Full-reserve banking (also known as 100% reserve banking, or sovereign money system) is a system of banking where banks do not lend demand deposits and instead only lend from

time deposits A time deposit or term deposit (also known as a certificate of deposit in the United States, and as a guaranteed investment certificate in Canada) is a deposit in a financial institution with a specific maturity date or a period to maturity, co ...

. It differs from

fractional-reserve banking Fractional-reserve banking is the system of banking in all countries worldwide, under which banks that take deposits from the public keep only part of their deposit liabilities in liquid assets as a reserve, typically lending the remainder to ...

, in which banks may lend funds on deposit, while fully reserved banks would be required to keep the full amount of each customer's demand deposits in

cash In economics, cash is money in the physical form of currency, such as banknotes and coins. In book-keeping and financial accounting, cash is current assets comprising currency or currency equivalents that can be accessed immediately or near-i ...

, available for immediate withdrawal. Monetary reforms that included full-reserve banking have been proposed in the past, notably in 1935 by a group of economists, including

Irving Fisher Irving Fisher (February 27, 1867 – April 29, 1947) was an American economist, statistician, inventor, eugenicist and progressive social campaigner. He was one of the earliest American neoclassical economists, though his later work on debt de ...

, under the so-called "

Chicago plan The Chicago Plan was introduced by University of Chicago economists in 1933 as a comprehensive plan to reform the monetary and banking system of the United States. The Great Depression had been caused in part by excessive private bank lending ...

" as a response to the

Great Depression The Great Depression was a severe global economic downturn from 1929 to 1939. The period was characterized by high rates of unemployment and poverty, drastic reductions in industrial production and international trade, and widespread bank and ...

. Currently, no country in the world requires full-reserve banking across primary credit institutions, although

Iceland Iceland is a Nordic countries, Nordic island country between the Atlantic Ocean, North Atlantic and Arctic Oceans, on the Mid-Atlantic Ridge between North America and Europe. It is culturally and politically linked with Europe and is the regi ...

's legislature considered it in 2015 after the

2008–2011 Icelandic financial crisis The Icelandic financial crisis was a major financial crisis, economic and political event in Iceland between 2008 and 2010. It involved the default (finance), default of all three of the country's major privately owned commercial banks in late 2 ...

. In a 2018 Swiss ballot initiative, 75% of voters voted against the Sovereign Money Initiative which had full reserve banking as a prominent component of its proposed reform of the Swiss monetary system.

Concepts

Full-reserve banking requires banks to maintain 100% reserves against demand deposits. This is a significant change from

, where only a small percentage of deposits must be on reserve.

Basic Principles

Full-reserve banking effectively splits banks into two distinct functions, described by Benes and Kumhof (2012) as the "separation of the monetary and credit functions of the banking system." # Custody and Transaction Services: Banks hold deposited currency as 100%-reserve deposits, transferable to third parties. # Investment Intermediation: Banks would become true intermediaries, transferring from savers to borrowers. Jackson and Dyson (2012) argue this separates transaction accounts and investment accounts.

Money Creation

McLeay et al. note that in the current system, "Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower's bank account, thereby creating new money." In contrast, Sigurjonsson explains that full-reserve banking, "transfers the power to create money from commercial banks" to the central bank. This has several implications: # Money Supply: Dyson et al. argue that banks would no longer be money creators and so generate less financial instability. # Credit Creation: Kay argues for managing maturity mismatch through markets not within financial institutions.

