Full-reserve banking

Full-reserve banking (also known as 100% reserve banking, or sovereign money system) is a system of banking where banks do not lend demand deposits and instead only lend from time deposits. It differs from fractional-reserve banking, in which banks may lend funds on deposit, while fully reserved banks would be required to keep the full amount of each customer's demand deposits in cash, available for immediate withdrawal.

Monetary reforms that included full-reserve banking have been proposed in the past, notably in 1935 by a group of economists, including Irving Fisher, under the so-called "Chicago plan" as a response to the Great Depression.^[1]^[2]

Currently, no country in the world requires full-reserve banking across primary credit institutions, although Iceland has considered it.^[3]^[4] In a 2018 ballot referendum, 75% of Swiss voters voted against the Sovereign Money Initiative which had full reserve banking as a prominent component of its proposed reform of the Swiss monetary system.^[5]^[6]^[7]

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Narrator: I do want to clarify that the whole point that I'm showing these weaknesses in Fractional Reserve lending isn't to argue that it necessarily has to go away or that it is somehow unviable. It's clearly viable, it's the system that most market economies, actually all that I know of, use today. The reason why I am doing it is to show that it's not the only type of system that we really should scrutinize any systems that we have in place to realize that they aren't a law of physics, that we have to have Fractional Reserve lending. That in order to have this system function there has to be engineering in place and there still are some drawbacks, the un-stability in order to combat that you need to have central bank insurance and you also have to have the central bank as a lender of last resort of reserves. The bad incentives ... and these are well documented, these aren't just coming from me. Bad incentives, if you were looking to invest in any other type of investment company, someone who is taking your money and investing it on your behalf, they would typically be talking about how good they are at investing money. Most, when you're looking at Commerical banks that's not what they're talking about because they know that that's not what consumers care about because of the insurance there. They will talk about things like how easy it is to access your money with their ATM's and their online banking, how low their fees are. They won't even bring up the idea that hey, we're lending your money and we're lending it in really, really, responsible ways. It is also well documented by having a Fractional Reserve lending system, it is putting a significant amount of the money creation system, essentially the checkable deposits, it's putting it in the hands of private banks as opposed to the central banking authority. With that out of the way you're probably saying are there any other alternatives. I'm not advocating one or the other, but I'm just showing you that this is not necessarily the only way that we would have to set up our banking system. In fact, the original way is the alternative. The original way would be Full Reserve banking. (writing) full, full reserve, reserve banking. It is exactly what it sounds like, which is that a bank would have to ... if someone puts reserve or cash dollar or federal reserve notes in their demand deposit account then the bank would just have to keep it there. If I have a bank, right over here, (drawing) If I have a bank and if I were to put $3. (drawing) $3, 3 federal reserve notes here 3 federal reserve notes here. If I were to say that this is in my ... I want to have this on demand. I want to be able to go to the bank at any moment in time and be able to take these things out then the bank would have to keep all of these reserves there. You might say, well then how will lending happen and all the rest? In order for lending to happen the bank would have to say hey, look, you're not going to need them to have all of this on demand, why don't you keep some fraction of this on demand, maybe it's this dollar bill right over here and the rest of these, we, the bank, will literally borrow that from you. This isn't an actual foreign concept. When you go buy a certificate of deposit at a bank, when you put your money in a CD at the bank that's essentially what the bank is doing. They are borrowing that money from you, they're making it explicit. They're not saying that that money will be on demand. They're saying this is a timed deposit that this money, you are giving it to us now and then you can get it back in 6 months, or a year, or 2 years or whatever. Usually the longer the duration, the longer you keep your money ... you lock your money in with them the higher the interest they would pay. They'll say, look, this is on demand (writing) This is on demand, that's in a demand deposit. Then this right over here, you will loan it to us, this is a time deposit. (writing) This is a time deposit. Then the bank could loan this money out. It could loan these reserves out. This loan process would not increase the money supply, so that money could be loaned out maybe to someone else and maybe that gets deposited in another bank and maybe in a demand deposit, it gets deposited right over here in a demand deposit. You might say, well isn't this just like Fractional Reserve lending? Now you have $5 in the system. The difference is, is that no one can now use this perceived money right over here as money. You wouldn't be able to write checks against this money right over here. You could write it against this over here and that's okay. You could write a $1 check and it's backed by this $1 of reserves so you're not creating any new money. The only reserves here that really can act as money or be used to back checks are now the original $3. (writing) The original $3 here. The value of this type of a system, and there are drawbacks to it, the main drawback is, that the bank is not going to be able to make any money on its demand deposits so it will probably have to charge higher fees to customers to keep their money. They'll say, hey I'm safeguarding your money, I'm putting it in a vault for you, I'm making it accessible to you through checks, through ATM's so I'm going to charge you more money for me to essentially safeguard your money. Right now what banks are doing and Fractional Reserves system is like, hey, we'll do all of these services for you for a lot less, sometimes even free if you keep a large enough deposit with them. We're going to hold your money for you, we're going to keep it accessible on ATM, we're going to give you a bank ATM card and all of these things. The reason why the bank is able to do that is because they're essentially doing ... they're lending out a significant fraction of your money and getting interest on it and that's how they're making money. Here it just becomes much more explicit. The bank is saying, look, on this right over here we are doing a service for you, we are holding your money, we are keeping it on demand from wherever you want to access it and over here you are doing a service for us, you are lending us your money and then we are going to lend it out probably for higher interest so that way we can make money off of it. Obviously if we were to convert to some type of a system like this, there wouldn't be as much money being created or actually no money would be created by this lending process. So, the central bank or whoever the monetary authority is in the country would have to essentially print more money to have the money available to essentially be the grease in the economy. Just to make it clear that this isn't a fringe idea, that this is essentially what banking was until the mid 14th Century. It was the Venetian bankers who first brought up the idea of Fractional Reserve lending and there were some very mainstream banks that did full reserve lending into the 1800s. As The Great Depression got longer and longer, in 1939 some very serious economists proposed a reversion back to Full Reserve banking. They even articulated exactly how it would do and how it would not introduce too many interruptions to the economy. Although, anything like this would be dangerous because you introducing a whole new way of doing things and you don't know exactly what the repercussions will be on the economy. If you want to read their proposal it's actually quite fascinating. In just reading their proposal you'll get more depth on how the monetary system works. It's written by mainstream economists. Do a Google search for A Program for Monetary Reform. (writing) ... for Monetary, monetary Reform. It was written in 1939, so you can also do a Google for that. On Wikipedia there is actually the full text of A Program for Monetary Reform. When it was published it was supported actually by a majority by mainstream economists to go to a Full Reserve banking system.

