Thread: Why have fractional reserve banking?

Can anyone explain to me why? If you had a 100% reserve ratio then all deposits would be covered and banks would be very stable, investments would then be procured from time deposits where people sign a contract explaining that for x time period they cannot withdraw their funds and they might lose said investment money.

Originally Posted by Kman

Can anyone explain to me why? If you had a 100% reserve ratio then all deposits would be covered and banks would be very stable, investments would then be procured from time deposits where people sign a contract explaining that for x time period they cannot withdraw their funds and they might lose said investment money.

If you started that way , excellent . No problem .
No risk , and I guess a boring world with a much reduced rate of growth or progress .
But we are in the middle -- or near the end -- of a completely different system and no institution works in the way you suggest .
If , absurdly , it was decided that everybody would switch tomorrow , the whole system would come tumbling down .
The amount of money needed to make reserves equal borrowings is so great I cannot even sensibly guess the figure --- $ 250 000 trillion , perhaps .
Our present system is fine -- with wise regulation and huge risk averse practises .

The risk from fractional banking occurs during runs on the bank, or when a the percentage of borrowers that defaults exceeds the reserve.

When times have been good (like the last 25 years during the "great moderation"), a lot of economists think they have everything figured out. The fraction for reserve erodes, and those reserves can be AAA rated mortgage funds. AAA mortage funds created from less than stellar mortgages by PhD's.

Instead of the gold standard, we have been operating on the PhD standard.....

I have found some PhD's to be educated well beyond their intelligence.

Because the banks would have to charge us to hold our money.

Originally Posted by Kman

Can anyone explain to me why? If you had a 100% reserve ratio then all deposits would be covered and banks would be very stable, investments would then be procured from time deposits where people sign a contract explaining that for x time period they cannot withdraw their funds and they might lose said investment money.

Originally Posted by dixon76710

Because the banks would have to charge us to hold our money.

Would you deposit money having to pay for the pleasure and knowing the bank could lose if for you?

I'll stick with a lumpy mattress.

Originally Posted by Not Amused

Would you deposit money having to pay for the pleasure and knowing the bank could lose if for you?

I'll stick with a lumpy mattress.

I would love to stick my dollars in a mattress....too bad through inflation and the ever expanding money supply that I have to invest or spend otherwise lose purchasing power. I guess it is nice to have bought gold when it was cheap otherwise all my purchasing power would be gone within next decade or so.

Too bad the govt allows this fraud on people who are less fortunate, live on fixed incomes and grandmas who have saved their dollars all theirs lives.

Originally Posted by Not Amused

Would you deposit money having to pay for the pleasure and knowing the bank could lose if for you?

I'll stick with a lumpy mattress.

With 100% reserve ratio there would be no risk of the bank losing your money, silly.

Originally Posted by Kman

investments would then be procured from time deposits where people sign a contract explaining that for x time period they cannot withdraw their funds and they might lose said investment money.

Originally Posted by dixon76710

With 100% reserve ratio there would be no risk of the bank losing your money, silly.

Not my words - Kman's

Originally Posted by Not Amused

Not my words - Kman's

Kmans words having NOTHING to do with YOUR words I quoted in my response, that you are now responding to.

Originally Posted by Kman

Can anyone explain to me why? If you had a 100% reserve ratio then all deposits would be covered and banks would be very stable, investments would then be procured from time deposits where people sign a contract explaining that for x time period they cannot withdraw their funds and they might lose said investment money.

There are plenty of hedge funds that operate that way, and a lot of investment pools, like mutual funds. They attract people willing to put up with the risk of losing their entire investment in return for possible large gains. Those who are more risk averse put their money in low risk money market funds which make only short term loans to low risk borrowers but even money market funds are subject to loss.

Many banks operate money market funds for time deposits but that is periphery to their primary economic functions which are to keep depositors money safe and use that money to make judicious medium and long term loans.

In a 100% reserve scenario banks could not lend deposits, ever, even with time deposits. What 100% reserve means is that the bank has 100% of its deposits on hand at all times.

What you are proposing is that banks operate an investment fund on the side, which many already do, especially the "investment banks".

The reality of fractional reserve banking is that it has been around for about 500 years and is what banking is all about. Since depositors do not ask for all their money every day the bank only needs to keep on hand enough for day to day business along with a cushion for bad loans and emergencies, a reserve.

This leads to the classic dilemma of banking. In order to make money banks need to lend as much as possible. In order to survive emergencies they need to keep as large a reserve as possible. Historically, banks have been generally left to themselves to decide their reserve ratios.

This has not always worked out very well in times of economic calamity since the banks did not keep adequate reserves. Since this required government intervention to preclude a complete economic collapse government regulators have stepped in and required banks to increase their reserve ratios. The problem is not fractional reserve banking per se, just its implementation.

Fractional reserve banking allows savings to be recycled into the economy, giving it employment. In 100% reserve banking deposits are not employed, they do no work.