Thursday, 21 January 2016

A sensible plan for fixing the banking system.

From City AM Forum:

Deposit insurance has been the most sacrosanct component of the regulatory regime for banks since it was widely introduced during the 1970s following the collapse of the Bretton Woods regime. However, while it seeks to protect consumers against the undercapitalisation of banks and their tendency to collapse in times of stress, it has also encouraged such undercapitalisation.

Since the early 1970s, the number of countries with government insurance of customer deposits has increased tenfold while the number of banking crises worldwide has risen by a factor of almost 500 compared with the preceding 25 years. Deposit insurance subsidises an already cheap form of debt whose supply is almost unlimited for banks. Banks have therefore been able to operate at very high levels of leverage with very limited constraints on growth.

All very true. So what's the solution:

First, the abolition of deposit insurance after two years together with an amendment of the Financial Services Act 2013 to make all deposits preferential liabilities in an insolvency.

Second, legislation banning compensation paid to depositors as a result of losses they may suffer in the event of a bank insolvency.

Third, an announcement that National Savings and Investments (NS&I), the state-owned bank, would henceforth offer savings and current accounts to everyone; and

Fourth, a requirement that all deposit-taking banks publish prominently their capital/leverage ratios.

To really nail this down, we would of course have to add...

Fifth, public collection of all or a large part of the rental value of land to prevent credit- and land-price bubbles with purchase mortgages for land only available from the NS&I (private loans would not be recognised by HM Land Registry);

Finally, a strict ban on central bank lending to private banks and abolition of the 'lender of last resort' concept

Even if that were not full-on LVT, it would be the government collecting the interest on land purchases, i.e. quasi-LVT in a politically sellable form.


Lola said...

All true, except 3. That's the government then. And who got us into this mess in the first place? Yup, the government. And do you trust the government? (Labour voters don't trust Tory governments and Vicky verky). So. No. NS&I can stay as it is.

Lola said...

Also have you see the ASI paper on free banking? And the various comments on it at places like the Cobden Centre?

Ralph Musgrave said...

Basically that City AM article advocates full reserve banking, an idea that has been backed by quite a few economics Nobel laureates, e.g. Merton Miller, James Tobin, Milton Friedman and Maurice Allais. It’s an idea I agree with.

Lola, if we’re going to make deposits at private banks less than totally secure, then there has to be some sort of state backed bank account for those who want total security, or at least what they THINK is total security. Also, all the NSI has to do is an utterly boring and banale job of accepting deposits and honouring cheques, debit card transactions, etc. They can hardly go wrong there.

But if you really don’t like the NSI, an alternative (one that’s been discussed by advocates of full reserve for a long time) is to let private banks run “totally safe” accounts with the relevant money being simply lodged at the central bank and/or put into short term government debt.

In the US, the money market mutual fund industry will have to obey the above sort of rules shortly: e.g. where a fund promises $X back to those lodging $X, the money must be put into just the central bank or short term government securities.

Lola said...


Para 1 and 2 of your comment cancel each other out. With full reserve banking the depositor must by definition have 'total security'. (There is, of course, no such thing as 'total security').

Para 3 then says what I have just writ above. Although you needn't have a central bank to make it 'secure'. The issue really is how do you have full reserve? What do you reserve against/with? You clearly can't trust governments as all they will do is inflate away their debts to us.

I personally think that in a free banking / properly reserved world the market would gravitate back to a metallic standard.

Personally I'd make it clearer that NS&I was in reality an operation by the government to borrow money. I'd would keep all its restrictions in order that it could not out-compete private banks.

Lola said...

I really think that the land bubble / credit creation thing would be solved by full on LVT / bank asset tax / proper bank reserving / scrapping of deposit insurance (which actually insures the bank not the depositor) such that the NS&I bit you advocate would be unnecessary.

Anyway such and arrangement is subject to political expediency a la Fannie Mae and Freddie Mac - and look what a mess they've caused.

Lola said...

...and 'sound money', of course.

Mark Wadsworth said...

L, this 'free banking' strikes me as a load of faux lib one-sided waffle. What I liked about this article is that he laid out four simple easily understandable and do-able reforms.

RM, the article recommends nothing of the sort. "Full reserve banking" is more meaningless hogwash, it sounds nice but cannot exist. Unless of course you mean banking with NS&I which is a perfectly sensible idea.

L, no, I do not trust the government, but I trust banks even less. If the government is inflating away its debts, then you are losing money whether it is cash, in a private bank or in a government bank. Inflation is a separate problem to "banks being twits" which is what the article is talking about.

Yes of course NS&I is a way by which the government borrows money. It's a good way of doing it though (until and unless we take over the country and pay off all the debts). If it happens to reduce the captive market for private banks, so what? That's like saying state schools are bad because they put private schools out of business. (State schools might be worse than private schools, but again, that is a separate topic).

Bank asset tax, that would be item number 7 on the list, sorry I forgot that one.

Agreed, the TSB and Fannie Mae tell us that some future government wouldn't be able to resist privatising the state run deposit and savings bank.