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In favor

Economist Milton Friedman at one time advocated a 100% reserve requirement for checking accounts,^[8] and economist Laurence Kotlikoff has also called for an end to fractional-reserve banking.^[9] Austrian School economist Murray Rothbard has written that reserves of less than 100% constitute fraud on the part of banks and should be illegal, and that full-reserve banking would eliminate the risk of bank runs.^[10]^[11] Jesús Huerta de Soto, another economist of the Austrian school, has also strongly argued in favor of full-reserve banking and the outlawing of fractional reserve banking.^[12]

The financial crisis of 2007–2008 led to renewed interest in full reserve banking and sovereign money issued by a central bank. Monetary reformers point out that fractional reserve banking leads to unpayable debt, growing economic inequality, inevitable bankruptcy, and an imperative for perpetual and unsustainable economic growth.^[13] Martin Wolf, chief economist at the Financial Times, endorsed full reserve banking, saying "it would bring huge advantages".^[14]

Martin Wolf, Chief Economics Commentator at the Financial Times, argues that many people have a fundamentally flawed and oversimplified conception of what it is that banks do. Laurence Kotlikoff and Edward Leamer agree, in a paper entitled "A Banking System We Can Trust", arguing that the current financial system did not produce the benefits that have been attributed to it.^[9] Rather than simply borrowing money from savers to make loans towards investment and production, and holding "money" as a stable liability, banks in reality create credit increasingly for the purpose of acquiring existing assets.^[15] Rather than financing real productivity and investment, and generating fair asset prices, Wall Street has come to resemble a casino, in which trade volume of securities skyrockets without having positive impacts on the investment rate or economic growth.^[9] The credits and debt banks create play a role in determining how delicate the economy is in the face of crisis.^[15] For example, Wall Street caused the housing bubble by financing millions of mortgages that were outside budget constraints, which in turn decreased output by 10 percent.^[9]

Money supply problems

In The Mystery of Banking, Murray Rothbard argues that legalized fractional-reserve banking gave banks "carte blanche" to create money out of thin air.^[16] Economists that formulated the Chicago Plan following the Great Depression argue that allowing banks to have fractional reserves puts too much power in the hands of banks by allowing them to determine the amount of money in circulation by changing the amount of loans they give out.^[17]

