An Emotional Guide to 'Fractional Reserve Banking'

How our personal states of burnout are linked to bank overcommitment

Have you ever found yourself promising a friend that you’ll hang out, or telling your family that you’ll visit over summer, or assuring your boss that you’ll get a big project completed, only to discover that you feel extremely stressed when those commitments actually get called in?

Believe it or not, this personal experience of overcommitment is a great entry point for understanding what's sometimes called ‘fractional reserve banking’ (note: this term is somewhat archaic, but I'm using it here because it remains in popular usage). To do this, I'm going to take you on a journey through a few examples of the 'fractional reserve' principle is areas beyond banking, starting with our everyday relationships.

Fractional reserve relationships

Most of us run a fractional reserve relationship system. As we grow up we form relationships - with family, friends, lovers, associates, and colleagues. These relationships often require us to open ourselves up to being called upon by those people. They build expectations of us, but these obligations aren't necessarily activated every day. In any one moment, you're not going to have to WhatsApp every friend and family member, and you're not required to finish every single bit of work you've promised to colleagues. Actually, it would be impossible to do that. You have a limited amount of energy, and you can only manage the obligations and promises in increments. You can't simultaneously handle them all at once, because the total amount of promises you've issued out is greater than the reserves of energy you have to deal with them at any one point.

This the fractional reserve principle. At any particular moment you only have reserves to cover a fraction of your total commitments.

So, imagine if two of your friends experience a crisis at the very same moment as your dad calls asking you to finalise details of a visit you promised, while your boss emails irritably asking for a progress update. You're getting four simultaneous requests from people who've been led to believe they have a priority claim upon your energy, and this can very quickly overrun your emotional reserves. You find yourself trying to ‘juggle’ the calls upon your energy: you pretend to have not seen your friend’s message, and ignore your dad’s call as you desperately try to buy time with your boss.

There’s no inherent problem with moderate overcommitment, and most people can manage it OK most of the time. After all, if you made no short-term promises to others you’d probably have no long-term friends, work contracts, or any ties to the world at all, and those latter things are sources of support to you. Extreme overcommitment, however, gets toxic. It inspires quotes like ‘learn to say no’, or ‘it’s better to undercommit and over-deliver than to overcommit and under-deliver’, which encourage us to reduce the number of promises we issue out.

Excessive overcommitment can lead to burnout, but it’s easy to unknowingly enter into that state. A person who is burned out might have been energetic and optimistic a year ago, and might have made a lot of promises back then in the belief that they’d have the space and energy to cover them in future (they might have even made promises to themselves, such as ‘I'll learn a new language in the coming year’). If you issue too many optimistic future-facing promises out into the world, they can come back to bite you, as you suddenly find yourself mired in too many present claims upon your energy. Once you’re deep in a state of overcommitment, you find that everything starts to move sluggishly, because you can only deal with small fragments of the total commitment at once.

In a situation of burnout, you may develop a phobia of people calling on you, because you begin to feel overwhelmed by seemingly small tasks. A friend emails to say ‘hey, please check this over, it'll only take 10 minutes’, but with so little emotional reserves this can seem like a stressful ordeal. Overcommitting to potential things in future eventually leads to a deep fear of taking actual action on concrete things in the present.

So, what’s this got to do with banking?

Our small-scale personal overcommitment can be used as an emotional allegory for the large-scale system of money presided over by the banking sector. I’ve written various pieces showing that much of the money supply takes the form of bank IOUs - promises - issued out by banks. The banking sector issues these promises out far in excess of its ability to handle all of those being called in at once. But, while we may slide into a state of excessive overcommitment without being aware that we are doing it, bankers do it deliberately. Overcommitting, and then managing the results, is at the deep core of banking. Before we get to that, let’s visit another fractional reserve system.

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The fractional reserve gym

Deliberately overcommitting sounds irresponsible, but for many businesses it makes sense. To understand why, let’s think about a gym. It’s a building with a finite amount of floor space and equipment. Perhaps a particular gym has a maximum capacity of about 300 people, but if you're running this gym, should you only sell 300 memberships? From one angle it looks sensible: you’re promising 300 people access to the gym at any point, and you have exactly enough equipment and resources to ‘back’ this promise.

