Full-reserve banking means that banks have no excess reserves that can be used to make loans. As such banks do not function as financial intermediaries. They do nothing but store deposits.

The Fractional Alternative

Fractional-reserve banking makes it possible for banks to function as profit-seeking financial intermediaries (matching up lenders and borrowers) while ensuring the safety and liquidity of deposits, especially checkable deposits that are part of the economy's money supply.

Two Goals

• First, the safekeeping goal IS well served with full-reserve banking. Customers are always able to retrieve their deposits. In effect, banks are storage businesses. If bank security is sound, the security guards are alert, and the vault is well-constructed, then deposits should be safely protected.


• Second, banks would NOT be able to function as financial intermediaries. Banks could make no loans. They would have no excess reserves that could be used for lending. If all banks in the economy practiced full-reserve banking, then some other type of business would have to perform the financial-intermediary function of bringing borrowers and lenders together.


• Third, banks would not be able to generate profit from interest-paying loans. Profit would have to come exclusively from the storage function. That is, customers would have to pay banks to safely store their money.


• Fourth, the temptation to use the stockpiles of cash locked away in bank vaults would be enormous. Businesses, consumers, government agencies, and even the bank itself would undoubtedly want to borrow this wealth for capital investment, home construction, car purchases, or government spending. But if banks gave in to this temptation, then they would be back into the financial intermediary business, and doing fractional-reserve banking.

Fred the Goldsmith

The key is that Fred naturally acted to keep his own gold, the gold he used as an input in this goldsmithing business, safe and secure in a sturdy vault. The safety offered by Fred's gold-storing vault was not lost on others, such as Bill the Knight, who needed a place to safely store a satchel of gold while he journeyed off to faraway lands doing knightly deeds (dragon fighting, damsel rescuing, etc.).

If Bill the Knight leaves (deposits) 10 pounds of gold with Fred for safekeeping, the retrieves this satchel of gold upon his return, then Fred is practicing full-reserve banking.

The No-Reserve Alternative