Help keep family & friends informed by sharing this article

Ralph Musgrave.

The reason private banks are subsidized stems from the basic nature of the existing and flawed monetary system: “fractional reserve banking” as it is sometimes called.  For anyone new to this subject, that system will seem strange, but briefly it works as follows:

Most of the money in circulation is created by private banks, and those banks create  money  when they grant loans. When a bank grants a loan, it gives units (which it calls “pounds”, “dollars” etc and which it creates out of thin air) to the borrower, who then spends those units, i.e. passes them on to other people [1].  Those units are actually just a promise by the bank to convert those units to central bank cash, pounds or dollars, when the holder of those units so wishes. This, despite the reality that  private banks have nowhere near enough central bank cash to convert ALL the “promises to pay” into cash [2]. In fact your bank does a bit of this“conversion” when you go to an ATM and ask for $100: the bank supplies you with $100 worth of central bank dollars (i.e. physical cash) as long as you have at least $100 worth of “promises to pay” in your account.

But that system has collapsed regular as clockwork ever since banks in their present form first started centuries ago. That is, private banks have repeatedly gone bust. Thus to ensure that this chronic system soldiers on, governments stand behind, i.e. subsidize private banks.

The subsidy comes in different guises, of which three are as follows:

Three forms of subsidy

First, there is taxpayer backed deposit insurance. Being insured by an insurer with an infinitely deep pocket thanks to the insurer’s ability to grab limitless amounts of money off taxpayers is, in effect, a subsidy. Doubtless there are ship owners and others who would like to be insured by an insurer with an infinitely deep pocket, but that luxury is not available to them, thus what we have here is preferential treatment for banks and depositors.

Second, banks are only one of several types of lender. For example pension funds and mutual funds lend when they purchase corporate bonds, but there is no government bail out for those funds if they fail. Plus millions of firms lend when they supply goods on credit to customers. Government will not bail those lenders out either. Thus banks enjoy preferential treatment – effectively a subsidy – relative to other lenders.

Third, if a bank fails despite the latter two subsidies, then as a last resort there are multi billion dollar bail outs available for banks in trouble.

The basic problem here is letting private banks issue or “print” their own home made money (those “promises to pay”) while also letting them grant loans. The problem is that if a bank makes enough unwise loans, the value of the bank’s assets (those loans) then falls below the value of the “promises”: the bank is bust. (Incidentally, note that the latter problem does not arise with forms of privately issued money where there is no promise that the money units issued are totally safe: Bitcoin is an example of “unsafe” money.)

There is a better and Just way

But there is an easy solution to that problem, which dozens of economists have advocated for about a hundred years now, which is to outlaw those promises, which at best are flawed if not actually fraudulent. That ipso facto means a big cut in the supply of money, but that’s easily made good by creating and spending CENTRAL BANK money straight into the private sector or into the economy generally. Incidentally, the Nobel economist Maurice Allais said the latter creation of “promises to pay” by commercial banks was essentially counterfeiting [3].

The process of “creating and spending central bank money” straight into the economy mentioned just above is not technically difficult: it can be done in the way suggested by Congressman Dennis Kucinich in his NEED Act (HR2990 2012). In a Fortune article [4], Ben Bernanke said he saw nothing much wrong with something along the lines of the Kucinich system. Plus a Kucinich type system was supported by a group of academics in a submission to the UK government’s main investigation into the 2007/8 bank crisis [5]. As Bernanke and the latter academics made clear, if the government machine as a whole (i.e. politicians and central bank) creates money and spends it, it would be wise to keep politicians away from the printing press: i.e. there needs to be some sort of committee of economists, maybe at the central bank, which decides the amount of money to be created, while politicians retain control of strictly political decisions, like whether the extra money funds infrastructure, education, tax cuts or whatever.

Debt based and non debt based economic activity

Since privately issued money comes into being when a private bank grants a loan, i.e. causes someone somewhere to become indebted to a bank, the net effect of banning those promises would be less debt-based economic activity and more non-debt-based activity. Given the never ending complaints about excessive private debts, it’s hard to see what would be wrong with that.

Another effect would be that instead of everyone having a totally safe bank account available to them in the form of an account at a private bank which is only safe because of government backing,  they would have a safe account actually at the central bank. So called, “Central Bank Digital Currency” is an example of that. An alternative (advocated by the UK monetary reform group, Positive Money) would be to have safe accounts run by existing private banks, but insist that every dollar in such accounts is backed by a dollar held by the private bank at the central bank [5].

Having done that, there remains the question as to how to organise bank loans. Well the answer is to fund loans in exactly the same way that the above mentioned pension funds and mutual funds fund loans: anyone who wants to fund loans with a view to getting some interest puts their money into a fund run by a bank. As with pension funds and mutual funds, the person buying in to the fund takes a risk: they may make money or lose money.

And if the effect of that is to make loans more difficult to obtain, i.e. if the effect is a rise in interest rates, that is not a valid objection to the system proposed here (which is sometimes called “full reserve banking”). First, there are well known problems with low interest rates, e.g. asset bubbles. Indeed in the UK the rate of interest paid by mortgagors in the 1990s was about THREE TIMES the rate paid nowadays. The sky did not fall in in the 1990s: indeed economic growth was better than it is now, plus house prices, in real terms, were about half what they are now. (For a list of about sixty economists who support full reserve, see [6].)

Second, it is widely accepted in economics that a subsidy does not make sense unless there is an obvious social justification for it. Thus anyone who wants to defend the existing bank system and the bank subsidies involved needs to explain what the big social benefit of those subsidies is.

And finally, if disposing of bank subsidies is so simple, why, you might ask, has the above solution not been implemented? Well Milton Friedman, who backed full reserve banking, answered that. As he said in the preface of his book “A Program for Monetary Stability”, “The vested political interests opposing it are too strong.” In the UK, the finance industry spends about £100 million a year on lobbying, i.e. making sure politicians implement policies that suit the  finance industry rather than the country at large [7]. That is the existing system under which private banks take excessive risks and keep the profit when that works, while having taxpayers bail them out when it doesn’t suits private banks just fine.

Ralph Musgrave is the author of the book The Solution is Full Reserve / 100% Reserve Banking and runs the economics blog “Ralphonomics”.


  1. Money Creation in the Modern Economy” by Michael McLeay, Amar Radia and Ryland Thomas. See first few sentences.
  2. The Proof That Banks Create Money”, published by Positive Money. Word search for “promise” in the latter work.
  3. Credit Markets and Narrow Banking” by Ronnie Phillips. See opening sentences.
  4. Here’s How Ben Bernanke’s Helicopter Money Plan Might Work by Chris Matthews. Fortune. See para starting “A possible arrangement….”
  5. Towards a Twenty First Century Banking and Monetary System” by Ben Dyson, Tony Greenham, Josh Ryan-Collins and Richard A. Werner. Re how money is created under this system, see p.10-12. As for accounts at commercial banks which are backed by base money / reserves, see p.7.
  6. Our Fractional Reserve System is Nonsense by Ralph Musgrave.
  7. Revealed: The £93m City Lobby Machine” published by the Bureau of Investigative Journalism.

Share Now

About The Author

Notify of

1 Comment
oldest most voted
Inline Feedbacks
View all comments
Lucille Eckrich
3 years ago

Great piece, Ralph! Thanks! It took me a bit longer to read than AFJM’s “5 minute” estimate, but every moment longer was well worth it. You make a cogent, clear, compelling case for sovereign just money reform. Now we just have to get more of the public and their elected officials to read it, and other contents on this AFJM website. ~~Lucille