I have given thought to this and I can't find any a priori demonstration that fractional reserve banking is bad. Sure, it multiplies money in the economy and may create inflation, but it might very well be equilibrated with the investment-spending-saving behaviors of the people.
I usually check any issue by asking if it violates some hardcore axiomatic principle, but I can't think of any principle violated by fractional reserve banking.
People who deposit money in a bank already know the money will be used for loans. If they had a problem with that they would put the money in a safe box instead. So there is no moral problem involved.
Then there is the inflationary issue.
Some guy deposits money in the bank, the bank will pay a fee to the first guy (being a intermediary) and could lend all the money at a higher fee to someone else. The second guy uses it to buy a new car for his taxi company. The car dealer will pay for his expenses (including buying more cars) and deposit the rest of the money. The car manufacturer, at his time, will pay his expenses and deposit the surplus. The same will happen with every other person who becomes and indirect receiver of the loan. Most of the money will be flowing through the market, only a small part will be saved. An equilibrium will be achieved sooner or later. The bank (if it expects to recover the money) can only lend to people with guarantees and projects that have a sound plan, which are scarce. The surplus of money in any economy is scarce too. The lending doesn't go on ad infinitum, it will stop at a point that depends on the current situation of the economy.
The only problem could occur when someone doesn't really want to loan the money, but just it keep there to facilitate the handling of money by issuing checks instead of having to carry (for example) gold or silver with him all the time. Then he agrees to pay a fee to the bank, and expects to be able to withdraw the money at anytime. If the bank makes loans using that money then the banker really is committing fraud. Otherwise, he is not.
The issue really comes down to sound banking practices. Fractional reserve, as based in fixed term deposits, isn't immoral at all. The danger for any person making a deposit would be the same as if he was lending it directly to some friend. His friend's project may fail and he may have to execute the guarantee, maybe will lose his money, maybe will have to go to a trial to recover something.
Actually, informal loans could be considered banking operations with a zero-reserve.
So, what's the problem? What am I missing here? Why is everybody against it?
Pity the theory which sets itself up in opposition to the mind!
Carl Von Clausewitz
gussosa: The only problem could occur when someone doesn't really want to loan the money, but just it keep there to facilitate the handling of money by issuing checks instead of having to carry (for example) gold or silver with him all the time. Then he agrees to pay a fee to the bank, and expects to be able to withdraw the money at anytime. If the bank makes loans using that money then the banker really is committing fraud.
The only problem could occur when someone doesn't really want to loan the money, but just it keep there to facilitate the handling of money by issuing checks instead of having to carry (for example) gold or silver with him all the time. Then he agrees to pay a fee to the bank, and expects to be able to withdraw the money at anytime. If the bank makes loans using that money then the banker really is committing fraud.
What you have just described as "fraud" is fractional reserve banking.
gussosa: The issue really comes down to sound banking practices. Fractional reserve, as based in fixed term deposits, isn't immoral at all.
The issue really comes down to sound banking practices. Fractional reserve, as based in fixed term deposits, isn't immoral at all.
"Fractional reserve, as based in fixed term deposits" doesn't make any sense.
It's the fractional reserve system, not fiat, that's the problem - in theory, you could have 100% reserve banking with fiat money, and it wouldn't be a problem. I'm just saying it doesn't make sense to talk about "fractional reserve" on term deposits (even in a strong 100% reserve system, term deposits would have "0% reserves" - it doesn't make sense not to loan that out)
bigwig:If there aren't bank runs (99% of the time), doesn't it mean that depositers would not touch that money and thus allow it to be loaned out in a free market?
Not necessarily, because money can be transferred from one account to another without being withdrawn and redeposited - i.e., it doesn't have to exist to be used in payment. Given Internet banking, etc., a modern bank could allow you to specify how much you want to keep on demand for immediate use and let you put different amounts in various-length term deposits (e.g., they could offer 24 hour, 7 days, 30, 60, 90 days, 6 months, 1, 2, and 5 years, say), where they'd offer continuously varying higher or lower interest rates on each length depending on their need for loanable funds, etc. (I mean the offered rate would vary perhaps several times a day; once you committed some money to it, you'd get whatever rate was offered at that time); when you put some money into, say, a 7 day account, it would disappear from your current balance and be returned (with interest) 7 days later (you could have some sort of calendar display showing your future balances as well as the current balance) - now the banks could legitimately loan out your money (with no reserve requirement!), except whatever you keep on demand (for which you'd pay a fee), and hardly anybody would keep any significant amount on demand, and bank runs would be impossible. But that's not what they do today.
gussosa:In the United States transactions deposit is a term used by the Federal Reserve for checkable deposits and other accounts that can be used directly as cash without withdrawal limits or restrictions. They are the only bank deposits that require the bank to keep reserves at the central bank. This is in contrast to "time deposits" (aka term deposits).