Dunno what 'sound money' is. Money is just the flip side of debt. If the borrower has not over-stretched and has invested in something income generating or valuable, then the debt is just a proxy for the underlying asset i.e. the resulting 'money; is just as 'sound'.

Conversely, liar loans on inflated land values are not a very good basis for a money system, the money is just as 'unsound' as the liar loans etc.

Paul Lockett said...

You'd have to have leaving the EU as a first step, as deposit insurance is compulsory under EU regulations.

Mark Wadsworth said...

PL, another good point, and another reason why a sensible government would leave the EU. Problem is, the current lot would leave the EU and increase the deposit protection limit :-(

Random said...

Full Reserve is an illusion

Random said...

So Ralph have your views changed from your comment on the MMT Bank Reform Proposals:

Making Banks Work

"As to what the “point” of a bank is, “promoting the capital development of the economy” is certainly not the only basic objective as far as a VERY LARGE number of bank customers are concerned: DEPOSITORS. They’re after a variety of services provided by banks – the most important and obvious being somewhere to store money, and a money transfer system (cheque books, debit cards, etc)."

Lola said...


'Free banking' is what existed before central banks/government got in on the act.

You know full well what 'sound money' is. You're an accountant! 'Money' - an invention of the market BTW, was originally evolved to a metallic standard - traditionally gold (or some sub-division of gold - silver, copper). it fulfilled the three requirements of sound money; a medium of exchange, a store of value and a unit of account. It was universally acceptable and frangible and durable. Merchants could trust it and, crucially, easily test its purity. Then it occurred to everyone that goldsmiths had the best safes and could act as custodians. It then became easier to issue bank notes for trade settlements as claims against an account at a goldsmiths. No credit creation so far.

But, goldsmiths, now de facto banks, could issue notes against their own capital and could gear themselves up. i.e. FRB. Not in itself a problem unless it gets out of hand, which to a certain degree it always does - and what happens? The bank fails and the owners lose the lot - but not the depositors 'AS LONG AS THEIR DEPOSITS ARE SEPARATE FROM BANKS OWN CAPITAL - which is the key problem in the current settlement. Reform the 1833/1844 Bank acts to make it clear that money deposited in the bank remains the property of the depositor and the problem goes away.

So a 'bank note' is a debt instrument - a sort of undated bearer bond, which under free banking with the reforms of the banking acts would be reliable. Is it 'money'? (anything can be 'money' as long as everyone agrees that whatever it is is 'money' - cans of bean, conch shells, cigarettes, future rights to someone else's pudding). Of course, as long as it conforms to the three core criteria. And being properly backed by something that everyone agrees has a reasonably consistent value, what's the problem?

I do not trust governments at all. I trust 'the market', society if you like. You have keep government's hands off as much as you possibly can because history shows that they can never ever resist the temptation. Keep government solely as 'umpire'. "Put not your trust in Princes" as the Bible and the Bard have it.

No one sold off Fannie Mae or Freddie Mac. They remain state sponsored institutions with pretty well zero accountability and are / were in large part responsible for the excessive expansion of housing credit in the US. TSB was indeed sold off. That would not have been a problem were the banking system not organised as it is.

I am quite content for NS&I to continue, as long as it makes it clear that it is a system for the government to borrow money directly from the populace (a very good thing as it makes it much less likely for the government to default directly or with inflation), but there has to be limits on all aspects of its operation otherwise governments will be tempted to monopolise banking.

I am quite sure that banking reforms as set out in the links and elsewhere, combined with LVT and a bank asset tax will pretty well deal with the money printing/land buying financing/rent seeking foulness. I also think it will drive banks to seek returns by lending to wealth creating private business - as they used to do. If you also placed restrictions on the ability of the government to borrow, that'd certainly be the case.

Apropos of which, the government could do this best by issuing bonds to back annuities. Which was how they originally borrowed money - issuing annuities (and running lotteries). Until such time as they managed to monopolise money, of course...

Ralph Musgrave said...


Re your fears that NSI might “monopolise” banking, one needs to make a distinction between two quite separate activities of banks under existing arrangements. Banks first store and transfer money. Second, they lend on money. There is absolutely no reason for those two to be combined, and advocates of full reserve claim there are plenty of reasons for them NOT TO BE combined.

In fact as Adam Levitin put it in the first sentence of the abstract of one of his papers, those two activities are “irreconcilable”. See:

Under full reserve, government certainly monopolises the “storage and transfer” activity, though it can sub-contract much of that work to private banks. As to lending money, that involves commercial risks, and government should have absolutely nothing to do with that.

NSI actually already transfers money in that it offers to transfer customers’ money to any bank account of their choice. That’s not quite the same thing as cheque books and debit cards, but it’s very close.

Mark Wadsworth said...

RM, good points and agreed, esp the bit about governments not lending money (especially not to banks!)

Lola said...


Levitin ,misses it again.

There is nothing irreconcilable between the two functions - as long as the previous banking acts are reformed.

Properly reformed banks would trend to offering various types of account priced according to service and risk. Thusly a 'current' account would be a storage and transmission account and would likely have charges for that as there used to be.

Whereas the bank could offer a range of investment accounts with differing risk levels and differing and appropriate interests rates.