Much confusion reigns over what the defenders of 100 percent reserves for banks would imply for the investment community. Free bankers argue that fractional reserves are necessary and beneficial for a healthy financial system. Credit (via fractional reserves) must be allowed lest the financial community find themselves with a dearth of capital.
The arguments in favor of 100 percent reserves for banks, when properly understood, lead to no capital shortage. The argument centers on loan and deposit contracts. There are three specific differences between the two.
First, loan contracts involve an exchange of present for future goods. A borrower receives a good now, and will pay something back in the future. Loans entail a transfer of the availability of the good lent. The lender renunciates the availability and use of a good until the termination point of the contract. Finally, as loans represent a transfer of present for future goods, an interest payment is involved (although this can be waived out of a myriad of reasons).
The result of an adherence to the legal norms surrounding the distinction between deposit and loan contracts is that deposits must be available on demand. As such a full and continual reserve must be kept. In the banking system, this implies a 100 percent reserve to back up the redemption requests of demand deposits.
This in no way curtails financing availability for the investment community. Guido Hülsmann points out in his The Ethics of Money Production that a shift to equity financing would result if banks adhered to these norms. No longer would debt be the primary means to fund projects. Philipp Bagus and I have recently clarified the point that the legal norm in no way impedes bank lending in an article in the Journal of Business Ethics. Time deposits, which are not available on demand, will entail no such reserve requirement. Lending practices as exist today could continue uninterrupted provided that the money they are based on was lent (or available via a modern “time deposit”).
Full reserve banking would involve no curtailment of credit. Businesses would still have full access to funding based on either equity or time deposits. Adherence to 100 percent reserves fulfills legal obligations, thus diminishing the ambiguity of modern banking. In no way does this also entail a denial of financing for businesses in need.
