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)

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)

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)

What role do demand deposits serve in the financial system? The answer to this simple question has great implications in keeping the legal terms of the contract consistent with the demands of the financial system. Demand deposits are a perfect monetary substitute. Since money is only held to hedge against perceived uncertainty in both the timing and magnitude of future expenditures, demand deposits are demanded for the same reason. From this we derive three main conclusions. First, a financial contract similar (...) to a demand deposit cannot substitute for money. Second, full agreement to a financial contract does not create a perfect substitute for money unless it provides money’s two key characteristics: on demand and par value redemption. Finally, the demand for fractional-reserve demand deposits is fostered by an exogenous source and that demand for a good or service is not a sufficient condition to justify its legality or ethicality. (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)