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OTHER THINGS EQUAL: A common assumption used in economic analysis that often goes by the technical Latin term, ceteris paribus. This assumption is used when identifying the relation between two specific variables, such as price and quantity for the law of demand. In so doing, the causal connection between the two variables can be identified. However, economic analysis becomes more interesting and useful when this assumption is relaxed, which makes it possible to examine how these "other things" affect the relation under study.
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                           NO-RESERVE BANKING: A (hypothetical) method of banking in which banks keep 0 percent of their deposits in the form of bank reserves, meaning that ALL deposits are used for interest-paying loans. No-reserve banking is one of two theoretical alternatives designed to help illustrate a contrast to the fractional-reserve banking actually practiced by modern banks. The other alternative is full-reserve banking. With the no-reserve approach a bank operates as financial intermediary or broker, matching up borrowers and lenders. No-reserve banking occurs if banks keep no deposits in reserve. Customers make deposits, which is then transferred (almost immediately) to awaiting borrowers. None of the deposits are set aside as reserves to satisfy withdrawal demands of the customers. The only way deposits can retrieve funds is to await loan repayments by the borrowers.The Fractional AlternativeNo-reserve banking is a theoretical alternative to fractional-reserve banking. Fractional-reserve banking is a method of banking activity in which banks keep less than 100 percent of their deposits in the form of bank reserves and use the rest for interest-paying loans.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 GoalsConsider how no-reserve banking would work toward the two goals of the modern banking system--profitability as a financial intermediary and safekeeping of deposits.- 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 AlternativeTo polar opposite to no-reserve banking is full-reserve banking. With this alternative, banks keep 100 percent of deposits in reserve. Every dollar of deposits received by banks is stored securely and safely in a vault. In effect, banks are nothing more than storage facilities.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. With full-reserve banking, the temptation to use the stockpiles of cash locked away in bank vaults is enormous. Businesses, consumers, government agencies, and even the bank itself undoubtedly are motivated to use this cash, to borrow this wealth for capital investment, home construction, car purchases, or government spending. But if banks give in to this temptation, then they are back into the financial intermediary business, and fractional-reserve banking.
Recommended Citation:NO-RESERVE BANKING, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2022. [Accessed: January 20, 2022].
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