On the banking system
Deposits to the bank are liabilities of the bank. Banks, however, lend these deposits out for interest which often have a maturity date. This illiquidity causes bank runs should there be sudden spike in demands due to unforeseen circumstances (loss of confidence, etc)
The fractional reserve banking is inherently fragile, because customers can demand liquidity any time against illiquid assets.
Paul Sheard: “Under a fractional-reserve banking system (the system in operation virtually everywhere in modern developed economies), banks have to hold a fraction of their deposits (a liability for them) as deposits at the central bank (called reserves) (an asset for them), but they can “lend out” the remainder”
In current age of instantaneous information flow, consumer demand can shoot up exponentially and rapidly.
Solutions proposed
Chicago Plan
Iceland’s alternative - the separation of bank deposits into two types of accounts:
- Interest-free Transaction Accounts kept at the Central Bank, which are not available for banks to invest, and redeemable on demand
- Yield-bearing Investment Accounts which are invested by the bank, and only redeemable at maturity, ranging from 45 days to a few years.
Thoughts
Article does not talk about capital efficiency