Wednesday, 27 June 2012

John Kay makes the same mistake as Vickers.

Summary. John Kay’s paper entitled “Narrow Banking” advocates (unsurprisingly) what he calls “narrow banking”. Like Vickers, he is concerned about the low or non-existent interest that would be earned on 100% safe accounts where the relevant money is invested in 100% safe investments. He therefor advocates investing the money in ways which are about as risky as existing bank accounts. But that gives rise to all the problems that have arisen with banking to date! So what was the point of his paper?


This Positive Money article claimed that John Kay and Lawrence Kotlikoff’s ideas on bank reform were similar to the ideas in the joint submission to the Vickers commission made by Positive Money, Prof.R.A.Werner and the New Economics Foundation. (I’ll refer to the latter work henceforth as the “submission”).

Kotlikoffs ideas are certainly similar to those in the submission. As to Kay, his ideas might seem to be similar, given that the title of his paper is “Narrow Banking”. However, the small print reveals a different story.

Incidentally I enjoy Kay’s regular articles in the Financial Times, but he definitely had an “off-day” when writing this paper on narrow banking.

In some passages he seems to advocate full-blooded narrow banking. For example he says (p.58), “The most effective way to ensure that public subsidy to failed financial institutions is not required is to insist that retail deposits qualifying for deposit protection should be 100% supported by genuinely safe liquid assets.” Agreed.

That is much the same as a point made by Mervyn King: “…eliminating fractional reserve explicitly recognises that the pretence that risk free deposits can be supported by risky assets is alchemy.”

But Kay also says (p.50), “Narrow banks might (but need not) engage in consumer lending, lend on mortgage, and lend to businesses….” Well hang on – banks that engage in the latter activities are pretty much bog standard banks!!!!

Moreover, allowing narrow banks to engage in similar activities to standard banks just gives rise to the very problems we’ve had with standard banks, and which Kay himself eloquently describes: one of these being the complexity of the regulations needed to control such banks . Indeed, he describes Basle type regulations as “worse than useless” (p.7). And on his page 5 he describes these type of regulations as “massively inadequate”. I second that.

Unsurprisingly, Kay’s own attempts to work out how his so called narrow banks should be regulated runs into exactly the same problem: complexity. He devotes about FIVE PAGES (p.53 onwards) describing such regulation.

Well banks just love complex regulations. It’s precisely the complexity that enables them to nibble away at the regulations bit by bit.

Should narrow banks invest in government securities?

Bot Kay and Vickers think they are caught between a rock and a hard place: they want to make bank accounts (or at least some bank accounts) far safer, but they realise that if this is done by putting depositors’ money into ultra-safe investments, those investments will inevitably yield little interest.

Indeed, depositors might well pay monthly bank charges. That is, they would effectively get a NEGATIVE rate of interest.

As a way out of this dilemma, they advocate that at least depositors’ money can be put into government securities. Well unfortunately even government securities are not 100% safe. Ever heard of Greece? As to more responsible countries, even there the value of government securities rises and falls.

Biting the bullet.

The idea that those who want absolute 100% safety are not entitled to interest is a big political step to take: the peasants might revolt. Thus Vickers perhaps cannot be blamed for not taking that step: i.e. perhaps Vickers cannot be blamed for producing a whitewash report.

Perhaps members of the allegedly “independent” Vickers commission were quietly told that if they didn’t rock the boat they’d all get honours. Or perhaps they were told by City of London worthies that if they advocated getting the banking system more or less “back to business as usual” they’d get lucrative bank directorships.

But John Kay has not such excuses.

Moreover, depositors have been getting approximately nothing by way of interest over the last couple of years because of the low interest rates designed to get us out of the recession, and the peasants HAVE NOT REVOLTED. To that extent, one has to wonder why Kay and Vickers are so concerned about zero interest earning accounts.

Stricter bank regulation does not harm growth.

Another reason that Vickers wanted to channel money from 100% safe accounts into risky investments was that the Vickers commission thought that tying up too much money in non-productive accounts would reduce bank lending, which would reduce economic growth. Presumably Kay thinks the same – thought I can’t actually find a passage in Kay’s paper that says this.

Well clearly any restrictions on bank lending will be deflationary ALL ELSE EQUAL. But all else does not need to be equal. That is, government can easily expand the monetary base to compensate for any deflationary effect coming from stricter bank regulation.


If we are going to have a rational banking system, we will just have to get depositors used to the idea that little or no interest is earned on 100% safe accounts. And the submission to the Vickers commission by Positive Money, Prof.Werner and the New Economics Foundation was right to advocate this “little or no interest” policy.

Of course the TEMPTATION for politicians is always to promise bread and circuses: i.e. to tell the population they can have their cake and eat it. That is, politicians like to tell voters that interest can be earned on 100% safe accounts, while keeping quiet about the fact that voters as taxpayers pay for this absurdity.


  1. "As a way out of this dilemma, they advocate that at least depositors’ money can be put into government securities. Well unfortunately even government securities are not 100% safe. Ever heard of Greece? As to more responsible countries, even there the value of government securities rises and falls.

    The way out of that dilemma is to offer a storage facility with the currency issuer - aka a savings account.

    In the UK we call it National Savings.

    That is then the 100% secure 'charged at inflation rate' financial wealth storage facility that the commercial banks have to compete with.

    The banks risky assets have to be backed by risk liabilities.

  2. Fractional Reserve banking is at the core of our ongoing disaster. I would gladly trade a zero pc return to ensure we never have another kind of these horror shows again.


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