Fractional reserve banking

[drhobomanxxiii]

Peterz, I don't think you really understand how FRB works.

Think about it this way... If you are in debt, you hold an account payable to a bank that's greater than your assets currently on hand. Are you committing fraud? Before you answer, realize that this is the exact same scenario that the bank engages in, except that there are different actors in play and the banks do this en-mass.

Or, hows about this one... Insurance providers rarely, if ever, have enough reserves on hand to handle all of their liabilities if a large number of people place legitimate claims under their contracts. Is this fraud? Again, it's a nearly identical scenario.

FRB isn't fraud. There is certainly risk management involved, but it isn't fraud.

"the FRB could survive a longer run only if there is an entity of last-resort-lender"

This isn't the case. You're assuming, first, that any non-100% reserve rate would result in bank runs, and that said bank runs would bankrupt all banks. Second, you're assuming that any such bank runs would bankrupt all banks, thus removing the FRB system. I could go in-depth as to why these are incorrect assumptions, but I think some minor thought put onto my explanation of the assumptions themselves should reveal that reasoning.

As for the economic arguments you make, I would love to see your supply/demand analysis given the circumstances leading up to changes in reserve rates. For example, if an increase in deposits occurs, how does this affect the money supply, and in turn, what does this do to prices? Or, if the reserve rate goes down due to a change in society's time preference (see also, discount rate, or interest rate,) is the drop in reserve rate the cause, or effect, of any increase in prices that follows?

I used to be against FRB, but now I'm not 100% certain. There's far too many variables to account for. In the case of FRB under Bitcoin, I believe many of those variables will be accounted for in a way that enables markets to properly set both reserve rates and interest rates in light of changes in the values of said market. And, you must remember, changes in prices are not necessarily good nor bad in and of themselves. If there's a lower reserve rate due to changes in market values, that will likely coincide with an increase in prices. This wouldn't be bad at all -- in fact, it would be a sound market correction due to changes in supply/demand.

[NsxV2rAt5E]

The FRB doesn't make lending possible, FRB only by fraud allows banks to do the lending instead of the rightful  owners.

I thought the rightful owners lend their money to the bank and earn interest.  The banks in turn lend this money at higher-risk loans and earn higher interest.

[peterz]

<Peterz, I don't think you really understand how FRB works.

Think about it this way... If you are in debt, you hold an account payable to a bank that's greater than your assets currently on hand. Are you committing fraud? Before you answer, realize that this is the exact same scenario that the bank engages in, except that there are different actors in play and the banks do this en-mass.

Or, hows about this one... Insurance providers rarely, if ever, have enough reserves on hand to handle all of their liabilities if a large number of people place legitimate claims under their contracts. Is this fraud? Again, it's a nearly identical scenario.

FRB isn't fraud. There is certainly risk management involved, but it isn't fraud.

"the FRB could survive a longer run only if there is an entity of last-resort-lender"

This isn't the case. You're assuming, first, that any non-100% reserve rate would result in bank runs, and that said bank runs would bankrupt all banks. Second, you're assuming that any such bank runs would bankrupt all banks, thus removing the FRB system. I could go in-depth as to why these are incorrect assumptions, but I think some minor thought put onto my explanation of the assumptions themselves should reveal that reasoning.

As for the economic arguments you make, I would love to see your supply/demand analysis given the circumstances leading up to changes in reserve rates. For example, if an increase in deposits occurs, how does this affect the money supply, and in turn, what does this do to prices? Or, if the reserve rate goes down due to a change in society's time preference (see also, discount rate, or interest rate,) is the drop in reserve rate the cause, or effect, of any increase in prices that follows?

I used to be against FRB, but now I'm not 100% certain. There's far too many variables to account for. In the case of FRB under Bitcoin, I believe many of those variables will be accounted for in a way that enables markets to properly set both reserve rates and interest rates in light of changes in the values of said market. And, you must remember, changes in prices are not necessarily good nor bad in and of themselves. If there's a lower reserve rate due to changes in market values, that will likely coincide with an increase in prices. This wouldn't be bad at all -- in fact, it would be a sound market correction due to changes in supply/demand.>

Yes, FRB is fraud. The bank doing FRB claims all your deposit is available at any time. That is a lie because they are playing with your money and trying to earn profit on that, and therefore not all your money is available at any time as they claim. That is the nature of fraud, somebody claims something which is not true.

