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A critique of full reserve banking

Author

Listed:
  • Sheila Dow

    () (Department of Economics, University of Stirling & University of Victoria)

  • Guðrún Johnsen

    () (University of Iceland)

  • Alberto Montagnoli

    () (Department of Economics, University of Sheffield)

Abstract

Proposals for full reserve banking have been put forward as a radical way of preventing further financial crises. They rest on the argument that crises are caused by excessive money supply growth brought about by inadequately controlled bank credit creation. Our aim is to provide a critique of the theoretical assumptions underlying the plans for full reserve banking. In particular some of the plans rely on the view that the money supply is a key causal variable and that it is feasible for central banks to identify and enforce an optimal quantity. Second, the plans all rely on an unsupported confidence in the efficiency of financial markets outside the centrally controlled banking system. Third, by removing profit-making opportunities from banks, the proposals may unduly tip the balance further in favour of shadow banking. Finally, as the case of 95% liquidity requirements on Kaupthing, Singer and Friedlander in the wake of the Great Financial Crash shows that modern financial engineering makes such policy-making difficult to execute. A Minskyan analysis rather emphasises the inherent instability of the financial system such that it is subject to systemic crises and the indeterminacy of demand for liquidity, while also emphasising the contribution prudent banking can make to financing economic activity and providing a safe money asset. While a return to a traditional separation of retail banking (regulated and supported by the central bank) from investment banking (regulated differently but not supported) would contribute to financial stability, it is argued that the full reserve banking proposals go too far.

Suggested Citation

  • Sheila Dow & Guðrún Johnsen & Alberto Montagnoli, 2015. "A critique of full reserve banking," Working Papers 2015008, The University of Sheffield, Department of Economics.
  • Handle: RePEc:shf:wpaper:2015008
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    File URL: http://www.sheffield.ac.uk/economics/research/serps/articles/2015_008
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    References listed on IDEAS

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    Cited by:

    1. Gerasimos T. Soldatos, 2017. "Globalization, Inequality, Say’s Law, and Fiscal Globalism," Challenges, MDPI, Open Access Journal, vol. 8(2), pages 1-9, July.
    2. Pfister Christian, 2020. "The 100% Reserve Reform: Calamity or Opportunity?," Working papers 786, Banque de France.
    3. Patrizio Lainà, 2015. "Proposals for Full-Reserve Banking: A Historical Survey from David Ricardo to Martin Wolf," Economic Thought, World Economics Association, vol. 4(2), pages 1-1, September.

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    More about this item

    Keywords

    bank regulation; full reserve banking;

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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