Practical analysis for investment professionals
27 June 2016

The Vollgeld Initiative and the Future of Fractional Reserve Banking

Posted In: Economics, Future States

The 2008 financial crisis jolted many of us out of our comfort zones, leading to the argument for a complete overhaul of the monetary and banking system. This very concept has recently been petitioned in Switzerland. Known as the Vollgeld Initiative, its primary objective is to separate money creation from fractional reserve banking. After receiving the requisite number of signatures, the initiative will be up for a public referendum in 2017 or 2018. If successful, it will be such a profound change that it is worthy of exploration.

Supporters of the initiative believe that it will strengthen the Swiss franc and make the banking system more stable. Their objectives are to separate cash creation and payment systems from lending; create a stable money supply; reduce the burden of personal and household debt; align risk and reward; and create a structure allowing banks to fail. These are, indeed, laudable goals.

Two of the most important proposed changes are 100% currency-backed deposits and government funding for commercial bank loans. In fact, the currency deposited at banks would never actually be a liability of the banks, but rather a singular liability of the federal government. Banks will earn a small fee for storing the cash and processing payments. Funding loans through the government will effectively concentrate its power, enabling it to serve primarily government and political interests, but not necessarily the well-being of the public.

The focus is on the commercial banking system. Lending exists wherever two parties come into a contract as borrower and lender. For example, insurance companies enter into contractual relationships all the time to lend money and earn interest in return. Likewise, investment banks use their balance sheets to structure and purchase, for example, mortgage-backed securities. In essence, they are funding loans. These are examples of “shadow banking” activities that work outside the traditional banking system, and these “shadow lenders” each have third-party funding. So, while commercial banking itself could be tamed and harnessed by the initiative, it is silent on how shadow banking might be affected. Human nature being what it is, the lending function is likely to shift more heavily into the shadow banking sector.

In terms of systemic risk, the causes of systemic instability include: leverage, interdependence and buffers. While proponents want leverage in the commercial banking sector to diminish, it is not clear what might happen as a result. In order to get an adequate return on capital, commercial banks may be forced to lever up through third-party funding sources (not deposits). The initiative is also silent as to how leverage might manifest itself in other sectors, such as investment banks and other financial intermediaries.

Regardless, commercial banks will each be beholden to a singular funding source (i.e., the treasury), thus elevating the interdependence of the entire system. Mistakes made by the government will immediately be propagated throughout the financial network. Finally, the Vollgeld plan is silent on buffers. It is unclear how much capital banks and other financial institutions may hold, or how much collateral may be required for financial transactions. Consequently, if the effect of Vollgeld is negative, both the private and public sector may then reduce buffers in order to achieve higher growth rates, causing further systemic instability.


Would an end to fractional reserve banking be, on balance, a positive or negative development for capital markets or investors?

Would an end to fractional reserve banking be, on balance, a positive or negative development for capital markets or investors?


It appears that CFA Institute Financial NewsBrief readers are concerned about the adverse consequences of the Vollgeld Initiative. When asked, “Would an end to fractional reserve banking be, on balance, a positive or negative development for capital markets or investors?” our respondents answered overwhelming in the negative. Of the 437 participants, almost 58% said it would be negative, while only 19% suggested it would be positive. The rest were undecided. For a more complete examination of the Vollgeld Initiative and what it might mean for the future of fractional reserve banking, Dirk Niepelt, director of the Study Center Gerzensee and professor at the University of Bern, and I debate its merits:



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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

About the Author(s)
Ron Rimkus, CFA

Ron Rimkus, CFA, was Director of Economics & Alternative Assets at CFA Institute, where he wrote about economics, monetary policy, currencies, global macro, behavioral finance, fixed income and alternative investments, such as gold and bitcoin (among other things). Previously, he served as SVP and Director of Large-cap Equity Products for BB&T Asset Management, where he led a team of research analysts, 300 regional portfolio managers, client service specialists, and marketing staff. He also served as a Senior Vice President and Lead Portfolio Manager of large-cap equity products at Mesirow Financial. Rimkus earned a BA degree in economics from Brown University and his MBA from the Anderson School of Management at UCLA. Topical Expertise: Alternative Investments · Economics

6 thoughts on “The Vollgeld Initiative and the Future of Fractional Reserve Banking”

  1. Joseph Pijanowski says:

    It seems by the results of the poll that the readers are not fully informed as to the basis of our current system (and its inherent instability) and the basis of a sovereign money system (and its inherent stability). Two of the best papers (my opinion) to become quickly acquainted are “The Chicago Plan Revisited” By Kumhof and Benes and “Workings of A Public Money System” by Karou Yamaguchi. The only real negatives would be born by the banks as they would be required to change their business model. Once you understand our current money system and the proposed sovereign money system you may well begin to demand this change. The power of money creation rightfully belongs to the citizens…….not private banking corporations.

