Wednesday, 1 July 2015

Troika rescued the clapped out fractional reserve bank system.

A billion members of the chattering classes have pointed out in recent months that the take over by the Troika of debts owed by Greece to (mainly) North European banks was a rescue of those banks rather than a rescue of Greece.

What the chatterers have universally failed to spot is that that take over was also a rescue of the fractional reserve bank system, which regular as clockwork needs rescuing from its own follies. To elaborate….

First, neither “fractional reserve” nor “full reserve” are entirely satisfactory phrases, but we’re stuck with them, so I’ll continue to use them.

Fractional reserve is a system under which private banks can fund themselves largely by debt (e.g. depositors or bondholders) and to a very small extent by equity. That means that when a smallish proportion of those to whom banks have loaned money can’t repay that money, those banks are bust. The chattering classes and everyone else then runs around like headless chickens not knowing what to do, apart from grab billions from taxpayers in order to rescue fractional reserve banks.

In contrast, under full reserve, banks or bank subsidiaries which lend in any faintly risky manner (e.g. to mortgagors, countries like Greece, etc) are funded just by equity. That means, first, that it’s plain impossible for them to go bust. Thus no Troika or other body funded with taxpayers’ money is required to bail them out.

If a Greece can’t pay its debts, those equity holders take a hair-cut, and serve them right: they shouldn’t have loaned money to dodgy borrowers.

Of course that’s not of any HUGE benefit to the Greeces of this world, but at least no taxpayers money is used to rescue irresponsible borrowers.

Having said there is no HUGE benefit for the Greeces of this world, there is a minor benefit. It’s that under full reserve, lenders act more responsibly: thus the hike in interest charged to Greece would have started earlier. And that is of some benefit because as Simon Wren-Lewis (Oxford economics prof) pointed out, a longish period of mild austerity is probably better than a shorter period of extreme austerity.

1 comment:

  1. Is fractional reserve relevant in a banking system that doesn't have a reserve requirement? Doesn't a reserve free requirement disprove the idea of a fractional reserve and prove the endogenous money system we in fact have.

    This isn't an argument for the system we now have over, say, full reserve. It is simply an acceptance of the fact that the system we have is an endogenous one, not a fractional reserve one.


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