Iceland Ponders Radical Money Plan Including Elimination Of Fractional Reserve Lending And Deposit Insurance

I have long railed against fractional reserve lending, duration mismatches (e.g. banks issuing 2-year CDs and lending money for 15-year mortgages), bank’s ability to lend money into existence, and deposit insurance.  

Fractional reserve lending allows banks to lend out a near infinite amount of credit with essentially no backing. Money inevitably creates asset bubbles, but as long as the bubbles are expanding it appears the system is solvent. 

Money that depositors believe is available on demand in their checking accounts is not actually present at all. And banks are not required to hold any reserves on savings accounts at all. 

Deposit insurance is the epitome of moral hazard. It guarantees money will flow to banks offering the highest yield. Of course, banks offering the highest yields on deposits need to take the highest risks to be able to pay that interest. Depositors do not care because the deposits are insured.

Iceland Ponders Radical Money Plan

I am somewhat surprised by this development, but Iceland is investigating a banking system that will eliminate all of the above flaws. 

The Telegraph reports Iceland Looks at Ending Boom and Bust with Radical Money Plan. 

 Iceland’s government is considering a revolutionary monetary proposal – removing the power of commercial banks to create money and handing it to the central bank.

The proposal, which would be a turnaround in the history of modern finance, was part of a report written by a lawmaker from the ruling centrist Progress Party, Frosti Sigurjonsson, entitled “A better monetary system for Iceland”.

“The findings will be an important contribution to the upcoming discussion, here and elsewhere, on money creation and monetary policy,” Prime Minister Sigmundur David Gunnlaugsson said.

The report, commissioned by the premier, is aimed at putting an end to a monetary system in place through a slew of financial crises, including the latest one in 2008.

According to a study by four central bankers, the country has had “over 20 instances of financial crises of different types” since 1875, with “six serious multiple financial crisis episodes occurring every 15 years on average”.

Mr Sigurjonsson said the problem each time arose from ballooning credit during a strong economic cycle.