If you think we have fractional reserve banking, we don't. We have zero reserve banking.

The above image from Fed Policy Tools. 

"This action eliminated reserve requirements for all depository institutions."

The Fed openly encouraged and sought both inflation and speculation. It got what it wanted and then some. 

Now the Fed has no idea how to fix the mess it created.

Fictional Reserve Banking

The number of people defending fictional reserve banking caught me by surprise. Here is a Tweet chain worth exploring.

I don't endorse fraud, because that is what it is.

A person deposits money and a bank lends it for a long period of time.

Both claim rights to the money at the same time.
It's logically impossible and in fact legalized fraud. https://t.co/2vPW8G23QK

— Mike "Mish" Shedlock (@MishGEA) March 20, 2023

Schools Need Fractional Reserve banking?!

Ben, tuition never would have gotten as high as it did without the Bankruptcy Reform Act of 2005 that made student debt not dischargeable in bankruptcy.

And of course we have public unions and excessive benefits everywhere. Don't forget Pell grants and gov't pressures.

— Mike "Mish" Shedlock (@MishGEA) March 20, 2023

If It's Not Fraud, What Is It?

What the hell else is it Ben?

Someone puts money in the bank in a demand deposit acct. The money is supposed to be available on demand.

But it isn't, is it? Two entities have a 100% claim on the money at the same time.

If you accept that as legit, you need to think again.

— Mike "Mish" Shedlock (@MishGEA) March 20, 2023

Car Lease Comparison

Money that is supposedly 100% payable on demand was in fact NOT payable on demand.

It's like leasing your car to two people simultaneously, banking on the notion one will not show up.

I call that fraud. You can call it a peanut butter sandwich. No one can stop you.

— Mike "Mish" Shedlock (@MishGEA) March 20, 2023

What Stops a Bank From Doing This?

Are you proposing a strictly dollar in dollar out banking system? If so, what stops a start-up bank from doing this?

I have a $100,000 business line of credit that I’ve only dipped into 10% of for one month. That line of credit is backed by my assets. …

— Clark Crawford (@ClarkGab_le) March 20, 2023

Good question. 

The answer is the Fed. It will not allow a safekeeping bank. If it did, there would be a run on every questionable bank to a bank that only invested in very short-term duration treasuries. 

Interest on Reserves

The Fed used to pay interest on excess reserves (IOER). That series has been discontinued. 

Given there are no reserve requirements at all, the IOER series morphed into IORB.

Interest on Reserve Balances

Note that the Fed pays free interest on money it crammed down the throats of banks. The Fed also pays interest on Reverse Repos. 

How Much Free Money?

There are two factors in play. Quantitative Tightening (QT) acts to slowly decrease the free money while rising interest rates increases free money.

Explaining the SVB Failure

• The Fed crammed deposits down the throats of banks via QE
• The Zero Reserve requirement by the Fed encouraged banks to speculate.
• Not happy with free money for nothing, banks invested deposits into long duration treasuries and mortgage backed securities.
• Regulators at the banks and Fed did no duration risk analysis
• As the fed hiked rates, total bank losses hit $620 billion.

Instead of making $253 billion in annualized free money, banks collectively managed to lose $620 billion. Way to go! 

Silicon Valley Deposits 

Silicon Valley Bank had about $200 billion in deposits before the bank run started. 

Just by parking money at the Fed, it could have collected $9.3 billion in interest. Instead, greed wiped the bank out. 

Not all of that free money would have been profit though. One has to factor in interest paid on deposits. 

Most of the big banks paid nothing on deposits, so small businesses and venture capitalists (who knew the risk), flocked to SVB. 

SVB was not happy with the free money spread. 

A Profitable Safekeeping Bank 

The above example shows that it would be easy to create a profitable safekeeping bank. Such a bank would pay a high enough rate to attract deposits but under the amount paid on deposits at the Fed or short term treasuries. 

If the Fed stopped paying interest on reserves and the short term treasury rate went close to zero, perhaps a bank would have to charge a nominal fee.

The Perfect Solution to the Banking Crisis Is to Make a Truly Safe Bank

I explained my proposal in The Perfect Solution to the Banking Crisis Is to Make a Truly Safe Bank

Unfortunately, the Fed not only sponsored the biggest asset bubble in history, it also failed to understand how free money, student debt cancellations, and zero percent interest rates might cause inflation.

If the Fed cannot see the obvious, why is there a Fed? The only answer I can come up with is Congress would be worse.

I prefer a 100% gold-backed dollar. As it stands we do not even have a 100% dollar-backed dollar! 

I can understand someone questioning parts of my proposal, specifically the idea of not lending money into existence. 

However, it's important to understand deposits do not fund loans, rather deposits result from lending money into existence and QE.

One Simple Rule

One simple regulatory rule would have saved SVB, that being a 100% reserve requirement on deposits instead of a 0% reserve requirement on deposits. 

Money that is supposedly 100% payable on demand was in fact NOT payable on demand. It's like leasing your car to two people simultaneously, banking on the notion one will not show up. 

The story is simple: SVB took long-term risk on money available on demand. Then depositors wanted their money back. Oops. Two people wanted the same money at the same time.

If I constantly lent the same car to two people hoping that one would not show up, I would be arrested. 

Amazingly, people defend this practice. 

The Impact of Fraudulent Practices

A 100% reserve requirement would have stopped the run and thus bank failures due to greed. 

Moreover, given that money is lent into existence (rather than deposits funding loans), a mandatory requirement to park money at the Fed or in very short term treasuries would not have impeded bank lending at all!

Free money was just not enough for these banks.

And now, capital impairment due to greed and incompetent regulators will dampen lending. That's the sorry irony of it all.

As I explained in The Perfect Solution to the Banking Crisis Is to Make a Truly Safe Bank "We don't need to up the FDIC limit, we need to eliminate the need for FDIC and create a safekeeping bank."

A 100% reserve requirement on deposits would do just that, and it would not at all hinder lending.

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