Irina Natasha

008201400047
Accounting 2014 - Taxation
Fractional Reserve Banking, Client Collaboration, and
Fraud
I.

Motivation (Research Question)

whether maturity mismatching and fractional reserve banking
are fraudulent

II.

Theory
1. General
- A deposit is defined as a contract where the depositors deposit
goods with the depositary because they wish for the depositary
to safe-guard the goods, while retaining at all time the
availability of their use.
- A loan involves the borrower relinquishing the availability of
the car, olive oil, or money for a specified time period.
2. Evans
- Fractional reserve banking that arises out of lending money
placed with the banker for the explicit purpose of safe-keeping
and nothing else (a storage contract) amounts to fraud.
- Callable loan: Deposits that promise redeemability of money
while openly lending it out further do not involve a violation of
any contract or fraud. Evans describes this type of redeemable
deposit contract as a loan may be callable, and be repaid
upon the lenders demand.
3. Bagus and Howden (BH)
- Fractional reserve banking that involves the loaning out of
money placed in a redeemable checking account violates the
initial terms of the contract (safe-keeping and availability).
Since a loan contract does not promise the constant availability
of money, but only that the money be repaid when the loan is
due, such maturity transformation is not illegitimate.
- Aleatory contract: classify a fractional reserve demand deposit
contract showing that it may be considered, at best.
4. Barnett and Block (BB)
- The over determination of property titles representing an
inherent conflict of rights applies in the case of both fractional
reserve banking and borrowing short and lending long and
hence see both these practices as fraudulent

III.

Hypothesis
Could not it be that fractional reserve banking, even if we were to
accept the aleatory label, could have a prominent role to play in a free
society?

IV.

Methodology (using case)

Depositor A deposits $1000 cash in checkable deposit account at

Bank B.
Bank B issues a checking deposit with a balance of $1,000 and gives
A a check book, debit card, and ATM card. A is free to with- draw
cash at any time; he may write checks or even pay for goods using
his debit card.
The actual cash or money is with the bank.
Over a few weeks Bank B learns of As spending and redemption
habits. Every week A only withdraws $50 in cash while making
payments worth $100 using her debit card. Bank B makes the call
that if it were to keep and maintain $100 in reserves and lend out
the rest, it will be able to satisfy redemption demand as well as
meet contingency redemption for A with ease. So it proceeds to lend
out $900 in cash.

First Conclusion: BB claim that the Bank has committed fraud, for the
bank has managed to nearly double the money supply in this
economy.
-

Depositor A deposits $1,000 in Bank B. This time Bank B keeps

$1,000 as cash reserves and makes loans worth an additional
$1,000 to Borrower C by checking deposit.
Hence, the bank has made loans this time by issuing more money
substitutes.
It is clear to see that the bank has effectively created money,
since now there is $2,000 worth of checking deposits backed by only
$1,000 cash.

Second conclusion: At that point still, no fraud would have been

committed. For as long as people choose not to redeem for cash, the
ability of banks to create money is enlarged.

V.

Result

VI.

Conclusion

1. There is more common ground between the views of BH and Evans

than meets the eye regarding the possibility of contractual
arrangements that lead to legitimate fractional reserve banking.
2. Using current common law definition of fraud, one cannot classify
contractual fractional reserve banking as fraudulent on the charge
of its ability to create money.
1. Both BH and Evans agree that there is one type of contract under
which fractional reserve banking may be rightfully seen as
fraudulent, the storage or bailment con- tract.
2. Demand deposits of the type defended by the free bankers have the
same essential features as the aleatory contract.
3. The disagreement between can thus be seen no longer to be on the
question of ethics, rather one of practice as to how much such
contractual arrangements may proliferate in a free society.
4. One cannot classify fractional reserve banking as fraudulent on
account of money creation alone for it is impossible for the bank to
pull it off without requisite client collaboration.