Fractional Reserve Banking, Option Clauses, and Government

The anti-fractional reserve banking (FRB) Austrians sometimes allege that FRB would not have survived without governmental intervention. By this, they usually mean that governments sometimes allowed suspension of specie during financial crises. While that is true, many times governments have legislated to stop banks from inserting “option clauses” in their demand deposit contracts allowing them suspend specie payments for a temporary period.

The so-called “option clause” (to suspend specie payments temporarily) was used freely in private FR banking contacts in Scotland from 1730–1765, Sweden from 1864–1903 and Canada during the 19th century (Selgin 1996: 247). The banks required no government support or intervention to allow them to suspend specie payment in liquidity crises, to stop runs and bank collapses.

The option and discretion to create an option clause in a bank’s FR contract gave the bank the right, in some circumstances, to suspend payments temporarily until it was able to obtain the liquidity needed for meeting obligations (Barth et al. 2001: 30). When its customers accepted such a contract, this was a perfectly voluntary and successful example of free contact: a “wicked” or “evil” government was not needed to enforce temporary suspensions of specie payment in such a case.

If that “option clause” was in your contract and the bank decided to suspend for a temporary period, this was not fraud, but free contract. Nor was government required for this process to arise and operate in free markets with fractional reserve banking. Nor was government required for the origin and success of fractional reserve banking.


BIBLIOGRAPHY

Barth, J. R., Brumbaugh Jr., R. D. and G. Yago (eds.), 2001. Restructuring Regulation and Financial Institutions, Kluwer Academic Publishers, Boston, Mass. and London.

Selgin, George A. 1996. Bank Deregulation and Monetary Order, Routledge, London and New York.