Douglas Carswell MP's Bill to stop fractional reserve banking

It's pretty obvious that bank behaviour worldwide has been disastrous, but isn't this throwing the baby out with the water?

Banks need income to pay their staff (and shareholders). So they must lend. Fractional reserve banking places a limit on the amount of lending, but it needs to be a sensible limit.

With a 100% reserve, a bank cannot lend at all, has no income, and goes out of business.

With a 50% reserve, its total lending cannot be more than its total deposits, which seems pretty conservative, and means that the bank does not create money.

Every loan creates a deposit. (Because money circulates.) So if a bank is allowed to loan only 50.00 of a 100.00 deposit, it can expect to get back that 50.00 (if not immediately, then after it has passed through other hands such as another bank). That's true even for an Islamic bank. (Unless the bank is so hopelessly uncompetitive that no one deposits there.)

Having received a 50.00 deposit, they are allowed to loan only 25.00 of it. Again they can expect to get back 25.00 in the form of a deposit. Now they are only allowed to loan out 12.50 of that sum.

And so on - mathematically it's a simple convergent series, with a limit of 100.00 loaned out in total. A very conservative situation.

It's a neat way of automatically limiting lending to match deposits.

Seems to me that the problem arises when banks are allowed to use a very low fractional reserve. I've heard that Canadian banks use 10% but that some U.S. banks use more nearly 1% which seems very risky indeed.

I'd bet that banks use all manner of tricks to get around a safe but less profitable reserve, fractional or otherwise, but a proper fractional reserve could be as conservative as one wanted it to be.

Your links should make interesting reading. What could replace the fractional reserve system? Daily memos from the government to each bank, telling them how much they are to be allowed to lend today?

I hope this isn't analogous to the U.S. situation where they passed a bill with a rider which repealed the law of gravity.

How does the government currently place limits on the money creation which lending implies when the fractional reserve is small? Is most of the created money soaked up by taxation?

Might it be the banks themselves who are worried about a high fractional reserve requirement which would reduce their profits at the same time as it reduces their risks?

It doesn't! The BoE fractional reserve requirement at this time is 0%

Banks in theory are therefore allowed to lend right up to the limits of their deposits. In reality this is not possible since loans are always being repaid.

What is being created is not money in the accepted sense of the word but credit sometimes termed "bank money" in turn shortened to the term "money" which can be confusing. The difference between credit and the physical money in your wallet (or if you like the electronic money in your bank account) is that, as you say this money circulates. You buy something, you become a little cash poorer and your seller becomes a little cash richer and that's it.

Credit is created whenever a loan is negotiated and is destroyed whenever a loan is repaid. All credit does is grant permission for the debtor to use the creditor's money. The "real" money, the basis of credit would circulates as before and as it would if the creditor had put the money to his own use. It's only the user who changes.

The supply of credit (money) is limited by affordability. All money borrowed has to be repaid with interest.

Thanks for the clarification. I had been puzzling over the situation where some kind of virtual money, possibly a great deal, is created by credit. And still don't feel I truly understand it; when one properly understands something, one becomes able to see the implications.

There really should be an economics primer (not 'Economics for Dummies'; those books tend to bury facts in so much verbiage that the wood is concealed by the trees). The Open University doesn't seem to have anything basic, and old geezers like myself aren't interested in degree courses.

The economy is far too important to be left entirely to governments, banks, and economists. The general public should also be able to disagree with itself. :-)

Commonly with a great deal of interest, so I presume you're saying that interest rates are what limits the amount of this virtual bank money.

As an aside - banks are *now* lending bugger all in any case, "fractionally" or otherwise.

Once depositors get the right to tell the bank that they can only look after their money, and not use it to lend to others, then the banks will need to find other ways to make profits on the money deposited with them.

The two most obvious ways are:-

1. drastically hike banking charges on non-lending accounts
2. charge their customers (ie. the depositors themselves) interest for the pleasure of putting money into their bank accounts

I imagine that once people realise that there is such a downside to the elimination of fractional reserve lending, they will simply give banks permission to lend their deposits - and we'll be back where we started.

If the banks were not allowed to lend out depositor's money, then how could that original investor's "money" have come into existence in the first place?

Wouldn't we then be back to the situation where banks started off, where someone uses them to look after their physical gold, or whatever, and the bank lends on the basis of that?

Chris

"Minimum retained amount" is just another name for "fractional reserve", and "the amount of money originally credited" is still really the money on deposit, even if the bill would require it to be called something other than "money".

"Each institution is expected to take measures to ensure that it has sufficient funds available to re-credit Customer Transaction Accounts, as and when Customer Investment Accounts mature."

Basically says that a financial institution can still default.

More generally, it is a manifesto, not a well drafted bill. It will never become law and it will waste parliamentary time that could be used for a private member's bill that could have a real effect. However, if it did become law, there is so much open to interpretation that it would be a charter to enrich the constitutional lawyers.

If this was written by an MP, I'd have some serious concerns about their ability to understand the structure of the mainstream legislation upon which they are voting.

Overall, it doesn't seem to be as radical as it at first seems. It is still fractional reserve banking, but, in its New Speak, money on deposit is no longer classified as money, even though it continues to be money in the current sense. It's really just a change in the accounting rules, together with some additional bureaucracy and breaches of civil liberties (a quasi-governmental organisation gets to know how much is in everyone's bank accounts).

About the one thing it does do is to effectively nationalise the holding of current accounts and require them to be held on trust. (That will more or less require banking charges to be introduced.)

At the moment, I can't see why it wouldn't also catch out loans made to friends, if the lender were themselves in debt (e.g. a mortgage).