Munich Personal RePEc Archive

The crucial flaw in the bank system.

Musgrave, Ralph S. (2020): The crucial flaw in the bank system.

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One of the main activities of banks is accepting deposits, lending on most of the money concerned, while telling depositors their money is safe, which it quite clearly is not, because loaned on money is never totally safe. That is fraud: indeed when any other financial institution does that (e.g. a mutual fund or private pension scheme), that activity is classed as fraud. The latter problem can be dealt with via taxpayer backed deposit insurance and billion dollar bail-outs for banks in trouble, but that puts banks in a privileged position relative to other financial institutions, and indeed non-financial institutions and corporations. I.e. taxpayer backed deposit insurance and bailouts amount to a subsidy for banks. Plus taxpayer backing for depositors who want their money loaned out with a view to earning interest flouts a widely accepted principle, namely that it is not normally the job of governments / taxpayers to stand behind commercial activities, and having a bank lend on your money is certainly a commercial activity. The solution is full reserve banking (also known as Sovereign Money), which consists of abandoning deposit insurance and bailouts, and giving depositor / investors the choice between, first, a totally safe method of storing money, which consists simply of having money lodged with government or the central bank, with that money earning little or no interest, and second, an account where money is loaned out, with the result that a higher rate of interest is earned, but depositor / investors carry the risks.

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