Weaknesses of fractional reserve lending발음듣기
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Weaknesses of fractional reserve lending
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Voiceover: What we're going to talk about in this video are the negatives of fractional reserve lending.발음듣기
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And the biggest negative of fractional reserve lending, and these are all related, is that it's fundamentally unstable unless you have a lot of engineering on the part of central banks and governments to make it more stable.발음듣기
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And the reason why I say it's unstable is because all of these depositors have been promised that their money is safe and sound, that at any point they can come to the bank and get their money.발음듣기
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You can imagine, let's say that all of these banks are lending out the money responsibly, but let's say this bank something shady happens.발음듣기
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It lends out money in a really bad way and it doesn't get it back, or maybe it's even worse.발음듣기
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If you don't have any support from central banks or from governments, now all of these customers are going to say, "Wait, I heard something shady happened at this bank."발음듣기
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They're all going to show up at this bank all on the same day and they're going to say, "Give us back our money."발음듣기
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Then it will be pretty clear that their money actually was not available, that it was lent out, some of it was lost.발음듣기
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If even rumors start to spread that something at this bank is a little bit fishy, you could imagine every one of these bank's customers showing up when that news report hits and says, "Give us back our money."발음듣기
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As soon as these people try to go get their money and they're not able to see it, then the rest of the economy, all the other actors in it will say, "Wow, the banking system isn't as solid as I thought it was."발음듣기
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So all of these other banks, and maybe there wasn't any news report written about them and they didn't do anything shady.발음듣기
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They're going to say, "Well, you promised me that my money is available on demand, well I'm demanding it right now."발음듣기
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The whole banking system essentially has to unwind in some way and it would probably throw the economy as a whole into something of a downward spiral.발음듣기
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So the way that governments attempt to address this issue and in particular it's usually the Central Bank, is they say, "Okay we'll insure banks."발음듣기
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That's why you'll often see at the front door of a bank you'll see FDIC, which means Federal Deposit Insurance Corporation, which means that the federal reserve is insuring that bank.발음듣기
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So for whatever reason, it's usually up to some amount of deposits, if one of these scenarios happens and the bank does not have the money on hand, the Federal Reserve will say, "Okay, we'll just make sure that you have the money."발음듣기
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It's not an easy process and it takes some time but eventually the Federal Reserve will give them the money.발음듣기
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So that creates really the second problem is bad incentive, or nonmarket, I would say discipline.발음듣기
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Because in a traditional system if I was giving my money to someone and they were going to go and lend it to someone else, I would really care how they're lending that money.발음듣기
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I would want transparency in terms of what investments they're making and how safe they are etc, etc.발음듣기
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But in a situation where all of the banks have this FDIC insurance, they essentially are back stopped by the government.발음듣기
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Now all of the sudden when customers go to the bank they're like, "You know what? I really don't care what you do with my money."발음듣기
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I have FDIC banking so all I really care about is if you have cute kittens on your checkbooks and you have lots of ATMs.발음듣기
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So you don't have that market incentive anymore for banks to say, "Hey look, we are good shepherds "of your money.발음듣기
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Look at where your assets are being spent.We want the market to scrutinize us onto "whether we are making good loans "or we are making bad loans."발음듣기
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The third problem with fractional reserve lending is that because of fractional reserve lending, you're giving the private banking system a good deal of control over the money supply.발음듣기
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If they lend more, so lending translates into more money in the money supply or the other way around, if lending were to go away, that would mean contraction of money in the lending supply.발음듣기
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Let's say you have a recession, standard monetary policy arguments you would say, you want to increase the money supply.발음듣기
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Maybe you want to lower interest rates so that people will borrow and start to consume or invest again.발음듣기
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When it is clear that it is in a recession, the Central Bank will attempt to print more money.발음듣기
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In a boom when the economy is well heated or overheating, Central Bank will say, "Hey let me take a little bit of that fuel out of the fire."발음듣기
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So what you want is less money and Central Bank might do that by taking securities it owns, selling it in the open market and then it takes that cash and it could even discontinue that cash, and that's what Central Bank could do.발음듣기
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They get less risk and start understating the risk and so the reality is you have more lending.발음듣기
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More money in the system and essentially adding more fuels to the flame in an economy that is already getting overheated.발음듣기
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