So-called narrow banking isn't a substitute for full- service institutions, according to a new Federal Reserve Bank of Minneapolis study.
The study evaluated the often-debated premise that regulators should require banks to match short-term deposits against short-term assets.
The narrow bank theory holds that this requirement would make banks more liquid, eliminating the threat of failure if depositors suddenly demanded their money back.
Several economists have proposed replacing the current deposit-insurance system with a system based on narrow banks. These narrow banks would hold deposits, while investment houses and other institutions would take care of a consumer's other financial needs.
But Neil Wallace, an adviser to the Minneapolis Fed and Barnett Banks professor of money and banking at the University of Miami, said the theory is fatally flawed. He said it would eliminate the banking system, rather than reduce the threat from bank runs.
He said only a regular bank can make long-term investments, providing a higher return for customers. Individuals, who don't know when they will need their money, can't tie up their assets like this. He said this is a crucial service for short-term depositors that a narrow bank wouldn't be able to provide.
"Using narrow banking to cope with the potential problems of illiquidity is analogous to reducing automobile accidents by limiting automobile speeds to zero," he wrote.
In fact, Mr. Wallace found, long-term assets provide greater stability to the banking system.