If you store your furniture in a storage facility, and they would use it at the same time, it would be the same kind of fraud.

Insurance is a business, if insurance company is not able to fulfill its obligations to its clients then it is fully liable for it like any other kind of business, which could be caused by bad management bad calculation, but not fraud. There is no FRB involved.

To the economics, don't you see how much new money is being printed by FEDs nowadays in order to keep otherwise failed institutions alive? They do that only because otherwise those institutions would be insolvent because of FRB. Therefore the bailouts , and therefore the increase of money supply which causes inflation.

Without central bank, all the FRB banks would fail sooner or later,  because any suspicion of bank not having enough reserves would cause bank run. Then no business would try to repeat such model, since it would render highly unprofitable.

[peterz]

RE: drhobomanxxiii

The FRB is fraud. The bank which does FRB claims that all of your deposits are available for withdrawal. At the same time it is not true because it uses portion of your deposits (nowadays the fiat bank use about 90% of them) for their own investments trying to make profit on it.

The fraud is when somebody claims something, while knowing that it is not true.

The insurance business is like any other business, it has to fulfill its obligations to the clients. If it is not able to fulfil them, due to bad management, bad calculation or else, it goes bankrupt. That is not FRB, it's just a bad business run.

The FRB increases money supply because at the end the central bank prints new money to cover the otherwise insolvent institutions. You can see it anywhere in the world, every fiat currency loses its value in the long run, prices in those currencies go only up.

Just use common sense, you don't need to do crazy mathematical analysis.

[drhobomanxxiii]

"The bank doing FRB claims all your deposit is available at any time."

And they are. You can withdraw all of your funds at any given time. That being said, the bank is managing the risk that more people will withdraw than they have the reserves to cover, and that's why they don't lend out all of their reserves.

If you had more funds deposited to the bank than the bank had in reserves then your argument would carry weight, but that's not the case. Since money is a perfectly homogeneous good, it doesn't matter if your specific dollars/bitcoins/rubles were the ones you get back, it only matters that you do get them back as allowed by the contract set forth in the depository agreement.

"Insurance is a business, if insurance company is not able to fulfill its obligations to its clients then it is fully liable for it like any other kind of business, which could be caused by bad management bad calculation, but not fraud. There is no FRB involved."

Banking is a business. Remove the last sentence, replace "insurance" with "banking" and you have the exact argument that I'm making about FRB not being fraud. In the case of insurance, the reserves play a different role than that of banking, so it wouldn't be called fractional reserve banking, though it is certainly a fractional reserve system.

"don't you see how much new money is being printed by FEDs nowadays in order to keep otherwise failed institutions alive? They do that only because otherwise those institutions would be insolvent because of FRB. Therefore the bailouts , and therefore the increase of money supply which causes inflation."

FRB isn't the cause of this, rather, moral hazard is. When the government insures deposits, for example, the banks readjust their risk management accordingly because they bear less of the risk of their actions. This is a fantastic argument against institutions like the FDIC, and even the Fed, but not FRB.

I would also like to make it clear that FRB doesn't require the creation of new monetary specie to inflate the supply of said monetary unit. Any time funds are held on account and treated as readily available (as on demand deposits are,) but any amount of those funds are reapplied elsewhere in the economy, the effective supply of that currency is expanded. This is neither permanent, nor bad in and of itself.

[peterz]

<And they are. You can withdraw all of your funds at any given time. That being said, the bank is managing the risk that more people will withdraw than they have the reserves to cover, and that's why they don't lend out all of their reserves.>

What are you talking about? Since the FRB bank used 90% of my money, they have only 10% of my money available. Where they'd take the other money from if I want to withdraw all my money?
They can go around that problem only if central bank stands behind them, and prints the missing money when needed, which has a lot of bad consequences. Without central bank the FRB bank would go bankrupt immediately people would be suspicious about its insolvency.

My argument is that bitcoin FRB won't work because there is no possibility to create central bank which could create new bitcoins when they want and back the fraudulent FRB banks.

