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Full-reserve banking, also known as 100% reserve banking, refers to a hypothetical alternative to fractional reserve banking in which banks would be 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 ensure an adequate reserve for customer payments. 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.

Full-reserve system is not currently in practice anywhere in the world, however full-reserve banking was practiced briefly by the Bank of Amsterdam in the early 17th Century. A system of full-reserve banking was discussed by economist Irving Fisher in 1935.

History

Views on full-reserve banking

In the post-World War II era, economists have shown little interest in 100%-reserve banking, although some have examined the issue and concluded that the costs and inconvenience of a full-reserve banking system would outweigh any benefits. However, economist Milton Friedman at one time advocated a 100% reserve requirement for checking accounts and economist Laurence Kotlikoff has also called for an end to fractional-reserve banking. Murray Rothbard examined the possibility of full-reserve banking and stated that it would eliminate the financial risks associated with bank runs.

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 likely be rejected by the public. Because banks would not be permitted to lend out funds deposited in demand accounts, lending could be expected to be done instead by unregulated institutions, possibly destabilizing the financial system. Unregulated institutions (such as high-yield debt issuers) would take over the economically necessary role of financial intermediation.

Current examples

There is currently no full reserve banking system in existence anywhere in the world.

Islamic banking

In theory, Islamic banking is often synonymous with full-reserve banking, with banks achieving a 100% reserve ratio. In practice, however, this is not the case, and no examples of 100 percent reserve banking are observed. According to Islami Bank Bangladesh:

The fractional reserve system versus 100% reserves would have different policy implications. Under the former system, banks would have the ability to draw profits on funds that they have exerted no productive effort. Such earning is against the original spirit of Islamic banking. One solution may lie in the nationalization of commercial banks, which has already occurred in most of these countries. As regards the latter, we have a fair amount of theoretical insight from the western literature but do not have any valuable empirical observations on the operations of 100% reserves even in countries that have adopted Islamic banking. These Islamic banks are still operating under fractional reserve system. Hence, the operation of monetary policy under 100% reserves system needs further research.

Digital gold or silver

Some monetary reformers believe a new free market in money production and distribution will one day erode the government's control of the currency. They state that in a free market, and in the absence of legal tender laws, a predominantly full-reserve banking system with a gold standard or silver standard would develop spontaneously.

Since 1996, various private firms have promoted a form of private currency called digital gold currency. Many of these currency providers have claimed to act as full-reserve "private banks" with a one-to-one ratio of the currency they issue to an underlying hard asset, usually gold or silver metal which they hold in vault as reserves. The most prominent recent example was e-gold. In 2011 e-gold pleaded guilty to U.S. Federal charges of money laundering and is currently being liquidated under the trusteeship of a court-appointed agent.

Most economists and other observers believe that the free market favors fractional reserve banking and that 100% reserve banking can meet the needs of only a small, extremely risk-averse, niche market.

See also

• Gold standard
• Silver standard
• Irving Fisher
• Ludwig von Mises
• Murray Rothbard
• American Monetary Institute
• Committee on Monetary and Economic Reform (Canada)
• Money creation
• Monetary reform
• Reserve requirement
• Seignorage
• NEED Act
• Chicago plan
• The Chicago Plan Revisited
• A Program for Monetary Reform

References

1. "A Program for Monetary Reform, Douglas, Paul H.; Hamilton, Earl J.; Fisher, Irving; King, Willford I.; Graham, Frank D.; Whittlesey, Charles R. (July 1939)".
2. Fisher, Irving (1935), 100% Money
3. ^ Diamond, Douglas W (1986), "Banking Theory, Deposit Insurance, and Bank Regulation", The Journal of Business, 59 (1): 55–68, doi:10.1086/296314, JSTOR 2352687, In conclusion, 100% reserve banking is a dangerous proposal that would do substantial damage to the economy by reducing the overall amount of liquidity. Furthermore, the proposal is likely to be ineffective in increasing stability since it will be impossible to control the institutions that will enter in the vacuum left when banks can no longer create liquidity. Fortunately, the political realities make it unlikely that this radical and imprudent proposal will be adopted. {{citation}}: Unknown parameter |coauthors= ignored (|author= suggested) (help); Unknown parameter |month= ignored (help)
4. ^ White, Lawrence H. (2003). "Accounting for Fractional-Reserve Banknotes and Deposits—or, What's Twenty Quid to the Bloody Midland Bank?" (PDF). The Independent Review. 7 (3): 423–41. ISSN 1086-1653. {{cite journal}}: Unknown parameter |month= ignored (help)
5. Solow, Robert M. (March 28, 2002), "On the Lender of Last Resort", Financial crises, contagion, and the lender of last resort, Oxford University Press, p. 203, ISBN 978-0-19-924721-9 {{citation}}: External link in |chapterurl= (help); Unknown parameter |chapterurl= ignored (|chapter-url= suggested) (help)
6. Kotlikoff, Laurence J.; Leamer, Edward (April 23, 2009), "A Banking System We Can Trust" (PDF), Forbes.com, retrieved September 14, 2010
7. Rothbard, Murray N., The Mystery of Banking (PDF), Ludwig von Mises Institute, ISBN 978-1-933550-28-2, retrieved September 14, 2010
8. The Case for a 100% Gold Dollar, Murray Rothbard
9. Allen, William (1993). "Irving Fisher and the 100 Percent Reserve Proposal". Journal of Law and Economics. 36 (2): 703–17. doi:10.1086/467295. JSTOR 725805. {{cite journal}}: Unknown parameter |month= ignored (help)
10. Diamond, Douglas (2000). "Bank Runs, Deposit Insurance, and Liquidity" (PDF). Federal Reserve Bank of Minneapolis Quarterly Review. 24 (1): 14–23. Retrieved 29 August 2012. {{cite journal}}: Unknown parameter |coauthors= ignored (|author= suggested) (help); Unknown parameter |month= ignored (help)
11. A Monetary System with 100-per Cent Reserve Requirement and the Gold Standard: Theory, Fact and Policy
12. Siegfried, Nikolaus A. (2001). "Concepts of Paper Money in Islamic Legal Thought". Arab Law Quarterly. 16 (4): 319–32. doi:10.1163/A:1013840123393. JSTOR 3382052.
13. "Concept and ideology :: Issues and problems of Islamic banking". Archived from the original on 2007-07-16.
14. Hayek, F.A. (2008). Free Market Money System. ISBN 978-1-933550-37-4.
15. von Mises, Ludwig (1953). The Theory of Money and Credit. LCCN 52-12074.
16. e-gold liquidation website {http://www.egoldclaimsprocess.com/}
17. e-gold blog {http://blog.e-gold.com/}
18. Internet currency firm pleads guilty to money laundering

External links

• FullReserveBanking.com
• The Mystery of Banking, Murray Rothbard
• Alternatives to Conventional Banking Products By Maryam Ayaz
• In Defence of Fractional Reserve Banking (Pascal Salin)
• The Chicago Plan Revisited, IMF Working Paper, Jaromir Benes and Michael Kumhof, August 2012

• Banking
• Banking terms
• Monetary policy
• Monetary reform