Comparing Full Reserve to Free Reserve Banking

[William Hummel]

Regardless of the required reserve ratio, a bank can lend only to the extent that it acquires reserves sufficient to cover its loans. As long as the Fed targets the interbank lending rate rather than the quantity of money, the required reserve ratio appears to be of little significance.

Common Features

A startup bank must use its own capital to open a reserve account at the Fed.

Thereafter the Fed provides additional reserves in the aggregate via OMO at no cost to banks. [Thus reserves are not a tax on banks, as often claimed.]

An interbank lending market is needed to rebalance reserves among banks.

A bank must have enough free reserves to cover a loan on the day it lends.

A bank increases aggregate transaction deposits when it lends

An increase in transaction deposits increases demand for reserves which the Fed must supply.

A bank can acquire the reserves needed to cover its lending in any of the following ways: (1) Borrow from the Fed,  (2) Borrow from another bank,  (3) Borrow from a non-bank,  (4) Induce transaction account holders to move funds into savings or time deposits,  (5) Sell assets in the open market,  (6) Sell additional bank shares to investors.

Differences

ZRB: Has no mandatory reserve requirement.

FRB: Must hold mandatory reserves equal to transaction deposits at all times.

ZRB: Banks have no requirement to report on transaction deposits versus reserves. 

FRB: Banks must report daily on their transaction deposits versus mandatory reserve status.

ZRB: A new transaction deposit brings a bank equal reserves which could be used to cover a new loan.

FRB: A new transaction deposit brings a bank no free reserves, only mandatory reserves.

[Jean Erick]

     That's a saver.

(1)    Intermediary lending of money:  An amount of money is  transferred from A to B.  Debt is created.  Now, B lends it to C.  Same amount of money, debt doubled.

       One intermediary lending has "serialized" into many, debt increases.

(2)  Bank "multiplier" lending:  Misnomer.  No amount of money is transferred.  Drawing rights on money are created.  As drawing rights are exercized, debt is created.

      More and more people are giving drawing rights on the, essentially, same amount of money.  Creates the "musical chairs" effect at crisis.  There is not enough money

     to pay all the debts.  Of course there isn't.  There never was beyond the first lending.

 

     Money is a direct draw on goods.

     Debt is a direct draw on money.  A, once removed, draw on goods.

 

     Money passes around.  Debt increases with each passing.  And drawing rights created.  Debt increases.

     FRB is a somewhat restricted ZRB.

 

     This allows a different mechansim to define how money is really created.  For instance, wages and salaries paid is money, even if it was paid from debt.  It brings no liability with it to the payee.

 

James