Suppose that banks today were required to keep 100 per cent reserves against their deposits. What would be the result?
If banks were required to keep 100% reserves against their deposits, it would imply that they would have to hold onto the entire amount of deposits received from customers and not lend or invest that money. This system is known as full reserve banking.
Here's how you can logically reason the potential effects of implementing full reserve banking:
1. Limited lending and investment: Banks make profits by lending out the funds deposited by customers or investing them in various financial instruments. If banks were required to keep 100% reserves, they would no longer have funds available to lend or invest. This would significantly restrict their ability to generate profits from interest on loans or investments.
2. Decreased money supply: One of the consequences of full reserve banking would be a decrease in the money supply. Since banks would hold all customer deposits, there would be a reduced amount of money circulating in the economy. This could lead to a decrease in consumer spending and economic activity.
3. Increased banking stability: Full reserve banking could potentially make the banking system more stable. With all deposits backed by reserves, there would be little risk of bank runs or failures. Customers would have greater confidence in the safety of their deposits. However, this stability could come at the cost of limited economic growth and reduced access to credit.
It is important to note that the implementation of this system would have both positive and negative consequences, and its impact would depend on various factors, including the specific regulations and policies in place, as well as the overall economic conditions.