Monday, 13 July 2020

Remove bank subsidies, and the existing fractional reserve system automatically becomes a full reserve bank system.

For several centuries prior to the mid 1900s, when deposit insurance was introduced, one of the basic activities of banks was to accept deposits, lend out money while promising depositors their money was safe, which it quite clearly was not. Reason was that if any bank made enough silly loans it was then unable to repay depositors’ money. Indeed, banks failed regularly. Thus the latter promise or suggestion was plain simple fraud.

That fraudulent activity of banks was remedied to some extent in the mid 1900s when taxpayer backed deposit insurance was introduced. That deposit insurance could be said to have changed a form of fraud into a form of legalised fraud.

Unfortunately deposit insurance was essentially a form of jumping out of the frying pan into the fire because banks are not the only form of lender. That is, if taxpayers stand behind banks via deposit insurance and multi-billion dollar bail outs, the question arises as to why those other lenders should not enjoy the same privileges.

Those other lenders are numerous. First there are peer to peer lenders, and an important type of peer to peer lender comes in the form of the friends and relatives of those running small and medium size enterprises (SMEs) who lend to the latter businesses. Indeed, the total amount loaned that way rivals the amount loaned by banks to SMEs.

Second, there are what might be called “trade credit lenders”: firms which allow other firms to which they have supplied goods and services an extended period before payment is demanded. There again, the total amount loaned rivals bank lending.

Third, there are institutions and individuals who buy bonds issued by corporations, cities and so on, i.e. who lend to the latter borrowers.

To summarise, featherbedding banks via deposit insurance and multi-billion dollar bail outs, while other lenders don’t enjoy those privileges results in a non-level playing field as between banks and other lenders which doesn’t make sense.

Now the latter non-level playing field could be remedied by extending the privileges enjoyed by banks to other lenders. But that flouts a principle, widely accepted in economics, and indeed which is no more than common sense, namely that it is not the job of governments to subsidise activities which are quite clearly commercial in nature.

So we’re forced to conclude that all forms of support for all lenders, banks included, should be abandoned. But that leaves the problem that if state support for banks is withdrawn, then people and indeed firms no longer have a totally safe method of storing and transferring money. And clearly having a totally safe method of storing and transferring money is a basic human right. As for firms, maybe they don’t have that basic right, but certainly a totally safe form of money is something that millions of firms would be happy to pay for.

Well actually a totally safe form of money has long been available in many countries: state run savings banks, like National Savings and Investments in the UK. NSI is not quite as convenient as a conventional bank (e.g. it does not offer debit cards) but there is no reason it couldn’t be made as convenient.

So the solution to the mess that the bank system has been for centuries would seem to be to abandon all forms of support and featherbedding for banks, while governments provide a totally safe form of money for those who want that.

And what do you know?

A system exactly like that has been advocated by numerous leading economists, including a few Nobels for well over a century! The relevant system is called “full reserve banking”, “100% reserves”, “narrow banking” and “Sovereign Money”. I’ll use the term “full reserve”. (See this article for a list of some of the latter economists.)

Under full reserve, those who want to expose themselves to risk by placing money with an entity which also lends out money can do so. The advantage is that they earn interest, but since they’re into commerce, they have to accept relevant risks.

In contrast, those who want extreme safety place their money with the state, though those state backed accounts could actually be administered by commercial banks, as explained on p.7 here. However, relevant depositors get no interest, and indeed must pay for all costs involved in providing that service.

There are of course a large number of objections that have been raised to full reserve, some of them extremely silly. I dealt with about forty of those objections in section two of my book “The Solution is Full Reserve / 100% Reserve Banking”.

And the final big advantage of full reserve, is that bank failures are impossible. Re the latter risky accounts, relevant banks cannot fail because it’s depositor / investors who carry relevant risks. And as for safe accounts, those cannot fail either, because the entity holding relevant monies does not also lend out money.


Earlier and other versions of the above article.

I put a copy of the above article on the Researchgate site on 12th July 2020, though with a slightly different title.

There is an extended version of the above article here (3,000 words as opposed to the above article, which is about 800 words), also at the Researchgate site.  That 3,000 word version has also been published in the “Advances in Social Sciences Research Journal”.

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