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.

While modern banks practice fractional-reserve banking, they actually come close to the no-reserve alternative. That is, most banks keep less than five percent of deposits in reserve, often in the range of one percent. While some reserves are available to process deposit withdrawals, the inflow of loan repayments and new deposits is often sufficient to satisfy the demand for withdrawals.

Two Goals

• First, banks would be able to profitably function as financial intermediaries. Banks would be able to use all deposits for no loans. More loans mean more interest payments and thus more revenue and profit.


• Second, the safekeeping goal IS not necessarily well served with no-reserve banking. Customers are likely to encounter problems retrieving their deposits. While the inflow of loan payments and new deposits might be sufficient to satisfy withdrawals, the safety net provided by reserves is not available. The odds are relatively high that banks will fall short of meeting the demand for withdrawals.


• Third, if customers are unable to withdraw deposits, then they are unlikely (very unlikely) to make deposits. With no deposits, banks would not be able to function as financial intermediaries and make interest-paying loans.

The Full-Reserve Alternative

With full-reserve banking, the safekeeping goal is well served. Customers are able to retrieve their deposits. However, banks cannot function as financial intermediaries. They cannot make loans. And with no loans that generate interest, they need to obtain revenue in other ways, presumably by charging for the storage of deposits.