Account Types

Full-reserve banking proposes two distinct types of accounts, analyzed by Pennacchi (2012). # Transaction Accounts #* 100% backed by reserves #* Available for immediate withdrawal #* May charge service fees #* Cannot be lent #* Legally separated from other bank activities # Investment Accounts #* Fixed terms for withdrawal #* Can be used for lending #* May offer different risk-return profiles #* Risk explicitly borne by depositor #* Returns based on investment performance

History

In the 1840s,

British Currency School The British Currency School was a group of British economists, active in the 1840s and 1850s, who argued that the excessive issuing of banknotes was a major cause of price inflation. They believed that, in order to restrict circulation, issuers of ...

theorists argued for 100% reserves. In the early 20th century,

classical economics Classical economics, also known as the classical school of economics, or classical political economy, is a school of thought in political economy that flourished, primarily in Britain, in the late 18th and early-to-mid 19th century. It includ ...

was widely accepted. In the 1930s,

Keynesianism Keynesian economics ( ; sometimes Keynesianism, named after British economist John Maynard Keynes) are the various macroeconomics, macroeconomic theories and Economic model, models of how aggregate demand (total spending in the economy) strongl ...

gained prominence as policymakers sought solutions for the Great Depression. Economists proposed various strategies to address financial stability, including the

Chicago Plan The Chicago Plan was introduced by University of Chicago economists in 1933 as a comprehensive plan to reform the monetary and banking system of the United States. The Great Depression had been caused in part by excessive private bank lending ...

's full-reserve banking. Irving Fisher's "The Debt-Deflation Theory of Great Depressions" (1933) analyzed how debt cycles contributed to economic instability. Fisher proposed in his 1935 "100% Money" disconnecting money and credit. Albert G. Hart detailed in 1935 how to maintain economic stability during the transition to 100% reserves. William R. Allen recounted in 1993 how Fisher's proposals influenced banking reform discussions. Full-reserve banking did not become law.

Maurice Allais Maurice Félix Charles Allais (31 May 19119 October 2010) was a French physicist and economist, the 1988 winner of the Nobel Memorial Prize in Economic Sciences "for his pioneering contributions to the theory of markets and efficient utilization ...

presented a 100% reserve proposal in a 1948 book.

Milton Friedman Milton Friedman (; July 31, 1912 – November 16, 2006) was an American economist and statistician who received the 1976 Nobel Memorial Prize in Economic Sciences for his research on consumption analysis, monetary history and theory and ...

advocated for 100% reserves in 1960 with

A Program for Monetary Stability A Program for Monetary Stability is a book by the US economist Milton Friedman. It has been published by Fordham University Press in 1960 with consecutive re-prints appearing in 1961, 1963, 1965, 1969, 1970, 1975, and 1980.Milton Friedman, ''A Pr ...

James Tobin James Tobin (March 5, 1918 – March 11, 2002) was an American economist who served on the Council of Economic Advisers and consulted with the Board of Governors of the Federal Reserve System, and taught at Harvard University, Harvard and Yale Uni ...

proposed a deposit currency system in 1985 with aspects of 100% reserves.

Laurence Kotlikoff Laurence Jacob Kotlikoff (born January 30, 1951) is an American economist who has served as a professor of economics at Boston University since 1984.https://kotlikoff.net/wp-content/uploads/2024/02/Vita-2-21-24-Laurence-Kotlikoff.pdf A specialis ...

called for 100% reserve banking in his 2010 book Jimmy Stewart Is Dead. In the 2014 Money Creation and Society debate in the UK Parliament,

Zac Goldsmith Frank Zacharias Robin Goldsmith, Baron Goldsmith of Richmond Park, (born 20 January 1975) is a British politician, life peer and journalist who served as Minister of State for Overseas Territories, Commonwealth, Energy, Climate and Environmen ...

called for a monetary commission on full reserve banking.

Views

In favor

Economist

at one time advocated a 100%

reserve requirement Reserve requirements are central bank regulations that set the minimum amount that a commercial bank must hold in liquid assets. This minimum amount, commonly referred to as the Bank reserves, commercial bank's reserve, is generally determined ...

for checking accounts, and economist

has also called for an end to fractional-reserve banking.

