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Talk:Fractional-reserve banking

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This Economics related article has been awarded BRONZE status for quality. It's getting there, but could be better with improvement. See RationalWiki:Article rating for more information.


Bronze? Тиранесseize aerodynamic, exorcise option? 20:46, 3 February 2011 (UTC)

Really good article on the matter[edit]

SlayersX of Thrive Debunked, a blog that takes down one of the more recent libertarian propaganda/conspiracy theory movies around the web, just posted a really good article about fractional-reserve banking. I think this is a good source to use for our article. What do others think? Mr. Anon (talk) 01:35, 24 April 2012 (UTC)

However, letting these banks fail would have wiped out the cash and savings of every depositor[edit]

Is this true? I thought that's what the FDIC is for. Perhaps I'm missing something Cow...Hammertime! 16:32, 14 August 2012 (UTC)

The FDIC is financed by the banking industry so any payments come out of the Deposit Insurance Fund which currently covers only about 1.15% of all deposits. If they had to pay out a significant proportion of that then there could well be a crisis of confidence and a run on the banks which might have caused further banks to fail through a liquidity crisis, although they can borrow up to $500bn from the US Treasury. The FDIC can handle the odd financial institution failing but not a group of really large ones. However, wiping out [all] the cash and savings of every investor is a slight overstatement as obviously some people would get some compensation. Redchuck.gif ГенгисRationalWiki GOLD memberModerator 20:02, 14 August 2012 (UTC)
Very interesting & very good, but can you cite a source on the 1.15% figure? Is this the assets of FDIC? If the FDIC were to fail (as I understand it, it never was in danger of failing in 2008) this would necessitate some emergency Congressional (and Federal Reserve) action like the TARP program. nobsCorporations are people, too 20:17, 14 August 2012 (UTC)
According to WP the FDIC are mandated to have the DIF at a minimum of 1.15% after it had previously gone as low as 0.25%. Redchuck.gif ГенгисRationalWiki GOLD memberModerator 20:27, 14 August 2012 (UTC)
Like all insurance, the premiums banks pay for deposit insurance are regulated by the number of anticipated bank failures in the near future, including presumably a fairly widespread catastrophic crisis. And this phrase, "If there is an excess of the number of people demanding money in a day, and the bank cannot come up with the money, the bank becomes insolvent," is incorrect. If the amount of cash withdrawals in a 24 hour period exceed the reserve requirements, the net effect is only a temporary liquidity squeeze, solved by interbank overnight borrowing. Insolvency is when the total claims (not just a claims in a 24 hour period) against the bank exceed bank assets. nobsCorporations are people, too 20:34, 14 August 2012 (UTC)

My understanding is that the "banks" that were bailed out are financial institution completely different from the normal understanding of "place where you get a savings and checking account" understanding of banks. They did not have "depositors", they had investors.Fdof (talk) 05:38, 24 August 2012 (UTC)

There's a difference between investment banks and commercial banks, the latter being the familiar "place where you get a savings and checking account." However, after the partial repeal of Glass-Steagall, these two types of institutions were allowed to merge. Bailouts went to investment banks and insurance groups (e.g., AIG) as well as your merged commercial/investment banks (Citigroup). So letting some institutions, i.e. insurance and investment banks only, fail would have had no direct effect on depositors. Letting anything with conjoined commercial bank fail would have, though. Nebuchadnezzar (talk) 05:59, 24 August 2012 (UTC)
Yes, that's a good understanding of it. The repeal of Glass-Steagall allowed wp:proprietary trading on behalf of a banks own interests. Previously, banks were regulated to use bank capital (that is to say, the bank's own money, not depositors money) only on extremely conservative investments, such as T-bills, or to produce earnings through brokerage on other people's money, not direct investment of their own funds. The Volker Rule is an attempt to regulate proprietary trading, which appears here to stay, cause there is now no un-repealing the repeal of Glass-Steagall. nobsCorporations are people, too 20:32, 24 August 2012 (UTC)

LIBOR & Fed Funds[edit]