It would, however, be a major mistake to only sell 300 memberships. This is because not everyone comes into the gym every day, and not everyone comes in at the same time. Maybe only 15 of the 300 members come in at any one point, which means the majority of your equipment stands unused. Your reserves are being heavily underutilized, and the vibe in in the gym might be very quiet.

If you’re the manager, you may think ‘if only 5% of members come in at any particular point, I can actually sell a lot more memberships and still cover the commitment’. Under the assumption that only 5% of members will come in, you can sell 6000 memberships for a gym with a 300-person capacity. You’re now running a fractional reserve gym. You cannot simultaneously serve 6000 people, but you’re assuming you won’t have to. Much like you might assume that only a small fraction of your friends will call upon you for support at the same moment, a gym assumes that only a fraction of their members will simultaneously come in, and that the gym will have enough reserves to deal with that.

The trade-off now becomes apparent. With 6000 members, the gym’s reserves are going to be used to the full. The vibe will be buzzing, and they’re going to be a lot more profitable. If, however, there’s a sudden small surge in the percentage of people coming in - let’s say it goes to 7% - the gym will suddenly have 420 people trying to get into a space that only holds 300. If that happens the owner will quickly find themselves overwhelmed and under-delivering, turning members away at the door, trying to explain why their right to enter has been curtailed. In fact, in that situation, the job of making excuses to those let down would become as draining as trying to serve those who managed to get into the gym.

It’s the business equivalent of burnout.

So, a prudent gym owner will certainly sell more than 300 memberships - to make sure that their reserves of equipment are not underutilised, and to make enough revenue - but will also build in a buffer against dangerous levels of overcommitment. Perhaps they will only sell 4500 memberships. Now, if there’s a sudden surge to 7% of members coming in, it equates to 315: there still might be some annoyed people at a busy time, but not nearly as much as before. The gym’s profits have gone down somewhat, but so too has the owner’s stress levels, and they are better prepared for variability.

The fractional reserve principle might be summarised as overcommitment in expectation of under-utilisation, and it’s a core feature of many systems that experience variable levels of use. It works most of the time, but can fall apart too. During the early months of the COVID-19 pandemic we saw a very serious example of that trade-off in the health sector. Most hospitals were only geared up to serve a fraction of society at any one point, which works most of the time, but when the pandemic hit, their reserves of bed space and equipment very quickly got overwhelmed. On the other hand, if they always assumed a pandemic was about to hit, and constantly maintained high overcapacity, most of that capacity would remain unused during normal times. It's a tricky balance.

Full vs. fractional reserve

There are some businesses where the owners expect close-to-full simultaneous redemption of promises issued out. Consider, for example, tickets. A ticket is a legal promise guaranteeing access to something. If a movie theatre has 100 seats, it's unlikely that the bosses will sell 200 tickets, because the ticket guarantees a seat for a once-off time-specific event (e.g. 1 entry to Pulp Fiction screening at 20:30), rather than a generalised 'come whenever you want' type of affair. Such a theatre will run a full reserve system: every ticket they sell is 'backed' by a guaranteed seat. 100 tickets for a 100 seats. After this they tell you that they're 'sold out'.

Another interesting example is chips issued out by casinos. Unlike a theatre with limited tickets for limited seats, there's no specific limit as to how many chips a casino might issue out, but they're only going to issue them as new capacity (reserves) is added to their system. When you hand over $100 in cash to the casino, they'll issue out $100 worth of chips to you. You put new reserves into the system (cash that they take ownership of), and they issue chips to you in return.

You now own the chip, but what is that chip? It's a privately-issued legal promise - an IOU - that can be used within the confines of the casino, and which you can take back to the cashier at any point to redeem for cash (the chip is essentially pulled out of circulation when you take reserves out of the system). In principle then, every chip in the casino is 'backed' by money held at the cashier. The chips are a small-scale private money system that only works within the casino, but they derive their power from the reserves.

Let's summarise all these different examples, by splitting out their reserves versus their promises.