Fractional-reserve banking fraud issues

Deposit bankers become loan bankers when they issue fake warehouse receipts that are not backed by the assets actually held, thus constituting fraud.^[16]^{[page needed]} Rothbard likens this practice to counterfeiting, with the loan banker extracting resources from the public.^[16] However, Bryan Caplan argues that fractional-reserve banking does not constitute fraud, as by Rothbard's own admission an advertised product must simply meet the "common definition" of that product believed by consumers. Caplan contends that it is part of the common definition of a modern bank to make loans against demand deposits, thus not constituting fraud.^[18]

Balance sheet fundamentals

Furthermore, Rothbard argues that fractional reserve banking is fundamentally unsound because of the timescale of a bank's balance sheet.^[19] While a typical firm should have its assets be due prior to the payment date of its liabilities, so that the liabilities can be paid, the fractional reserve deposit bank has its demand deposit liabilities due at any point the depositor chooses, and its assets, being the loans it has made with someone else's deposits, due at some later date.^[19]

Against

New fees

Some economists have noted that under full-reserve banking, because banks would not earn revenue from lending against demand deposits, depositors would have to pay fees for the services associated with checking accounts. This, it is felt, would probably be rejected by the public.^[20]^[21] However, in economies where central banks enact zero and negative interest rate policies, some writers have noted depositors are already paying to put their savings in fractional reserve banks.^[22]

Shadow banking and unregulated institutions

In their influential paper on financial crises, economists Douglas W. Diamond and Philip H. Dybvig warned that under full-reserve banking, since banks would not be permitted to lend out funds deposited in demand accounts, this function would be taken over by unregulated institutions. Unregulated institutions (such as high-yield debt issuers) would take over the economically necessary role of financial intermediation and maturity transformation, therefore destabilizing the financial system and leading to more frequent financial crises.^[23]^[24]

Writing in response to various writers' support for full reserve banking, Paul Krugman stated that the idea was "certainly worth talking about", but worries that it would drive financial activity outside the banking system, into the less regulated shadow banking system.^[25]

Misses the problem

Krugman argues that the 2008 financial crisis was not largely a result of depositors attempting to withdraw deposits from commercial banks, but a large-scale run on shadow banking.^[26] As financial markets seemed to have recovered more quickly than the 'real economy', Krugman sees the recession more as a result of excess leverage and household balance-sheet issues.^[26] Neither of these issues would be addressed by a full-reserve regulation on commercial banks, he claims.^[26]

Further reform

Kotlikoff and Leamer promote the concept of limited purpose banking (LPB), in which banks, now mutual funds, would never fail, as they would be barred from owning financial assets, and their borrowing would be limited to financing their own operations.^[9] By establishing a Federal Financial Authority, with the task of rating, verifying, disclosing and clearing all LPB mutual funds, there would be no need to outsource such tasks to private entities with perverse incentives or lack of oversight.^[9] Cash mutual funds would also be created, holding only cash tied to the value of the United States dollar, eliminating the threat of bank runs, and insurance mutual funds would be established to pay off the losses of those that own part of the mutual fund, as insurance companies are currently able to sell plans that purport to insure events for which it would be impossible for them to pay off the entirety of the losses experienced by the insured parties.^[9] The authors contend that LPB can accommodate any conceivable risk product, including credit default swaps.^[9] Under LPB, liquidity would increase as such funds become publicly available to the market, which would determine how much bank employees would be paid.^[9]

Most importantly, what limited purpose banking won't do is leave any bank exposed to CDS risk since people, not banks, would own the CDS mutual funds.^[9]