In Great Britain interbank borrowing is done at the LIBOR rate. In the United States, commercial interbank borrowing to meet reserve requirements is done at the Federal Funds rate. Please read the citation provided, the Federal Reserve Bank of New York, which states, "Federal funds, or fed funds, are unsecured loans of reserve balances at Federal Reserve Banks that depository institutions make to one another. The rate at which these transactions occur is called the fed funds rate" before reverting. While LIBOR is used in the United States for various other purposes, LIBOR is not the United States commercial banks use for overnite interbank lending to meet reserve requirements. It is the Fed Funds rate, published daily in any newspaper. nobsCorporations are people, too 20:08, 21 August 2012 (UTC)

supporting cites

  • Wikipedia: In the United States, the federal funds rate is the interest rate at which depository institutions actively trade balances held at the Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis. Institutions with surplus balances in their accounts lend those balances to institutions in need of larger balances" (i.e. reserve requirements).
  • wp:Federal_funds_rate#Comparison_with_LIBOR: Though the London Interbank Offered Rate (LIBOR) and the federal funds rate are concerned with the same action, i.e. interbank loans, they are distinct from one another...

The Good and Bad[edit]

  • In the world of electronic banking, banks can now create "money" out of thin air, through create accounts.

No sure this belongs on the Bad side. Wikipedia says in its wp:Interbank lending market,

  • Low transaction volume in this market was a major contributing factor to the financial crisis of 2007.

Comments (1) banks creating "money" through interbank lending accounts is not new; (2) these new electronic (presumably consumer) accounts appear to be a step to mitigate another "credit freeze". nobsYe shall all perish in flames - Kim Jong-un 09:04, 3 April 2013 (UTC)

This article contradicts itself[edit]

First, it's said that banks "loan out the remainder to generate revenue for the bank and depositors by charging interest on loans of that money."

Then, "loans can be made by the combined accounts of many depositors, instead of having a few very wealthy people make personal loans. Most Americans would not have home loans or employers meet payrolls without fractional reserve banking. It has incentive, by paying interest, to keep money in banks so they may generate loans."

The quote from Lord Adair Turner seems contradictory to all of this: "Banks do not, as too many textbooks still suggest, take deposits of existing money from savers and lend it out to borrowers: they create credit and money ex nihilo – extending a loan to the borrower and simultaneously crediting the borrower’s money account."

At the moment, the article is suggesting that deposits create loans in one place, then suggesting that loans create deposits in another. Some clarification of which perspective is actually correct would be helpful.— Unsigned, by: Infinitebloom / talk / contribs

As a very basic example...If you take out a loan to buy a friends car it comes from deposits in bank 1 (your bank) and becomes a deposit in bank 2 (their bank). As long as the reserve requirement is met, say 10%, bank 2 can loan out the remaining 90% as long as the deposit remains. The bank makes money on the interest it charges.
That quote is also an incomplete quote of a point by Knut Wicksell (1898), and you can read the full paper and quote here, in Adair Turner's paper. This was before the need for reserve requirements and was one of Knut's criticisms of the banking practices during his time. -EmeraldCityWanderer (talk)

How would ending fractional reserve banking destroy capitalism?[edit]

The first footnote on the page states that ending fractional reserve banking would destroy capitalism. I clicked on the link but the page has been destroyed. Could someone explain to me why this would be the case? Also, I think it would be beneficial for this to be explained in the wiki. Random guy (talk) 13:56, 25 April 2015 (UTC)

