Now imagine you've finally settled on a cost structure that can pay all of your insurance, operating costs, payroll, and everything else. You charge monthly fees and you might also charge per-interaction fees to do anything or talk to anyone.
Then a competitor comes along that operates in a fractional reserve manner. They not only offer zero fees, they actually pay customers interest to keep their money in the bank. There is a risk of failure, but it's rare and all evidence points to customers not suffering massive losses when it does happen due to various regulations. Inconvenient, yes, but it's unlikely that you're going to lose all of your money.
The majority of your customers would leave for the competitor bank.
As time goes on it's becoming more obvious that the current status quo is unstable. Our financial institutions regularly engage in ponzi like activities and we've become accustomed to near catastrophic collapse at the end of every business cycle.
If we are going to stick to fractional reserve banking then we need to come up with better reasons why otherwise I feel like the entire system needs to be reevaluated.
the best reason is to allow more risks to be taken.
A 100% reserve system means that a bank would not be able to make loans that they'd want to make (aka, a customer wants the loan, and they can service it, etc).
A 100% reserve system would seize up at a small shock much more easily than a <100% reserve system. The reason is that if a bank required 100% reserves, they would not lend money (even to another bank), even if the lending would've been profitable. This means a bank must standalone on an island, rather than as an inter-connected network with other banks.
You pay for <100% fractional reserve system with some risk of bank runs. If the majority of people can get a gov't backed guarantee that they would be made whole, these runs tend to be minor or not happen at all. And overall economic activity is smoother due to more liquidity available to lubricate everything (e.g., it's easier to get loans to do things to provide more economic activity).
Also, in your model, where does money for loans come from? How are borrowing costs impacted by a major source of funds for loans going away?
Which services? And those services would need to be something that I can only provide by being your depositor (otherwise I'll get beaten by someone who provides those services without the added burden of holding and securing your physical money.
You've basically designed a system that increases the costs of being a bank, and eliminates the main source of profit, and hand-waived over how to close that gap.
I suspect it's simply unprofitable to run a bank in the model you've provided. I suspect the only way to make that system work is by saying "banking is a public good, it's OK if it runs at a loss" and making it a gov't provided service. I don't really see a path to private banks existing in the model you outlined.
You're right, in this model it wouldn't be nearly as profitable to be a bank as it is now. Potentially, it could be a "public good" provided by the government, or it could be like a lot of the brokerages who provide investment services and charge a commission on top.
Also, you're right it would be very hard for banks to be anywhere near as profitable as they are now if assets are backed 1:1.
But in some sense, banking is already viewed as a public good since the FDIC is backing all of the bank deposits. So at the moment we kind of have a weird hybrid situation where banks are kind of pseudo-private, but also backed by the government.
Then you could have banks handle the process of matching lenders to depositors. With varying systems...
But from time immemorial banks work by taking money from you (short term) and selling it to someone else (long term). Originally the banks were "protected" by being able to claw back the long term at anytime; but that caused even worse problems.
FDIC provides a way for "common people" to be protected from this; the other option would involve something like the USPS offering cash-only banking for people.
This is such a great question. It has depth and nuance. If I understand it correctly, it comes from a place of wanting stability. Why wouldn't anyone design a banking system that is fully backed and stable? Who the hell wants these violent booms and busts? This looks like something that can be kept stable right from the get go.
I hear you. The main reason I can think of is that "banking is crookery".
The old goldsmiths were crooks who understood fractional reserve. Imagine if we were to ban the current system and asked banks to hold every deposit 1:1, they could - for a small fee. But that will mushroom a black market of lending for interest. All the banking crooks will have no choice but to go to the black market. This will cause the black market to grow faster than stable banking, which will lead to more unregulated chaos.
The only alternative I can think of is equity-based islamic finance style banks. While these banks have interest in varying forms, they don't have as much asset risk because the interest rate is largely meaningless because lending/borrowing is not the main way to earn money.
Probably invest then. Why would the bank put its money in the bank if you are not?
Because that's how you make real money.
Fractional reserve banking is the biggest scam in history.
How banks actually work was described well by the Bank of England. https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/m...
Not completely wrong, after all.
Notice the issue that SVB had was a huge influx of deposits and not enough loans.
It generally works because while any one depositor's funds are short term, the pool of such deposits is generally stable. A good chunk of today's deposits will fund tomorrow's withdrawals. Banks also have elaborate instruments like commercial paper and the Fed discount window to cover short-term liquidity gaps. A bank with assets it can't sell quickly enough can generally borrow briefly from some other bank to cover the term gap. But there is a limit on how much such borrowing a bank can do, and SVB has hit it.
It seems that SVB made a classic mistake of putting a lot of "hot" money into long-term assets, thus taking on interest rate risk. They probably should have put the surge of deposits into shorter-term instruments, but that would have forced them to reduce interest on deposits or their own profits.
So it looks like in this case SVB chose MBS with a pretty low interest rate and long maturity, which they now have to sell due to the bank run you mentioned.
People don't want to lose their money to inflation, so banks are implicitly required to make up for that. Also, it's just too tempting for them not to use the money that is collecting dust.
Hopefully people will emerge from this with a better understanding of Bitcoin's advantage to normal fiat system, which is something that is severely lacking in discussions I see here in HN.
I also long for a system where everyone holding the currency isn't implicitly taxed through dilution, forcing them to passively invest, creating bubbles... and still being taxed on the "gains." These passive investments are more about stashing wealth in something with a limited supply (stocks etc) than about the actual business they're investing in, making them not all that different from BTC.
The point of a bank is to loan money. That's it. This is how they make money. They need deposits so they can loan money. They pay the depositor a part of the interest on the loans they write. They don't exist to sell services because that's a really bad business. They provide services to attract deposits so they can write more loans. That's what banks are.
> ...and then invest that money trying to make a return on it.
No, they don't do that. They loan the money. If they can't loan it then they put it into a variety of safe places that can earn some interest, among other things. But they don't gamble depositors money. Investment banks may, but that's an entirely different thing.
Because people want economy to be self-regulating. What is the correct amount of money in circulation? What are interest rates? Let the market decide. Banks is how market decides, basically.
How you think the banking system works is how "educated" people think it works and even that isn't correct, by the way. There is no reserve. The funds aren't real. It's all just made up numbers. There have been several Hollywood films made about it (e.g. The Big Short and Margin Call). It's almost so stupid you think there must be something else to it, but it's just people playing with numbers.
Imagine you were designing the bank from scratch having no knowledge of the current banking system. How would you do it? The most obvious thing would be if a customer deposits money, you would hold 100% of the money 1 to 1 exactly how they deposited it. Then the bank could make money by providing services to their customers.
If I had to bet, most people who have money in a bank today think this is how banks work.
But in reality, when a bank receives money, a bank will take some percentage of their customers deposits (90% or so), and then invest that money trying to make a return on it. This works as long as all customers don't try to withdraw their money at once.
But when enough customers... say 10% of the customers try to withdraw money from the bank at once, since 90% of the money was in other investments, the money isn't really there, and you get a bank run.
Silicon Valley Bank is not new, the whole reason we have FDIC insurance is to protect against bank runs. As long as this is the system we follow, we will continue to get bank runs.
I feel like the entire banking system is broken because "The money isn't actually there". There needs to be a better way then relying to the government to bail out banks who make bad investments. Either a bank should be backed 1 to 1, or there should be some other way to keep hold of your money.