Since the financial crisis first erupted in the summer of 2007, there has been a renewed interest in what is now commonly called ‘fractional reserve banking’. This is mainly from those who contend that it is the root cause of the problems besetting the world economy. But is this idea really plausible? Both logic and the available evidence would indicate not.

Fractional reserve banking (the idea that the banking system can lend out vast multiples of what has been deposited with it) is not a new theory. It is also – and perhaps more accurately – sometimes called ‘credit creationism’ as it assumes banks can create almost endless amounts of credit from what has been deposited with them by savers. Ever since the MacMillan Report into Finance and Industry in the UK in 1931 gave it credence, variants of this theory have been taught to students in universities and colleges across much of the world.