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The economic and legal significance of “full” deposit availability


Bank deposits have two characteristics: they are available on demand and at par value. Deposit redemptions face, at least given current technology, a lag between when they are requested and when they are delivered. This fact leads some to argue that as a deposit is not fully available, all deposits are, in fact, loans and that the legal obligation of the depository changes. We argue that this lag does not nullify the original economic intent of the deposit, and hence, does not alter the legal obligations that a depository faces. Deposits must be held safely to ensure that the depositor′s money will be available when an unforeseen event occurs.

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  1. Defenses of fractional reserve free banking are found in Selgin (1988), Dowd (1989), Glasner (1989), White (1984, 1989), and Yeager (1997). The economic case for 100 percent banking is made by Hoppe (1994), Hülsmann (1996), Huerta de Soto (2006) and Bagus and Howden (2011, 2012a).

  2. Rozeff (2010), Selgin (1988), Selgin and White (1996), White (1989) and Yeager (2010) make the ethical and legal case in favor of fractional reserve free banking. The opposing viewpoint which regards fractional reserve banking as legally and ethically problematic is made in Bagus and Howden (2009), Barnett and Block (2005), Hoppe (1994), Hoppe and Block (1998), Huerta de Soto (2006), and Hülsmann (1996, 2008).

  3. Note that in full-reserve banking systems, depositors would have to reimburse banks for the service of safeguarding their funds, as was the case in some historical examples such as the Bank of Amsterdam (Smith 1776, volume 2: 74). Alternatively, banks could offer deposit accounts for free or at a reduced charge, taking a loss in order to generate additional business (Bagus and Howden 2009: 400fn5; Bagus et al. forthcoming: fn5).

  4. Robert Eisenbeis and Larry Wall (2002) assess the failures in regulatory agencies and weigh the costs and benefits of bank regulation, specifically in the area of deposit insurance. High deposit insurance premia guard against bank failures, but draw the ire of bankers who perceive that they are overpaying for the service, or being forced to insure more than they otherwise would. Lower premia satisfy the banking establishment, but leave the general public open to ex post losses either through bank insolvency or public sector bailouts.

  5. O’Driscoll (2010) criticizes Kotlikoff’s plan for prohibiting necessary leverage in banking, and convincingly argues that a prohibition of bailouts would be sufficient to limit leverage in the financial services industry. He also points to the overregulation issues that Kotlikoff’s plan entails, focusing on the risk of capturing the regulator.

  6. Along similar lines, but more concerned with the base money regime, is O’Driscoll’s (2009) monetary reform plan. While recommending a commodity to replace fiat money as the base money standard, O’Driscoll does not touch upon reserve requirements as a source of banking sector instability.

  7. Although traditionally the lender of last resort only lent to illiquid but solvent institutions, Kaufman (1999) finds that during the United States’ S&L crisis in the 1980s, over 90 percent of all emergency lending from the Federal Reserve went to institutions that subsequently failed. Kaufman holds that private institutions are better able to assess whether a bank is solvent and lend accordingly, a difficulty that central banks lacking a hard budget constraint face.

  8. More recently the IMF has assessed the moral hazard aspects of deposit insurance, especially in the role of institutionalized risk taking in explicitly defined and guaranteed plans (McCoy 2007).

  9. Deposit insurance plans are often preferred to the suspension of convertibility, though this insurance comes at a cost of its own through the distorted incentive structure altering depositor behavior, and the creation of moral hazard increasing bank risk and potential taxpayer liability (Bhattacharya et al. 1998).

  10. The interested reader may consult Huerta de Soto (2006: chap. 1), Bagus and Howden (2009), or Bagus et al. (forthcoming) for a comprehensive overview of the objective legal principles in question.

  11. Note that in modern monetary economics, the demand to hold cash balances comes (primarily) from two factors—income and the interest rate on interest-bearing assets. Yet these factors are only consequences or constraints on the demand to hold cash balances to mitigate uncertainty (Mises 1949: 404). The interest offered on “safe” interest bearing bonds does not condition our decision to hold a certain quantity of money in our cash balances. It is our demand to hold a cash balance to mitigate future uncertainty that determines what interest rate these bonds will bear (Rothbard 1962: 787–789).

  12. This becomes clearer if we ask the simple question as to why an individual would choose a demand deposit over a time deposit, or investing in a highly liquid bond. If the individual was not concerned with full availability than the latter options would be suitable substitutes for the former. The fact that individuals utilize demand deposit accounts suggests that they do find the options distinct. Likewise the objection that if a depositor was concerned with safekeeping he would make use of a safety deposit box rather than a demand deposit in the modern banking system is not sound. For only if the former were seen as a good substitute for the latter would this reasoning be correct. The fact that a safety deposit box cannot offer the availability of a demand deposit and is more costly (economies of scale apply when deposits are held in big vaults) makes them poor substitutes for each other (Bagus et al. forthcoming).

  13. The problem of the current (and long-running) fashion of calling short-term loans “time deposits” becomes evident in light of the contractual differences between deposits and loans. Eliminating such confusing terminology would do much to reduce error on the theoretical side by economists (Mises 1949: 403). Likewise, eliminating such terminology would do much to erase the practical ambiguities plaguing the current banking system (Bagus and Howden 2009: 401fn8).

  14. We refrain here from commenting on whether such a transaction would really honor the original tantundem. While it is clear that it is possible that such a transaction would potentially result in the same quantity of monetary units being returned to the depositor, it is less clear if the monetary units will be of the same quality. In making a loan against a deposit, the core practice of the fractional-reserve banking system, the value of each individual deposited money unit is diminished. In other words, while the quantity of deposited notes can be, in most cases, easily returned to the depositor, their individual quality may be purposefully reduced in quality by the depository. Rothbard (1962: 765) discusses the differences in social benefit between increasing the supply of consumers’ goods as opposed to increasing the supply of money.

  15. Even if the bank could forecast redemption demands accurately, the appropriation and use of the money would represent a violation of the safekeeping obligation. An analogous case arises if your friend entrusts you to watch their car to keep it safe while they go on vacation. If you make use of the car while your friend is away, even if they are unaware of your use of the car (and assuming that the car is not damaged), a break of fiduciary duty has occurred. In both cases an unethical use of goods transpires.

  16. Interestingly, the deposit/loan continuum is asymmetric. While it is easy to see how a continual shortening of the maturity of a loan causes it to approximate a deposit, a deposit can never commence to approximate a loan. Lacking any maturity—or, being continually redeemable on demand—removes any possibility that a deposit could ever be misconstrued in this regard for a loan.


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Correspondence to Philipp Bagus.

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Bagus, P., Howden, D. The economic and legal significance of “full” deposit availability. Eur J Law Econ 41, 243–254 (2016).

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  • Deposit availability
  • Demand deposits
  • Full availability
  • Legal obligations in deposit contracts
  • Safekeeping
  • Fractional reserve banking

JEL classification

  • G 21
  • K10
  • K20
  • K40