Fractional reserve banking is the ubiquitous practice where banks take in demand deposits and lend out a portion (or fraction) of those deposits to borrowers. The banks are counting on the fact that not everyone will want to withdraw their deposited funds at the same time. Of course this exposes the banks to some degree of risk in the form of a “run on the bank” if too many people want their money at once. Jimmy Stewart explains this scenario elequently in “Its a Wonderful Life”
Eliminating fractional reserve banking would require banks to have a one dollar of cash on hand (not necessarily paper cash) for each dollar deposited in a demand account (i.e. your typical checking or savings account). Loans would only be made based on longer term deposits into the bank (such as CDs).
