Wednesday, 11 March 2015

Fake bank capital isn't possible under full reserve banking.

Barclays came up with a good trick for improving its capital ratio a year or two ago, and it wasn’t the only bank that employed this trick. What Barclays did was to lend money (produced from thin air) to an Arab oil Sheik on condition that the Sheik “bought” shares in Barclays.

In effect, Barclays just printed extra shares to make its balance sheet look better.

Of course in the event of Barclays going insolvent, Barclays creditors can in theory chase after the Sheik for money. But I’m sure the Sheik will have taken the precaution of putting his own person wealth beyond the reach of those creditors. He’ll have put the debt owed to Barclays in some sort of limited liability company or something of the sort.

In contrast, under full reserve banking, commercial banks cannot simply create money out of thin air. The only form of money is state issued or “base” money. Thus anyone wanting to buy shares in Barclays first has to obtain something of real value, that is, some of that base money, and give it Barclays in exchange for the shares.

Of course whatever banking laws we impose, there’s a high chance that banks will cheat, lie and game the system. Thus the latter “anti share printing” characteristic of full reserve banking may well not be fool-proof. Still, it’s an improvement on the existing banking system.

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