Because the entire point of banking with reserves is to stabilize the money market in both directions. Require some reserves to prevent sudden collapses, and smooth out the money supply by lending more in high demand, less in low demand. Gold can't do this. At all. Oh, and all those adverts talking about investing in gold? Notice that they are willing to accept your "worthless fiat" for all that delicious gold.
Think of money as just another commodity like corn, oil, or shovels. I'm not using my shovel 24/7, so I put it in my shed. But while in the shed, it does nothing. So I lend my shovel to the shovel bank, and they pay me a small amount of money. They lend out the shovel to someone else for more money. The result is that there are "more" shovels in existence, because I "have" a shovel and the person who the bank lent to also has a shovel. But what if I want my shovel back if someone else has it? They have a reserve so they always have a few shovels just in case. To prevent the scenario where EVERYONE wants their shovel back being an issue, the shovel banks of the country have their own reserve, like the fed.CorruptUser (talk) 13:18, 25 April 2015 (UTC)
So full-reserve banking would result in less economic activity in the economy as less capital is available to be loaned out for investment and to increase production in the economy. So the Austrians believe that full reserve banking will allow capitalism to prosper as usual but without the risk of bank runs and "fraud" of lending over reserve requirements. But in reality, the two go hand in hand and without such risk, economic activity will ground almost to a halt. But then they would argue that we find other ways financing these things. Couldn't the role of making loans, financial intermediation and maturity transformation be taken over by other institutions other than banks? Also, wouldn't the prices of things that traditionally we use loans for, such as commercial property, come down as a result of the free-market mechanism? Random guy (talk) 14:11, 25 April 2015 (UTC)
Well, yes, there were a number of different things tried before banks existed and franctional reserve banking was tweaked into current interations. I'm not sure how indepth to get with the explanation because it's the economic history of the world from the beginning of money to about the 1500's for organized mercantile banking and 1900's for really regulated fractional reserve banking. It might be good to catch up on that information before continuing. -EmeraldCityWanderer (talk) 14:36, 25 April 2015 (UTC)
"Full reserve" means "we can't lend anything at all". I mean, think about it. That defeats one of the purposes of banks. If you think "oh, they have $500k, we deposit $500k and they lend out their $500k", no, that's not what will happen. They will just become money lenders and lend out their $500k and not bother accepting deposits. But the lending will still happen, just without reserves. And that money will be traded to someone else who could also lend it, and the money multiplier will STILL happen. In other words, "Full Reserve" banking is the same as "NO Reserve" banking. And unlike the current system, you won't have a safe place to store your money, lending will be made by unprofessionals, less sound ideas will receive more approval (this might explain the crank magnetism here; "WAAAAH A BANK WON'T LEND ME MONEY TO START MY NEW CELTIC MEDICAL CLINIC!!!"), oh and people tend to be FAR more bigoted than sociopathic banks, and to top it all off it will have even fewer regulation and safety controls in place! CorruptUser (talk) 14:47, 25 April 2015 (UTC)
Go as in-depth as you want with the explanations! I study economics at university and I've found that the textbook explanations of how banking works are fairly unsatisfactory. Have any of you read the Bank of England bulletin "Money creation in the modern economy" 2014 Q1? It talks about how reserves aren't a binding constraint on lending and that the central bank doesn't mandate the amount of reserves that are available. This seems at odds with the description on the ratwiki page as it emphasises the role of the reserve requirements and the money multiplier effect as limits to lending, when in reality many countries such as Canada don't have a reserve requirement. I've read a lot of different accounts on what fractional reserve banking actually is so it's very confusing what's actually the correct description. Especially when your university textbook is inadequate. Random guy (talk) 15:20, 25 April 2015 (UTC)
A reserves requirement is held against depositor's money; a capital requirement, as in Canada, means the bank lends against its own money. Since it takes the bank longer to increase its capital, versus lending out depositors money daily as quick as it comes in, no reserve requirement restricts the bank's ability to make loans. nobsI was in Bagdad when u wer swirling in yur Dads' bag. 22:15, 26 April 2015 (UTC)

Banks don't lend out reserves[edit]

Please read the antidote to cranky yank economics: http://www.bankofengland.co.uk/publications/Pages/quarterlybulletin/2014/qb14q1.aspx Many nations like my very own UK and Canada have *no* reserve requirements. Explain that one yanks! When you take out a loan, the bank just creates the corresponding deposit. So called "reserves" are simply settlement balances. Reserves are on the wrong side of the balance sheet to lend out. "Fractional reserve" is BS (talk) 18:11, 17 August 2015 (UTC)

Yes, it got switched to an alternative unit called a capital requirement that must still be held in reserve with differeing asset types, fiat currencies and faster transactions. They don't just create deposits and assets out of thin air. Talk about complete ignorance of accounting basics. -EmeraldCityWanderer (talk) 18:33, 17 August 2015 (UTC)

You're wrong and the original poster is right. Loans create deposits and this has been known for quite a long time but recently confirmed by the Bank of England in the above paper. Fractional reserve banking is a complete myth in the modern financial sector. I suggest a Google of the book "Debunking Economics" or watch some videos by Professor Steve Keen.

