Private banking and fractional reserve

[Ian Maxwell]

I notice that there is a huge intersection between Bitcoin advocacy and total reserve advocacy, and I'm sort of curious how big that intersection is.

It sort of rubs me the wrong way that people who consider themselves free-market advocates are opposed to fractional reserve banking even when it's a publicly stated policy of a free, privately operated bank. If this opposition takes the form of simply saying "I don't want to put my money there," there's no argument in principle---you are free to take your business wherever you choose. But saying that fractional reserve is a fraud seems extreme to me. It's only a fraud if it's advertised otherwise.

I also ask because it seems to me there are some forms of fractional reserve that are perfectly safe and non-inflationary. For example, consider the clearing houses that used to operate at medieval city fairs, with merchants coming from afar to trade goods. Rather than bring all their precious silver along and open themselves up to the threat of highwaymen, merchants would register the sale price of their wares, and be issued paper scrip to trade with. At the end of the fair, traders would bring their remaining scrip back to the clearing house to settle up. If you had a surplus, it was payable in coin; if you had a deficit, presumably you had some unsold (or purchased) products you could use to pay off the debt. Everything was nominally done in metal coin, and debts were payable in coin, yet very little reserve was needed. If this was an act of fraud, who was defrauded?

We're so far removed from a commodity-based currency system now that people don't actually have a good idea of how one works in practice. Tools like the above were in use for centuries without any damage to the value of money. I'm not even going to say they're the right thing, but they're at least reasonable enough that I would like the option to be available.

[pusle]

Would such a clearing house actually be fractional reserve?

Anyway. From what I've read in ye olde times there was savings banks and investment banks.
You actually paid the bank to keep your gold safe back then. They didn't use it for loans etc.
Then you had the investment banks where people with cash to burn got together with a pool of money and invested in some business.
Today all types banking are blurred together in one big mess.

I'm not an expert but I'll now attempt to trace how fractional reserve banking works.
For simplicity I'll omit the interest which will just make everything worse anyway.

100 BTC gets deposited into Bank A.  Let's say they run a 10% fractional reserve system.

Bank A loans out 90 BTC and keeps 10 BTC as reserve.

Most of these 90 BTC will end up in a bank somewhere, lets call it Bank B.

Bank B loans out 81 BTC and keeps 9 BTC as reserve.

Again those 81 BTC end up in another bank, Bank C

Bank C loans out 72,9 BTC and keeps 8,1 BTC as reserve.

....etc etc etc 

Worst case this would mean that all the banks A+B+C+D+E+F+..etc  accumulated have outstanding debt of 10 times the original amount of 100 BTC = 1000BTC.

This is now counted as banks assets? and used to set price for it's stock, which gets bought with BTC.
Debt is also packaged together and sold as "products" to others who pay BTC for them.
This gives the banks more BTC, to lend out at fractional rate as before and the loop can go on and on for a while.

Then suddenly people realise the stocks and "products" aren't worth what they first thought it was.. Banks folds,  people lose their savings... major crash, rich bastards at the top with super salaries sell out just before it all goes to hell and laugh like crazy.

So what got inflated here?
As far as I can see it was not BTC, but rather the stock and the perceived value of the banks and their products.
The trade going on here kinda makes both debt and stocks into money, and they can be generated at will causing wild inflation.

Is this assessment correct? If not please educate me/us.


How can the buyer/investor know the real assets backing the banks in a free market system?
Is there some way to use bitcoin system to make banks transparent? or is trust the only thing we have..

[BitterTea]

I'm fine with fractional reserve banking, as long as there is no central bank. If people understand the drawbacks of fractional reserves, I think most will naturally gravitate toward banks with high reserve ratios, and only those that understand the risks will keep their money with a lower reserve bank. The threat of runs will serve as a market regulator of the reserve ratio.

[FooDSt4mP]

I'm fine with fractional reserve banking, as long as there is no central bank. If people understand the drawbacks of fractional reserves, I think most will naturally gravitate toward banks with high reserve ratios, and only those that understand the risks will keep their money with a lower reserve bank. The threat of runs will serve as a market regulator of the reserve ratio.

I agree... the ratio should be chosen by the bank and it should be well publicized.  Let the market decide.

