In Switzerland, a new format for commercial banking is being proposed in a referendum to be held June 10, a format not based on fractional-reserve banking.
The stability of the current commercial banking model is being questioned again as concerns rise over the possibility of new financial problems coming from distressed banks.
The concern over the stability of the commercial banking system increases when one starts to think about how information technology is changing the speed at which financial transactions take place.
The banking system is changing. Perhaps the greatest movement right now is the increased use of modern information technology.
The banking system has been lagging behind much of the rest of the world in terms of moving to use the new technology that is available to them. But, this “catch up” seems to be accelerating and who knows where it will take us.
Also, there is much discussion about how the banking system should be regulated. Commercial banks create money through the lending process. The amount of demand deposits…or time deposits…that exist within the banking system depends on how aggressively the commercial banks use the monetary base created by the Federal Reserve System to expand their lending activities.
The monetary base is composed of coin and currency outside the commercial banking system and commercial bank reserves, held either at an individual bank, or in the form of deposits the bank holds at the Federal Reserve System.
The basic banking literature shows how a bank can take $10 of the monetary base, and if the reserve requirement behind demand deposits is 10 percent, turn that $10 into $100 of loans.
Other than the reserve requirements behind deposits, commercial banks can be controlled by limiting the leverage ratios a bank can use to “multiply” its equity capital. For example, the regulators can require the banks to use no more than a 20-to-1 leverage ratio. This means that if the value of a banks assets fall by 5 percent or more, the bank would become insolvent.
Right now in the United States, banks are seeing many of the regulations they have to adhere to weakened. As is typical, bank regulations are made more strict following an economic crisis, like the Great Recession, and are then loosened up as an economic recovery proceeds.
So, the banking system is faced with cycles of regulation, attempting to make the banking system “safer” from its becoming less risky before the last crisis and then becoming “safer” as politicians and regulators move to tighten up bank regulations after a crisis.
With fractional reserve banking, the banking system will, forever, face these swings in the regulatory environment as governments attempt to reduce the impact of the cyclical movements. The IMF has compiled data on banking crises and indicates that there have been...