Does a 100% reserve fully protect depositors?[edit]

Suppose depositors open accounts at a bank totaling $1 million. The bank then lends out this $1 million. Then the borrowers put the $1 million into risky investments aaaaaaaand it's gone, so they have no way to repay the bank. Then the depositors say, "Okay, we're ready to withdraw our money." They're pretty much fucked, are they not? Men's Rights EXTREMIST (talk) 21:39, 5 March 2016 (UTC)

Edit Conflict[edit]

I am attempting to fix this part of the article to reflect reality, but it keeps getting reverted. Others have also pointed out the disparity on this talk page here and here.

First of all, the content that I am trying to add is already agreed upon in other parts of the article. See "The Bad" section of the article, particularly the quote in the last line. Also see the "Multiplier effect" section.

It is true that banks don't loan out the the actual money that was deposited into their bank, but instead they loan out newly created money (in other words - money that they don't have), which is their "excess reserves" (equivalent to the amount in excess of their reserve requirement). On the balance sheet, deposited money (which includes loaned money from a bank) is accounted for as a liability, while reserves ("excess" reserves and "required" reserves) and loaned money are both are accounted for as an asset.--FedTruther (talk) 23:04, 5 March 2016 (UTC)

Tool analogy[edit]

"While it may seem a bit like smoke and mirrors to someone unfamiliar with economics, imagine instead of cash it was something with 'obviously' more use such as tools. We all need tools to work, but the vast majority of time we own the tool we aren't using it. So we put the tools in a tool bank, so that others can use it while we are not. If we only need the tools for about 20% of the time, the result is that the bank causes there to be effectively 5 times as many tools in the system. That it's currency instead of tools doesn't change the effect."

This doesn't make any sense to me. If we only needed money 20% of the time (because we wanted to put it in our pockets or whatever), then yeah, the bank could lend out the money, and in a way there would be 5 times as much money (in the sense that five times as many people could walk around with money in their pockets 20% of their time). But this is true even without fractional reserve banking, and does not involve the multiplier effect mentioned above. (talk) 21:39, 9 July 2016 (UTC)

How is it true without fractional reserve? CorruptUser (talk) 22:11, 9 July 2016 (UTC)

The Good[edit]

I probably just haven't understood the subject well enough, but I can't see where "The Good" section says anything good about fractional reserve banking.

"banks would like to loan out as much money as they can" is good for the banks, but it is not obvious how it is good for the economy.

"the bank falls below its reserve requirement and faces a liquidity squeeze" is something that can only happen under a fractional reserve banking system, and should therefore be under "The Bad".

"This happened to many small banks in the US before the Federal Reserve was introduced, causing numerous bank failures and financial panics" concerns the Federal Reserve specifically and not the fractional reserve system (which is newer). Also, "bank run" is a term which specifically concerns fractional reserve systems, so similar things obviously happen under such systems. Are "financial panics" really much more common under non-fractional reserve systems than under fractional reserve systems? If so, this should be made explicit.

"Being able to loan out money is also in many people's favor." This can be done without fractional reserve systems; indeed, without reserve systems at all.

"This way loans can be made by the combined accounts of many depositors, instead of having a few very wealthy people make personal loans." This can also be done without reserve systems (fractional or non-fractional).

"Most Americans would not have home loans or employers meet payrolls without fractional reserve banking" This is techically "good", but it comes out of thin air. Nothing above suggests why it is so.

"It has incentive, by paying interest, to keep money in banks so they may generate loans." This suggests that fractional reserve banking leads to higher interest on deposits, which leads to more people depositing, which leads to more money available for loans. If this is true, it should be VERY explicit, because it sounds like the most important reason for having a fractional reserve banking system in the first place. Can someone find a source saying explicitly that the interest rate on deposits will rise (a lot) with fractional reserve banking? It should be available in the article, and I would also personally be very interested.

