Archive for the 'Full Reserve Banking' Category

Date: July 1st, 2008, Filed under Entrepreneurship, Finances, Full Reserve Banking

Los Angeles, CA
By A.B. Dada
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I’ve been a promoter of the idea of a full reserve bank for many years. So far, we’ve never had the chance. Lately, though, I’ve come to realize that one of my “investment” vehicles is the closest thing to a full reserve bank, ever. That vehicle is Prosper.com.

Prosper.com is a website where lenders (you and me) offer small loans to borrowers, usually in amounts of $50 or greater. You can pick what candidate you want to loan to, bid on the loans, and then you collect over the term of the loan. You pick the risk and reward.

Prosper uses your money, tied up for the life of the loan, to create the loan. It does not use fractional reserve lending to create leverage to try to make more money for itself. It is the only full reserve bank in existence, other than possibly paypal, which does not offer investment opportunities like Prosper.

I love Prosper, because it rates the borrower’s credit, tells me how extended or over-extended the borrower is, tells me what they need the money for, and lets me ask questions of the borrower. I’ve been fairly lucky with my Prosper loans, making over 10% regularly with no significant losses yet.

I pick my Prosper loans to lend based on a number of concerns I have in the market as a whole. Here is how I pick who to lend to:

1. I generally aim for people with a credit rating of “B”, rather than A (better) or AA (best).  The reason I pick people with a lower credit rating is that I get a better interest rate return, albeit for a higher risk.
2. Since I pick people with not-prime credit, I also look at their DTI, or debt-to-income ratio.  I try to pick people below 20%, with 15-18% as my primary goal.  Even if they historically had some credit problems, they’re not over-extended.  People with previous credit problems will usually explain why they’re a higher risk.  If their reasoning is acceptable, they’re a lower risk to me than someone with AA credit who has a higher-than-20% DTI.
3. I look for borrowers who need the money for specific reasons that should not rely on market troubles.  I will never loan money for property investments or maintenance.  I will never loan money for businesses that blossomed during the housing boom (coffee shops, restaurants, marketing groups, etc).  My favorite area to lend to are people who need to purchase equipment for work or for their businesses.  As a small business owner myself, I know how hard it is to buy something you desperately need, such as a new printer or vehicle or other acquisition.
4. I look for borrowers who have a good grasp of the English language.  People who misspell or can’t use proper grammar are out, instantly.

One nice thing about Prosper is that you can be as prejudiced as you want.  If you don’t like a certain industry, don’t lend there.  If you don’t like what a person says or how you feel they live their lives, you don’t have to lend there, either.  Because Prosper also allows you to choose your own collections firm, you have a second back-stop to trying to prevent permanent default.  Since you can lend as little as $50, you can vary your total loan money to many different people, hoping to reduce default rates.  I tend to loan a lot to one person rather than a little to many, especially if I see an opportunity that others ignore due to a lower credit rating or an odd request.

If you’re looking for a reasonable place to invest, I highly recommend Prosper.  They’re as close to a full reserve bank as possible, and you have unlimited options to manage your risk/reward ratio.

Prosper offers me a $50 bonus for signing up friends and collegues.  If you’re interested in signing up, please e-mail me today and I will send you a referral link.  Proceeds I receive from referrals go to pay for the Global Unanimocracy Network.

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Date: June 19th, 2008, Filed under Full Reserve Banking

Chicago, IL
By A.B. Dada
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It’s a wonder that so many people are debating the idea of whether or not to bail out the banks from their losses during the subprime “crisis” that we’ve been warning about for years here. There’s two schools of thought: bail out the banks by boosting their reserve assets through additional monetary inflation (Federal Reserve/Treasury collusion to print more money), or let the fail. Both sides ignore a market truth that needs to be settled during this crisis: fractional reserve banking always leads to bank failures and bank bailouts.

In the short history of the U.S. central bank (since 1913), we’ve seen the problem of bank runs rear its head over and over. We’ve had numerous big bailouts over that time-frame, but we also have a daily form of bailing out called the Discount Window that the Federal Reserve uses to shore up bank reserves that go below the Central Bank’s mandate. The Discount Window is where banks can borrow money against assets held to keep their reserves over a certain pre-set percentage (thought to be 10%, but it could be less). The problem with this discount window is that the assets used to borrow short term money from the Fed are assets that are generally already guaranteeing other loans to borrowers. The bank is allowed to double-dip. In the past, the discount window was for a VERY short period of time, usually overnight, giving the bank time to acquire private deposits or investments to shore up that reserve ratio.

Because of the banking crises we’ve faced, the Fed has allowed banks to borrow money “overnight” for 30 days, and extend it almost indefinitely. This gives banks little reason to acquire their own private deposits to back up their ratio. What is worse is that the Fed’s money may allow the banks to save more than their reserve requirement, and when this happens the bank can now create new loan money “out of thin air.” If a large bank is mandated to keep a 10% reserve ratio (10% cash versus 100% loans) and it drops to 9%, it can borrow from the discount window to bump it up. Let’s say the big bank borrows enough to bump it up to 12%. This now allows them to loan out an additional 20% to new borrowers, which increases the bank’s leveraging risk, and causing price increases through new monetary inflation.

