100% Reserve Banking doesn't workSubmitted by yonemoto on Wed, 10/15/2008 - 06:08
This has bothered me for weeks, but I now know how to fix the banking system. Enforcing 100% Reserve banking doesn't work because there is no incentive for the bank to keep any sort of savings accounts, in fact, for it to work, they would have to charge negative interest for the service of holding your money.
Of course the FDIC is a horrible idea because it incentivizes risky business on the parts of the banks. It's also clear that ultra-low fractions on reserve is dangerous. The formula to calculate the inflation as a result of fractional reserve is: MONEY/(100%-n%), so $1000 is inflated to $1000/(10%)=$10k in a 90% fractional reserve system. You can see the problem when the fractional reserve is at 100% (opposite of 100% reserve banking) because then you get $1000/(100%-100%) which approaches infinity!
Instead, banks should be allowed to float their Reserve percentage. However, they must inform their customers exactly what percentage reserve the account is being held at, how much reserve is a guaranteed withdrawal at any given time, and how long they have to wait to withdraw up to their reserve percentage. They must also allow the public to know exactly (say within +/- 2% on a unannounced spot check without penalty) how much money they have on reserve, how much they have loaned out, and how much is going in and going out, and what percentage of their holdings are in various financial mechanisms so the public can make an informed decision about whether or not the bank is on solid ground.
Of course these rules would only apply to interstate banks. Banks or credit unions operating in only one state would not be under any federal oversight, but most state would probably adopt similar rules.
Notice having a higher reserve percentage is naturally encouraged because those banks will be able to offer a competitively low interest rate in exchange for the added security of holding. Those banks could flip a higher profit on a competitive loan, but would need bigger volume in terms of savings in the reserve to flip the same amount of money. This is perfect; one of the problems in our current system is that bigger, national banks are easy to collapse, in this system bigger banks fundamentally have more stability because they will be biased towards having a higher percentage of their holdings on reserve.