Robert P. Murphy does not understand banking

In his article Banks Can Perform Their Two Functions With 100% Reserves, Robert P. Murphy writes:

Let’s start with the basics: There are two functions that banks serve:

(1) They act as credit intermediaries, in which the banks take funds from savers and channel them to borrowers.

(2) They act as warehouses, in which the banks store their customers’ deposits in huge vaults and provide services such as check-clearing and ATMs.

Murphy does not get the basics of banking right. Actually banks perform two main functions: payment managers and financial intermediaries (debt or credit intermediaries). Banks are not money warehouses; deposit contracts are not warehousing contracts. Banks perform their payment management function by issuing their own liabilities (bank notes and demand deposits) and ideally backing them with very short term and very low risk assets. Only a small part of those assets is money proper, therefore banks naturally operate with fractional reserves. Bank liabilities are not money in the strict sense (outside money, probably some commodity) but money substitutes, promises to pay money, fiduciary media (inside money). They are used by their clients because they can be more convenient than using only money. The problem with banks is not fractional reserves, but maturity and risk mismatch between their liabilities and assets (borrowing short and low risk and lending long and high risk).

According to Murphy:

100% reserve banking is possible in a market economy.

It is possible in the same sense that less efficient and competitive agents are possible: in principle they are not impossible, but competition tends to expel them from the market.

100% banking could work, yes: badly.


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