Austrian School The Austrian school is a Heterodox economics, heterodox Schools of economic thought, school of economic thought that advocates strict adherence to methodological individualism, the concept that social phenomena result primarily from the motivat ...

economist

Murray Rothbard Murray Newton Rothbard (; March 2, 1926 – January 7, 1995) was an American economist of the Austrian School,Ronald Hamowy, ed., 2008, The Encyclopedia of Libertarianism', Cato Institute, Sage, , p. 62: "a leading economist of the Austri ...

has written that reserves of less than 100% constitute fraud on the part of banks and should be illegal, and that full-reserve banking would eliminate the risk of

bank run A bank run or run on the bank occurs when many Client (business), clients withdraw their money from a bank, because they believe Bank failure, the bank may fail in the near future. In other words, it is when, in a fractional-reserve banking sys ...

s.The Case for a 100% Gold Dollar
Murray Rothbard

Jesús Huerta de Soto Jesús Huerta de Soto Ballester (; ; born December 23, 1956) is a Spanish economist of the Austrian School. He is a professor in the Department of Applied Economics at King Juan Carlos University of Madrid, Spain and a Senior Fellow at the Mises ...

, another economist of the Austrian school, has also strongly argued in favor of full-reserve banking and the outlawing of

fractional reserve banking Fractional-reserve banking is the system of banking in all countries worldwide, under which banks that take deposits from the public keep only part of their deposit liabilities in liquid assets as a reserve, typically lending the remainder to ...

. The

2008 financial crisis The 2008 financial crisis, also known as the global financial crisis (GFC), was a major worldwide financial crisis centered in the United States. The causes of the 2008 crisis included excessive speculation on housing values by both homeowners ...

led to renewed interest in full reserve banking and sovereign money issued by a

central bank A central bank, reserve bank, national bank, or monetary authority is an institution that manages the monetary policy of a country or monetary union. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the mo ...

Monetary reform Monetary reform is any movement or theory that proposes a system of supplying money and financing the economy that is different from the current system. Monetary reformers may advocate any of the following, among other proposals: * A return to ...

ers point out that fractional reserve banking leads to unpayable debt, growing economic inequality, inevitable

bankruptcy Bankruptcy is a legal process through which people or other entities who cannot repay debts to creditors may seek relief from some or all of their debts. In most jurisdictions, bankruptcy is imposed by a court order, often initiated by the deb ...

, and an imperative for perpetual and

unsustainable Sustainability is a social goal for people to co-exist on Earth over a long period of time. Definitions of this term are disputed and have varied with literature, context, and time. Sustainability usually has three dimensions (or pillars): env ...

economic growth In economics, economic growth is an increase in the quantity and quality of the economic goods and Service (economics), services that a society Production (economics), produces. It can be measured as the increase in the inflation-adjusted Outp ...

Martin Wolf Martin Harry Wolf (born 16 August 1946 in London) is a British journalist who focuses on economics. He is the chief economics commentator at the ''Financial Times''. He also writes a weekly column for the French newspaper ''Le Monde''. Earl ...

, chief economist at the ''

Financial Times The ''Financial Times'' (''FT'') is a British daily newspaper printed in broadsheet and also published digitally that focuses on business and economic Current affairs (news format), current affairs. Based in London, the paper is owned by a Jap ...

'', endorsed full reserve banking, saying "it would bring huge advantages".

, Chief Economics Commentator at the ''

'', argues that many people have a fundamentally flawed and oversimplified conception of what it is that banks do.

and Edward Leamer agree, in a paper entitled "A Banking System We Can Trust", arguing that the current financial system did not produce the benefits that have been attributed to it. Rather than simply borrowing money from savers to make loans towards investment and production, and holding "money" as a stable liability, banks in reality create credit increasingly for the purpose of acquiring existing assets. Rather than financing real productivity and investment, and generating fair asset prices, Wall Street has come to resemble a casino, in which trade volume of securities skyrockets without having positive impacts on the investment rate or economic growth. The credits and debt banks create play a role in determining how delicate the economy is in the face of crisis. For example, Wall Street caused the housing bubble by financing millions of mortgages that were outside budget constraints, which in turn decreased output by 10 percent.

