Will the banking system be tested?

Fractional-reserve banking is the elephant in the room.

When the financial crisis is discussed, the (nature of the) banking system itself is rarely mentioned as a possible root cause. Many euphemisms have been generated such as "getting the banks lending again" and "lost confidence" but people apparently feel unable to discuss the actual situation.

http://www.phrases.org.uk/meanings/elephant-in-the-room.html
An important and obvious topic, which everyone present is aware of, but which isn't discussed, as such discussion is considered to be uncomfortable.

Why don't people think that it is profitable to mention Fractional-reserve banking?

The main reason, it would seem to me is a fear that to mention it creates a larger problem of (further) reduced "trust" in the banking system. There is a fear that widespread knowledge of the way the banking system "works" will result in a devastating collective bank run.

But it must be clear by now that those who are curious will already have a fairly good understanding of at least the general nature of the problem, if not the intricacies. They will be at least vaguely aware that Fractional-reserve banking might have something to do with the problems.

If the Authorities were to announce that a collective bank run is not a threat because they would print all the money necessary, it would allow people to discuss the system. They might be alarmed to discover that the Authorities are willing to print the money in this manner... but that would be at least moving the discussion forward. People would then (perhaps) question the wisdom of allowing commercial banks to force the hand of the Authorities by creating credit which must be replaced eventually with cash.

If the Authorities persistently refuse to confirm that they are willing to print money in this circumstance, people will come to suspect that not all bank deposits can be redeemed. This can lead to a continued stand-off whereby the public, collectively do not want to trigger a collapse of the banking system and so continue to pretend that they have no doubts.

In Argentina the general public decided to test the banking system, whereas in Japan they allowed it to go untested.

Given that the percentage of the population who have significant bank deposits is relatively minor, that would suggest a willingness for the banks to be tested is likely but it would need to be those with significant deposits (with the most to lose) who would need to make the withdrawals. So in a sense, it would be a rebellion of the middle-class and the rich (as in Argentina) for the banking system to be tested.

The public might not want to test the banking system (collectively) but if they decide (or fear) that it will be tested this will precipitate (further) withdrawals.

If people think that it will, then it will be tested... who can say?


20th February 2009

Surely the public don't have an appetite for Corralito: http://en.wikipedia.org/wiki/Corralito? (21st Feb'09)