Inefficient Provision of Inside Money by Banks

The role of banks in creating inside money is studied. It is shown that even in the absence of asymmetric information or an agency problem, the private provision of inside money is generally inefficient. In a competitive equilibrium, banks tend to generate too much money relative to what is socially efficient, while a monopolistic bank chooses too little money.  It is argued that a regulator can eliminate these inefficiencies by promoting competition and imposing a ceiling on the loan-to-deposit ratio of each bank.