So, it's only transactions deposits that make the problem. Does anyone have a copy of the legislation on FRB? I want to know if the reserves required are a percentage of all transactions deposits or of all deposits (including savings and term deposits)
In the case of transactions deposits, it is your money and they shouldn't use it. Period. A 100% reserve should be the standard for that.
In the case of savings and term deposits, the bank works as a commissioner (an intermediary who works for a fee that amounts to a percentage of the business). You could lend the money yourself to make a profit, but you would have to deal with engineers and financial advisers to evaluate the projects, with lawyers to take insolvent debtors to the court, with auctioneers to sell confiscated properties, and you might not be able to loan to the most interesting businesses because you just haven't got 800 million dollars to finance the construction of a new coal-based electricity plant. A bank makes it easier for you and lets you pool resources with other investors. That's why a time deposit pays an interest.
Paul: Maxliberty: Look at the run on the bank in the movie "It's a Wonderful Life", the customers all want their money. Our hero Jimmy Stewart tells them that their money is invested in the houses of their neighbors and if they want their money they will have to wait the sixty days they agreed too when they opened the account. If they agreed to wait 60 days, then there's not a problem; and that's not an example of fractional reserve banking. The problem is where they didn't agree to wait 60 days - where the bank agreed to return their money instantly, on demand.
Maxliberty: Look at the run on the bank in the movie "It's a Wonderful Life", the customers all want their money. Our hero Jimmy Stewart tells them that their money is invested in the houses of their neighbors and if they want their money they will have to wait the sixty days they agreed too when they opened the account.
Look at the run on the bank in the movie "It's a Wonderful Life", the customers all want their money. Our hero Jimmy Stewart tells them that their money is invested in the houses of their neighbors and if they want their money they will have to wait the sixty days they agreed too when they opened the account.
If they agreed to wait 60 days, then there's not a problem; and that's not an example of fractional reserve banking. The problem is where they didn't agree to wait 60 days - where the bank agreed to return their money instantly, on demand.
In this example there was still a run on the bank. The bank was practicing fractional reserve and had on hand, just enough cash as it turned out, to meet the demands for the day.
If I run a bank and tell you in the fine print that there could be a delay in receiving your funds of up to 60 days to receive your funds but through good cash management I always have enough for your when you want to take out money, how is this fraud?
scineram: Paul:What? They're lending out demand deposits, but he isn't paying a fee so it's somehow not fraud? Pull the other one. What you call demand deposit is a loan to the bank. So it is not fraud to relend it.
Paul:What? They're lending out demand deposits, but he isn't paying a fee so it's somehow not fraud? Pull the other one.
What you call demand deposit is a loan to the bank. So it is not fraud to relend it.
No, I don't think you can call it a loan. If I loaned you some money, would you accept the condition that I could come and take it back at any time?
Even if you thought of it as a loan, there is a big problem. The bank relends the money like doing a time deposit. So, they guarantee you that the money is available on demand, but they time-deposited (a part of) them to another entity. This guarantee simply can't be true.
This is because nobody really likes the collusion between loans and on-demand deposits. The banks artificially separate what has been artificially colluded in the first place.
Maxliberty:If I run a bank and tell you in the fine print that there could be a delay in receiving your funds of up to 60 days to receive your funds but through good cash management I always have enough for your when you want to take out money, how is this fraud?
If it says in the fine print that there will be a delay then this would be a timed deposit and not a demand deposit therefore no fraud has taken place.
If it says that your money is available 'on demand' but they don't have enough money to fulfill this contract, for whatever reason, then they are engaging in fraudulent activity.
On an account that serves as 'cash on hand' such as a checking/debit card account you have every reason to believe that if you write a check on the account that the bank will redeem the check 'on demand' to whomever you write the check out to. The check itself serves as 'money' (or fiduciary media as Mises calls it) and is treated as such by both the issuer and person accepting it.
As soon as the bank runs out of reserves to pay out all the 'on demand' accounts, for whatever reason, this is the very definition of bankruptcy. Just because they practice 'good cash management' and this doesn't happen very often doesn't in any way change the nature of the fradulent activity or the inherent insolvency of the system they chose to operate under.
If everyone you wrote a check to understood that there may be a delay up to 60 days in receiving their funds from your bank then they are in effect extending you a line of credit. That's not the way it works in actual practice, is it? Business are under the impression that if they accept your check or run your debit card they will receive (close to) immediate payment and structure their business activities around this. If they were forced to wait 60 days to redeem your check or have their account credited from your debit card they would have to restructure their 'good cash management' which would probably include a premium charged for this extension of credit to you as a customer.
Anonymous Coward:If it says that your money is available 'on demand' but they don't have enough money to fulfill this contract, for whatever reason, then they are engaging in fraudulent activity.
