100 percent-reserve banking is being introduced through the backdoor by U.S. regulators who remain queasy about banks runs in a future crisis. Under rules instituted in September 2014 by the Fed and other financial regulators, banks are mandated to hold only high-grade liquid assets against risky large demand deposits in order to cover estimated deposit losses for 30 days. These so-called “hot-money deposits” are those that are most likely to be suddenly withdrawn at the onset of a crisis. The required backing assets consist of bank reserves held at the Fed and short-term U.S. government securities. The new rules require banks to hold up to 40 percent reserves–versus the standard 10 percent–against certain corporate deposits and up to 100 percent reserves for some deposits from hedge funds. The deposits that qualify for such treatment are technically known as “non-operational” deposits, which are not immediately required for the depositor’s business and usually exceed the maximum federal deposit insurance limit. Movements of these deposits tend to be volatile and unpredictable especially in times of trouble. Analysts at Credit Suisse Group estimated last August that the four largest U.S. banks held approximately $650 billion of such deposits.
In addition to the heightened reserve requirements, new rules raising capital requirements for large banks and the Fed’s low interest rate policy have significantly increased the costs and lowered the benefits to banks of holding large demand deposits. In response, some banks like JP Morgan Chase and State Street of Boston are charging fees to some customers for holding non-operational deposits while others are contemplating doing so on a case by case basis. The unintended consequences of these policies is that banks are being induced, at least in the case of large demand deposits, to begin operating as true custodians of their clients’ cash in exchange for storage fees.
But, come to think of it, all demand deposits under fractional-reserve banking are “hot-money” ready to flee into cash at the first sign of trouble–even those deposits formally or informally covered by government deposit insurance. Just think back to WaMu and BlackRock. This key feature of all fractional-reserve deposits has recently been summed up in a pithy remark by Bloomberg columnist Matt Levine:
Corporate demand deposits are viewed as risky funding for a bank, which of course they are. . . . And so regulators, who want to make banks less risky, discourage banks from taking that flighty short-term funding and investing it in risky loans. But the exact and only purpose of a bank is to take flighty short-term funding and invest it in risky loans. Everything else is ancillary
This being the case, as long as we have a regulated banking system, abolishing deposit insurance and mandating that demand deposits in all their forms be treated as custodial accounts in a separate department of the bank is a reasonable short-term palliative until money is completely separated from the state and free banking or, more accurately, free financial markets are permitted. Under this transition plan, banks would of course be able to continue to lend funds raised by borrowing and issuing stocks, bonds and certificates of deposit.