[metavox]

<I do not see these two competing systems co-existing together for the long term. Guess which one I am going long on? : )

What two competing systems? FRB will exist regardless of whether the asset is $, BTC, or metal.>


Nope, the FRB could survive a longer run only if there is an entity of last-resort-lender, which has an ability to create new units of money out of nothing (i.e. in current fiat money systems - those are the central banks - which uses that to do the bailouts of otherwise failed institutions on regular basis).

With bitcoin no such entity like central bank could possible exist. There is no way to create new bitcoins on demand out of nothing, that's the beauty of it.

Just spit-balling here...   Banks could cooperate. Let's say there's a run on one bad bank and its reserve drops to zero. Instead of reaching out to central bank to print more money, the bad bank could reach out to other banks to secure a series of small loans to pay everyone back. The failing bank would need a way to pay it's loans back...so I'm at a loss there.  Also, it does become circular at some point, but given a large enough network of banks, one or two failing banks won't bring down the whole financial system. 

What if a bank in this sense wasn't thought of as a safe haven, but as a loan co-op?  Everyone shares fully in loan decisions, profit, and risk.  If a loan goes bad, well, that money disappears.  Runs would still have to be mitigated somehow.

[drhobomanxxiii]

"What are you talking about? Since the FRB bank used 90% of my money, they have only 10% of my money available. Where they'd take the other money from if I want to withdraw all my money?"

You're not the only one with money in the bank. If there are deposits on account worth $10,000,000 and you have an account worth $1,000, then with a 10% reserve the bank still has $1,000,000 they can use to fund withdrawals.

As I said before, you really don't understand how FRB works. It's fine, but you should learn how it works before feeling as if you have a sound conclusion on the subject.

As for your argument, I've understood it and have already addressed that in one of my first responses to you. Since you seem not to be satisfied, I'll go one step further and leave it there.

Suppose a bitcoin bank exists and holds fractional reserves. That alone is completely possible. Suppose, now, that there is a run on that bank, and withdrawals cannot be satisfied. In this case, the reserves are depleted. In this case, the bank has lost all credibility, and either a) all borrowers from the institution are forgiven of their debts and the depositors lose their deposits, b) another institution buys up the bank's ledger and funds the repayment of depositors to pick up the loan obligations of any [edit: borrowers from] the institution, or c) the bank continues functioning and directs all payments of debts straight to fulfill withdrawal requests of depositors until solvency is reached.

In this case, the single bank is affected, not FRB as a whole. In this case, it was the single bank that miscalculated the risk (or properly calculated, but lost their bet on solvency, so to speak.) This neither requires a central institution to bail the bank out, nor does it act as a reflection on FRB as a whole.

At this point, there's really no further that this discussion can go. As it stands, you haven't accepted any arguments against your position despite any validity they hold, and there's really nothing else to say on the subject. It's up to you, and others reading the thread, to make the choice to accept the more reasonable position despite any personal attachments to a previously held opinion. I hope that I have given sufficient reason to believe that my position is the superior one, and I believe that I have done so.

Good day, Peterz.

[peterz]

<You're not the only one with money in the bank. If there are deposits on account worth $10,000,000 and you have an account worth $1,000, then with a 10% reserve the bank still has $1,000,000 they can use to fund withdrawals.>

It is not important if one person made all the deposits, or 1000 of persons. The point is if bank has only 10% of reserves and if its clients want to withdraw let's say 20%, the problem is there.

[peterz]

<As I said before, you really don't understand how FRB works. It's fine, but you should learn how it works before feeling as if you have a sound conclusion on the subject.

As for your argument, I've understood it and have already addressed that in one of my first responses to you. Since you seem not to be satisfied, I'll go one step further and leave it there.

Suppose a bitcoin bank exists and holds fractional reserves. That alone is completely possible. Suppose, now, that there is a run on that bank, and withdrawals cannot be satisfied. In this case, the reserves are depleted. In this case, the bank has lost all credibility, and either a) all borrowers from the institution are forgiven of their debts and the depositors lose their deposits, b) another institution buys up the bank's ledger and funds the repayment of depositors to pick up the loan obligations of any depositors to the institution, or c) the bank continues functioning and directs all payments of debts straight to fulfill withdrawal requests of depositors until solvency is reached.

