In the following we describe a functional equivalent of the full reserve system which is simpler and more efficient. It consolidates the transaction deposits of the many thousands of banks and thrifts into a single institution called the National Depository, run as a public service by the Fed.  A key difference from the full reserve system is that deposits in the National Depository would be actual base money rather than claims on base money. In effect the deposits would be legal tender in digital form. The term reserves would no longer be relevant and could be dropped from the financial lexicon. 

One should not confuse the National Depository with Federal Reserve Banks. The latter would continue to implement monetary policy through open market operations and provide loans to banks. All such transactions result in credits or debits to accounts in the Depository and thus affect the total money supply.

Implementation of the National Depository System

Transition to the National Depository system would begin after the full reserve system had been in operation long enough to settle into steady state. The required infrastructure must be built and ready for use. It would consist of a secure computer network of the 12 district Fed banks and their 24 branches, and an ATM system to acquire and deposit currency. The ATMs could be located in banks that offer to provide the service as well as in post offices. The Depository itself does not handle currency.  

All reserve accounts at the Fed would be transferred to the Depository. Bound reserves (those backing transaction deposits) would become deposits in the accounts of the respective owners. Free reserves would become deposits in accounts of the respective banks. At their option, banks could exchange their vault cash for deposits at the Depository. The balance sheets of banks would be downsized by the transfers, but the net worth of each would remain unchanged. 

For economic analysis, each account would have a label to indicate the type of owner, for example:  bank, credit union, non-bank financial institution, non-financial firm, non-profit organization, eurodollar bank, foreign central bank, or household. Labels to further subdivide accounts by owner type within the top levels could also be helpful. Without disclosing the owners of individual accounts or their holdings, the data could be aggregated on a minute by minute basis and made available for analysis. This would be particularly useful in times of economic or financial stress. 

Depository Services

The National Depository would offer accounts to all who need the payment services of a traditional bank. It would only hold transaction deposits and would pay no interest. The Depository would neither lend nor borrow. It would simply execute payment orders and handle the accounting. Banks would be required to provide payment services against their customers' respective accounts in the Depository if requested.

The computer used by the National Depository would be an extension of the Fed's computer system. Payment orders would be accepted by electronic means via plastic cards, the Internet, Fed wire, smart phones, or by telephone. Paper checks would be phased out, after which verifying balances and making payments would all be done in real time. The time delays and nuisance of check float would vanish. Payments would be executed by simply transferring funds between accounts. The only exception would be transactions with the Fed which would involve a transfer of funds by wire in or out of the Depository.

Banking after the Transition

Banks could neither create nor accept transaction deposits. However they could accept term loans of various maturities and pay interest on them. Term loans would be insured by the FDIC, which would be renamed the Federal Loan Insurance Corporation (FLIC). The funds paid by an investor in a term loan to a bank would be credited to the bank's account in the Depository, and immediately useable by the bank for its own investments. Banks would hold no short-term liabilities except to the Fed or to other banks. Thus there is no possibility of a bank run in the National Depository System.

Banks could provide most of the same services they do in a fractional reserve system, including making payments out of a customer's account in the Depository. The customer  would have to authorize each payment, and fees might be charged. However a bank would likely provide such services without charge if the customer held a term loan to the bank.

Money in the Depository earns no interest so banks would normally hold only what is needed in the near-term for redeeming maturing liabilities and for operating expenses. Money acquired in excess of that would be used to buy securities such as Treasury bills or loaned short-term.   

A bank makes a loan by simply transferring funds from its own account in the Depository to the borrower's account, and recording a new loan asset on its books. If the bank had to acquire additional funds in order to make the loan, it has many options -- repo its securities, sell securities outright, borrow in the interbank lending market, borrow from a non-bank, or borrow from the Fed. Borrowing from the Fed would increase the total money supply, but the others simply move funds between accounts within the Depository. 

In general, the Fed should charge banks more than the other options in order to encourage them to first look elsewhere for funds. However a growing economy needs an increasing money supply and the Fed must stand ready to lend to banks or to monetize securities for that purpose. Indeed the Fed is the only institution capable of increasing the money supply in the Natonal Depository System.

Monetary Policy Implementation

The Fed would implement monetary policy by setting a target for the interest rate on interbank loans. It would buy or sell securities in the open market as needed to balance supply against demand at that rate. The Fed’s purchase of securities from the non-bank sector would not directly increase bank-owned funds. However the sellers would seek to reinvest the proceeds in order to earn a return rather than leaving them idle. Regardless of where invested, the excess funds would remain in non-bank accounts at the Depository until invested in term loans to banks. It is likely a sizable fraction of the excess would end up at banks and thereby enable the Fed to control the interbank lending rate. 

To enhance bank liquidity, the Fed would offer to lend to banks against adequate collateral at 40 basis points above the target rate, and borrow from banks at 40 basis points below the target rate. By observing the amount loaned versus the amount borrowed in a given period, the Fed can determine the amount of money it needs to add or drain to keep the average interbank lending rate close to the target rate. The ability to borrow directly from the Fed in order to lend greatly enhances the flexibility of a bank in a full reserve system.   

Treasury Operations

In addition to serving the private sector, the National Depository would serve the U.S. government, and offer accounts to foreign banks and governments that need to transact in U.S. dollars. With the exception of U.S. currency in circulation, the entire U.S. dollar supply would exist in accounts at the National Depository. 

The general fund of the Treasury would be held in the Depository where it would deposit receipts from Federal taxes and the sale of its securities. All government spending would be paid out of the Treasury's account. To avoid interfering with the Fed’s monetary policy operations, the Treasury would target a fixed balance in its account, sufficient to meet its near-term payment obligations. It would do so by selling or redeeming securities to cover the imbalance between government spending and tax revenues, in effect paying for government deficit spending with securities rather than money. 

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