This submission outlines a proposal for full-reserve banking, where the transactional function of banking (the payments system) is separated from the lending function.
This system would be stable than under the current business model, which is often labeled ‘fractional reserve banking’.
We also believe this reform would create greater competition within the banking sector, by hugely reducing the barriers to entry in the retail sector. In particular, we would hope to see it made much easier for new, ‘Transaction Account’-only banks to enter the market to increase competition in the provision of this core payments system service. We also believe this reform would support the development of a more diverse financial services sector, placing institutions such as credit unions and traditional building societies on a level playing field with banks.
The key feature of fractional reserve banking is that the lending activity of banks effectively creates new money, in the form of new bank deposits. In contrast, in a full-reserve banking system, the effective money supply is unaffected by the lending activities of banks. An economy running on a foundation of full-reserve banking will be less prone to pro-cyclical tendencies and less inflationary than an economy based on fractional-reserve banking.
Our proposal for full-reserve banking ensures that risk-free deposits in the payments system ‘do not coexist with risky assets’. The proposal to achieve this is simple: we simply require that banks keep safe the money which customers wish to keep safe, and invest only the money that customers wish to invest.
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