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Banish fractional reserve – would Attwood agree with the Chief Economist of Deutsche Bank?

June 26, 2013

Thomas Mayer bankingIn the Financial Times this week, Thomas Mayer, Chief Economist of Deutsche Bank, asserted that no reform can make banking really safe as long as the industry operates within a fractional reserve system, where banks create “inside” money (for example sight deposits) by extending credit and promise to exchange this against “outside” (ie central bank) money at any time on demand. He continued:

“As the Spanish economist Jesús Huerta de Soto has shown, banking crises have been a recurrent feature since the early 14th century, when fractional reserve banking became the dominant business model of banks in northern Italy.

“This was recognised in the 1844 UK Bank Charter Act requiring full reserve coverage of bank notes and in a proposal made in 2010 to the UK parliament by the MPs Douglas Carswell and Steven Baker”.

Mayer believes that fractional reserve banking only remains in place because the ‘modern welfare state’ is reluctant to rein in the banks, which satisfy the state’s enormous appetite for credit. His solution:

A banking regime without state backing could be built in four steps

  • First, define as safe an asset that can be converted any time and under any circumstance at face value into legal tender.
  • Second, create safe (“insured”) deposits by requiring banks to back them fully with reserves at the central bank.
  • Third, create a cascade of loss-absorbing bank liabilities, starting with bank equity and ending with investor deposits (not subject to the 100% reserve holding).
  • Fourth, make banks treat eurozone government bonds as assets that can default and help them to reduce their holdings of these bonds.

Would this work?

For more information he recommends: Centre for European Policy Studies Policy Brief No. 290 “A Copernican Turn for Banking Union”.

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