Fractional Reserve Free-Banking Theory

In the economic history, the economic crisis continues to recur, recorded since 1923, 1930, 1940, 1970, 1980, 1990, and 1998, until 2008. In the book The History of Money From Ancient time to Present Day (1996), Roy Davies and Glyn Davies explained clearly the chronology of the global economic crisis as a whole. Throughout the 20th Century there have been more than 20 major crises that hit many countries. This means, on average every 5 years a severe financial crisis occurs which causes suffering for hundreds of millions of human beings.1 The phenomenon of the economic crisis above is a fundamental problem that does not end as long as the monetary system is still based on interest.

In recent decades, the growth of Islamic banking as a representation of the Islamic economy has taken a lot of attention. Islamic banking has been widely established in various countries, not only in Muslim-majority countries, but also in minority regions, such as Britain, Japan and America. Even Earnst and Young provided predictions for the development of the Islamic banking industry for years to come.

In recent decades, the growth of Islamic banking as a representation of the Islamic economy has taken a lot of attention. Islamic banking has been widely established in various countries, not only in Muslim-majority countries, but also in minority regions, such as Britain, Japan and America. Even Earnst and Young provided predictions for the development of the Islamic banking industry for years to come.

Operationally, it must be recognized that Islamic banking has not yet found a clear concept in carrying out truly Islamic banking. Because Islamic banks still apply fractional reserve banking . Whereas the fractional reserve system that has been implemented as the European banking system for over 400 years is one of the modern banking systems which economists assess as a source of systemic problems and causes crises repeatedly.

Technically, with this system banks indirectly have the ability to create their own money ( creation money ), so that the quantity of money circulating in the community can be illustrated as an inverted pyramid, namely, a basic reserve that is smaller than the amount of deposits and credit.3 Proportion of money physically represented as deposits in a bank account, where for the most part money is almost fully represented by electronic bank deposits and transfers.

As a result, it is not uncommon for banks to become a source of economic crisis, caused by lack of liquidity. Based on a number of recent studies such as Cavalcanti (2004), Singh (2009), Krainer (2013), Sanches (2013), Chary (2013), show that banks will have greater liquidity risk4 if they apply fractional reserve banking. The structure of the global economy continues to experience instability and undermine the business community in the world, thereby creating poverty and unemployment which is a frightening specter for everyone.

FRACTIONAL RESERVE THEORIES

  • Positive Moneydomiciled in the UK,
  • New Economics Foundation(NEF)
  • Chicago ‘plan,
  • Narrow Banking
  • Limited Purpose Banking(LPB).

POSITIVE MONEY AND NEF

  • The Positive Money and New Economics Foundation (NEF) aims to ensure that commercial banks no longer have the ability to create money and separate payment systems from lendingaccounts (investment creation) and investment activities carried out by banks.
  • PM and NEF are more technical by creating new accounts that can be used by banks such as Transaction accountsInvestment accounts and Operational accounts .

Chicago Plan

  • The criticism of Chicago economists in general lies in the ability of the fractional reserve bankingsystem that banks use to create money out of nothing .
  • Chicago economists propose a series of plans, one of which is by advocating the separation of the functions of money and bank credit.
  • Implicitly, at least the role of banks will be divided into two, namely as ” money banks”and ” credit investment trusts “.

Narrow Banking

  • Narrow banking’s proposal is to remove the ability of banks to utilize government insurance or guarantee deposits and demand deposits. Deposit insurance can only apply to backing upliquid assets.
  • Narrow Banking provides two main services, namely payment systemand savings.

Limited Purpose Banking (LPB)

Under the LPB, all financial industries have limited liability to be operated like holding companies through a mutual funds mechanism . All intermediary forms in this proposal are treated equally to create a simpler system where there is no government guarantee. Mutual funds are not allowed to lend funds except for equity -based investments

 

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