How is money “virtualized,” what prevents banks from misreporting funds, and what would a new bank need to do to accept and hold digital balances?

William Emmanuel Yu answers this correctly. You cannot just unilaterally go and change a value in a database. Even if you tried, it would not be possible. Banks use multiple ledgers, for an account that holds $1 Million to be made in $2 Million, the bank would have to show a double-ledger entry, if an account is being credited, there has to be a debit somewhere. If a cash deposit is made, then the bank's ledger for cash deposits would change. At the end of the day if the bank cannot show that $1 Million in cash, then something somewhere is wrong.

The entire money supply is very meticulously tracked by the central banks and other banks via cross-ledgers. If a bank says the $1 Million came from another bank (say Deutsche Bank), then Deutsche bank's ledgers would have to match the transactions (which they clearly would not).

When banks have a ledger mismatch (a very very rare occurrence), they have to inform the regulator immediately, and may even cease activity on the ledgers until the issue is resolved.

There are many controls in place, specifically for self-induced forging of the ledger or collusion based forging of the ledgers.

Its a issue that is very well known and very acutely addressed so that collusion based malicious attempts are thwarted.