How is a 100% Reserve Banking System Regulated?

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  • #17919
    p.jeffgodley
    Member

    The property rights case for why anything less than 100% reserve banking is pretty clear to me: money certificates are property titles to money, and you can’t have more than one title to the same property.

    My question is, what prevents a bank on the Unhampered Market Economy from keeping anything less than 100% reserves? Is it simply the inherent risk of a bank run? If so how great is that risk? Or is there something else which provides incentive to keep 100% reserves?

    It seems like, while keeping 10% reserves without rapidly going bankrupt would be nearly impossible without government intervention and a Central Bank, why not keep 90% reserves? Wouldn’t that reduce risk to a manageable level and allow the bank to make short-term profits on the extra loans they could make?

    Perhaps it’s because I’m young enough that I’ve never known anything except central banks and fiat currency that I don’t see how much risk is involved for a free market bank to keep less than 100% reserves. It just seems like there could be a case for reserves less than 100% that did not pose all that great a threat to the bank. What am I missing?

    #17920
    jmherbener
    Participant

    Your inquiry raises two related issues. First, would anything except money itself and money certificates be used by people as media of exchange on the unhampered market. Would merchants in general throughout the economy accept claims on short term loans, i.e., fractional-reserve deposits like our checking accounts, instead of money or money substitutes? Not likely. Second, given that merchants accept claims on short term loans as a medium of exchange would they tolerate reserve ratios much below 100 percent. Not likely.

    For time deposits, which are loans, banks will structure their reserve ratios to manage unanticipated defaults and other factors affecting the asset value of the loans. These ratios may be quite small, certainly under 10 percent for high quality loans.

    Any fiduciary media issue, however, involves malinvestments in the economy. Of course, there would be fewer malinvestments the closer the reserve ratio was to 100 percent.

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