WI: No fractional reserve banking?

The thing is, I'm okay on some level with almost any banking or financial trick every conceived. So long as the people who invest in the bank are understood to own it. Banks are a special case where other peoples capital is pooled to the advantage of the debtor, not the creditor; though they're happy to take on the standard role of creditor at other times. For most standard bank accounts, it costs the creditor money to keep it there, but when the debtor uses the, they get to keep the profit.

Economies plan for 2% inflation, so really the standard employment contract should have a standard 2% raise per year, and every standard bank account needs to provide at least that much in interest per year.

One important thing to be recalled in my original question is that I specified demand deposits would need to be fully backed. However, the banks could still offer loans by first offering term deposits. You give a bank some money, they give you a certificate that says you'll get your money back in a year, plus, let's say, one percent. The bank then lends out that money at, let's say, two percent. So you get back a hundred dollars, plus one dollar in interest, and the bank has a dollar more than they had the year before. I know, that's all really basic. I just wanted to spell it out because it was apparently getting ignored.

Like this peep says. Everyone can actually win with banking, but some people don't feel like they win unless someone else loses.
 
I'm glad I've discovered this thread as it's been an excellent discussion on an important financial issue. Congratulations to everyone!

My own views are mixed and affected by my background. First degree in Economics (40 years ago mind!) and worked for 35 years until 2011 in a major bank, specialising for 25 years in country risk. I've worked through various global financial crises and a lot of banking/sovereign debt ones in individual countries. also, unsurprisingly, I've read a fair bit of the literature on past crises. \So I am very definitely aware of the problems of over leverage (and sometimes outright fraud) with fractional reserve banking systems. And of the moral hazard involved in deposit guarantee schemes, bank bail-outs etc. I'm quite open to new ideas to either tame banks or replace fractional reserve banks altogether.

The biggest problem I've seen with most modern proposals is in part how do you manage the transition form 'here to there'? Something not relevant here though! I'm not sure the argument made against Full Reserve Banking over the lack of finance for capital investment or consumer durables spending holds good. Other institutions can develop to put cash-rich investors into touch with entrepreneurs needing funding, for the necessary fee. Peer to Peer lending, bond issues, stock issues, all can provide "project finance". Non-deposit taking institutions (funded by long-term bonds and term deposits) could offer residential mortgages and consumer finance, though probably not credit cards.

This leaves banks offering a mix of Instant Access accounts and possibly term deposits. The former are 100% backed by either cash or liquid sovereign bonds, the latter could be used to offer forms 'working capital' (a problem if Full Reserve Banking is absolute) and maybe household overdrafts. But it would be necessary to have tight controls over the possible leverage from this!

Would it work though? Perhaps in theory, though it's possible that innovation and investment would be slower and steadier as suggested above. In practice? Well, while all financial crises involve the use of excessive leverage to generate new money and a boom in prices of whatever assets are over-hyped, I'm sceptical that shutting off the banking route will alone do the trick. People are very creative in this area and can find new ways of making assets liquid and pledgeable over and over. So I'd see asset bubbles and bursts continuing but - crucially - having less impact on banks.

This could at least prevent the loss of people's savings by cutting the risk of bank failures - not to be sneezed at.
 
One important thing to be recalled in my original question is that I specified demand deposits would need to be fully backed. However, the banks could still offer loans by first offering term deposits. You give a bank some money, they give you a certificate that says you'll get your money back in a year, plus, let's say, one percent. The bank then lends out that money at, let's say, two percent. So you get back a hundred dollars, plus one dollar in interest, and the bank has a dollar more than they had the year before. I know, that's all really basic. I just wanted to spell it out because it was apparently getting ignored.

It wasnt getting ignored as much as it is hard to address everything.

The problem is that unless demand deposits are legally segregated, it doesnt really solve the problem. Let's say I have a $1mm in demand deposits backed by $1mm in US Treasuries complemented by $1mm in a 1 year loan that is funded by a $1mm in a 1 year CD. Let's say the 1 year loan defaults at 100% (unrealistic but for the sake of simplicity), the bank now has $1mm in assets and $2mm in debts (the 1 year CD and the demand deposits). Unless they are legally segregated entities, the CD holders will want a portion of the remaining assets. The demand deposit holders, even if they have a senior claim, wont want to wait around to see what happens so they'll pull their money and you have a bank run. Practically speaking, this is about what you have in modern banking whereby the required reserves are there to satisfy this situation. You can review, to some extent, the banks assets and liabilities to match up demand deposits as a percent of assets with their reserves etc.

One way to get around this would be to convert all demand deposits to money market mutual funds whereby via the fund, all savers have a direct claim on the underlying assets as they actually are held as a separate legal entity, which I suggested earlier. Again, I am not sure how easy this would have been 300 years ago given the limitations on communications etc.
 
Top