An Assessment of Fractional Reserve System Based on Efficiency and Justice Benchmark

A fundamental question in examining the monetary system is "who should have the right to create money?" The response provided by the conventional monetary system (fractional reserve system), is to distribute this right between the central bank and commercial banks. But this "historical response", is a "Public Choice", not necessarily based on efficiency or equity. In recent decades, eminent economists such as Simmons, Fisher, Friedman and Tobin have criticized fractional reserve system from different points of view and have recommended a reform toward full reserve banking. Among Muslim economists, Monzer Kahf, Mohsin Khan, Mirakhor, Dallali and Al-Jarhi have such a view. In the present paper, using documentary research method, the theoretical basis of the full reserve banking and the views of its most famous supporters are examined. Then, the most important criticisms regarding the fractional reserve banking are described from two points of view: efficiency and justice. In terms of efficiency, the main critique of the fractional reserve system are: the aggravation of monetary shocks and escalation of macroeconomic fluctuations, increasing the risk of bank-run, the need for increased government interventions and complex regulations, inefficient allocation of resources as a result of information asymmetry, and the continuous increase of public and private debt. On the other hand, in terms of justice, the main critique of the fractional reserve system are: granting the power to decide about the most important near-public good to private-motivated enterprises, institutionalizing usury (interest) in contracts, violating distributive justice (bankers' monopolistic profitmaking vs. loading banking system losses on the general public), and the transfer of assets ownership without complying with legitimate property rights.