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Federal Reserve Bank of Philadelphia
Working Papers
On the welfare properties of fractional reserve banking
Daniel R. Sanches
Abstract

Supersedes Working Paper 13-32/R. Monetary economists have long recognized a tension between the benefits of fractional reserve banking, such as the ability to undertake more profitable (long-term) investment opportunities, and the difficulties associated with it, such as the risk of in-solvency for each bank and the associated losses to bank liability holders. I show that a specific banking arrangement (a joint-liability scheme) provides an effective mechanism for ensuring the ex-post transfer of reserves from liquid banks to illiquid banks, so it is possible to select a socially efficient reserve ratio in the banking system that preserves the safety of bank liabilities as a store of value and maximizes the rate of return paid to bank liability holders.


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Daniel R. Sanches, On the welfare properties of fractional reserve banking, Federal Reserve Bank of Philadelphia, Working Papers 15-20, 14 Apr 2015.
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Keywords: Fractional reserve banking; Reserve management; Risk sharing
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