Example 1: Personal relationships

• Reserves: your personal energy and time
• Promises: your commitments and obligations to others
• Ratio between the two: the promises are greater than the reserves, which means the reserves are a fraction of the promises ('fractional reserve')
• Process of managing the balance: you build up energy via a range of processes (e.g. eating, resting etc.), and you issue out promises in the process of creating relationships, expecting that only a fraction will be called upon at any one time
• Redemption process: a person who holds a promise from you calls on you, after which the promise is either retired or renewed (depending on the nature of the relationship)

Example 2: Gym

• Reserves: space and equipment
• Promises: memberships issued out
• Ratio between the two: the promises are greater than the reserves, which means the reserves are a fraction of the promises ('fractional reserve')
• Process of managing the balance: the owners buy the space and equipment for money, and then sell memberships for money, expecting that only a fraction of members will come in at any one time
• Redemption process: a member turns up at the gym and expects entry, and will hold this same expectation until their membership expires

Example 3: Theatre

• Reserves: seats available
• Promises: tickets issued out
• Ratio between the two: the promises are equal to the reserves ('full reserve')
• Process of managing the balance: the owner buys the space, equipment and film rights for money, and then sells tickets for money, expecting that most people will come in at the exact time the ticket specifies
• Redemption process: a ticket-holder turns up to claim entry, after which their ticket is used up and has no future power

Example 4: Casino

• Reserves: money held by casino
• Promises: chips issued out by casino
• Ratio between the two: the promises are equal to the reserves ('full reserve')
• Process of managing the balance: the owners get their money reserves by issuing chips, expecting that the chips will be reassigned between different gamblers during the course of the night, after which the chip-holders will come back to reclaim money. The casino doesn't expect them to leave the casino without redeeming the chips
• Redemption process: chip-holder goes to cashier and asks for cash, after which the chip is taken out of circulation and waits behind the counter to be issued to new punters who turn up

Note that in the first 3 cases the reserves take the form of some non-monetary thing (personal energy, equipment, space, seats etc), and that the promise gives someone access to that thing. In the case of the casino, however, the reserves take the form of money, and the promise (chip) grants access to that.

Is there any scenario in which the casino would issue out more chips than the money they collect? Well, probably not. Remember that a chip gives the holder the right to go to the cashier and reclaim cash, so if the casino gave it out to you 'for free', it's like giving you a claim upon their money reserves without asking for anything in return. If the casino found itself in a 'fractional reserve' scenario, where they had more chips outstanding than money reserves, they'd quickly get in trouble. They gain nothing from it, and would in fact lose a lot.

Banks, however, do gain something from issuing out more 'chips' than they have in reserves. Let's turn to that.

Banking on overcommitment

The biggest system of deliberate overcommitment in our economy lies within the banking sector. Before you can understand this, you have to realise that the units you see in your bank account are not government-issued money. They are promises issued out by banks, promising you access to their reserves of government money (should you call upon them). Our earlier casino example is a good starting point for understanding this. Much like a casino hands us chips when we hand over cash, banks issue out 'digital casino chips' to us when we hand over cash to them. Those 'digital chips' are what you see in your account.

Unlike a casino, though, banks issue out far more of these digital chips than they have in government money reserves, and this is because they issue out chips in two different scenarios.

1. The first scenario is reminscent of the casino: you hand over cash, and they issue out chips to you. This is what people commonly call 'depositing money in the bank': the bank gets government money from you, and then issues you chips in return, which you'll now see in your bank account
2. In the second scenario, however, they issue out chips to people who do not give them money, but who rather promise to give them money in future. This is what people commonly call 'getting a loan from the bank'. The bank gets a legal promise from you, saying that you'll give them government money in future, and then issues you chips in return, which you'll now see in your bank account

In both scenarios you end up with the same thing: bank-issued chips. Once you've obtained these chips through one of the methods above, you have two basic choices for what you can do with them.

1. You can either move them to someone else (just like gamblers might pass chips between themselves in a casino), which is what happens when you pay by bank transfer with a card or app. You're using bank-issued chips to buy things
2. Alternatively, you can redeem them for cash (just like gamblers might hand in their chips to leave the casino), which is what happens when you go to the ATM. You're converting your bank-issued digital promises into government-issued physical money. You can then use that cash to buy things

Note then, that both the bank-issued chips and government-issued cash can be used to buy things, which is why both of them get called 'money' in common parlance, even though they're technically two different things.

