A Deeper Look
Impact that the distributed ledger technology (DLT) has had on the broader banking world is very significant as the transactional nature of this new technology will improve decentralization, anonymity and efficiency. I touched briefly on the potential of DLT to facilitate a Transparent Asset Liquidity Settlement and Storage System (TALSSS) in my two part series The Alternative Asset Clearing and Settlement System Part 1 and Part 2. This post I want to look deeper t the topic of the structure of the current fractional reserve system, and how a DLT such as TALSSS combined with a full reserve banking model present a genuine opportunity to create a sustainable, ethical and functional banking relationships and systems.
The Sum is Greater Than The Part
As explored in part 2 a TALSSS introduces all the advantages of a DLT system such as decentralization, privacy, instantaneous settlement between buyers and sellers and further provides “a very clear and transparent structure of ownership which is extremely valuable during a general market and economic crises.”4. Although this distributed ledger clearing system is a necessary component, it is not in itself sufficient to ensure the effective operation of a TALSSS. The banks participating themselves must ensure that their own internal banking ledger technologies are compatible with the values of this DLT. We will explore the advantages that a 100% reserve, no debt and no lending structured bank can provide to the marketplace, and how this banking structure enhance the efficiency and effectiveness of a TALSSS. Currently most if not all banks in general are operating under a fractional reserve banking model. This means that only a portion of a client’s deposits are held reserve and available for withdrawal on demand. In his work An Overview of the Canadian Banking System: 1996 to 2015 Robert J. McKeown provides some very thorough data on the actual balance sheets of the grouping of Canadian banks that made up the financial system from 1996 to 2015. On page 16 of his research paper he shows a progression from 1997 to 2015 related to assets and liabilities of all Canadian Banks. In 1997 the Office of the Superintendent of Financial Institutions (OFSI) shows a total of 609 billion in total loans and 94.7 billion in cash equivalents on the banks’ balance sheets for a total cash to loan ratio of 15.54%. Compare this to 2015 where the total loans are 2491.6 billion and total cash equivalents 268.1 billion for a cash to loan ratio of 10.8%. This model of fractional reserve banking allows the banks to incumber, loan and hypothecate clients’ assets and cash deposits in the aim of increased banking profitability. Generally, the risk associated with the fractional reserve banking structure falls upon depositories who receive a very small reward for capitalizing the banking system. Although consumers should have the option to choose to put their capital in a leveraged fractionally reserved bank, there is an alternative for consumers which aligns more with the application of distributed ledger technology to banking.
A 100% Reserve Cryptographic Banking Model.
The idea of full reserve banking is not revolutionary in any sense as banks in the past operated simply as depository institutions which were tasked to protect assets in exchanges for fees. I will not go over the history of banking in great detail in this post but for a good guide to early and modern banking I would recommend reading Richard Hildreth The History of Banks. The bank that I utilize as a reference for our thought experiment is the seventeenth century Bank of Amsterdam as the “profits of the bank were made by these commissions, and by the premium it obtained on the sale of coin, bullion, and bank money. It made no loans; and therein differed essentially from our modern banks.” If a financial institution is to take clients deposits it should not leverage deposits and hypothecate them as loan collateral unless such arrangement is made clear to all parties of the bank account contract. The modern bank agrees to provide its clients with some nominal interest rate in return for fiduciary power to risk assets in such a manner which is in line with the bank’s general strategy. The structure of the current interbank clearing and settlement systems is defined in such a manner that clear ownership of assets is often long and arduous to ascertain, additionally the banks fractional reserve lending practices further exacerbates structural instability at the detriment of liquidity settlement. These structural limitations open a niche market opportunity for entrepreneurs to offer banking services that facilitate a Transparent Asset Liquidity Settlement and Storage Systems for digital currencies while maintain a 100% client deposit reserve ratio. Not only are we utilizing blockchain and distributed ledger technology for asset clearing, storage and management, but given that a bank’s assets are all 100% fully liquid and the bank itself has no debts the parties utilizing such banking and settlement services will be provided with long term structural stability. Such a structure would not come without a cost and the consumer would recognize the need for a reasonable premium to be earned by the bank for it to forgo the profit it would make as a member of the fractional reserve baking system. The fee details could be established in a transparent manner and there are many ideas as to how one can structure this, but the main point to take away is that such a bank would reduce current risk substantially for its clients.
A Call Out to the Community
In conclusion, I hope to be able to flush out this topic in more details, and it would useful to get some feedback from you ‘the community’ as to how you would expect the fees of a bank with this form of full reserve crypto currency and asset clearing services to be structured. As we push forward with blockchain and distributed ledger technologies we must also push for the general reorganization of our banking business structures to align with the values of our communities. Such a large opportunity to take back our communities’ currencies and manage them in line with values may not present itself again so we must act as time is of the essence.