in fact, our current system has roots back in the times of gold money. bankers were gold smiths. people would take gold to goldsmiths for authentication and storage, for a fee. the deposit receipts became known as gold notes. soon, instead of taking the trip to the goldsmith to settle transactions, the people traded the notes (which were all redeemable in gold).

soon, the goldsmiths realized that only a tiny portion of gold notes (say 10%) were ever redeemed for gold. as such, they were able to multiply the outstanding gold notes (by as much as 10 fold, in our example) and still be able to fulfill all redemption requests. the accounting entry would be very similar. instead of debiting “gold” as the asset, they would debit “loans receivable” instead. every new gold note issued would render all gold notes worth only a fraction of the gold. hence, “fractional reserve lending” was born.

nowadays, the system works much the same. instead of gold, various forms of equity form the reserves. the primary rules of the system are listed in the Basel III accord.