Fractional Reserve Banking from a legal perspective

The effects of Fractional Reserve Banking (FRB) called «The Financial Crises» is currently ravaging the world’s economies and causing serious conflicts with strikes and violence. The purpose of the current monetary system as organized by the IMF, BIS and national Central Banks is to finance the government’s expenses by diluting the currency to avoid unpopular taxes.

Unfortunately some supporters of liberty are supporting the institution of FRB. Most of these supporters are aware of the economically damaging effect but supporting it still from a moral\legal standpoint.

One argument is thet FRB is not fraud so it’s OK. But in business and commerce contracts and disputes may be settled in one way or the other without any of the parties being criminal. So this is a false dichotomy reflected in the common legal distinction between criminal law and civil law.

Another typical argument is that people should organize themselves as they like under capitalism. End of discussion.

This begs the question. Capitalism is the «Rule of law» If the practice of FRB is supported by unlawful institutions and actions the system under discussion is no longer capitalism. A deeper investigation of the question is therefore needed;

The FRB irregular deposit

The largest part of the money supply (some 92% of the supply in Norway) is bank accounts which over the last 200 years has replaced coins and bank notes as money. The single most important contract to discuss concerning FRB is therefore the contract between the depositor and the bank.


A contract is a mutual agreement between two or more parties. An essential feature of a contract is «The meeting of the minds» (consensus ad idem). The fact that the contracting parties have a common idea about what they are agreeing about.

Deposit contract

One party putting something in the other party’s possession for the purpose of storage and safeguarding.

Examples may be

  • storing your furniture while you are working a year abroad.
  • storing valuable jewelries and paintings to avoid theft or fire.
  • a dealer in wheat may use third party storage facilities for cooling and placement between buying and selling.

The irregular deposit

A special instance of the deposit contract is the irregular deposit consisting of fungible goods like oil, wheat, or gold. The purpose of the contract is still storage, safeguarding and facilities but the contractor is free to return a similar quantity of the goods on demand. If you request say your deposited oil you will not get exactly the oil you deposited, just a similar quantity of the same kind and quality of oil.

In the deposit contract there is no transfer of ownership of the deposited good. The fact that the contractor in the irregular deposit may return som other oil does not mean he owns the oil.

It is just a practical arrangement because it is practical to have one storage facility.


The loan is contrasted to the deposit in the fact that ownership is transfered from the lender to the borrower.

A characteristic feature of a loan is the time for the return of the goods. This both enables the borrower to plan for the return of the good and secures the lender a fixed event (the time) for return of his goods.

( It is possible to construct contracts without a fixed time of return;

«You may borrow my cycle until I request it back».

But such contracts make no sense whatsoever for the case of fungible consumer goods.

«You may borrow my coke until I want it back».

This contracts implies that the borrower can make no use of the coke (i.e. drink it) because he is requested to keep it ready for return. Henceforth there will be no such contracts.)

Aleatory contract

This contract is used in among others insurance. The return of the goods is triggered by a certain external event ( A fire, a stroke, an earthquake..)

(This is opposed to the loan contract where the return of the goods is triggered by the passing of a certain time. )

The FRB Bank Deposit Contract.

The bank promises to return the depositors money on demand and is simultaneously engaging in lending out money to other customers.

This is an irregular deposit as the bank will not return exactly the same money.

Money is consumable from the point of view of the borrower. When he spends the money they are gone like drinking a coke and he plans to earn and return some other money when the loan expires.

Jesus Huerta de Soto lists the legal «hurdles» ,seven in total, to FRB in his book Money Bank credit and economic cycles. De Soto in italics:

  1. There is deception or fraud: the crime of misappropriation is committed and the contract is null and void (the historically corrupt origin of fractional reserve banking).
  2. There is no deception, but there is an error in negotio: contract null and void. ( This means the intention of the depositor is to avoid walking around with a lot of cash and he likes the convenience of electronic payments. His main purpose of the contract is depositing his money. The bank on its side is considering the money a loan. The deposit requirement of immediate return and safeguarding is incompatible with the risk taking and fixed expiry date of the loan. There is no meeting of the mind and the contract is void. )
  3. There is no error in negotio, but each party pursues his typical cause in the contract: contract null and void due to essentially incompatible causes. ( This is the same argument as 2 put this points to the self contradictions in the FRB contract which will manifest in self when put into practice. )
  4. Even if the incompatible causes are considered compatible, the contract is null and void because it is impossible to carry out (without a central bank). (The borrowers of the bank will default on their loans because their investments are founded in thin air and not real savings. Thus external institutions is necessary to keep the system afloat)
  5. Subsidiary argument: even if the “law of large numbers” were valid (which is not the case), the contract would still be an aleatory contract (it would be neither a deposit nor a loan contract).
  6. The implementation of the contract depends on a government mandate (privilege) and the support of a central bank that nationalizes money, imposes legal-tender regulations and creates liquidity.
  7. In any case, the contract is null and void because it does serious harm to third parties (economic crises aggravated by the central bank), much greater harm than that caused by a counterfeiter of money.


As you see there are several hurdles to be passed before legally accepting FRB. Personally I find clause 2&3 enough. The deposit and the loan are incompatible and the contract is void. Without the FRB Irregular deposit there is no Fractional Reserve Banking.

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