Modeling the textbook fractional reserve banking system

Abstract

Banking systems based on the fractional reserve banking process have been in use for several hundred years. However textbook models of these systems do not include either loan repayments or loan defaults, and predict the evolution over time of a stable, asymptotically converging process governing credit and money supplies to the general economy for which there is no empirical evidence in long run monetary time series. In this paper we describe a computer simulation of a simplified model of a fractional reserve banking system that includes loan repayment. We show that this demonstrates several issues in the accepted model including instabilities arising from flows of money and credit between different banks, a discrepancy with the accepted value of the money multiplier within the system, and the appearance of a cyclic governing function over time. © Springer-Verlag Berlin Heidelberg 2011.