The bifurcation between the overnight rate and the lending rate gives banks reason to try to extend as many loans as possible versus their reserve ratio. If the bank borrows at 2% and lends at 7%, why wouldn’t the bank take huge risks since the money can be re-borrowed again and again?

My solution is to neither bail out the banks nor let the fail, but to remove the Federal Reserve from the picture entirely. If banks need money, they can acquire it from depositors by offering a generous and competitive interest rate (higher). If the banks have too much money, they can loan it out at generous and competitive interest rates (lower). The Fed’s artificially low interest rates give the banks almost no reason to try to get private depositors. They can borrow at ridiculously low rates and lend at ridiculously low rates. This is a long term problem that is made worse and worse by the Fed’s ever loosening rules for how banks can borrow money for the “short term” (which ends up being the long term).

The Fed’s policies are the number one reason for bank failure. Requiring just 10% reserves means the bank may loan out 900% more than they legally could in a free market. Allowing the bank to borrow money at low interest rates and lend at higher rates means the bank will take higher risks with taxpayer dollars than they might with private depositor dollars. Freeing the bank from paying on their defaults due to protection from the FDIC means the banks will take much higher risks with the money they’re lending out. The Fed is, and will always be, the number one enemy of a country’s economy. Savers create wealth and price stability, borrowers create unhealthy price increases.

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Date: December 19th, 2007, Filed under Full Reserve Banking

One question I hear often about full reserve banking is how a bank would supply capital (money) for a person borrowing a mortgage, or a loan towards buying a house. Since the bank can only loan out money that is deposited, and untouched, by others, some people see a problem in depositing money that is tied up for 30 years. Hopefully this article explains how such a system would work, and why it would be better than the current fractional reserve banking and central banking system.

Read the rest of this article at the full reserve banking site.

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Date: December 10th, 2007, Filed under Full Reserve Banking

In a fractional reserve banking system, credits cards and other unsecured lines of credit are not very different from how a bank handles the financial end of mortgages and loans: because it only needs to keep a small reserve from depositors in their vaults (digitally or physically), it can loan out the rest in the form of loans and lines of credit. If the reserve was set to 10%, the bank could use 90% of a deposit for credit cards or mortgages and other loans.

In a full reserve bank, credit card lines of credit (unsecured) would still be available, but the process at which the bank covers purchases made on the credit cards is directly tied to depositors who want a higher return on their investment. In the case of a mortgage or loan secured with an assets (say, a house, car or business), the interest rate paid to investors is lower as there is an asset backing the deposit. In the event of a delinquency from the borrower, the bank would repossess the asset, sell it, and pay back the depositor based on what the asset sold for. Since credit cards are unsecured, a depositor would want a higher interest rate to overcome the risk of delinquencies.

Read this entire article at the full reserve banking site.

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Date: December 6th, 2007, Filed under Full Reserve Banking

Since all businesses must make a profit to survive, a bank’s ability to make a profit sets its ability to stay in business. Modern, fractional reserve banks make their profits in a multitude of ways: fees, profits from investing people’s deposits, and other collections they receive. Since a fractional reserve bank makes its profits from investments by using other people’s money (even without them knowing it), I don’t believe it is a moral profit.

A full reserve bank, on the other hand, is not allowed to use your deposits to make itself money, without your approval and commitment to also taking a risk. If you deposit US$10,000 in a full reserve bank, the bank has to be able to pay you your US$10,000 on demand, as well as all other depositors if they want their money as well. A fractional reserve bank would have to borrow money from other banks, or the Federal Reserve, if everyone wanted their money — a fractional reserve bank doesn’t have to actually save your money from loss.

Read the rest of this article at full reserve banking

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Date: December 5th, 2007, Filed under Full Reserve Banking

In both full reserve banking and fractional reserve banking, we have the adjective of “reserve.” It is this adjective that is part of the fraudulent aspect of fractional reserve banking, as its definition can vary from country to country and even bank to bank.

At the simplest definition, a reserve for a bank defines what the bank holds as security against a depositor’s balance. In a full reserve bank, if you deposit US$10,000, the bank physically stores US$10,000 for you against theft, fire and other calamity. In a fractional reserve, the bank is regulated (usually by the government) in how much it must reserve, but it doesn’t have to reserve the total amount. If the official regulated reserve ratio is set to 10%, the bank must keep at least 10% of your deposit in reserves, but is free to do what it wants with the rest. If you deposit US$10,000 in a fractional reserve bank with a 10% regulated reserve ratio, the bank must keep US$1000 in reserves, but can loan out the other US$9,000.

Read this entire article at the Full Reserve Banking site.

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