Are the Public Ignorant of the Nature of Fractional Reserve Banking?

The short answer is, of course, that there is no doubt some degree of ignorance – perhaps even a great degree of ignorance – about the nature of fractional reserve banking amongst the public, but as to what percentage of people are ignorant I would prefer to see more than one well-sampled survey before giving definitive numbers. One survey that is available from the UK that can be read here (“Public Attitudes to Banking. A Student Consultancy Project by ESCP Europe for The Cobden Centre,” June 2010) finds that 74% of people surveyed (in August 2009) thought that they were the legal owner of the money in their FR current account (p. 6). A further 16% thought that both the bank and the depositor were joint owners of the money (p. 6). Only 8% knew that the bank was the legal owner (p. 6).

Now 74% is indeed a high percentage, but what is very interesting to me is that, despite this number, 61% of people surveyed also said that they did not mind the bank lending out some of the money in their current account as loans (p. 8)! Only 15% said that they keep money in a FR current account for safekeeping (p. 5).
Furthermore, only 33% thought that the bank lending out some of the money from their current account was wrong because they did not give permission (p. 8). This strongly suggests to me that in fact if people were properly informed of the legal nature of FR banking (with the proviso that their debt/deposit is insured), they would not object to the actual practice of FR lending or its legal status. People want banking services with a return on their money. A majority do not mind that the bank lends their money, even though a majority most also think that they remain the legal owner of the money.

Now of course the objection that can be made to fractional reserve banking is that a majority (at least from this UK survey) do not understand the legal nature of the FR contract as a mutuum. In response to this:

(1) The existence of bank runs strongly suggests that historically many people have understood the basic facts behind fractional reserve banking. Bank runs were frequent during financial crises before the 1930s when modern fiat systems and deposit insurance generally became the norm. Now I cannot resist posting this video of one of the best movie bank runs I can think of, because it really does illustrate the issues involved.



Even as a fiction, it is illustrative. In order for such bank runs to have occurred, many people must have understood that the banks do not operate on a 100-percent-reserve basis. Nor am I insensitive to the suffering and negative economic effects caused by the failure of a FR bank (see point (2) below).

I suspect that before the 1930s there was probably a greater degree of public understanding of the nature of FR banking (though I would need empirical evidence to prove it), but in the modern world, as bank runs virtually disappeared, public ignorance has grown. Another crucial point is that before the 19th century, ordinary people did not normally use FR banking systems. FR banking was limited to the wealthy, the commercial and mercantile classes and businessmen, people who had a much better understanding of finance and the contracts they were entering into. There is, then, a strong case to be made here that the widespread ignorance of the legal nature of FR banking has only become a problem in the modern world, as ordinary people have come, in vast numbers, to open FR accounts with the money they earn.

Furthermore, people are surely aware that the money they “withdraw” from their FR reserve account cannot be the same money they deposit in a physical sense. The money you withdraw from an ATM is not the same money you may have physically deposited or that was credited to your account by electronic transfer from your paycheck. It would take but further reflection to see that the belief that your FR account is a mere bailment cannot be true.

(2) If you have failed to read your fractional reserve bank contract, whose fault is that? As a client, you ought to understand the contract that you sign. If, for example, I contract with you to lend you my wheat as a mutuum loan where I have signed a contract that explicitly states that I transferred ownership of the grain to you, but then I think that it is a mere bailment, then this is my misunderstanding. I would be a poor and incompetent businessman. There is no fraud involved, simply ignorance and misunderstanding on my part. This does not mean that there is no consequentialist moral argument for intervening to stop the distress and economic disaster caused by the failure of a fractional reserve system: on the contrary, I hold that there are strong consequentialist moral arguments for government intervention to stop the pro-cyclical nature of unregulated FR banking which lacks an effective lender of last resort. Without modern fiat money, a well-regulated financial system, deposit insurance and a central bank ready as the lender of last resort, fractional reserve banking can be extremely destabilizing and has led to disastrous bank collapses and recessions in the past.

(3) The solution to the problem of modern people not understanding the nature of fractional reserve banking – if we perceive it as problem – is simply legislation to make banks explicitly explain to potential customers when they sign a contract how FR banking works. Specifying to clients that the property rights to the money had passed to the bank, and in return an IOU or credit had been granted to the depositor, that the bank lends your money out, and that it will return not the same money, but other money from its reserves will solve the moral problem of clients not understanding the nature of FR banking. Under these circumstances, FR banking is not fraud. It is a free contract. There was very probably a strong moral argument for enforcing such legislation in the days before deposit insurance, so that people understood the risks involved in FR bank accounts.

In practical terms, however, modern FR systems are protected by deposit insurance and the central bank as a lender of last resort: there is no need to warn depositors that they could lose their money, because that simply does not happen these days. The issue of explaining FR banking to consumers is a far less pressing moral issue than it is made out to be by opponents of FB banking.

UPDATE
I have updated the post in light of this survey.