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The Hubris of Hybrids


In the pages of this journal, a fruitful debate has evolved on the ethical legitimacy of fractional-reserve banking. In this article, we respond to the new arguments raised by Evans (J Bus Ethics, 2014) as we clarify our (Bagus et al. in J Bus Ethics 128:197–206, 2015a) position on the unethical and illegitimate nature of fractional-reserve banking. Fractional-reserve banking is not a recent financial innovation (unlike, e.g., money market mutual funds) but represents a long-standing legal aberration. The co-mingling of two mutually exclusive financial contracts, deposit and loan, confounds the contracting parties’ purposes, intents, rights, and obligations. As a result, it creates unsolvable legal difficulties and ethical dilemmas. While these problems are most evident in the case of a bank run, they also arise when trying to answer the simple question of “who owns a deposit?”

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  1. For a detailed look at the differences between deposit and loan contracts, see Huerta de Soto (2009, ch. 1), Bagus and Howden (2013) and Bagus et al. (2013). For a legal analysis of the characteristics of the deposit contract, see also Mano (2014).

  2. In the case of fungible goods such as money, safekeeping and custody refers to the tantundem (an asset equivalent in quantity and quality of the deposited good).

  3. Any loan transaction lacking a term is best classified as a gift (Bagus and Howden 2012b, 2013fn4).

  4. All participants to this debate agree that banking services would be better provided lacking deposit insurance guarantees or a central bank acting as a lender of last resort.

  5. In terms of Roman law, we would speak of an “error in negotio.”

  6. The question of the survey was (Evans 2010): “You may or may not have been previously aware that banks lend out some of the money deposited within current accounts by their customers to fund loans. Which of the following best describes how do you feel about the fact that your bank lends out some of the money in your current account as loans?” One-third of the interviewed people answered: “This is wrong—I have not given them my permission to do so” showing a clear lack of a ‘meeting of the minds.’

  7. When Evans (2014, p. 3) writes: “Let’s for the sake of argument accept that there must be an implicit minimum and maximum term,” he agrees with us only rhetorically that a loan needs a term but does not apply this insight to any of his arguments.

  8. On Austrian business cycle theory see von Mises (1953, p. 98), Hayek (1931) or (Huerta de Soto 2009).

  9. It is striking that Evans (2014, p. 3) calls a bank run a “freak event.” Fractional-reserve banking systematically causes such “freak events” in the absence of a central bank functioning as a lender of last resort. Nevertheless, we must point out that the economic fact that fractional-reserve banking triggers the process that leads to bank runs does not affect our legal assessment of the fractional-reserve demand deposit contract.

  10. BHG do not suggest that in the case of the jointly owned tennis racket there is an “interfering with other people’s property” as Evans seems to believe (2014, p. 3). The tennis racket example was just to show that there is a difference between joint ownership, which is possible, and joint availability, which is impossible.

  11. Depositors not only believe that they have full availability of the money in their accounts. According to Evans’ own survey evidence, 74 % of respondents even believe that they are the “legal owner of the money in their current account,” while under current banking law the bank is the owner (Evans 2010).

  12. In this way, some have argued that fractional-reserve banking resembles a tragedy of the commons situation (Huerta de Soto 2009, pp. 666–669; Bagus 2004, 2011).

  13. See Hutt (1956) and Hoppe (2009) for the use of money held in ‘idle’ cash balances.

  14. Rothbard (2011, p. 171–72) reminds us concerning the meaning of subjectivism in economics: “[R]ecent Austrian paradigms have allowed ‘subjectivism’ to run riot: to extend from legitimate subjective value theory to a virtual denial of the objective existence of the real world, of the objective laws of cause and effect, and of the objective validity of deductive logic.” In short, a real world exists with objective legal principles and deposit contracts with an objective “essential element.”

  15. On the practical meaning of full availability see Bagus and Howden (2012a).

  16. Stated another way, subjectivism determines the value of a deposit and the quantity of deposits that an individual demands. Subjectivism does not (cannot) alter what a deposit is.

  17. Technically, this product would be more aptly called a short-term loan with an embedded extension option at the discretion of the lender (Bagus et al. 2015b).

  18. Evans (2014, 5, fn. 8) similarly states: “In other words, they [BHG] say that a time deposit with a withdrawal clause, that operates as a demand deposit, suffers from the same illegitimacy as an actual demand deposit. But this de facto/de journo [sic] distinction isn’t clear cut.” In theory, the distinction is clear cut. Everything that resembles a demand deposit with its typical characteristics is a demand deposit and the traditional principles apply. Everything that resembles a loan is a loan. In practice, judges must decide. But the fact that judges must decide does not imply that there are hybrid contracts, nor that there is an overlap between deposit and loan contracts such that some hybrid contract is, e.g., 50 % deposit and 50 % loan. Note that the legal system does not adjudicate that the defendant acted 50 % in self-defense and 50 % in first-degree murder, nor that an advertising campaign is only 25 % deceptive.

  19. This point is especially important as all sorts of financial contracts contain “Act of God” clauses to indemnify the relevant parties for events outside of their control. One advantage of an irregular money deposit is that the depositary is responsible for the loss of money even in the case of an “Act of God” (Huerta de Soto 2009, p. 7).

  20. Price changes in response to supply–demand conditions to alleviate shortages or avoid surpluses are an omnipresent feature of market economies. Retailers change thousands of prices on a daily basis. Amazon changes even millions of prices (Wilson 2013).

  21. The natural sciences have proved that time moves backwards when one exceeds the speed of light. No serious economist would use this to argue that time preference does not cause higher valuations on the present than future goods. .

  22. Linguists agree that the predicate is the core of a complete thought and thus a necessary part of every sentence. (Otherwise the statement would lack meaning.) The subject is also necessary but can be implicit, as is the case with the English imperative, e.g., "Jump!” whereby the subject ("you") is implied by the predicate. Similarly, the loan’s term must be established at least implicitly in order to give meaning to the action of lending. On subject and predicate being necessary parts of a sentence see Rowe and Levine (2015, p. 113).

  23. On the evolutionary origin of institutions see Menger (2007). See Hayek (1973), or Leoni (1991) for the evolution of law.

  24. Of course, we might imagine a society where “in dubio pro reo” is turned on its head and the accused must prove his innocence. Yet, we would consider such a principle not only unjust but it would cause severe social problems due to the rights violations of the accused innocents, and would likely be short-lived.

  25. See Hayek (1973, 1989) for a defense of historically evolved institutions against attempts to improve them by deliberate planning.

  26. Legal principles can be found a priori by human reason. In addition to more recent expositions, e.g., Block (2001) and Hülsmann (2004), there are more traditional strands of legal apriorism, both nominalist (Kant 1990) and realist (Reinach 1989).

  27. The investor may try to recuperate the money through sale of the bond or loan. But this will take time and involves sacrificing the bond’s fixed yield for the prevailing market value at the time of sale.


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Bagus, P., Howden, D. & Gabriel, A. The Hubris of Hybrids. J Bus Ethics 145, 373–382 (2017).

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  • 100 % reserve requirement
  • Banking
  • Demand deposits
  • Fractional-reserve banking
  • Fraud