100 %-Reserve Banking

Imagine a hypothetical economy with no banks.

The entire money supply consists of currency—paper bills held by the public. The public includes households and firms. Suppose there is exactly $100 in this economy.

Now, a new commercial bank, called Bank A, is introduced.

The public is assumed to deposit the $100 of currency into Bank A for safekeeping.

It is assumed that Bank A accepts deposits but makes no loans. Bank A holds the full $100 as bank reserves, which are liquid assets like vault cash used to meet withdrawals.

This setup is a 100-percent-reserve banking system, where banks hold all deposits as reserves.

Look at Bank A’s balance sheet, which assumes the bank holds no assets other than reserves.

On the assets side, Bank A holds $100 in reserves.

On the liabilities side, Bank A has $100 in deposits, which it owes to its customers.

The money supply, which was initially $100 in currency in circulation, is now $100 in demand deposits.