[goatpig]

Sounds like a problem of semantics to me. Makes no sense to have anarchist tendencies and ask for a mere banking tool to be outlawed.

It sort of rubs me the wrong way that people who consider themselves free-market advocates are opposed to fractional reserve banking even when it's a publicly stated policy of a free, privately operated bank.

Being opposed as in trying to take down the bank by force? When I read this sentence I just understand that free-market advocates refuse to use banks with fractional reserve policies.

[Ian Maxwell]

I'm not totally sure whether clearing houses are considered 'fractional reserve'. They are an example of the real bills doctrine in action; this is a rather misunderstood doctrine and needs some explanation.

Under the real-bill system, a bank pays for assets delivered with a bill of credit: a bearer note that it promises to accept as a tender for one silver dollar. In fact, the bank may even have some silver dollars on hand and exchange them with notes as a convenience (but doesn't promise this). Because the bank is so widely known and trusted, others are also willing to accept this note. Since all notes are issued in exchange for assets, they can all be honored: in the limiting case, if the bank shuts down and sells all its assets, you will be able to buy them with the notes you are holding. The only risk is that the bank's assets will depreciate so far against silver that they can't cover all their circulating notes, and this is fixable: the bank can divert some of its income to buy more silver or other stable commodities, or simply hold insurance against depreciation.

This has a lot of liquidity benefits for the public, compared to keeping an actual silver dollar on deposit for every note issued. Silver is quite valuable, but not as valuable as the rest of the ownable universe put together; if I wanted to sell a few ounces of, say, antihydrogen, it's doubtful anyone could amass enough silver to pay for it. I'd have to barter it away and then find either a use or a buyer for all the assorted goods I received. I'd much rather receive notes I can trade as if they're silver, because one or more well-known creditors have made a binding promise to accept them as if they were silver.

The real-bills doctrine says that this system will not lead to inflation as long as bills of credit are only issued against true assets (not expenses). This is the case even if the bank holds no silver at all, as long as it is bound to accept its own notes at parity with silver. The Keynesian school agreed with this analysis: the reason the system was dropped was precisely because it was non-inflationary.

It's arguable whether this is really fractional reserve banking, since the bank has enough assets to outweigh all its silver-denominated debts, just not enough silver. But if the assets issued against are accounts receivable (i.e. loans), it looks pretty similar to me.

[FreeMoney]

Sounds like a problem of semantics to me. Makes no sense to have anarchist tendencies and ask for a mere banking tool to be outlawed.

It sort of rubs me the wrong way that people who consider themselves free-market advocates are opposed to fractional reserve banking even when it's a publicly stated policy of a free, privately operated bank.

Being opposed as in trying to take down the bank by force? When I read this sentence I just understand that free-market advocates refuse to use banks with fractional reserve policies.

No anarchist is suggesting that frac banking be outlawed. It's just a matter of weather you think it's good, would do it, condone it, associate with those doing it. I don't think it's fraud if it's clearly stated.

If you say "You can get your money anytime, we keep a 10% reserve." That's not actually clear and honest. "You can get your money if we have some, we keep 10% around." is pretty good.

I mean a charity is fine. And names don't change reality so a 'bank' that says "We keep no money available for withdrawal, we'll pay you if we have money available." is stupid to use, but not fraud.

[goatpig]

No anarchist is suggesting that frac banking be outlawed. It's just a matter of weather you think it's good, would do it, condone it, associate with those doing it. I don't think it's fraud if it's clearly stated.

If you say "You can get your money anytime, we keep a 10% reserve." That's not actually clear and honest. "You can get your money if we have some, we keep 10% around." is pretty good.

I mean a charity is fine. And names don't change reality so a 'bank' that says "We keep no money available for withdrawal, we'll pay you if we have money available." is stupid to use, but not fraud.

This is essentially my point. This is why I said I think it's a problem of semantics, as in a misunderstanding of the meaning conveyed when people say "we are opposed to fractional banking".

[pusle]

I'm fine with fractional reserve banking, as long as there is no central bank. If people understand the drawbacks of fractional reserves, I think most will naturally gravitate toward banks with high reserve ratios, and only those that understand the risks will keep their money with a lower reserve bank. The threat of runs will serve as a market regulator of the reserve ratio.

I agree... the ratio should be chosen by the bank and it should be well publicized.  Let the market decide.

