Narrow Banking with Modern Depository Institutions: Is there a Reason to Panic?

• Authors: Hugo Rodríguez Mendizábal.
• BSE Working Paper: 112148 | February 17
• Keywords: monetary policy , liquidity , bank solvency , narrow banking , endogenous money , interbank market
• JEL codes: E4, E5, G21
• monetary policy
• liquidity
• bank solvency
• narrow banking
• endogenous money
• interbank market

What would be the effect of imposing a 100 percent reserve require- ment to depository institutions? This paper contends that reserves do not compete with loans on the asset side of bank’s balance sheets. Thus, they only affect liquidity provision by banks indirectly through their impact on the cost of loan and deposit creation. This cost could be driven to zero if, as the Eurosystem does, central banks remunerated required reserves at the same rate of their refinancing operations. The paper argues that the crucial constraint imposed by a fully backed banking system is collateral availability by depository institutions.