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Full-reserve banking is the banking practice in which the full amount of each depositor's funds are available in reserve (as cash or other highly liquid assets) when each depositor had the legal right to withdraw them. Full-reserve banking was practiced historically by the Bank of Amsterdam and some other early banks but was displaced by fractional reserve banking after 1800.^{citation needed} Proposals for the restoration of full-reserve banking have been made, but are generally ignored or dismissed by mainstream economists.

History

Debate over full reserve

Proposals for full-reserve banking are rarely discussed in mainstream circles. By contrast, within the Austrian school of economics, the relative merits of full-reserve and fractional-reserve banking are the subject of active debate.¹²³

Some argue that the strict enforcement of full-reserve banking would mean that there would be no entity to carry out true "banking" functions, because full-reserve banking would restrict potential intermediation activities between lenders with short-term deposits and borrowers with longer-term borrowing needs. However, 100% reserve banking would still allow for lending and borrowing between parties with similar time horizons.⁴⁵

The case for full reserve

This would eliminate (or at least greatly reduce) the financial risks associated with bank runs, as the bank would have all the money in reserve needed to pay depositors - regardless whether depositors actually claimed their money.⁶⁷⁵

This form of banking would also eliminate the need for a lender of last resort (such as a central bank), which is normally needed to support the banking system in times of systemic risk or financial contagion, as these financial risks would not exist in a full-reserve banking environment.⁸

This simply requires that the resources available to the banks issuing credit money and demand deposits would be sufficient to convert all currency at once if so required. It was a central component in Social Credit proposals.⁹

It is argued by these economists that, in contrast to fractional-reserve banking, full-reserve banking guarantees a stable money supply, which ensures that the means of exchange is not debased over time. This improves the efficiency of the price mechanism, promotes saving and the deferral of consumption, provides much greater confidence in the financial system and in the integrity of all commercial transactions and therefore encourages sustainable, non-speculative productive investment.¹³¹⁴⁵¹⁵

Reserve ratio

The reserve ratio of all banks operating in such a system would be 100%, making the deposit multiplier equal to one (1xM=M). The opposite of this system is fractional-reserve banking, in which the bank would hold only a fraction of all client deposits as reserves with the remainder used to supply loans and create credit.

Some advocates believe that full-reserve banking should only apply to demand not fixed loan deposits.¹⁶ The distinction that full reservists make is that demand deposits such as checking and some modern savings accounts are available for immediate use by the owner of the account, whereas a traditional savings account is restricted.

A system in which all currency is backed by another asset and commercial banks are required to maintain a 100% cash reserve ratio has never been implemented in any actual economy.^{citation needed}

Criticism

Among criticisms of a full-reserve banking system is the argument that full-reserve banking implicitly means that there is no government-controlled "monetary policy" at all. Critics might also argue that a full-reserve system leaves us with an inelastic currency. Proponents would likely argue that the lack of a government-manipulated currency (the lack of a "monetary policy") and the presence of a sound currency (as opposed to an "elastic" one) are advantages to a full-reserve system. More subtly, since full-reserve banking means that during periods of high demand for money, the prices of other goods must fall, the economy will bear costs that are (in principle) no different from those it would bear during periods of moderate inflation (that is, if the cost of adjusting to absolute prices is low or negligible, moderate inflation should be no more problematic than moderate deflation).¹⁷

Pascal Salin, former professor at the Université Paris-Dauphine and former Mont Pelerin Society president, opposes such regulation of banking and disputes Murray Rothbard's characterization of fractional-reserve banking as a simple form of recursive embezzlement. He argues that a situation of perfect certainty doesn't exist even in a full-reserve banking system. He also argues that in a perfectly free banking system any customer must be free to choose the kind of notes and the system of payments for services he prefers since optimality cannot be defined independent of the wants of the individual.¹⁸

Advocates of full-reserve banking do not necessarily advocate that the government lay down regulations stipulating such a system. In fact, some economists, such as Murray Rothbard (of the Austrian School) believe that government intervention sustains fractional-reserve banking, as governments have formalized the practice by making it legal and supporting it through the creation of central banks. Murray Rothbard argues that in doing this they have prevented periodic bank runs and other natural checks that would otherwise be placed on banks by astute customers, anti-fractional-reserve consumer groups, and other such organizations. Rothbard expresses this concern, and argues the case for 100% gold or silver-backed money, in his book What Has Government Done to Our Money? and other prominent published works.¹⁹

Current Examples

There are no current examples of full reserve banking. However, some currently existing institutions aspire to a full reserve banking model.

Islamic banking

In theory, Islamic banking is often synonymous with full-reserve banking, with banks achieving a 100% reserve ratio.²⁰²¹ In practice, however, this is not the case, and no examples of 100 per cent reserve banking are observed. According to Islami Bank Bangladesh:

Digital gold

Since 1996, a form of private currency called digital gold currency has been in circulation. Many of these currency providers claim to act like full-reserve "private banks" with a one-to-one ratio of the currency they issue and the hard asset, usually gold or silver, that they store as reserves.^{citation needed} The most prominent examples are e-gold, e-Bullion and GoldMoney. The status of these institutions is problematic. The operators of e-gold have pleaded guilty to money laundering charges ²³, and the operator of e-Bullion has been charged with financial misappropriation of resources used in the murder of his estranged wife.²⁴ Also available are physical gold exchangers and storage providers, such as BullionVault.^{citation needed}

Some monetary reformers believe a new free market will emerge in money production and distribution, as the internet allows renewed decentralisation and competition in this area, eroding the central government's and bankers' old monopoly control of the means of exchange.^{citation needed} Some monetary reformers believe that in a genuine free market, where government did not impose a monopoly currency on the populace, a predominantly full-reserve banking system, backed by a gold standard or silver standard monetary system, would arise spontaneously out of the free market.²⁵

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