Wednesday, 9 September 2015

Full reserve banking - with a massive bloody loophole.

Having hopefully grasped the concept of banks 'splitting the zero', various people have proposed Full Reserve Banking, defined on Wiki as follows:

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.

OK, that makes sense so far, banks would just be keepers and guardians of physical notes and organise transfers between people's current accounts.

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.

Exactly, there's your massive bloody loophole which holes the whole thing under the waterline from the word 'go'.
So along comes our mortgage borrower, wants to borrow £100.

All the banks need to go back to the good old 'splitting the zero' is to persuade a few current account holders with £100 in the bank (literally) not earning any interest to transfer that money to a 'time deposit' or 'savings account' or 'investment account' (as Positive Money call it, page 8).

The banks then allocate £100 cash to the mortgage borrower, he withdraws it, gives it to his vendor, who puts in back in the bank. Clearly, the money would not physically move, but it's easier to imagine it if it does. And clearly, there is no need for physical money at all, whether the Bank of England gives you a bit of paper or records your cash electronically is neither here nor there.

To make it even easier than that, let us imagine that the original current account holders convert their investment accounts back into current accounts (having been paid a small commission for the few hours that their money was inaccessible), and the vendor converts his current account to an investment account.

At the end of the day, how does the bank's balance sheet look different?

The physical cash is exactly the same, but now they have:
- an additional asset (the mortgage i.e. future payments in from the borrower).
- an additional liability (the vendor's investment account).

The zero has been split and the status quo has been reinstated.

I've tried explaining this to Positive Money and others, but they flatly refuse to accept that there is a massive fucking huge great colossal flaw in their 'full reserve banking' plans which you can actually see from space.

"Oh well, yes, maybe, but we'll think up a few more rules and regulations to prevent banks doing this, yada yada yada."

Top tip: anybody who talks about banking and uses the word 'reserve' or 'reserves' without specifying whether he means on the asset side (i.e. spare physical cash) or on the liability side (retained profits) doesn't know what he is talking about.


mombers said...

Wouldn't FRB require that a 25 year mortgage be matched by a 25 year deposit though? This would likely be structured as a bond so the holder could get out earlier if they wanted to by selling it to another mug. That said, the loopholes are enormous. No doubt there would be provisions to convert time deposits to demand deposits, or for the 25 year maturity instrument to have all sorts of things appended to it that made it more like a demand deposit...

Lola said...


Carswell's plan is based upon having checking accounts fully reserved and time deposits not necessarily 100% reserved. But the time deposits would offer varying rates of interest to reflect riskiness. It would even be possible to specify that only (say) 80% of your deposit was reserved and that therefore you get rate X%. But if you wanted to go for a 50% reserved time deposit your rate would 3X% (say).

This still means that banks can split the zero, but everyone (i.e. the market) would have a bloody sight better idea what they were actually up to.

I think that this plan could have 'traction'. It would mean you scrap all the appalling statutory 'depositor protection' nonsense.

It would also make banks make transparent charges for their account management services.

Lola said...


Oh, and if you also returned the freedom to banks to issue their own bank notes, these would have to be fully reserved, like chequing accounts.

I think that this is where the 1844(?) Bank Charter Act failed. It made bank notes 100% reserved but didn't deal with chequing accounts which banks just substituted for the own bank notes.

Mark Wadsworth said...

M, not a problem.

L, sorry but you used the meaningless term "reserved" rendering your whole comment meaningless.

Random said...
Positive Money's proposals are criticised here.
They make for more expensive not better banking.

Lola said...

MW. No I haven't. The thing is 'reserved' would need defining. Now, I agree there will be all sorts of wriggling but when I am in charge....

Random said...

We need to be like the Germans and Japanese and promote capital development of the economy.

About the only reason we should pay bankers to do anything is if they can demonstrate the skill of underwriting capital projects against a prospective income stream.

In simple terms this means somebody going into a bank with a proposal that requires a certain amount of money. The bank staff considers whether the prospective income stream proposed to repay that money is adequate to repay the loan and pay the wages and costs of the bank - including a reasonable return to whatever risk capital underpins the bank.

Note that there is no asset collateral involved in this process.

You make the loans unenforceable unless they fulfil the criteria laid down by the central bank. That turns anything outside the criteria into gifts of shareholder's funds. Since judges don't like calling in loans anyway (particularly mortgages) they would relish the power to declare a loan Ultra Vires.

Once you have that in place then the banks will stick very well inside the criteria determined by the central bank and banks would undertake multiple checks and balances to ensure they could make the loan stick- because one bad loan undos the earnings from dozens of sound loans. And of course such a risk would automatically put up the cost of loans as well.

No need for bureaucrats to monitor every loan that banks make.

Details here:

Whereas we in the UK have in all our wisdom have said house prices should (Orwellian) be left to the "free market." All our bank lending is on pointless land speculation, additionally leading to boom and bust (aka "credit crunch")

About half of all loans are for the purchase of EXISTING houses. Those loans do not promote capital development one iota. Nuts.

Mark Wadsworth said...

R, apart from the Japanese land price bubble of the 1980s from which they have yet to properly recover…

And while the Germans don't have Home-Owner-Ism in the British sense, they still have Land-Owner-Ism - a smaller group of landowners share much larger gains. I used to do their tax returns, I know this stuff.

But the rest of your comment stands, agreed.

Bayard said...

R, what you propose sounds very like shariah-compliant banking. You have to hand it to the Muslims, banking is one of the things they get right.