Money supply problems

In '' The Mystery of Banking'',

argues that legalized fractional-reserve banking gave banks "carte blanche" to create money out of thin air. Economists that formulated the Chicago Plan following the Great Depression argue that allowing banks to have fractional reserves puts too much power in the hands of banks by allowing them to determine the amount of money in circulation by changing the amount of loans they give out.

Fractional-reserve banking fraud issues

Deposit bankers become loan bankers when they issue fake warehouse receipts that are not backed by the assets actually held, thus constituting fraud.^:97 Rothbard likens this practice to counterfeiting, with the loan banker extracting resources from the public. However,

Bryan Caplan Bryan Douglas Caplan (born April 8, 1971) is an American economist and author. He is a professor of economics at George Mason University, a senior research fellow at the Mercatus Center, an adjunct scholar at the Cato Institute, and a former c ...

argues that fractional-reserve banking does not constitute fraud, as by Rothbard's own admission an advertised product must simply meet the "common definition" of that product believed by consumers. Caplan contends that it is part of the common definition of a modern bank to make loans against demand deposits, thus not constituting fraud.

Balance sheet fundamentals

Furthermore, Rothbard argues that fractional reserve banking is fundamentally unsound because of the timescale of a bank's balance sheet. While a typical firm should have its assets be due prior to the payment date of its liabilities, so that the liabilities can be paid, the fractional reserve deposit bank has its demand deposit liabilities due at any point the depositor chooses, and its assets, being the loans it has made with someone else's deposits, due at some later date.

Against

New fees

Some economists have noted that under full-reserve banking, 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 probably be rejected by the public. However, in economies where central banks enact zero and negative interest rate policies, some writers have noted depositors are already paying to put their savings in fractional reserve banks.

Shadow banking and unregulated institutions

In their influential paper on financial crises, economists Douglas W. Diamond and Philip H. Dybvig warned that under full-reserve banking, since banks would only be permitted to lend out funds where depositors agreed to time-lock their deposits, need for extra credit would drive some borrowers to use unregulated institutions. Unregulated institutions (such as

high-yield debt In finance, a high-yield bond (non-investment-grade bond, speculative-grade bond, or junk bond) is a bond that is rated below investment grade by credit rating agencies. These bonds have a higher risk of default or other adverse credit even ...

issuers) would take over the economically necessary role of

financial intermediation A financial intermediary is an institution or individual that serves as a " middleman" among diverse parties in order to facilitate financial transactions. Common types include commercial banks, investment banks, stockbrokers, insurance and pens ...

and

maturity transformation Maturity transformation is the practice by financial institutions of borrowing money on shorter timeframes than they lend money out. Financial markets also have the effect of maturity transformation whereby investors such as shareholders and bondhol ...

, therefore destabilizing the financial system and leading to more frequent financial crises. Writing in response to various writers' support for full reserve banking,

Paul Krugman Paul Robin Krugman ( ; born February 28, 1953) is an American New Keynesian economics, New Keynesian economist who is the Distinguished Professor of Economics at the CUNY Graduate Center, Graduate Center of the City University of New York. He ...

stated that 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 The shadow banking system is a term for the collection of non-bank financial intermediaries (NBFIs) that legally provide services similar to traditional commercial banks but outside normal banking regulations. S&P Global estimates that, at end-2 ...

Misses the problem

Krugman argues that the

was not largely a result of depositors attempting to withdraw deposits from commercial banks, but a large-scale run on shadow banking. As financial markets seemed to have recovered more quickly than the 'real economy', Krugman sees the recession more as a result of excess leverage and household balance-sheet issues. Neither of these issues would be addressed by a full-reserve regulation on commercial banks, he claims.

References

External links

The Chicago Plan Revisited
IMF Working Paper, Jaromir Benes and Michael Kumhof, August 2012
In Defence of Fractional Monetary Reserves
(Pascal Salin) {{Portal bar, Business and economics, Money, Banks Banking Banking terms Monetary policy Monetary reform