In this case, the single bank is affected, not FRB as a whole. In this case, it was the single bank that miscalculated the risk (or properly calculated, but lost their bet on solvency, so to speak.) This neither requires a central institution to bail the bank out, nor does it act as a reflection on FRB as a whole.

At this point, there's really no further that this discussion can go. As it stands, you haven't accepted any arguments against your position despite any validity they hold, and there's really nothing else to say on the subject. It's up to you, and others reading the thread, to make the choice to accept the more reasonable position despite any personal attachments to a previously held opinion. I hope that I have given sufficient reason to believe that my position is the superior one, and I believe that I have done so.>

In your scenario, point b) why would other institution buy subject which has no assets only obligations? No such c) point will happen.

If a) happens no customer will ever trust any bitcoin bank using FRB, and if they do not announce it, the run will happen after first suspicion of FRB in such institution.

I think the one who doesn't understand FRB is you.
You don't seem to understand that in fiat money world the FRB is sustained solely only because of central bank ability to print new money out of nothing. Without that FRB collapses, entirely.

Have a nice day too!

[drhobomanxxiii]

Eh, I've got another ~30 minutes... I'll use 'em here, I guess... Then I'm done.

"The point is if bank has only 10% of reserves and if its clients want to withdraw let's say 20%, the problem is there."

If the clients *collectively* want to withdraw 20%, then that's called a bank run. The fact is that this is an extremely rare case, especially in light of the fact that many transactions go from one account in the bank to another. Bank runs generally only occur when people fear the institution is insolvent in some way, or that their money is at risk. See the recent Cyprus debacle.

"In your scenario, point b) why would other institution buy subject which has no assets only obligations? No such c) point will happen."

This isn't what occurs under a standard bank run scenario. It's possible, but only if massive defaults occur in the assets that the bank holds. Said differently, the bank loans out money in order to run down its reserves, it doesn't just spend it and leave it. Banks work by seeking a return on those investments. If those investments themselves turn sour, then yes, it could have liabilities that it cannot cover even if all of its assets are liquidated. That would most likely cause the bank to completely collapse, resulting in scenario a).

As for scenario c), it's an unlikely scenario, but I was listing all possibilities.

"If a) happens no customer will ever trust any bitcoin bank using FRB, and if they do not announce it, the run will happen after first suspicion of FRB in such institution."

This isn't entirely true. Bank runs in any bank do tend to cause runs in others due to fear, however, if a bank holds sufficient reserves then this isn't a fatal blow to that bank. This is why the market should determine that reserve rate, and why it's so important that you can determine that using the bitcoin protocol. If the market is allowed to do this, then the interest rate will be the barometer for the market's tendency to run on banks, thus allowing banks to properly set reserve rates. If reserves drop too low, then someone looking to deposit their money in a bank will generally avoid that bank, thus rewarding another bank with higher reserves with their business.

With all of this information available, it is apparent that a market would be better able to adapt to shocks in the market than under the current dollar based system, and the price instability caused by static supply of a currency will be mitigated by adjustments made in the loanable funds market.

This is an extremely complex topic, but a very important one. I do urge you to step back for a moment and stop assuming that you have the right answer. Monetary theory is an incredibly complex topic, and you can't just attack it outright as a "common sense" issue. As I said before, there are far too many variables involved.

[peterz]

<market should determine that reserve rate, and why it's so important that you can determine that using the bitcoin protocol.>

This is probably only point I am going to agree with you.
Therefore picked it up, so we don't depart in bad mood. 

My stand is that in case of Bitcoin the reserve rate will be 100% in long run (and would be with every currency unless government creates central banks and bailouts insolvent institutions). Only 100% reserve would work for Bitcoin banks because nobody can create central bank for Bitcoins.

OK, even though we disagree, it was nice to have this thread.

Take care!

[drhobomanxxiii]

Well, I'm happy we can agree on something!

My last thought I'd like to leave you with...

What if it were a 99% reserve rate? I have a feeling you don't think that would end in bank runs! The only point here being that if any non-100% reserve rate is possible in the long run, then it is very likely to happen, and it's probably a good thing.

[cal_guy]

My stand is that in case of Bitcoin the reserve rate will be 100% in long run (and would be with every currency unless government creates central banks and bailouts insolvent institutions). Only 100% reserve would work for Bitcoin banks because nobody can create central bank for Bitcoins.

