What are the Merits and Demerits of Banking Principle as Advocated by the “Banking School”?

The banking principle is advocated by the ‘banking school’, the important members of which are Thomas Tooke, John Fullarton James, Wilson and J.W. Gilbart. The banking principle is based on the assumption that the common man is not much interested in getting his currency notes converted into gold or silver.

Therefore 100 per cent metallic reserves may not be necessary against note issue. It is sufficient to keep only a certain percentage of total paper currency in the form of gold or silver reserves.

The banking principle of note issue is derived from the practice of the commercial banks to keep only a certain proportion of cash reserves against their total deposits.

Merits

The following are the merits of banking principle:

(i) The banking principle renders note issue system elastic. The monetary authority can change the supply of currency according to the needs of the economy.

(ii) Since the banking principle does not require 100 percent metallic backing against the note issue, it is the most economic principle and thus can be followed by both rich and poor countries.

Demerits

The banking principle has the following demerits:

(i) The banking principle is inflationary in nature, because it involves the danger of over-issue of paper currency.

(ii) The monetary system based on the banking principle does not command public confidence because the system is not fully backed by metallic reserves.