Why is 100% Reserve Banking Inefficient?

Abstract

Financial crises are an important concern today. One part of the problem is banking crises, at the root of which is the bank run problem. One solution is 100% reserve banking. But this is inefficient. The reasons are, however, not obvious. The literature on bank runs following Diamond and Dybvig (1983) is based on banks? role in consumption smoothing. However, the earlier (rich) literature is based on banks? role in issuing deposits, which are a component of money and are a source of credit. In this context, a high reserve ratio for commercial banks obviously decreases commercial bank credit. However, in general, it does not decrease total credit. Despite this, 100% reserve banking is inefficient if competitive banks have a comparative advantage over the central bank in providing credit. The paper ends by examining the implications of a decrease in gold reserves held by the central banks.