  2. Emma Dawnay says:

    (This comment is from Dr Emma Dawnay, a board member of MoMo – the organisation bringing the Swiss Sovereign Money Initiative, or Vollgeld Initiative).

    Great you’re continuing to cover this topic, and I enjoyed listening to your discussion with Dirk Niepelt.

    The main point about the Vollgeld Initiative, which I’m not sure comes across absolutely clearly, is that money and credit are separated for the M1 money supply – similarly to times of old when M1 would have been gold. However, unlike gold, the central bank can control the supply of this money “in the best interests of the country” to support the economy, e.g. in periods of growth, more money can be created.

    Some points regarding your blog above:

    1) You mention that the Vollgeld Initiative does not safeguard against the shadow banking sector. You are right, BUT: if the whole banking system were to collapse, the transaction payment systems would NOT also collapse – as it would now (unless banks are bailed out with taxpayers’ money). The “man in the street” would not lose his money in this catastrophic scenario. This means that governments would not have to bail out banks (as they do now) – which should lead to banks taking fewer risks (as they can be allowed to go bankrupt). A shadow banking system may well develop, and institutions operating in the shadow banking sector may collapse in a financial crisis – but, as mentioned, this would not bring down the whole payment transaction system as well (like now). If governments think the collapse of institutions in the shadow banking sector would be too costly for society (e.g. with pension funds being wiped out), then they will need to bring in regulation – exactly as they need to now.

    2) You mention that commercial banks will be beholden to a particular funding source. There is no reason why banks won’t be able to borrow money (i.e. Sovereign Money or “Vollgeld”) from each other. If the bank’s customers want to earn interest, they must put their money into savings account (with time restrictions on withdrawals). It is likely one bank will require money to fund a loan request, whilst another has too much of this savings money – so they will lend and borrow from one another and the interbank loan system will be alive and well. It is also true that the central bank can lend to commercial banks directly.

    3) You mention that loans are funded through the government. This is not correct: the central bank can bring money into circulation by one of two means: it can give money to the government to spend into circulation (this isn’t a loan: it’s like giving gold), or it can lend money to commercial banks. In neither scenario is the central bank responsible for what projects get funded. In the first scenario, it is indeed true that the government can chose how to spend the money. If they do this unwisely their politicians will, no doubt, suffer at the ballot box. If the banks lend unwisely – and after all they lend with their profits in mind (not with the stability of the financial system nor with the best interests of their countrymen) – then they can cause asset bubbles and potentially banking crises rather than providing the useful function of getting funds into the real economy.

    4) Minor points: the Vollgeld Initiative has no goal of supporting, or otherwise, the Swiss Franc. The Swiss National Bank can influence the strength of the Swiss Franc, much it does now.

    The Vollgeld Initiative is not meant to be a panacea for all possible financial problems, but it does address a major one: the possibility that a banking crisis will bring down the whole payment transaction system, something which would be catastrophic for society.

    Finally, I agree with the comment above: many people are not aware of the way that the current banking system functions. I would also add the book recommendation: “Modernising Money” by Andrew Jackson and Ben Dyson to the texts recommended above.

  3. Jamie Walton says:

    Some clarification is necessary here:

    1. Many economists and others believe that the term “fractional reserve banking” implies some sort of mechanical money-multiplier function between central bank reserves and commercial bank deposits. This implies that there is some (indirect) limitation on the amount of money banks can create when they make loans and purchase assets. This is the picture given in almost all economics textbooks. The economics textbooks are wrong, and this has been empirically proven in the 2010 Federal Reserve paper “Money, Reserves, and the Transmission of Monetary Policy: Does the Money Multiplier Exist?” (https://www.federalreserve.gov/pubs/feds/2010/201041/201041pap.pdf). There is of course still a fraction of reserves compared to deposits, so the current system is a fractional reserve system, but it is not the fractional reserve system described in economics textbooks.

    2. The article by Ron Rimkus above appears to give the impression that banks fund their loans and purchases from the deposits of their customers: “commercial banks may be forced to lever up through third-party funding sources (not deposits).” This could be interpreted to give the impression that banks are intermediaries of money. The fact is that banks are the creators of deposits when they make loans and purchases*. While it might look like banks source most of their funding from customers’ deposits when looking at a bank’s balance sheet, this is not what happens. This important point has been authoritatively made in the Bank of England paper “Banks are not intermediaries of loanable funds — and why this matters” (http://www.bankofengland.co.uk/research/Documents/workingpapers/2015/wp529.pdf) which uses standard macroeconomic modelling techniques to show that banks’ creation (and destruction) of money results in much greater instability in the economy than would otherwise be the case.

