I AGREE with Jim Stamper and Robert Ingram (Letters, December 15) that Scotland should move to its own currency and Central Bank as soon as practicable after independence (and “as soon as practicable” is really all you need for the official policy – no 10 years’ delay, tests and sundry other garbage!), but I do have a degree in economics and I can’t see any sense in the idea of “full reserve” banking.

In fact I think it would be impractical, dangerous (all loan funds would be provided by the state via the Central Bank), and bad for the economy. In a strange sort of way, actually it would be zero reserve given the Central Bank holds essentially nothing to back the money it issues.

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The old building societies were not full reserve, and in fact I doubt if there has been any full reserve bank anywhere at least as far back as the Florentines and Lombards developing the forerunners of modern banks.

A full reserve bank would not be something we would recognise as it would be little more than a safe-deposit box. If you have to keep 100% reserves against the value of all accounts (eg by a deposit at the Central Bank) then you can’t lend at all (other than any shareholder’s funds – usually tiny), so there would be no credit cards, mortgages, and the like from commercial banks.

You would also have to pay fees to cover the costs of running the accounts, since the only income of the bank would be interest paid on deposits by the Central Bank (generally small).

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The problem in 2008 wasn’t fractional reserve banking as such, but regulators and banks colluding over many years to game the system. So in the old days you had a simple rule, eg 10% reserves across the board on all accounts. Then some clever person came up with the idea of risk-weighted reserves. So now we classify some loans as low risk (low reserves) and others as high risk.

So mortgages, because all humans seem to have a fixation with bricks and mortar, get classified as low risk. That is despite the fact that almost every single bank failure in history has been caused by a property market crash. Strictly speaking mortgages should be classified as the highest possible risk for a bank!

Different weights for different loans also leads to flipping assets (loans) between categories. That was why flipping high-risk sub-prime mortgages into low -isk (so they said!) credit default swaps was so important – you needed much less reserves for the latter.

Generally speaking, banks can get into trouble with any lending that is long-term, and the more so when the asset is highly illiquid (as is a house – it can’t be sold quickly, and certainly not in a slump).

That was what the actual difference was with the old building societies – much of the deposit base was tied in for one year, five years etc. Plus as “members”, depositors were more loyal, and indeed many depositors would also be the borrowers.

We got rid of that by allowing building societies to become banks and banks to become building societies. The old commercial banks generally did not offer many long-term mortgages precisely because they are dangerous if your deposits can be withdrawn without notice.

That is also why you need the Scottish National Investment Bank to fund business – long-term loans (eg five years) to risky businesses (and as 90% of start-ups close within 10 years, every new business is highly risky!) are simply neither safe nor sensible for a commercial bank.

Tim Rideout
Dalkeith