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Encyclopedia > Full reserve banking

Full-reserve banking is a theoretically conceivable banking practice in which all currency circulating in a financial system would be backed up by an asset that is generally considered to be a stable store of value, such as gold. This implies the existence of a government body (such as a central bank) that would convert currency to a more stable type of asset if requested to do so. It also implies that the resources available to the central bank (and commercial banks) would be sufficient to convert all currency if so required.

The cash reserve ratio of all banks operating in such a system would be 100%, making the deposit multiplier equal to zero. In such a system, commercial banks would have no obvious incentive to extend loans.

A system in which all currency is backed by another asset and commercial banks are required to maintain a 100% cash reserve ratio has never been implemented in any actual economy. The closest system is that of a currency board, in which commercial banks are not required to maintain a 100% cash reserve, but all of the money in circulation is backed by another asset held by the central bank. This system is in use in Hong Kong where the Hong Kong dollar is backed by United States dollars deposited in the Exchange Fund of the currency board.

More recently, since 2000, a new form of currency called Digital Currencies have emerged. Many of these currencies are in fact full-reserve "banks" and have a one to one ratio of the currency they issue and the hard asset, usually gold, that they keep in reserve. The most prominent examples are e-gold.com and goldmoney.com

See also: fractional-reserve banking.



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