References

^ A banking revolution Jeremy Warner, UK Telegraph
^ Weisenthal, Joe. "BAN ALL THE BANKS: Here's The Wild Idea That People Are Starting To Take Seriously". Business Insider. Retrieved 2020-11-30.
^ Iceland's daring raid on fractional reserve banks, Financial Times
^ "Iceland looks at ending boom and bust with radical money plan". The Telegraph. Retrieved 2020-11-30.
^ Switzerland's 'Vollgeld' banking overhaul: how reform would work
^ Atkins, Ralph (10 June 2018). "Swiss voters reject 'sovereign money' initiative". Financial Times. Archived from the original on 2022-12-10. Retrieved 2020-11-30.
^ swissinfo.ch/sb. "Vote survey shows no generation gap but misunderstandings". SWI swissinfo.ch. Retrieved 2020-11-30.
^ Solow, Robert M. (March 28, 2002), "On the Lender of Last Resort", Financial crises, contagion, and the lender of last resort, Oxford University Press, p. 203, ISBN 978-0-19-924721-9
^ ^a ^b ^c ^d ^e ^f ^g ^h ⁱ ^j Kotlikoff, Laurence J.; Leamer, Edward (April 23, 2009). "A Banking System We Can Trust" (PDF). Forbes. Archived from the original (PDF) on June 4, 2011. Retrieved September 14, 2010 – via Boston University.
^ Rothbard, Murray N. (2008), The Mystery of Banking (PDF), Ludwig von Mises Institute, ISBN 978-1-933550-28-2, retrieved September 14, 2010
^ The Case for a 100% Gold Dollar, Murray Rothbard
^ Jesús Huerta de Soto (2012). Money, Bank Credit, and Economic Cycles (3rd ed.). Ludwig von Mises Institute. ISBN 978-1-61016-388-0. Retrieved 4 August 2013.
^ Jackson, Andrew; Dyson, Ben (2012). Modernizing Money. Why our Monetary System is Broken and how it can be Fixed. Positive Money. ISBN 978-0-9574448-0-5.
^ Weisenthal, Joe. "BAN ALL THE BANKS: Here's The Wild Idea That People Are Starting To Take Seriously". Business Insider.
^ ^a ^b "Martin Wolf: Banking, credit and money". CORE. 2013-11-11. Retrieved 2020-03-11.
^ ^a ^b ^c Rothbard, Murray N. (2008). The mystery of banking (2nd ed.). Auburn, Ala.: Ludwig von Mises Institute. ISBN 978-1-933550-28-2. OCLC 275097518.
^ "100% Reserve Banking — The History". House of Debt. 2014-04-26. Retrieved 2020-03-17.
^ Caplan, Bryan (2011-05-12). "The Morality of Fractional Reserve Banking". Econlib. {{cite web}}: Missing or empty |url= (help)^{[unreliable source?]}
^ ^a ^b Rothbard, Murray N. (2008). The mystery of banking (2nd ed.). Auburn, Ala.: Ludwig von Mises Institute. ISBN 978-1-933550-28-2. OCLC 275097518.
^ White, Lawrence H. (Winter 2003). "Accounting for Fractional-Reserve Banknotes and Deposits—or, What's Twenty Quid to the Bloody Midland Bank?" (PDF). The Independent Review. 7 (3): 423–41. ISSN 1086-1653. Archived from the original (PDF) on 2015-04-29. Retrieved 2012-11-30.
^ Allen, William (October 1993). "Irving Fisher and the 100 Percent Reserve Proposal". Journal of Law and Economics. 36 (2): 703–17. doi:10.1086/467295. JSTOR 725805. S2CID 153974326.
^ Texan Gold Depository
^ Diamond, Douglas W.; Philip H. Dybvig (Jan 1986), "Banking Theory, Deposit Insurance, and Bank Regulation", The Journal of Business, 59 (1): 55–68, doi:10.1086/296314, JSTOR 2352687, In conclusion, 100% reserve banking is a dangerous proposal that would do substantial damage to the economy by reducing the overall amount of liquidity. Furthermore, the proposal is likely to be ineffective in increasing stability since it will be impossible to control the institutions that will enter in the vacuum left when banks can no longer create liquidity. Fortunately, the political realities make it unlikely that this radical and imprudent proposal will be adopted.
^ Diamond, Douglas; Philip Dybvig (Winter 2000). "Bank Runs, Deposit Insurance, and Liquidity" (PDF). Federal Reserve Bank of Minneapolis Quarterly Review. 24 (1): 14–23. Retrieved 29 August 2012.
^ Krugman, Paul (April 26, 2014). "Is A Banking Ban The Answer?". New York Times. Retrieved September 18, 2015.
^ ^a ^b ^c "Is A Banking Ban The Answer?". Paul Krugman Blog. 2014-04-26. Retrieved 2020-03-11.

External links

The Chicago Plan Revisited, IMF Working Paper, Jaromir Benes and Michael Kumhof, August 2012
In Defence of Fractional Monetary Reserves (Pascal Salin)

This page was last edited on 5 April 2024, at 06:21

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