If I issue out a promise, I create a liability for myself, because it means I owe something to someone. Similarly, a chip is a liability to a bank, but as we saw above, they issue these out in order to harvest two different assets: in scenario 1, they harvest reserves, and in scenario 2 they harvest loan agreements. That said, they run a risk in issuing out chip liabilities to harvest loan assets, because the latter are long-term (e.g. a 30 year mortgage that someone incrementally pays over time), while chips give the holders an immediate right to make demands on the reserves of the bank. (To briefly return to our emotional analogy, it’s somewhat like a machievellian ‘friend’ promising you a series of short-term favours in order to extract some much larger and longer-term committment from you in future)

So how is this risk managed? Well, it helps to return to the gym example to explain this. Much like a gym owner knows that only a small fraction of members will make demands upon the floor and equipment reserves of the gym at any one point, banks know that only a certain number of their account holders will ever redeem their chips at any one point.

One reason for this is that many of our payments are made by reassigning those chips, rather than by redeeming them for cash and then handing the cash to someone else. The entire 'cashless' digital money payments system - which you interact with via your debit card, mobile app, or internet banking site - is built to facilitate the monetary equivalent of reassigning chips. In the gym example, it's a bit like people passing gym memberships between themselves outside the gym, rather than ever going in.

To nuance this out, though, requires us to see that banks do not operate in a vacuum by themselves. They operate alongside other banks, and all of them are tied into a central bank. To explain this, I'm going to go into the dangerous realm of mixed metaphors.

Let’s imagine that the gym is the central bank. Now imagine that the individual banks are like private trainers who lease out different amounts of floor space, but who have the right to independently issue out entry tickets to the public on their own accord. They are collectively issuing out far more tickets than space, but to the public it looks like there’s a single class of tickets that floats around. In reality, though, those tickets are connected to specific trainers, and there’s an elaborate background system by which the individual trainers vie for floor space in the gym in response to movements of their tickets outside the gym.

If one trainer issues out tickets to their customers, but then finds that their customers then transfer them to people who are traditionally loyal to another trainer, you might find the latter trainer shouting at the former: “give me some of your floor space so I can be prepared in case more people come in for me!” In banking terms, this is the 'settlement' process by which one bank demands that another bank transfers central bank reserves to them, in response to their customers receiving transfers from the other bank's customers. Remember that the customers are transferring 'tickets', not reserves, but the banks must move the reserves between themselves in anticipation of possible redemptions.

Imagine, however, that outside our ‘gym’ there's generally enough cross-flow of tickets moving between customers loyal to different trainers, such that the cross-flows cancel each other out, meaning the trainers end up with roughly stable demands upon floor-space. In the banking sector this is the process by which cross-flows of payments between customers of different banks cancel each other out. If you’re in the UK, for example, the various ‘multilateral net settlement’ systems (like BACS) are designed to superimpose the payments requests made between customers of different banks, and then net them out, such that only small amounts of central bank reserves (‘floor space’) move between banks while huge numbers of bank ‘tickets’ move between customers.

The result of this is that the banking sector as a whole can issue out far more promises than they have in reserves, but nevertheless expect the entire system to stay relatively stable, provided that the variation in the cross-flows stays within a certain band. And, if that doesn’t work out, the central bank can always step in, like a big boss-man landlord who owns the gym building, and who'll have to take the hit if the trainers over-promise too much. This, though, is where my gym metaphor hits its limit, because a central bank - unlike our gym landlord - can expand the floor space at will. This is because our ‘floor space’ is state money, and state money is promises issued out by a state-backed central bank and treasury (if you want a different set of metaphors to get started on that concept, check out my piece on Ents and Squirrels).