But they usually do. If the bank has 100 million liability in demand deposits but only 1 million in reserves yet the biggest account is 100,000$ they do have enough to pay your demands.
scineram: People are warehousing wheat. They do not loan it to the depository.
People are warehousing wheat. They do not loan it to the depository.
As has been screamed at you several times already, a demand deposit is not a loan.
But what you are saying is that if the warehouse owned the wheat itself, it could issue as many claims to it that it wants?
Peace
It would still be fractional reserve because their money can not actually be called in within 60 days. 60 days is just an arbitrary buffer. The time delay on the withdrawal would have to be the same as the legnth of the loan.
scineram: Anonymous Coward:If it says that your money is available 'on demand' but they don't have enough money to fulfill this contract, for whatever reason, then they are engaging in fraudulent activity. But they usually do. If the bank has 100 million liability in demand deposits but only 1 million in reserves yet the biggest account is 100,000$ they do have enough to pay your demands.
They don't have enough money to pay all demands.
If for some odd reason 30% of all outstanding accounts showed up at the door at once and they didn't have enough money to cover them then 'they usually do' doesn't help all the people coming to claim their money that is available 'on demand'.
Why would people who 'loaned' their money to a bank in the form of a demand deposit account come demanding payment as soon as they felt the bank might be insolvent if they in fact loaned their money to the bank for a set period of time?
But as the 20 or so other threads on this subject have shown there is no way to convince someone who believes that a bank who successfully manages their ponzi scheme is acting within their contractual obligations in regards to a demand deposit account that they are in fact engaging in fradulent activities.
It's a losing game and honestly is becomming quite tedious.
February 17 - 1600 - Giordano Bruno is burnt alive by the catholic church. Aquinas : "much more reason is there for heretics, as soon as they are convicted of heresy, to be not only excommunicated but even put to death."
JonBostwick: Paul: Maxliberty: Look at the run on the bank in the movie "It's a Wonderful Life", the customers all want their money. Our hero Jimmy Stewart tells them that their money is invested in the houses of their neighbors and if they want their money they will have to wait the sixty days they agreed too when they opened the account. If they agreed to wait 60 days, then there's not a problem; and that's not an example of fractional reserve banking. The problem is where they didn't agree to wait 60 days - where the bank agreed to return their money instantly, on demand. It would still be fractional reserve because their money can not actually be called in within 60 days. 60 days is just an arbitrary buffer. The time delay on the withdrawal would have to be the same as the legnth of the loan.
No new money is being created.
If the bank has a timed deposit coming due they could either get another timed deposit and give the cash from that to the initial depositor or sell the loan backing the asset to another bank and use that cash to pay back the depositor.
That's why they get paid as a middleman, to juggle around all the different accounts so someone doesn't have to have their money tied up for a longer period of time than they wish and other people can get longer term loans than any individual investor is willing to give.
Anonymous Coward:No new money is being created.
...so long as the depositer doesn't get paid until the loan is cashed out.
JonBostwick: Anonymous Coward:No new money is being created. ...so long as the depositer doesn't get paid until the loan is cashed out.
...or if you read the rest of my comment for the reason why this doesn't matter.
gussosa: In exchange for keeping the money on deposit for the agreed-on term, institutions usually grant higher interest rates than they do on accounts from which money may be withdrawn on demand, although this may not be the case in an inverted yield curve situation.
In exchange for keeping the money on deposit for the agreed-on term, institutions usually grant higher interest rates than they do on accounts from which money may be withdrawn on demand, although this may not be the case in an inverted yield curve situation.
It's perhaps worth nothing here that I believe they do this precisely to maintain the illusion - there's no fractional reserve money creation going on when they loan out money from term deposits, therefore the income they earn from the interest spread (i.e., between the rate they charge for borrowing money and the amount they pay to their depositors) is far less than the interest income from loans made from demand deposits. E.g., if you assume a single bank with 10% reserve ratio and everyone keeps their money in the bank, you could deposit $1000 and the bank could loan out $9000; if they charge 10% interest on the loan, they get back $900 a year, therefore (ignoring operating expenses, etc.) they could pay depositors up to 90% interest - while only charging 10% to borrowers! So you'd expect them to pay (much) higher interest on demand deposits...
Anonymous Coward: If for some odd reason 30% of all outstanding accounts showed up at the door at once and they didn't have enough money to cover them then 'they usually do' doesn't help all the people coming to claim their money that is available 'on demand'.
And they can't do "good cash management" anyway - see Mises' discussion of "class" vs. "case" probability; or Nassim Nicholas Taleb's "Black Swan". This article, referenced here a few weeks ago, is good.
Anonymous Coward: JonBostwick: Anonymous Coward:No new money is being created. ...so long as the depositer doesn't get paid until the loan is cashed out. ...or if you read the rest of my comment for the reason why this doesn't matter.
Looked like a list of ways to cash out.