Will Fractional Reserve Banking Survive the Twenty-First Century?

24 July 2023

Caitlin Long’s endorsement of Idaho’s move to charter “uninsured, non-lending, 100% reserve banks” elicits grave concerns about the future of banking. Fractional reserve banking, where banks maintain a fraction of the total deposits as cash, poses a considerable threat in the digital age. If more than the maintained fraction is withdrawn abruptly, it could lead to bank failure, a phenomenon that’s getting more frequent and swift with internet speed transactions.

The trend of moving money to larger banks for a perceived safety is hardly a solution, as they hold only marginally more cash. Long proposes the return of narrow banking, a 19th-century norm, where banks hold 100% of their cash on deposit at the Federal Reserve. However, the Federal Reserve has shown resistance to this idea, as demonstrated by its rejection of TNB USA’s application for a Fed master account in 2017.

The emerging banking landscape paints a worrying picture. With bank runs speeding up due to the shift from paper to digital transactions, the banking system’s instability is becoming glaringly evident. Regulators might even have to resort to capital controls or “bank holidays” in times of stress, a concept that could cause panic. The collapse of smaller banks due to insolvency or consolidation is also anticipated, raising fears of financial instability.

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