or the “interest rate on excess reserves” (IOER). This rate serves as an incentive for banks for keeping excess reserves. Excess reserves refer to reserves that are over the level of reserve needed or required.

As mentioned earlier, banks with assets amounting to less than $124.2 million but more than $16.3 million have a 3% reserve requirement. Meanwhile, those with more than $124.2 million in assets have a 10% reserve requirement. As with banks with less than $16.3 million in assets, they are not required to hold reserves.

Please note though that the amount required may change from time to time.  Thus, banks need to always stay up-to-date with regards to their assets, and the requirements of the Fed.

HOW DO BANKS CREATE MONEY?

Now, it’s time to know how exactly banks create money. As a customer or a bank client, while it is not a prerequisite to understanding how a bank earns, we thought, it’s good information to know. This will also give you an idea if the bank is generous enough with their customers, or if their rates are reasonable or not.

Moving on, all commercial banks are required to hold only a certain percentage of customer deposits as reserves, while the rest has to be used for awarding loans to borrowers (which, by the way, is one way that banks earn money).

If you have loaned money from banks before, most likely you already have an idea that when a bank gives a loan, it accepts promissory notes in lieu of the credit that is deposited in the borrower’s account in the bank.

It is through depositing to the borrower’s account instead of giving loans in the form of currency is part of the process that banks use in creating money.

Remember we earlier said that the more loans a bank give or approves, the better? Well, that is because it is by giving out loans that the bank creates money. Every issued loan is equivalent to new money, which in return adds up to the increasing money supply.

WHAT DOES FRACTIONAL RESERVE MULTIPLIER EFFECT MEANS?

By now you already know what is fractional reserve banking is all about, right?

But just to reiterate, the fractional reserve is defined as the fraction of deposits that are held in reserves. For instance, if a bank has $400 million in assets, it is required to put $40 million (which is 10 percent of the total asset) on hold in reserve.

When estimating the impact of the reserve requirement on the economy as a whole, analysts refer to an equation called the multiplier equation. The multiplier equation basically provides an estimate for the amount of money created with the fractional reserve system. It is calculated by multiplying the initial deposit by one divided by the reserve requirement. So, for the above example, the calculation is $400 million multiplied by one divided by 10%, or $4 billion.

Again, here’s the multiplier equation for your reference:

  • Total Money Created = Initial Deposit x (1 / Reserve Requirement)

This equation is just a way to look into the possible impact of the fractional reserve system on the money supply of a bank. However, while the equation seems useful for economics professors, generally speaking, it is regarded as an oversimplification by legislators.

WHAT IS THE IMPORTANCE OF FRACTIONAL RESERVE BANKING?

We believe fractional reserve banking exists for a purpose. With all the information we shared, it truly is beneficial. Do you agree?

However, we thought one of the essential benefits of fractional reserve banking is the fact that it pools together smaller savings, which eventually are lent out to a variety of markets — to individuals, households, small enterprise, and even big businesses!

Furthermore, through fractional reserve banking, banks are able to earn. Without earnings, a bank cannot sustain itself. If the bank will not loan money to people, there is no chance they’ll earn money. More so, it would be impossible for them to offer interest rates.

WHAT ARE THE DISADVANTAGES OF FRACTIONAL RESERVE BANKING?

Critics will always be there. And yes, even fractional reserve banking has its own critics. They believe that the system is a Ponzi scheme. The process of fractional reserve banking is like robbing the depositor to pay the borrower, which critics find as something that is not sustainable in the long run.

Whether you agree to this perspective or not, the thing is, fractional reserve banking has glaring downsides that are difficult to refute.

One downside is that the money multiplier effect of fractional-reserve banking may result in a growing supply of money. As it is, as the money supply increases, the value of dollar decreases or also known as inflation. Over time, the rapid growth of the money supply may result in a massive decrease in the U.S. dollar’s purchasing power.

Another downside is bank runs, which we have already explained earlier. Bank runs can cause panic among depositors, and essentially, may result in a Depression, or put the bank in big financial trouble.

You see, nothing is really perfect. While fractional reserve banking has its highs, it definitely has its share of lows as well.

FINAL THOUGHTS ON WHAT IS FRACTIONAL RESERVE BANKING

Typically, bank depositors see banks as safe-keepers of their money. They go there, open an account, and save. That’s it.

But what most bank customers do not know is that fractional reserve banking does exist. What we do not know is that this system allows banks to hold a fraction of our money and use the remaining to lend to other people.

If the idea of fractional reserve banking is new to you, you may find it quite surprising. But essentially, understanding the whole concept of the system will make you realize that it’s part of the risks of putting your money in the bank, and you got to just really trust that the bank knows how to keep the wheel turning.

So, what are your thoughts on fractional reserve banking?

We hope this enlightens you about what is fractional reserve banking, and essentially, made you appreciate and understand the very purpose of its existence in the banking industry.