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Comment by Kelbit | Hacker News Reader

Except in a real fractional reserve system, the central bank usually sets reserve and/or capital requirements.

Well, in theory you could run fractional reserve bank by letting your deposit customers decide whether they want or not be making deposits to you at any deposit rate you are offering. This would work if you disclosed your balance sheet and your customers were smart enough to make proper capital adequacy calculations on that. In the real world, however, I am not sure if disclosing the balance sheet matters, expected outcome (deposit holders losing their money) is pretty much the same.

Tragedy of the commons? I want all of my money lent out, but I also want the bank to have a reserve in case I need it, which means none of your money lent out.

The only way out of this is for customers to bargain collectively for the proper reserve ratio.

It just needs to hold each account in a separate trust with a specified policy.

Nowadays the bank regulation is a bit more complicated than simple reserve requirements, and the capital held in "safe" assets (central bank deposits, government issued loans etc) is not there in the case if you need it (most of the time when you "need" your money, bank actually does not pay it out, but just changed whom it ows the money i.e. makes an account transfer), but it is there for the losses bank may make in their credit portfolio.

A simple example:

Bank has 90 deposits and 10 equity. That is used to finance 80 mortgages and 20 deposits in central banks.

Now, if the deposit customers have full understanding what kind of mortgages the bank has issued, they can estimate how likely it is that more than 10 of the mortgages fail, bank goes bankrupt and the deposit holder does not get paid full.

You see quickly that there is many ways how a bank kan reduce the risk in its credit portfolio. If the bank decides to lend only 10 and store 90 in central bank deposits, the risk of the bank losing more than 10 is quite small. but of course, you get more money from mortgages than from central bank, so you want to lend as much as you can to mortgages to maximize revenue. But then you need to pay also more to the (rational) deposit holders because of increased risk. You see also very quickly that even if the deposit holders had full understanding of the balance sheet, the calculations would be so difficult that wihtout regulation, most would inves their savings to banks that are riskier than what they think -> and lose their money.

Well put! Thank you.

I was sort of trying to get to a kind of the same point - tragedy of the point must yield regulation. Well, maybe it's not the same point. But I was trying!

Not to mention that in modern monetary systems, the central bank can always inject liquidity (new reserves) into the system if required (QE, etc.), and the Government also often insures people's bank deposits up to some limit. The Government can also choose to bail out the bank if required.

There is literally no comparison. If Tether runs out of US dollars, they have no options, and people holding Tether have no recourse...

Yep, but that’s a legal requirement tacked on by governments, not an actual theoretical requirement.

Sure, but assuming Tether are lying about their instrument being fully backed it doesn't meet any of the theoretical requirements either. Fractional reserve relies on banks being strongly incentivised not to issue too many bank notes because they earn profits only on repaid loans issued to creditworthy borrowers, not from the act of printing the bank note to sell for currency.

Even in the absence of regulation, centralised clearing and interbank loan markets and a central bank as lender of last resort, fractional reserve depends on bank notes circulating and retaining value because enough people actually need them to meet debt repayment obligations, not on sufficient numbers of people believing that it's fully backed by the financial asset they actually want in their portfolio.

(Also, the history of bank runs suggests the legal requirement might have been a rather good idea)

I’m a macroeconomist, a disbeliever in current cryptocurrencies (because they do not allow fractional reserve banking because they have finite supply) and I absolutely agree with you. I was being facetious further up, I thought that was clear (but apparently it wasn’t).

Fair enough. Difficult to tell sarcasm from true believing from shilling on crypto threads these days :-)

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