Fractional Reserve Systems

Fractional Reserve Banking – Two Approaches to Regulation

The meaning of a “fractional reserve” Banking system seems simply enough – the first way to understand it would be simply place it in opposition to a full reserve banking system. A full reserve bank is a bank where assets are placed in a vault, and held there (presumably against them). Owners of assets are given promisory notes which all them to return and withdraw their deposits when they please. For this protective service, the owners of they money held at the bank pay a fee. On the other hand, in a fractional reserve bank, we might assume that deposits are made by the owners of assets, the Bank holds a fraction of those assets are a reserve and loans the rest out at a rate of interest. They then pay some of this interest back in proportion to the deposits – and in a free system a tension between security (your assets will be there when you return for them.

On the surface, the fractional reserve system seems just as safe as the full reserve system because the possibility of a loan not being repaid (loosing a depositors money) is evened out by the interest paid on the loan (i.e. I pay interest to conver someone else’s actual default, which is in fact the possibility that I might default). However, this seems to hold true even when banks are making deposits in other banks. Imagine BankA makes a deposit of 100$ into BankB – the 100$ must have been taken out of moneys deposited into BankA, from the portion other than the reserve fraction, so in loaning the money from a bank to another bank, Bank A looses 100$ of money it could loan to someone else (it’s oppertunity cost), and Bank B gains 100$ more it can loan out, but must pay for it by an interest rate. This system has a high degree of protection from systemic risk – BankB might fail, but unless Bank A had made many loans to Bank B, Bank A will take a reasonable hit. The key here is that Bank A has not issued loans on the basis of money it has already loaned.

However, the fractional reserve system that we have is a bit different from this when it comes to deposits made by a central bank. Whereas when a depositer places money in the bank, the money, say 100$, is simply divided into the 20$ fractional share, and the 80$ loan share, when a central bank deposits 100$ into a bank there is a third thing created. In addition to the 80$ that can be loaned out and the 20$ that is kept as a reserve, there is another 80$ in the form of a promisary note, which is effectively the treatment of the loan as an asset. Since the bank has an extra 80$, it can loan this to another bank, who will take 16$ of that and place it in the reserves, and loan the 64$, and then loan the 64$ (again, this is not a 64$ bill from the reserve, but a promisory note for such a bill) again to another bank. This repetition means 100$ of money placed into a bank from the federal reserve creates 500$ (although not in a single bank, but spread across the banking system), whereas when 100$ is placed in a bank by an investor, only 100$ is created.

There is no way to tell between the “original” 80$ that is loaned out to the public, and the 80$ that is subsequently loaned to another bank – except when there is a run on the banks. When there is a run on the banks, people want federal reserve notes, not the promisary notes banks right to each other based on federal reserve notes – these are worth nothing to anyone except bankers – they do not represent actual M1 dollars, but rather are a mechanism to allow banks to lend more money out than there exists in M1.

The importance of this system in the U.S. has become great, although that is no argument that the system is neccesary. M1 in the U.S. is apparently 900 billion dollars – roughly half the size of the combined stiumulus packages to deal with the current crisis. However, the actual money supply is much greater than M1 – the amount it is greater depends on the reserve ratio (i.e. if it is 20%, the actual supply is something like 4.5 trillion).


Backcheck hath defiled my honour

I just got back from a job interview at a firm called Backcheck, at their Port Kells offices. I was rejected because I failed to meet the standard score on their intelligence evaluation test. Are they crazy? I don’t like to pull rank, but I have an M.A. in Philosophy, and although I couldn’t tell them this because I wasn’t planning on telling them I would be leaving after just a few months, but there are some people back East about to pay me a good chunk of change to keep studying Philosophy.

What is worse, is that the reprasentative who spoke to me admitted that it’s quite random what people score on the aptitude test – people may score low initially and high on second try, or high initially and low on second try. They encouraged me to re take the aptitude test, but after a three month waiting period. Three months? Do they honestly not think I would have a different and better job in three months?

All of this would be comprehensible except for the fact it is a human resources firm – their job is to do background checks and evaluate candidates for positions, other companies outsource part of their H.R. to Backcheck to do this. And yet, Backcheck themselves have a hiring practice which they admit has a high compontent of randomness in selecting out apt candidates. Shame on you backcheck, shame.

However, I’m not cross that I did not get the job. Backcheck must be a strange and awful place. There is a pond out front, and five electric radio controlled speedboats on shelves in the lobby. I can only guess that the use of these is given as prizes for excellent work done. How perverse.
I would, however, like to challenge Backcheck to a duel. Unfortunately this is illeagle, and impractical – as there is no “backcheck” person, it only appears on paper. What is not illegal, however, is writing the address and directions to their secret Pork Kells offices. They are located in the Cancar buidling, at 19433 96th Ave, Surrey B.C. Their offices are Suite 200, and you get to them by crossing bridge from the parking lot and ringing the buzzer at the doors on the far left.

19433 96th Ave Surrey B.C. Suite 200. Just walk over the bridge and its the left most door.