Fractional reserve banking has been considered by many economists as one of the most intricate ways towards financial ruin. The reason why this has been labeled as very erroneous method being implemented by banks is that this tends to create the impression that there is money. If most, if not all of the major banks in a country conduct this, there would indeed seem to be an increase in money supply. However, this is actually not true. In reality, such money supply is actually represented by debts. Debts, of course, cannot be considered as liquid and is, therefore, unreliable.

The term fractional reserve is based on the fact that the bank does not really deposit the entire equal value of depositors' money in the central bank. Generally, the principle followed by banks is that whatever money is deposited by its clients should be immediately sent to the central bank. However, in the fractional reserve banking system, only a portion is deposited in the central bank. Another portion is handed out to other entities as loans. Interestingly, the common practice is that the bigger portion is the one handed out as loans while only a small percentage is deposited in the central bank.

If ever a depositor wants to withdraw the total amount, the bank would have to make use of the money of the other depositors in the meantime. This is because, as mentioned earlier, a big portion has been made as loan. It would naturally take time before the said amount could be recovered. Once these loans become debts, it becomes even more difficult to recover. As long as the depositor does not wait for the bank to suffer from unpaid debts though, he may still be able to withdraw the total amount of his deposits. However, once the bank is unable to retrieve the value of the loans it has given to people, this would naturally mean that it may not be able to return a percentage of the deposits to the depositors.

Debts therefore are the principal reasons why the fractional reserve banking system is not viable. This may actually be good not just for the bank, but also for the depositor and the economy but only if people who have acquired loans actually pay the banks on time and at the right amount. With money being lent out, both the bank and the depositor could gain more through the loan's interest rates. The economy would also benefit from the fresh flow of money.

However, when too many debts start burdening a bank, the fractional reserve banking system would start rearing its ugly head. The banks would no longer be able to return the exact amount deposited in them by their clients. Because of this, they may no longer be able to operate fully in the manner that they used to. At this point, the viability of the banks could become very suspect. There would be panic among the depositors, causing immediate withdrawals which would hurt those who did withdraw last.