And how would you know if they are telling the truth about their reserve?  goverment audits 

[Mashuri]

I'm fine with fractional reserve banking, as long as there is no central bank. If people understand the drawbacks of fractional reserves, I think most will naturally gravitate toward banks with high reserve ratios, and only those that understand the risks will keep their money with a lower reserve bank. The threat of runs will serve as a market regulator of the reserve ratio.

I agree... the ratio should be chosen by the bank and it should be well publicized.  Let the market decide.

And how would you know if they are telling the truth about their reserve?  goverment audits 

Is the government the only one who can audit?

[Ian Maxwell]

And how would you know if they are telling the truth about their reserve?  goverment audits 

If I were running a private bank, I would probably agree to undergo up to one audit per year, conducted by any well-known audit agency at the expense of the party requesting the audit.

[FreeMoney]

I'm fine with fractional reserve banking, as long as there is no central bank. If people understand the drawbacks of fractional reserves, I think most will naturally gravitate toward banks with high reserve ratios, and only those that understand the risks will keep their money with a lower reserve bank. The threat of runs will serve as a market regulator of the reserve ratio.

I agree... the ratio should be chosen by the bank and it should be well publicized.  Let the market decide.

And how would you know if they are telling the truth about their reserve?  goverment audits 

If they can't convince you that they have the reserve they claim then don't use them. Just like you don't go to mechanics or restaurants that suck.

One really easy way to show the reserve would be to publish the reserve bitcoin address and demonstrate control of it periodically.

[FreeMoney]

And how would you know if they are telling the truth about their reserve?  goverment audits 

If I were running a private bank, I would probably agree to undergo up to one audit per year, conducted by any well-known audit agency at the expense of the party requesting the audit.

Pfft, my bank will have free audits daily.

[Ian Maxwell]

Well sure, with bitcoins an audit is cheap and easy. With assorted physical commodities, you need a detailed appraisal. If you want to go through that every day, be my guest.

[Ian Maxwell]

If you say "You can get your money anytime, we keep a 10% reserve." That's not actually clear and honest. "You can get your money if we have some, we keep 10% around." is pretty good.

I mean a charity is fine. And names don't change reality so a 'bank' that says "We keep no money available for withdrawal, we'll pay you if we have money available." is stupid to use, but not fraud.

What about a bank that says "You can buy some nice stuff from us against your deposits anytime, or give them to someone else, or we can pay you if we have money available"?

[pusle]

ok, maybe I'm stupid.
I thought the point of all this was to completely free oneself from the government and regulation in general.
audit/rating agencies hasn't proven to be worth much lately either.

Could you tell me exactly how a user can reliably check the reserve ratio for a bank operating with bitcoins?

[stillfire]

But saying that fractional reserve is a fraud seems extreme to me. It's only a fraud if it's advertised otherwise.

Fractional reserve banking got a bad name thanks to exactly this kind of fraud, and it deserves it. Like you said, the idea by itself would perhaps not be fraud, but the term has taken on the meaning of the wider use of it. I can't think of any regular person who clearly realises that the bank is not even remotely able to fulfil all its obligations if called upon to do so. People know of the term 'bank run' but they think it only happens during 'crashes'. They think the crash is the cause, not the effect.

[goatpig]

Well sure, with bitcoins an audit is cheap and easy. With assorted physical commodities, you need a detailed appraisal. If you want to go through that every day, be my guest.

I see this degenerating into a fundamental discussion on the concept of trust.

And how would you know if they are telling the truth about their reserve?  goverment audits

In a free-market, as it is done under our current system, there are business that make a profit of verifying commercial claims of other business, I think a reasonable measure of trust can be found somewhere amidst of all this

Could you tell me exactly how a user can reliably check the reserve ratio for a bank operating with bitcoins?

Bitcoin Explorer. Tedious but reliable.

[FreeMoney]

Well sure, with bitcoins an audit is cheap and easy. With assorted physical commodities, you need a detailed appraisal. If you want to go through that every day, be my guest.

If you buy stuff with deposits that doesn't count as a reserve. Obviously a frac reserve bank will have assets, but if we're just talking about showing the reserve that should be in the same form as deposits.

[em3rgentOrdr]

In a free market, FRB would simply be a form of gambling.  Nothing wrong with that.