On the Welfare Properties of Fractional Reserve Banking
Posted: 13 Aug 2013 Last revised: 25 Mar 2016
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On the Welfare Properties of Fractional Reserve Banking
Date Written: December 1, 2013
Abstract
Monetary economists have long recognized a tension between the benefits of fractional reserve banking, such as the ability to undertake more profitable (long-term) investment opportunities, and the difficulties associated with fractional reserve banking, such as the risk of insolvency for each bank. The goal of this paper is to show that a specific form of private bank coalition (a joint-liability arrangement) allows the members of the banking system to engage in fractional reserve banking in such a way that the solvency of each member bank is completely guaranteed. Under this arrangement, I show that a lower reserve ratio usually translates into a higher exchange value of bank liabilities, benefiting the consumers who use them as a means of payment.
Note: Superseded by Working Paper 15-20.
Keywords: bank coalition, fractional reserve banking, interbank credit, reserve management
JEL Classification: E42, G21
Suggested Citation: Suggested Citation