How ethical have recent banking practices been? We answer this question via an economic analysis. We assess the two dominant practices of the modern banking system – fractional reserves and maturity transformation – by gauging the respective rights of the relevant parties. By distinguishing the legal and economic differences between deposit and loan contracts, we determine that the practice of maturity transformation (in its various guises) is not only ethical but also serves a positive social function. The foundation of the (...) modern banking system – the holding of fractional reserves against deposits – is, however, problematic from economic, legal and ethical perspectives. Starting from a microanalysis of money's function, a reassessment of the current laws concerning the practice is encouraged, with the aim not only to rectify economic irregularities but also to realign depositors' rights with the obligations of the banking sector. (shrink)

Many scholars and activists favor banning illicit businesses, especially given that such businesses constitute a large part of the global economy. But these businesses are commonly operated as if they are subject only to the ethical norms their management chooses to recognize, and as a result they sometimes harm innocent people. This can happen in part because there are no effective legal constraints on illicit businesses, and in part because it seems theoretically impossible to dispose definitively of arguments that support (...) moral relativism. Progress is being made, however, towards a “second best” arrangement consisting of widespread institutional agreements regarding ethical norms. This development might eventually enable us to transcend moral relativism in some respects. Indeed, although some business ethicists who examine illicit business practices accept moral relativism, others attempt to surmount it. The latters’ endeavor, I show, is cross-cultural in nature in that it involves businesses that are deemed illicit in at least one but not every culture. I then recall some traditional solutions and their limits: ideological teachings are culture-specific, hence both temporally and spatially limited; legal constraints, though potentially helpful, are too diverse hence often narrow in reach. Especially problematic are defense industry businesses, which are inherently transcultural and, though uniquely harmful, are not effectively banned in any culture. Harm to quality of life (QoL) can, however, be measured. So I recommend institutional support for international human rights tied to QoL data as a workable way to counter moral relativism regarding illicit businesses. (shrink)

Depositors have perceived banks as acting unethically during the most recent recession. One area of consternation is the ambiguity of the legal obligations entailed by the deposit contract when it is backed with only fractional reserves. In this article, we apply an existing analysis of the legitimacy and ethicality of banking practices to a wider range of financial transactions, including insurance policies, securities lending, perpetual bonds, and callable loans. Securities lending in particular creates rights violations analogous to those in fractional-reserve (...) banking. Both callable loans and perpetual bonds have clear legal obligations which are not inherently problematic, though we herein clarify what these obligations are. Finally, we apply our ethical framework to demonstrate that insurance products are distinct from banking deposit contracts, and that perceived parallels between the two products underestimate these differences. (shrink)

Barnett and Block claim that Bagus and Howden support indirectly the concept of market failure. In this paper, we show that maturity mismatching in an unhampered market may imply entrepreneurial error but cannot be considered a market failure. We demonstrate why fractional-reserve banking leads to business cycles even if there is no central bank and why maturity mismatching does not per se lead to clusters of errors in a free market. Finally, in contrast to the examples provided by Barnett and (...) Block, we assure that maturity mismatching does not imply the creation of two incompatible contracts due to the fungible nature of money. (shrink)

In Barnett and Block :711–716, 2009a), the present authors claim that borrowing short and lending long is fraudulent, and thus ought to be prohibited on legal grounds. Bagus and Howden :399, 2009) take issue with our ethical analysis. The present paper is our response to these authors; it is an attempt to defend Barnett and Block :711–716, 2009a) against the very interesting and important, although we believe, erroneous, criticisms of Bagus and Howden :399, 2009).

How ethical have recent banking practices been? We answer this question via an economic analysis. We assess the two dominant practices of the modern banking system – fractional reserves and maturity transformation – by gauging the respective rights of the relevant parties. By distinguishing the legal and economic differences between deposit and loan contracts, we determine that the practice of maturity transformation (in its various guises) is not only ethical but also serves a positive social function. The foundation of the (...) modern banking system – the holding of fractional reserves against deposits – is, however, problematic from economic, legal and ethical perspectives. Starting from a microanalysis of money's function, a reassessment of the current laws concerning the practice is encouraged, with the aim not only to rectify economic irregularities but also to realign depositors' rights with the obligations of the banking sector. (shrink)

In Time Deposits, Dimension, and Fraud (2009), William Barnett and Walter Block argue that by borrowing short and lending long there is an over issuance of property rights. Their article, however, does not fully extend the consequences of their contribution. Once this is done, it becomes clearer that their argument suits a great impediment to banking, becoming a possible reason to support rather than to oppose fractional reserve banking. Bagus and Howden (J Bus Ethics 90(3):399–406, 2009) comment on Barnett and (...) Block (J Bus Ethics 88(4):711–716, 2009), the authors claim that while maintaining the illegitimacy of fractional reserve deposits, borrowing short and lending long it is actually not illegitimate. An extension on Bagus and Howden (2009) will show that their line of argumentation can be applied as a defense of fractional reserve banking as well. (shrink)

The financial crisis has led to new interest in the ethics of financial markets. In this article, we further the debate on the nature of banking contracts by showing that the fundamental subjective purposes of loan and deposit contracts are irreconcilable. Any resultant mixture of the two contracts is a legal aberration. We consider a mutual fund as an important and legitimate alternative to the common demand deposit to provide high liquidity and some yield without offering full availability of a (...) nominal sum. Besides being a close substitute for how many deposit accounts function today, the mutual fund has the additional benefit of satisfying all legal and ethical requirements. Loan and investment contracts allow for the “bank” to make use of their clients’ funds while the intents of money owners are clearly classified without running into legal or ethical problems. (shrink)