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Back to emotions

Let’s go full circle and bring this back to the example we began with. What's the personal emotional energy equivalent of the ‘gym’ with its ‘trainers’ issuing out excessive promises. Well, within ourselves, we might imagine it as the different parts of our person making promises at different times: your professional persona makes promises to your boss, while your family persona and friend persona makes promises to family and friends. Maybe your romance persona promises affection to a lover, while your hero persona promises solidarity to global causes. On a day-to-day basis your emotional reserves get juggled as you give space to your various personas to fulfil the obligations they issued out. Ideally over time this simultaneously replenishes you with new emotional reserves, but when one too many things gets called in at once, you can hit burnout.

Unlike the banking sector, we don’t have a ‘central bank’ that can expand our reserves of emotional energy to deal with such crises. We normally have to take cover from burnout by drastically reducing our commitments and giving ourselves time and space to recharge. When we excessively overcommit we tend to run down our reserves far faster than our ability to replenish them.

The banking sector doesn’t necessarily suffer from this. The promises they issue through overcommittment boosts the money supply in the form of digital chips, but also leads the central bank into expanding their collective reserves. This process can go on for a long time, and lies at the core of capitalist systems.

In this you can also glimpse many of the mysteries of booms and busts. Much like we may exuberantly issue out claims upon our emotional energy when we’re feeling relaxed and optimistic, when times are good banks reach forward into the future, or lean in to the world. They expand their promises and push the wave of general optimism out like a ripple of dominoes, as people spend while others hire. When they expand their promises, banks can induce others to expand their promises too. You can imagine an unfolding across time and space, a rippling out of positive vibes as everyone tells everyone that they can do everything.

But at some point that ripple outstrips the actual capacity of the earth and its people, and slows down. Somewhere far away it stops, and slowly starts reversing (a bit like when an ocean tide hits an inversion point and switches direction). Bankers might not see it for a while, but small cracks appear. Then suddenly the banking sector goes cold as they begin to imagine a wave returning to hit them, and they back away, or panic. They turn introverted, curling back from the future and from the world by retracting their promises. This is often when the ‘house of cards’ (or dominoes) can fall apart, and can lead to ordinary people rushing to call in bank promises out of fear, rather than simply transferring them around. This feeds into more crises, and then the central bank must step in to counteract the curling in by issuing new money (e.g. through processes like 'quantitive easing').

This is a wild and unruly assortment of metaphors, but hopefully it's a useful set. In case you don’t understand this, think about yourself. When you’re feeling optimistic, open and buoyant, do you reach for the future and expand your promises, or do you go inward and turn away? Probably the former. It’s only when you get burned that you curl away and generate fantasies of moving to a monastery somewhere to escape the commitments of the world. Have you ever had that feeling of ‘burning bridges’, that desire to just turn away from scenarios you can’t resolve rather than dealing with them? Well that’s the emotional equivalent of bankrupcy. You lose friends, but come out with a clean sheet to start over.

Not just a metaphor

If you emotionally overcommit, you deal with the fallout of under-delivering in the form of snarky comments from friends, rage from your boss and so on. If you’re a bank, though, you’re going bankrupt. You’re at the central bank requesting emergency injections of reserves, or you’re appealing to shareholders to inject reserves by buying new shares.

But while I’ve staged this piece as a series of comparitive metaphors, there’s actually a real world connection between large-scale bank overcommittment and small-scale emotional burnout experienced by individual people. What the banking sector (and corporate sector more generally) experiences as an exciting wave of ‘optimism’ can be experienced by us at the human level as a wave of frenetic overwork. That’s because corporations only feel good when they’re increasing profits, whereas humans actually value many things beyond that. When making profits comes at the expense of family life, time with friends, and connection to the environment, you begin to feel burned out, alienated and miserable. You don't share the corporate exuberance, within which you may be but a small worker.

The opposite scenario of a financial and corporate sector retraction burns people too. As banks and corporations become introverted, workers might get to slow down, but only at the expense of losing access to income, which for most people is mediated via the corporate sector (either directly or indirectly). And, because corporates don’t like the slow-down, they'll attempt to extract more from their workers for less. Your co-workers get fired as you are expected to shoulder more burden for less pay.

It’s false to imagine that our emotional lives can be separated from the planetary scale economic structures that we are enmeshed within. To strive for holistic emotional balance, in which our emotional reserves are boosted and not drained, we must seek to bring holistic balance to our economic system too. That’s a much larger topic for another time.