Fractional reserve banking is a system in which commercial banks are required to keep only a fraction of the funds deposited by their customers as reserves, while the remainder can be used for lending and other investment activities.
For example, if a bank has a reserve requirement of 10%, it can lend out 90% of the deposits it receives and keep the remaining 10% in reserve. This allows banks to earn interest on the loans they make, while also providing a measure of safety and liquidity for their depositors.
However, this system can also lead to a situation where banks have insufficient reserves to meet the demands of their depositors in times of financial stress or a run on the bank. This can potentially result in bank failures or the need for government intervention to prevent a systemic collapse.