"It is a great way to control inflation, by mandating the money available to make loans." This is also technically a good thing. However, it does not explain why you would want to have the "standard" reserve rate at anything other than 100% (adjusting higher and lower according to the circumstances). And if the standard rate is 100%, we just have non-fractional reserve banking with some extra tools for the central bank.

I'm probably making some basic errors here, but at least this is how I (as a layman) see the section as it stands. It doesn't make any sense to me as a "The Good" section for fractional reserve banking, since I don't see it writing anything good about fractional reserve banking. I suspect many other people will read it the same way, so it may be a good idea to improve it. Any thoughts? (talk) 22:00, 9 July 2016 (UTC)

So many things, so I may not get to all of them, so don't complain.
""banks would like to loan out as much money as they can" is good for the banks, but it is not obvious how it is good for the economy."
People borrow money to start/expand businesses and make large asset purchases (cars, houses, etc). The first is very good for the economy, and when people have trouble borrowing to establish businesses, well, redlining was when the banks refused to lend money to people to establish businesses because they were black living in a risky neighborhood, and it didn't help the economy at all. The second is not exactly good or bad for the economy, other than "stimulus", but for individuals it allows them to shift spending from different years around, so they can enjoy a better lifestyle now in exchange for less good lifestyle later, so utility is raised. Unfortunately government thinks that homes add to the economy, which they don't, and you have a bunch of fuckups as a result due to various regulations and tax breaks and so forth, but that's not the fault of fractional reserve itself.
"the bank falls below its reserve requirement and faces a liquidity squeeze" is something that can only happen under a fractional reserve banking system, and should therefore be under "The Bad".
It happens if the reserve is too low. It's the advantage of a fractional reserve over a 0 reserve system. And it very much happens without banks; you lend money to your buddy rather than depositing in a bank, but if he can't pay it back that day, you're fucked. Banks effectively lend to hundreds of your buddies, assess their risk, etc, but with the ability to withdraw money when you need it.

22:20, 9 July 2016 (UTC)

What happened to 'The Good' section of this article?[edit]

For example, if we look at the revision as of 11:29, 30 November 2016 by Reverend Black Percy, we can see a big chunk of the article which is dedicated to explaining why fractional-reserve banking is good for the economy, however if we look at today's version we can see no such thing. If anything the article has become more about the economic model of fractional-reserve banking than it has the merits of fractional-reserve banking as a part of an economic system.

In truth, I don't really mind us having an article dedicated to the model of fractional-reserve banking, but without an article covering why fractional-reserve banking as a part of an economic system is a good thing, I've got nothing to link people who are trying to argue for the gold standard or who are arguing for fractional-reserve banking to be abolished. --FRB (talk) 10:36, 20 December 2017 (UTC)

Here, apparently. The above topic might be of note. —Kazitor, pending 10:41, 20 December 2017 (UTC)
Is it worth doing anything to combine these two versions? Doing so would be outside of my expertise, but it seems like we've lost something of value.--FRB (talk) 11:09, 20 December 2017 (UTC)

This article seems to be turned into bunch of quackery.[edit]

Back in October 2017 a single person removed most of "common" knowledge and replaced it with demonization of FRB well into conspiracy territory. I don't think there is any merit in keeping the article as it is, reverting to before those edits would be the best solution IMO. 2A00:F41:4857:F251:9E73:DF9D:D2B:2117 (talk) 11:30, 8 May 2019 (UTC)

@Oxyaena Would you mind chipping in on the matter? The article really was overtaken by a single user over the course of like 2 weeks 2 years ago, and I really feel the revert is warranted. (To be clear, the post above is also me, just from a different IP address). (talk) 20:46, 24 June 2019 (UTC)
Do I know you? Also I know nothing about fractional reserve banking, you're gonna have to take this up with someone else. Oxyaena Harass 21:35, 24 June 2019 (UTC)