The flaw in deposit insurance.

Those who place money with a bank with a view to the bank lending on their money so as to earn them interest are protected by taxpayer backed deposit insurance, which is nice for them. But if people who want to lend out their money via banks are protected against loss gratis the taxpayer, why shouldn’t those who place their money with other investment intermediaries (e.g. unit trusts, mutual funds, private pension schemes, etc) enjoy the same privileges (where that’s what investors want)?

Unless other investment intermediaries enjoy the same luxury, deposit insurance is a form of discrimination in favour of, i.e. a subsidy of banks.

Moreover, the argument put for the existing bank system and deposit insurance by the UK’s Independent Commission on Banking (sections 3.20 – 3.24) namely that deposit insurance encourages lending and investment applies equally to other investment intermediaries.

On the other hand, the availability of a totally safe method of storing and transferring money is a basic human right, so it’s fair enough to have taxpayers stand behind THAT system. So what to do?

Well I suggest there is a very simple and widely accepted principle that helps sort this out: it’s the widely accepted principle that it is not the job of governments or taxpayers to stand behind COMMERCIAL ventures or transactions (as I argue here).

Depositing money with an investment intermediary with a view to earning interest is clearly a COMMERCIAL transaction, and should therefor not be protected by taxpayers / governments.

In contrast, the simple act of storing money and transferring it is not necessarily commercial in nature. But even where it is commercial in nature, the country’s money storage and transfer system cannot possibly be allowed to collapse. Thus there is a case for taxpayer / government insurance of that system.

And what d’yer know? That’s exactly what full reserve banking achieves. That is, under full reserve, those who want their money to be loaned out so as to earn interest are not protected, while those who simply want money STORED without earning interest are protected.

And as for any deflationary effect of the cut in lending that full reserve would bring, that’s easily countered by standard stimulatory measures, e.g. the suggestion made by Keynes in the early 1930s, namely that in a recession, government should simply create new money and spend it (and/or cut taxes). The net effect would be less lending and thus less debt, and given that the great and the good and every windbag in the country keeps going on about the excessive amount of private debt, what’s the problem?