4 ms·
That is not correct, unless you consider demand-deposits and intentional duration mismatch fundamental aspect of a fractionally reserved system. If you follow
by carsongross 11y ago
That is not correct, unless you consider demand-deposits and intentional duration mismatch fundamental aspect of a fractionally reserved system. If you follow that definition, then I concede the point, but I don't think it really matters to the fundamental argument.
All demand deposits must be reserved at 100%, of course, but duration-constrained savings vehicles (e.g. CDs) can be loaned against safely, allowing credit to expand as time horizons do.
- mrb 11y agoAn "intentional duration mismatch" (as you call it) between a CD and a loan would indeed create a case of fractional reserves. But it is not "fundamental" as there are other events that can cause fractional reserve to occur. For example the CD and the loan could both be established for, say, 5 years, but if the loan recipient defaults after 5 years the bank would be missing the money to repay the CD depositor; so safety policies need to be established to avoid this, eg. never loan more than 90% of the deposits.
- carsongross 11y agoYes, that's correct: the bank would no doubt need to have some capital on hand to deal with defaults, and may of course choose to loan its own capital in an unconstrained manner. A prudent regulator would demand that a bank demonstrate at all times that it can satisfy its duration commitments and, as defaults creep in, insist that bank capital be used and/or raised to cover the shortcomings. Eventually a bank may go bankrupt (although this would be a much slower process than todays panics) and would need to be liquidated via the normal bankruptcy mechanisms. I would expect a healthy secondary market for CDs (or the like) to exist as well.