If a casino told its customers they’re guaranteed to win, or get their money back, the casino would be prosecuted in Britain under the Trades Descriptions Act, and under similar laws in other countries.
But a bank can make virtually the same promise to its depositors, and no prosecutions ensue. To be exact, banks accept deposits, promise to return the money to depositors while investing the money in ways that are a bit of a gamble: ways that mean there is a chance of losing the money, or a portion of it. That is a false prospectus.
Of course well run banks don’t fail all that often. But the reality is that nowhere near all banks ARE run responsibly. They never have been and they never will be. Moreover, banks spend VAST SUMS bribing or persuading politicians to water down bank regulations. (In the UK, banks spend £93million year on lobbying). Thus the idea that the bank industry is honest or “responsible” is a joke, and a joke in very poor taste.
But even where a bank IS well run, it’s a statistical certainty that sooner or later it will make a string of bad loans or investments, and get into trouble.
In short, fractional reserve is fraudulent. It makes a promise which in the long run it can’t keep.
So to get round this, taxpayers stand behind the above fraudulent promise. Or put another way, fractional reserve cannot work without a taxpayer funded subsidy. But THERE IS NO EXCUSE WHATEVER for subsidising an industry which is supposed to be commercially viable. And the subsidy of our existing banking system is ASTRONOMIC. Andrew Haldane of the Bank of England estimated it as being several times bank profits over the last decade or so. So the idea that the banking industry is commercially viable is a joke.
Of course there is the possibility of some sort of annual levy or “insurance premium” imposed on banks which might pay for sorting out problem banks. That works where one or two small banks go bust. But in the case of several large banks, the sums involved are so large that only the state or central bank can effect a rescue.
Incidentally unit trusts (“mutual funds” in the US) engage in much the same activity as banks, but without making the above fraudulent promise. Unit trusts, like banks, take money from depositors / investors, and like banks, they invest the money. But they DON’T MAKE the same fraudulent promise that banks make. That is, unit trusts are perfectly open about the fact that depositors / investors may lose money.
Fractional reserve banking involves a bank monetising the assets of those who want to borrow.
But the problem (as intimated above) is that the value of the collateral is not always what it seems (think Spanish and Irish property development, NINJA mortgages, etc).
The problem arises because the above process involves no one taking responsibility for all potential losses. So the state ends up carrying the losses. Thus the solution is to make specific people responsible for ALL POSSIBLE losses: that’s bank shareholders, bondholders and depositors. And that’s what full reserve banking involves.
Central bank money.
It was claimed above that the basic activity of commercial banks is to monetise the assets of borrowers. That money is then of course moved by banks between different non-bank entities on instruction from those entities and as a way of paying for goods and services.
However, commercial banks actually deal in another sort of money: money that originates with central rather than commercial banks.This stock of “central bank” money is a small proportion of the total money supply, but for the sake of accuracy it cannot be totally ignored.
The principles that need to be applied under full reserve to this central bank money are actually just the same as are applied to money originating with commercial banks. The principles are thus.
If a depositor wants their money to be 100% safe and/or instant access, the money cannot be loaned on. If it WERE loaned on, then two entities than have a claim to the same tranche of money. Or put another way £X is turned into £2X. Money creation has taken place. Moreover, if the money is loaned on, the money is then not 100% safe.
And since such money is not doing anything, it won’t earn interest.
In contrast, if a depositor wants to earn interest, then the money IS LOANED ON. But the depositor cannot have instant access to the money, else again, money creation takes place. Plus the depositor must take a hit if the underlying loan or investment goes bad (and/or share in the profits if the underlying investment does well). And that latter stipulation is needed because if the depositor does not carry the risk, then the taxpayer does, thus a subsidy is involved.
The banks’ answer.
The answer given by banks to the above argument is entirely predictable: they claim that restraints in bank activity has a deflationary effect, or restricts economic growth. And 99% of politicians and about 50% of economists fall for that sob story. Suckers and mugs the lot of them!
The UK’s Vickers commission fell for this nonsense. Same goes in other countries (Basle, Dodd-Frank, etc).
Obviously any restriction on bank activity is deflationary ALL ELSE EQUAL. But all else does not need to be equal. That is, the above deflationary effect can be countered simply by having the central bank / government create and spend extra money into the economy (and/or cut taxes). That gives all participants in the economy (households, firms, etc) an extra stock of cash, and if the size of that extra stock is correct, it will counteract the above deflationary effect.
Indeed, removing a subsidy from any type of economic activity IS BOUND TO result in less of that particular activity. And that in turn will necessitate the expansion of some similar and alternative activity: exactly what giving non-bank entities a bigger stock of cash achieves.