Sure they can after all FRB existed when gold and silver were the mediums of exchange with and without central banks, and central banks certainly couldn't make gold or silver out of thin air. The central banks just need to keep a reserve of whatever medium of exchange they use in reserve if they're using a non-fiat system. Obviously unlike gold and silver transferring and holding bitcoins is not much of a burden so it doesn't make a whole of sense, but just like there's a chance of a 99% reserve bank system failing so is the possiblity of a bitcoin FRB system.

[Trongersoll]

Who would insure that a bitcoin bank would play by any rules? How does a virtual bank using a virtual currency insure that the people they loan money to would pay it back?

[pretendo]

Fractional reserve is definitely possible as soon as bitcoin credit and mainstream-like institutions appear. It is necessarily a good thing, but without the federal reserve and FDIC, there is no socialization of risk and moral hazard.

[peterz]

Sure they can after all FRB existed when gold and silver were the mediums of exchange with and without central banks, and central banks certainly couldn't make gold or silver out of thin air. The central banks just need to keep a reserve of whatever medium of exchange they use in reserve if they're using a non-fiat system. Obviously unlike gold and silver transferring and holding bitcoins is not much of a burden so it doesn't make a whole of sense, but just like there's a chance of a 99% reserve bank system failing so is the possiblity of a bitcoin FRB system.

That's a good point, but there is some difference. The central banks did exist. The difference is that there were banknotes which were backed by gold. Not the gold itself circulated, but the banknotes. The central bank could print more, even without having enough gold to back it, and they did so. To counter that, the governments restricted private individuals to convert the banknotes to gold, or allowed it at fixed price below the market price, or simply confiscated gold from private people. It was de facto a fiat currency (the banknotes), just technically backed by gold, but not really a gold.

If you go further back in time, when the real gold was used in circulation, i.e. the gold coins. Even that time they could debase the coins by "shaving" them, or adding less precious metals (all just different forms of inflation), or simply by fixing price by government.

All the above is not possible with Bitcoins, again I have to say, hats off to the creator.

[black flag capitalist]

 Fractional reserve banking was done in the free banking era buy banks when people deposited gold in the banks for gold promissory notes. The banks found that many just left there gold in the bank and never came to pick it up so many banks where tempted to create more promissory notes then there was gold in there vaults. Are current fiat system in the states is also fractional reserve, basically if the fed quits pumping money into the system everyone defaults on their loans and the economy stalls but the more it pumps the less usd is worth(inflation). I don't see a good way fractional reserve banking could be done with bit coin or crypto currencies and this is a good thing in my opinion.

[peterz]

Fractional reserve is definitely possible as soon as bitcoin credit and mainstream-like institutions appear. It is necessarily a good thing, but without the federal reserve and FDIC, there is no socialization of risk and moral hazard.

Yes I agree FRB is possible. But I don't agree it is a good thing. It is no because it is a fraud. And as it goes with any fraud it is possible to happen.

However my point is that because of Bitcoin nature one can not sustain such fraud in a long term, i.e. the FRB will not work. All attempts to do FRB will lead to a crash of such institution.

[yucca]

Fractional reserve banking was done in the free banking era buy banks when people deposited gold in the banks for gold promissory notes. The banks found that many just left there gold in the bank and never came to pick it up so many banks where tempted to create more promissory notes then there was gold in there vaults. Are current fiat system in the states is also fractional reserve, basically if the fed quits pumping money into the system everyone defaults on their loans and the economy stalls but the more it pumps the less usd is worth(inflation). I don't see a good way fractional reserve banking could be done with bit coin or crypto currencies and this is a good thing in my opinion.

Yes it's quite incredible that it's accepted, although I do prefer an asset backed fractional system to a fiat backed one which is a double fuku whammy.

But I think bitcoin will end up with fractional reserve layer on top simply because 95% of end users will allow it. They simply don't understand what fractional reserve is. Final end users will only know that their currency is "backed" by bitcoin and may see a nice reassuring holoram on their card or something. They will know nothing of the blockchain etc. And if you try and tell them about fractional reserve they will glaze over as soon as the first word "fraction..." passes your lips.