Full-reserve banking

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Full-reserve banking is a hypothetical banking practice in which all deposits, banknotes, and notes in a financial system would be backed up by assets with a store of value.^[1] This does not imply the existence of a body (such as a central bank) that would convert currency to a different type of asset if requested to do so. A bank could engage in full reserve banking by making loans backed completely by a commodity or government created currency. Banks would not have the power to create money as they are able to do with a fractional reserve banking. It requires that the resources available to the banks issuing credit money and demand deposits would be sufficient to convert all currency at once if so required. It was a central component in Social Credit proposals.^[2]

1 Reserve ratio
2 Criticism of 100% reserves banking
3 Examples
- 3.1 Islamic banking
- 3.2 Digital gold
4 Monetary reform
5 See also
6 External links
7 References

[edit] Reserve ratio

The reserve ratio of all banks operating in such a system would be 100%, making the deposit multiplier equal to one (1xM=M). The opposite of this system is fractional-reserve banking, in which the bank would hold only a fraction of all client deposits as reserves with the remainder used to supply loans.

Some advocates believe that full-reserve banking should only apply to demand deposits not fixed loan deposits [1]. The distinction that full reservists make is that demand deposits such as checking and some modern savings accounts are available for immediate use by the owner of the account, whereas a traditional savings account is restricted.

A system in which all currency is backed by another asset and commercial banks are required to maintain a 100% cash reserve ratio has never been implemented in any actual economy.

In monetary policy, the closest analogy to a full reserve bank is that of a currency board, in which commercial banks are not required to maintain a 100% cash reserve, but all of the money in circulation is backed by another asset held by the central bank. This system is in use in Hong Kong where the Hong Kong dollar is backed by United States dollars deposited in the Exchange Fund of the currency board. Other independent states such as Lithuania, Estonia and Bosnia have implemented currency board-like systems (local currencies are anchored to the euro). Argentina had a currency board-like system (anchored to the U.S. dollar) up until 2002 (when it broke the link with the U.S. Dollar and devalued the Argentine peso), and many Caribbean states have used this kind of system up until recently.

[edit] Criticism of 100% reserves banking

Among criticisms of a full-reserve banking system is the argument that full-reserve banking implicitly means that there is no government-controlled "monetary policy" at all. Critics might also argue that a full-reserve system leaves us with an inelastic currency. Proponents would likely argue that the lack of a government-manipulated currency (the lack of a "monetary policy") and the presence of a sound currency (as opposed to an "elastic" one) are advantages to a full-reserve system. More subtly, since full-reserve banking means that during periods of high demand for money, the prices of other goods must fall, the economy will bear costs that are (in principle) no different from those it would bear during periods of moderate inflation (that is, if the cost of adjusting to absolute prices is low or negligible, moderate inflation should be no more problematic than moderate deflation).^[3]

Pascal Salin, professor at the Université Paris-Dauphine and former Mont Pelerin Society president, opposes such regulation of banking. He says "a situation of perfect certainty doesn't exist"^{[citation needed]} even in a full-reserve banking system. He also states that "in a perfectly free banking system [...] any customer must be free to choose the kind of notes and the system of payments for services he prefers. [...] We cannot decide from outside that a 100-percent-reserve system is optimal, since optimality cannot be defined independent of the wants of the individual."^{[citation needed]}

Advocates of full-reserve banking do not necessarily advocate that the government lay down regulations stipulating such a system. In fact, some economists, such as Murray Rothbard (of the Austrian School) believe that government has everything to do with the pervasiveness of fractional-reserve banking, as governments have essentially formalized the process by making it legal; and, in doing this, they've lulled the public and prevented checks that would likely otherwise be placed on banks, by weary customers, anti-fractional-reserve consumer groups, and other such organizations. Rothbard expresses this concern, and argues the case for 100% commodity-backed money, in his book What Has Government Done to Our Money?.

[edit] Examples

[edit] Islamic banking

In theory, Islamic banking is often synonymous with full-reserve banking, with banks achieving a 100% reserve ratio;^[4]^[5]

[edit] Digital gold

Since 1996, a form of private currency called digital gold currency has been in circulation. Many of these currency providers claim to act like full-reserve "private banks" with a one to one ratio of the currency they issue and the hard asset, usually gold or silver, that they store as reserves. The most prominent examples are e-gold, e-Bullion and GoldMoney. Also available are physical gold exchangers and storage providers, such as BullionVault.

[edit] Monetary reform

A monetary reform for the information age on a full-reserve base is proposed by Joseph Huber and James Robertson.^[6] The fruit of collaboration between a German academic and a British economic writer, they argue for one reform: the reappropriation by governments of the right of seigniorage now possessed by private banks. About 95% of new money currently issued takes the form of loans made by private banks to their customers. Huber and Robertson want to make this illegal. The creation of new money, both cash and non-cash, should be the exclusive prerogative of the central bank. The latter should determine how much it creates in the light of the objectives chosen for the country's monetary policy, and credit the new money to the government, at no cost, who will then put it into circulation by spending it.^[7]

Another full-reserve proposal is put forward by the "American Monetary Institute" [AMI]. "The Federal Reserve banks would be nationalized, but not the individual member banks. The power to create money was to be removed from private banks by abolishing fractional reserves – the mechanism through which the banking system creates money. So the plan called for 100% reserves on checking accounts which simply meant banks would be warehousing and transferring the money and charging fees for their services."