Does maturity transformation achieve anything?

Maturity tansformation (MT) equals “borrow short and lend long”. It’s one of the basic activities of commercial banks.

Most economists, two of whom are listed below, think MT achieves something. In particular they think that it enables the short term savings of depositors to be “transformed” into long term loans. It seems that savings that would otherwise be unused can be usefully employed.

In fact MTing instant access accounts is a pointless activity.

Keep it simple.

Let’s start with a simple economy where there is no private bank created money. That is, there is an adequate supply of some sort of base money, perhaps gold coins or government issued fiat money. Plus I’ll assume the economy is at full employment equilibrium.  Plus I’ll assume to start with that no lending takes place. In that scenario, people and firms would maintain a sufficient stock of money to enable them to do day to day transactions. For example, wage earners would maintain a sufficient stock of money to tide them over from one pay day to the next, plus some of them would maintain a stock of “rainy day” money to deal with unforseen emergencies. Indeed, the economics text books refer to those two motives for holding money: they’re normally called the “transaction” motive and the “precautionary” motive.

Lending starts.

Now suppose people and firms start to lend to each other (via their banks) with a view to funding investments. You might think it would make sense for banks to fund loans by making use of some of the money that customers had placed with those banks. Of course that would mean that were all those customers to turn up at once and demand all their money back, banks wouldn’t have the money. But that wouldn’t matter because the chance of all customers, or even half of them, turning up at once is small.

And that of course is exactly what commercial banks do in the real world: that is, the vast majority of customers’ money which banks claim to be instantly available just isn’t there.

So MT has taken place and it seems to have achieved something: those loans have been funded with money that was apparently lying idle.

But there’s a catch as follows.

Creating or building those new investments (roads, houses, factories, etc) raises demand. And given the above assumtion namely that the economy is already at capacity, that isn’t possible without causing excess inflation.

Put that another way, to make real resources available to enable the creation of those investments, it is necessary to dissuade households, i.e. bank customers, from consuming so much. That can be done in the case of public investments by EXPROPRIATING money from bank customers in the form of tax. Or it can be done by raising interest rates, which would induce some bank customers to abstain from current consumption and place funds in saving accounts.

Current / checking account money cannot be “transformed”.

In short, current / checking account money (including the “precautionary” element) is money which each account holder WILL USE at some point in time. Thus such money cannot be MTed.  In contrast, deposit or term account money is money that the account holder is definitely given up access to for a specific period. That CAN BE MTed. Though clearly there is no sharp distinction between those two types of account.

New money.

The above can be put another way. Where a commercial bank DOES go throught the motions of MTing instant access money, it’s not actually MTing at all: it’s creating new money and lending it out. To illustrate, where £X in instant access accounts is allegedly loaned on, holders of those account still regard themselves as being the pround owners of £X, while the borrower ALSO HAS £X at their disposal. Hey presto: £X has been turned into £2X.

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1. Vickers, J. (2012) ‘Some Economics of Banking Reform’. Oxford Department of Economics Discussion Paper 632. On p.5 Vickers advocates MT. He says: “banks engage in maturity transformation insofar as they ‘borrow short but lend long’. This brings huge efficiency benefits…..It is efficient because it reconciles the freedom for depositors to meet their short-term liquidity needs with the financing of long-term lending both to households (e.g. residential mortgages) and for corporate investment.”  

2.  Krugman says “I think of the whole bank regulation issue in terms of Diamond-Dybvig, which sees banks as institutions that allow individuals ready access to their money, while at the same time allowing most of that money to be invested in illiquid assets. That’s a productive activity, because it allows the economy to have its cake and eat it too, providing liquidity without foregoing long-term, illiquid investments.”