Full-reserve banking, also known as 100% reserve banking, refers to an alternative to fractional reserve banking in which banks are required to keep the full amount of each depositor's funds in cash, ready for immediate withdrawal on demand. Funds deposited by customers in demand deposit accounts (such as checking accounts) could not be loaned out by the bank because it would be legally required to retain the full deposit to satisfy potential demand for payments. Proposals for full reserve banking systems generally do not place such restrictions on deposits that are not payable on demand, for example time deposits or savings accounts.
Monetary reforms that included full-reserve banking have been proposed in the past, notably by a group of economists, including Irving Fisher, as a response to the Great Depression. Full-reserve banking is not currently in practice anywhere in the world.
Views on full-reserve banking
In the post-World War II era, economists have shown little interest in 100%-reserve banking, although some have examined the issue and concluded that the costs and inconvenience of a full-reserve banking system would outweigh any benefits. However, economist Milton Friedman at one time advocated a 100% reserve requirement for checking accounts and economist Laurence Kotlikoff has also called for an end to fractional-reserve banking. According to Austrian economist Murray Rothbard, reserves of less than 100% constitute fraud on the part of banks, and full-reserve banking would eliminate the risk of bank runs.
Some economists have noted that because banks would not earn revenue from lending against demand deposits, depositors would have to pay fees for the services associated with checking accounts. This, it is felt, would likely be rejected by the public. Economists Diamond and Dybvig have warned that under full-reserve banking, since banks would not be permitted to lend out funds deposited in demand accounts, this function could be expected to be taken over by unregulated institutions. Unregulated institutions (such as high-yield debt issuers) would take over the economically necessary role of financial intermediation and maturity transformation, therefore destabilizing the financial system and leading to more frequent financial crises.
In the wake of the 2008 financial crisis, Martin Wolf endorsed full reserve banking, saying "it would bring huge advantages". John H. Cochrane also has come out in favor of full reserve banking. In a response in the New York Times, Paul Krugman said the idea was "certainly worth talking about", but worries that it would drive financial activity outside the banking system, into the less regulated shadow banking system.
There is currently no country in which the reserve requirement for banks is 100%, however there exist financial institutions that operate on this basis.
- Chicago plan
- Committee on Monetary and Economic Reform (Canada)
- Money creation
- A Program for Monetary Reform
- Reserve requirement
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In conclusion, 100% reserve banking is a dangerous proposal that would do substantial damage to the economy by reducing the overall amount of liquidity. Furthermore, the proposal is likely to be ineffective in increasing stability since it will be impossible to control the institutions that will enter in the vacuum left when banks can no longer create liquidity. Fortunately, the political realities make it unlikely that this radical and imprudent proposal will be adopted.
- White, Lawrence H. (Winter 2003). "Accounting for Fractional-Reserve Banknotes and Deposits—or, What’s Twenty Quid to the Bloody Midland Bank?". The Independent Review 7 (3): 423–41. ISSN 1086-1653.
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