A Bundling Argument for Narrow Banking
33 Pages Posted: 2 Jul 2016
Date Written: June 19, 2000
Abstract
This study demonstrates a substantial inefficiency in the banking industry resulting from allowing banks to maintain less than a one-hundred percent reserve requirement, thereby exposing depositors to unwanted risks such as investment risks as well as bank runs and bank crises (e.g., the crisis of Scandinavian banks during the early 1990s, and the S&L in the US during the 1980s). This distortion occurs since depositors with uncertain liquidity needs are unable to find riskless no-return banks who will store their money and perform other basic services (ATM, electronic transfers, checkbooks, and bill payment) by charging nominal fees without exposing depositors to any risk. Thus, it is demonstrated that a substantial welfare loss occurs when profit-maximizing banks bundle deposits accounts with risk taking. We further demonstrate that with the rapid development of securities markets a narrow-banking policy will expand consumers' saving/investment opportunities despite the lending restrictions imposed on the banks. Finally, we demonstrate that deposit insurance policies do not eliminate this inefficiency.
Keywords: Narrow Banking, Deposit Insurance, Bank Crises
JEL Classification: G21, G28
Suggested Citation: Suggested Citation