Fractional Reserve Banking Is a Fraud (But It’s Genius)


The recent purchase of First Republic, the second largest bank failure ever in the US, has raised serious questions about solvency and liquidity in the global banking system. Banks are considered volatile operations: customers deposit money into a bank account for safekeeping and withdraw it whenever they want to use it. And overall this system works.

But banks need to make money, and most banks in the United States offer basically free or low-fee accounts. So how do banks make money? By lending customer deposits to risky businesses in order to make a sure yield.

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In effect, banks run like this: Short-term, safe customer deposits come in the door, banks use those short-term customer deposits to invest in longer-term, riskier assets in exchange for future financial returns, and then the bank requests. Do as hell not all customers want their deposits at the same time because short term deposits are tied up in long term assets.

This is fractional reserve banking (where only a fraction of customer deposits are required to be held in the bank’s reserves) and is a widely known fraud. And while this hoax is indeed a hoax, it has been beneficial to society in a way, even though a way out of the hoax would be better for us.

a blog post by Steve Randy Waldman’s Interfluidity Puts it best on the subject of the complexity of finance:

“Financial systems help us overcome the problem of collective action. In a world of investment projects whose costs and risks are completely transparent, most people would be horrified… A banking system is a superposition of fraud and genius that itself between investors and entrepreneurs.

What does this mean?

Basically if banks weren’t able to invest short-term, low-risk customer deposits into long-term, high-risk assets, the availability of investment capital for most eccentric, world-changing ideas would never have occurred to entrepreneurs. funded. Banks help us in spreading the risk of financial capital allocation.

fraud and genius

In the absence of banks participating in this genius we could have a financial system where the only financial capital that invests in long-term risky investments is capital committed to investing in long-term risky investments (see: narrow banking,

Therein lies the deception. The con is that almost anyone who does not deposit money into bank accounts knows that they are choosing this particular solution to the “collective action problem” of financial capital allocation.

Here’s the thing though, this talent has been good for society. We have been tricked into making productive investments. Unproductive investment too, sure. But you’d be hard pressed to argue that we would have made more productive investments without the genius of fractional reserve banking.

But when backed by fractional reserve banking US Government When No Alternatives Are Available or even legally permitted, such as with Custodia Bank Or narrow bank, this is a problem. People should have the option of making deposits in these parochial banks that do not participate in fractional reserve banking practices because, as we have seen recently, when fractional reserve banking ceases to exist. the wrong result is disastrous,

See also: BNP Paribas Will Link Digital Yuan To Bank Accounts To Promote CBDC Use: Report

The good news is that banks are moving towards a more parochial model. Sure, it may be more expensive for companies to obtain capital because less capital will be available if the fractional reserve banking system becomes less popular, but that’s okay. People who invest in high-risk, potentially high-return investments and assets should be people who clearly declare: “I invest in high-risk, potentially high-return investments and assets.” want to do.”

Otherwise it is cheating.

So, the modern financial system is built on “fraud and genius”. Does the latter excuse the former?

Probably not.

The views and opinions expressed here are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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