{"id":88558,"date":"2025-12-19T07:55:11","date_gmt":"2025-12-19T07:55:11","guid":{"rendered":"https:\/\/www.taxresearch.org.uk\/Blog\/?p=88558"},"modified":"2025-12-19T07:58:01","modified_gmt":"2025-12-19T07:58:01","slug":"88558","status":"publish","type":"post","link":"https:\/\/www.taxresearch.org.uk\/Blog\/2025\/12\/19\/88558\/","title":{"rendered":"Full reserve banking"},"content":{"rendered":"
I received this email this week:<\/div>\n
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Dear Prof. Murphy,<\/div>\n
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I have been watching a great number of your videos on YouTube to clear up my understanding of economics, how it functions, and what can be done.<\/div>\n
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One thing I thought would be very interesting to hear a bit about, would be what you think about playing with the required reserves of banks. I am aware that most don't have any reserve requirements at present. I read that Switzerland had a ballot measure that got about a quarter of the vote, for enforcing full reserve banking.<\/div>\n
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I imagine this could be a way of limiting the power of finance over the rest of economy, but there must be some tradeoffs to this. If you could make a video talking a bit about why or why not that is a good idea, I'd be very grateful.<\/div>\n
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Again, thank you for all the educational material you put out, it has allowed me to make quite a bit more sense of the world around me than before happening upon your channel.<\/div>\n<\/blockquote>\n
I admit that this does not feel like a video idea to me: YouTube rewards excessive techniques with low views. But it did feel worth answering, so I have written two glossary entries on full reserve banking (which is currently technically Green Party economic policy) and on reserve requirements.<\/div>\n
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They are as follows, nd please note all the hyperlinks in this post are to glossary entries:<\/div>\n
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Full reserve banking<\/strong><\/h2>\n
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Full reserve banking<\/a>\u00a0is the proposal that banks should be required to hold reserves equal to 100 per cent of their customers' demand deposits, preventing them from creating\u00a0money<\/a>\u00a0through lending. Deposits would be fully backed by\u00a0central bank<\/a>-created money, and banks would only be able to lend money that already exists.<\/p>\n

In a modern fiat monetary system, this proposal is not coherent.<\/p>\n

The reasons are structural rather than technical.<\/p>\n

First, it misunderstands how money is created in a fiat economy.<\/b><\/b><\/p>\n

In a fiat system, money is created by the state through spending and by banks through lending, within a framework set by the central bank and regulators. Bank lending does not \u201cuse up\u201d deposits; it creates new deposits. Requiring full reserves against deposits, therefore, does not control lending in the way proponents imagine, because reserves are supplied elastically by the central bank. What it might do is transfer credit risk to the state.<\/p>\n

Second, reserves are not a funding constraint.<\/b><\/b><\/p>\n

Banks do not lend out reserves, and reserves are not the scarce resource that limits lending. Capital adequacy, creditworthiness and profitability matter. A full reserve requirement would simply force the central bank to supply whatever reserves are required, turning the rule into an accounting exercise rather than a real constraint.<\/p>\n

Third, it confuses payment safety with credit control.<\/b><\/b><\/p>\n

Safe payment systems can be achieved through deposit guarantees, central bank settlement and regulation without dismantling credit creation. Full reserve banking treats money safety as a balance-sheet ratio problem rather than as an institutional design issue.<\/p>\n

Fourth, it would require permanent state intervention to function at all.<\/b><\/b><\/p>\n

If banks cannot create money, the state must continuously inject new money or credit to prevent contraction. The system would therefore depend on discretionary public\u00a0money creation<\/a>\u00a0and credit allocation on a scale far larger than its advocates currently acknowledge. The state might not want to take on the micro decision-making involved, leaving a shortage of credit availability in the economy and creating the sort of crises seen in the gold standard era, e.g., the 1930s.<\/p>\n

Fifth, it offers false certainty.<\/b><\/b><\/p>\n

Financial instability arises from\u00a0asset<\/a>\u00a0bubbles,\u00a0leverage<\/a>, poor regulation and speculative behaviour, not from fractional reserve accounting. Full reserve banking targets a bookkeeping identity rather than the real drivers of crisis.<\/p>\n

From a Funding the Future perspective,\u00a0full reserve banking<\/a>\u00a0is a relic of commodity-money thinking applied to a fiat system where it no longer fits. It promises control and stability, but only by ignoring how modern money actually works.<\/p>\n

The real task is not to abolish bank money creation, but to govern it: through strong regulation, public banking options,\u00a0capital controls<\/a>\u00a0where necessary, active\u00a0fiscal policy<\/a>\u00a0and democratic oversight of credit allocation.<\/p>\n

In a fiat economy, money creation is already a public function. The question is not whether it should exist, but in whose interests it is exercised. Good governance and not rules that deny the nature of\u00a0fiat money<\/a> are required to address this issue.<\/p>\n

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Reserve requirements<\/strong><\/h2>\n<\/hgroup>\n
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Reserve requirements<\/span>\u00a0are rules that require banks to hold a specified proportion of their customer deposits as reserves, typically at the\u00a0central bank<\/a>, before or alongside lending.<\/p>\n

In the\u00a0UK<\/span>, there are\u00a0no formal\u00a0reserve requirements<\/a><\/span>\u00a0of this kind.<\/p>\n

1 . The UK does not operate a reserve-ratio system<\/strong><\/p>\n

UK banks are\u00a0not required<\/span>\u00a0to hold a fixed percentage of deposits as reserves at the\u00a0Bank of England<\/a>\u00a0in order to make loans. The idea that banks must \u201chave the\u00a0money<\/a>\u00a0first\u201d before lending is a legacy of outdated textbook models and does not describe how modern UK banking works.<\/p>\n

2 . Lending creates deposits, not the other way round<\/strong><\/p>\n

When a UK bank makes a loan, it simultaneously:<\/p>\n