An Alternative to Fractional Reserve Banking

In a very real sense, it is fractional reserve banking and not money itself that is the root of so many of today’s evils. Whenever fractional reserves are permitted, the banking system – including the one that exists today throughout the world – comes to resemble a classic Ponzi scheme which can only function as long as most people don’t try to get at their money.

A Better System

Now, is this critique of the current monetary system just impotent ideological whining over something that, like the weather, can’t be changed? Or could fractional reserve banking and the resulting need for economic central planning actually be replaced by something better? Specifically, how could a banking system without fractional reserve lending accommodate depositors’ demand that their money be there when they want it and borrowers’ desire for 30-year mortgages which would tie up those deposits for decades? And could this market operate without the need for government oversight and management?

The answer to that last question is yes. A better financial system is possible, and here’s how it would work:

First, today’s commercial banks would split into two types. “Banks of commerce” would take deposits and keep them safe for a fee, like the goldsmiths of old. “Banks of credit” would pay interest on deposits and lend out depositor money, but would have to match the duration of deposits with the duration of loans. Deposits that can be withdrawn anytime (a checking account for instance) could only be used to fund a loan which the bank can “call” on demand, while longer-term deposits (say a 5-year CD) would be matched to longer-term loans like a business term loan or 5-year mortgage. Really long-term loans like 30-year mortgages would be funded with deposits for which the bank would have to pay up in order to convince a depositor to part with his or her money for such a long time.

The resulting mortgage would carry a high enough rate to provide the bank with a small profit, which would make 30-year mortgages both expensive and hard to get. But the case can be made that they should be hard to get. Buying a house – or anything else that requires capital for extremely long periods – should require a hefty down payment, other liquid assets as collateral and a solid income stream. This coverage would give the bank the ability to foreclose and realize more than the value of the loan, which would protect its ability to repay its depositors, thus making depositors more willing to tie up their money for long periods. ….

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