User:Sceptical-h/sandbox

It seems to me that one purpose (or at least one function) of a Wikipedia entry is to enable someone coming across an unfamiliar concept to find out what it involves and how it should be used.

A complicating factor is that some concepts are routinely misused, misapplied or misunderstood. This is the case with Fractional Reserve Banking. What Fractional Reserve Banking is (as defined by the economists who constructed the models from which it is named), what people (including other economists) are describing when they use the term Fractional Reserve Banking and how banking actually operates in the leading industrialised nations are all totally different things. This is the challenge for this article to untangle.

I feel that this article attempts to cover too much. It describes an economic model of banking which, as a model, is uncontentious, which undobtedly served as an adequate description of the operation of the banking system at some stage in the past and which properly merits a Wikipedia entry of its own. It then purports to describe modern banking systems in the terms of this model. This is contentious, as previous discussion demonstrates. If modern banking operated under the fractional reserve system, then all central banks would impose reserve ratios. They don't. Instead, they impose capital adequacy ratios, the so-called Basel accords on which the fractional-reserve model remains silent. Reserve ratios address bank liquidity, capital adequacy ratios address bank solvency. Today's risks and problems with banking are perceived to be of a different order from those of the early decades of the last century when gold was the reserve currency. In the heyday of fractional-reserve banking, deposits were of cash which became the property of banks and could be lent out to customers. Nowadays, deposits are transfers of electronic records which may, or may not be accompanied by transfers of balances at the central bank. These cannot be lent out to customers. Then, reserves could be drained because gold was a universal currency, nowadays, reserves cannot be drained because central bank reserves are a private currency exclusive to the clearing banks and a few other financial and state institutions. Then, the problem was liquidity, now it is solvency.

ChDouglas is correct that the modern banking paradigm is the creation of bank credit by the extending of advances against the signatures of borrowers on loan repayment undertakings, to create new deposits. There are both liquidity (how and when the loan will be spent) and solvency (whether the loan will be repaid) issues to be considered here and banking systems have evolved new procedures to deal with these. These are fully documented in "Where does money come from" by Ryan-Collins et al. (2011) a publication of the new economics foundation in the UK, with a foreword by Professor Charles Goodhart, one of the world's foremost monetary economists. This book explains in detail how modern banking differs from the fractional reserve model. It does not give the modern system a name, but introduces its detailed description with the words "In the next sections, we go through the credit creation process by private banks and the relationship between private banks, the central bank and the payment system." (p.55) This should provide authority for the designation "credit-creation banking" to describe the modern system.

I suggest that the current article should concern itself with a description of the fractional-reserv banking model, how a banking system in accordance with that model would operate and when, or whether, such systems did operate. There should be a new article on Credit-creation banking describing the features of a system where banks operate as ChDouglas describes and, perhaps, a third on Modern banking to consider the extent to which elements of fractional reserve and credit creation systems are combined in actual banking systems.

As a start, I propose the following reworded introduction. New text is in italics, light text in square brackets is to be deleted:

Fractional-reserve banking refers to [is] a form of banking where customers deposit funds with banks which the banks then lend out to other customers, keeping [ banks maintain reserves (of cash and coin or deposits at the central bank) that are only a fraction of the customer's deposits. Funds deposited into a bank are mostly lent out, and a bank keeps] '''only a fraction (called the reserve ratio) of the quantity of deposits as reserves. Some of the funds lent out are subsequently deposited with another bank, increasing deposits at that second bank and allowing further lending. As most bank deposits are treated as money in their own right, fractional reserve banking increases the money supply, and banks are said to create money. [Due to the prevalence of fractional reserve banking, the broad money supply of most countries is a multiple larger than the amount of base money created by the country's central bank.] This process of successively depositing borrowed funds and  lending on a fraction of those deposits causes the level of deposits to grow to a multiple of the original deposit. That multiple (called the money multiplier) is determined by any [the] reserve requirement or other financial ratio requirements imposed by financial regulators, and by the excess reserves kept by commercial banks.[1][2]'''

In a system of fractional-reserve banking, [C]'c''entral banks would generally mandate reserve requirements that require banks to keep a minimum fraction of their demand deposits as cash reserves. This both limits the amount of money creation that occurs in the commercial banking system,[2] and ensures that banks have enough ready cash to meet normal demand for withdrawals.''' [Problems can arise, however, when depositors seek withdrawal of a large proportion of deposits at the same time; this can cause a bank run or, when problems are extreme and widespread, a systemic crisis. To mitigate this risk, the governments of most countries (usually acting through the central bank) regulate and oversee commercial banks, provide deposit insurance and act as lender of last resort to commercial banks.]

[Fractional-reserve banking is the most common form of banking and is practiced] 'Fractional-reserve banking results in the growth of customers’ deposits at a rate greater than the growth of banks’ reserves, and banking systems where this occurs (and this is the case in almost all countries), are commonly referred to as fractional-reserve banking systems. However, the mechanism of monetary growth in modern banking systems is different from the deposit-lend-redeposit mechanism of fractional-reserve banking and modern banking is better described as credit-creation banking(citation 1).' [. Although Islamic banking prohibits the making of profit from interest on debt, a form of fractional-reserve banking is still evident in most Islamic countries.]

'(Citation 1). Ryan-Collins, Josh; Greenham, Tony; Werner, Richard; Jackson, Andrew (2011), “Where does money come from? A guide to the UK monetary and banking system”, nef (new economics foundation), pp.55 et seq.)'