    * Banks do borrow reserves from other banks via various (mainly short-term) financial instruments, and likewise from the central bank, but this is merely to enable them to settle their payments to other banks arising from their loans and purchases, (generally) not to directly fund those loans and purchases. Banks also have bank accounts with other banks, and can settle some of their payments using these accounts (in effect using the other banks’ reserves).

    3. The article by Ron Rimkus above appears to give the impression that under the Vollgeld Initiative, the government would be funding bank lending: “commercial banks will each be beholden to a singular funding source (i.e., the treasury).” This is incorrect. As noted already by Emma Dawnay in her comment above, the main source of banks’ loanable funds would come either from a bank’s own customers in the form of savings and investment accounts, i.e., the system that is in current macroeconomic models (but is currently wrong), or from other bank’s (or other financial institution’s) customers, via the inter-bank lending market (or from selling bonds or shares). Any lending to banks from the central bank would normally only be for fine-tuning and “last resort” purposes (as it is supposed to be now, but isn’t). This would put banks on a level playing field with insurance companies, investment banks, and other financial intermediaries, and since banks would no longer be able to create money to fuel short-term speculation, the whole financial system would become more stable as well. One would think that financial intermediaries would welcome being able to compete on a level playing field with banks.

    4. As referenced in point 2 above, the standard macroeconomic analyses (used by central banks, the IMF, etc.) show that a monetary system like the Vollgeld Initiative would actually tend to reduce instability. With regard to buffers, the IMF paper “The Chicago Plan Revisited” (https://www.imf.org/external/pubs/cat/longres.aspx?sk=26178.0), cited in the comment above by Joseph Pijanowski, explains how capital buffers (and interest rate policy) would actually become effective macro-prudential tools (they aren’t currently, because they don’t effectively limit banks’ pro-cyclical effects on the economy).

    In conclusion, based on the empirical and calibrated analyses referenced above, there appears to be no rational reason to fear the proposals in the Vollgeld Initiative.

  4. Emma Dawnay, “The Vollgeld Initiative is not meant to be a panacea for all possible financial problems,”
    Gary Joseph Chandler, “LSPS [is] meant to be a panacea for turning OFF the Corruption Leaks in the Common Good Distribution Channels. LSPS [Transparency Act] would be a perfect dance partner for Vollgeld. One supplying security backed money and the other monitoring ALL Public Spending.
    *Live Streaming of Public Spending* Transparency! [All groups, including governments, religions & charities, that are charged with Collecting from us, the People, with the stated intentions of benefiting society, will be required to Live Stream the Spending, creating a Watch Dog in ‘Real Time’ that barks & bites.]”

  5. Ron Rimkus, “These are examples of “shadow banking” activities that work outside the traditional banking system, and these “shadow lenders” each have third-party funding.
    Human nature being what it is, the lending function is likely to shift more heavily into the shadow banking sector.
    In order to get an adequate return on capital, commercial banks may be forced to lever up through third-party funding sources (not deposits). The initiative is also silent as to how leverage might manifest itself in other sectors, such as investment banks and other financial intermediaries.”
    < Gary Joseph Chandler, "This is confusing to me. I thought the purpose of changing the Swiss Constitution was to Stop shady banking practises. [sorry 'shadowy']"
    R. R. "The initiative is also silent as to how leverage might manifest itself in other sectors, such as investment banks and other financial intermediaries."
    G. J. C., "Yes, Ron; why bother going through a Referendum if fractional reserve banking will, still, be able flourish wearing different masks. I was hoping this initiative was about ending "shadowy banking" and setting an example for the World. Now, we can't stop loan sharking and Ponzi schemes, completely so it's disheartening to read.
    R. R., "The initiative is also silent as to how leverage might manifest itself in other sectors, such as investment banks and other financial intermediaries."
    GJC, "What a crush on Hope to find out the end of fractional reserve banking will morph into, first cousin operations, shadowy banking." dang!

  6. Olivia Thamm says:

    Vollgeld or is there a better alternative?
    The discussion around this Initiative does not take into account the unimaginable corruption and criminality this system has spawned and is benefiting only an very small select clique who has their hands on the leavers of the existing system.
    Being able to leaver up on fictitious ‘assets’, valued at anything they please, i.e. print currency out of thin air, has accorded them enormous power over humanity.
    Ending this corrupt power is paramount in any amendment to the present financial system:
    https://quovadis4humanity.github.io/#4

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