In the pages of this journal, a fruitful debate has evolved on the ethical legitimacy of fractional-reserve banking. In this article, we respond to the new arguments raised by Evans as we clarify our position on the unethical and illegitimate nature of fractional-reserve banking. Fractional-reserve banking is not a recent financial innovation but represents a long-standing legal aberration. The co-mingling of two mutually exclusive financial contracts, deposit and loan, confounds the contracting parties’ purposes, intents, rights, and obligations. As a result, (...) it creates unsolvable legal difficulties and ethical dilemmas. While these problems are most evident in the case of a bank run, they also arise when trying to answer the simple question of “who owns a deposit?”. (shrink)

Barnett and Block (J Bus Ethics 18(2):179–194, 2011 ) argue that one cannot distinguish between deposits and loans due to the continuum problem of maturities and because future goods do not exist—both essential characteristics that distinguish deposit from loan contracts. In a similar way but leading to opposite conclusions (Cachanosky, forthcoming) maintains that both maturity mismatching and fractional reserve banking are ethically justified as these contracts are equivalent. We argue herein that the economic and legal differences between genuine deposit and (...) loan contracts are clear. This implies different legal obligations for these contracts, a necessary step in assessing the ethics of both fractional reserve banking and maturity mismatching. While the former is economically, legally, and perhaps most importantly ethically problematic, there are no such troubles with the latter. (shrink)

In a number of recent articles, the debate on the ethics of fractional reserve “free” banking has been extended to loan maturity mismatching, specifically the banking practice of borrowing short and lending long. Barnett and Block :711–716, 2009; 2010) claim the practice is illicit, because like fractional reserve banking it creates duplicate property titles. They argue there is a continuum in the time dimension between the two kinds of activities. Bagus and Howden :399–406, 2009; 106:295–300, 2012a; Eur J Law Econ, (...) 2012b; Bus Ethics 22:235–245, 2013) maintain that loan maturity mismatching does not create duplicate titles and is not illicit, and that from an economic and legal perspective there is no continuum with fractional reserve banking. Cachanosky and Evans enter the debate from the free-banking standpoint and view both practices as legitimate. In this paper, I agree with the conclusions of Bagus and Howden, but adopt a different approach to support this position. Using the title-transfer theory of contract, I demonstrate from first principles why loan maturity mismatching does not create duplicate property titles and is a legitimate practice. Employing this same theory, I then present a novel argument to show why the contractual arrangements found in fractional reserve banking are logically contradictory and illegitimate. (shrink)

If fractional-reserve demand deposits are common, and illegitimate, an obvious flaw in the banking system is exposed. However, this article maintains that the only reason why demand deposits may be considered illegitimate is because of a way of defining them that renders them almost irrelevant. This article provides a response to Bagus et al., and identifies examples of how they misrepresent Evans. It also provides further considerations on the tradeoffs relating to the availability of a deposit; methodological subjectivism; and the (...) potential for hybrid contracts. Deposit and loan contracts may be hard to mix, but the actual results of doing so should not be ignored. (shrink)

This paper traces the recent debate over the legitimacy of maturity mismatching and fractional reserve banking. It shows that there is common ground between Bagus and Howden :399–406, 2009, 106:295–300, 2012) on the one hand and Evans on the other regarding contractual arrangements that lead to fractional reserve banking, while both agree that fractional reserve banking that arises out of a bailment or storage contract constitutes fraud. Block and Barnett :711–716, 2009, 100:229–238, 2011) stress the illegitimacy of fractional reserve banking (...) for creating more money substitutes than there is actual money. While it is true that fractional reserve banks are capable of creating money, this activity still cannot be regarded as fraudulent using a common law definition of fraud for it can only take place with requisite client collaboration that makes it impossible to identify a victim. (shrink)

The present article is a continuation of the debate two sets of authors have been engaging in regarding one type of maturity mismatching: borrowing short and lending long. All four authors had agreed that this practice can set up the Austrian Business Cycle; the present author denies that BSLL would be a legitimate commercial interaction in the free society; Bagus and Howden continue to maintain that it would be licit. Our main criticism of Bagus and Howden is a reductio ad (...) absurdum: that this opens them up to the charge of embracing the doctrine of market failure; this is something highly problematic for the two of them, since all four contributors to this debate are well-known supporters of laissez faire capitalism. (shrink)

This article contributes to a recent debate between Barnett and Block : 711–716, 2009), Bagus and Howden : 399–406, 2009), Barnett and Block, Cachanosky and Bagus and Howden regarding the conceptual distinction between demand deposits and time deposits. It is argued that from an economic perspective there is nothing inherently fraudulent or illegitimate about deposit accounts that are available ‘on demand’, but that this relies on certain contractual provisions. Particular attention is drawn to option clauses and withdrawal clauses, which “solve” (...) the problems raised by Barnett and Block, and Bagus and Howden. Previous authors have also neglected the asset side of banks balance sheets, and this is shown to further justify the legitimacy of fractional reserve banking. (shrink)