Credit Cards and Full Reserve Banking

In a fractional reserve banking system, credits cards and other unsecured lines of credit are not very different from how a bank handles the financial end of mortgages and loans: because it only needs to keep a small reserve from depositors in their vaults (digitally or physically), it can loan out the rest in the form of loans and lines of credit. If the reserve was set to 10%, the bank could use 90% of a deposit for credit cards or mortgages and other loans.

In a full reserve bank, credit card lines of credit (unsecured) would still be available, but the process at which the bank covers purchases made on the credit cards is directly tied to depositors who want a higher return on their investment. In the case of a mortgage or loan secured with an assets (say, a house, car or business), the interest rate paid to investors is lower as there is an asset backing the deposit. In the event of a delinquency from the borrower, the bank would repossess the asset, sell it, and pay back the depositor based on what the asset sold for. Since credit cards are unsecured, a depositor would want a higher interest rate to overcome the risk of delinquencies.

Currently, credit cards do charge a much higher rate of interest than most loans, unless your credit score is very high. It is not uncommon to see banks charging 18% for a credit card, and I’ve even seen cards as high as 29% for those with very bad credit. This would easily cover a depositor’s risk and present a reasonable reward. The bank would also get a higher commission for handling the account.

A bank is a perfect middleman for finding credit card borrowers and those who have money. The bank would handle ascertaining a person’s risk (both through their credit score as well as any history they have in depositing in that bank or borrowing from that bank). The bank would then offer an interest rate for the borrower for a revolving line of unsecured credit. If the borrower accepted the interest rate, the bank could then shop out the borrower’s needs to depositors who are interested in receiving a higher reward (more interest) at the given risk factor (credit score and payment history).

Let’s say that you want a credit card, and your risk factor tells the bank that a 15% interest rate is reasonable based on your history of payments. If you accept the 15%, you can then tell the bank what amount of credit you’d want, and for what period of time. Today, credit cards have an expiration date, but most of the time the bank will automatically issue you a new card at the end of that date. In a full reserve banking system, your expiration date will actually end your contractual agreement with the bank. Let’s say that you accepted the 15% interest rate, and requested a line of $10,000 in revolving, unsecured credit, for a period of 4 years.

The bank can now go to depositors and offer a long term deposit at 10% to depositors, for a period of 4 years. This means that you would deposit money that can not be touched for 4 years (similar to a CD). If that money is being used, the amount lended would receive 10% back in interest. If the credit line is not touched, your money would receive no interest, but it would be safely stored at no cost to you. Upon each depositor’s acceptance of this agreement, your credit card’s credit line would go up, which you could see in real-time on the bank’s website or phone system. If a depositor accepted your agreement and deposited $2000 into a 4 year account, your credit line would be $2000. Other depositors could also join the agreement, up to your $5000 request.

As you make purchases to stores and service-providers, the depositors’ money would be used to pay for the purchase. The money would be equally paid based on the percentage of the total of the depositors’ money. If 2 depositors put in $1000 each, and 1 depositor put in $3000, and you made a purchase of $500, the 2 depositors would have $100 each used to pay for the purchase, and the third depositor would have $300 paid to the depositor. The interest you pay (15%) would then be used to pay the 10% amount back to the depositors based on that same percentage.

The bank’s profit would come from the transaction processing fee (called a merchant fee), usually 1-3% of each purchase, plus they’d make the difference between the interest rate you pay and the interest rate they pay out. Competition from other banks would likely reduce this difference to a slim margin, possibly as low as 1% or even lower. The bank just acts as a middle man between depositors (the lender) and creditors (the borrower). It is no different than you contacting a depositor and asking for a short term loan at a certain interest rate, but the bank handles processing your credit, collecting the depositor’s “loan,” and paying for the purchases you make.

When your contracted account expires, the balance must be paid in full, and the deposits are paid back to the depositors. If you can’t pay back the balance in full at the end of the contracted period, you would have the option to start a new credit line account, but you would be liable to pay the full balance at the end of the account. Banks could prepare for the end of the contractual period by reminding you to apply for a new account months before the current one expires.