Narrow banking is an alternative model to traditional banking that separates the role of deposit-taking from the business of lending. In a narrow banking system, deposits are invested only in the safest possible assets such as central bank reserves or short-term government securities. Loans, on the other hand, are made by investment funds or private credit institutions financed with long-term equity or locked-in capital.
This separation contrasts with the traditional fractional reserve banking system, in which banks use deposits to extend loans while relying on regulatory frameworks and deposit insurance to maintain stability. Narrow banking thus aims to reduce systemic risk by ensuring that deposits are always backed by low-risk assets.
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