Wednesday, 21 January 2015

Central bank accounts for everyone?

Dirk Neipelt (professor at Bern University) tentatively advocates the above, (which amounts to full reserve banking (FR)) in this recent Vox article entitled “Reserves for everyone…”. But I’m not sure how far he realizes he’s advocating FR. Certainly he doesn’t cite any of the well-known advocates of FR stretching back to the 1930s, e.g. Irving Fisher (1930s), Milton Friedman (1960s), etc. On the other hand he does make one reference to “narrow banking”, which on some definitions is the same as FR.

What Neipelt does advocate is letting everyone have an account at the central bank (CB): i.e. let everyone have a stock of base money.

Of course, many central banks would not want the hassle involved in opening accounts for every other household and firm. But that problem is easily solved: have commercial banks act as AGENTS FOR the central bank. Another solution (already up and running in the UK) is to have some sort of separate government run bank organise the relevant accounts. And in the UK that is currently done by “National Savings and Investments”.

NSI currently doesn’t offer ALL THE services you’d expect of a deposit accepting entity / bank, e.g. it doesn’t offer cheque books or debit cards. But letting it do so wouldn’t be difficult.


As Neipelt rightly says, CB money is as near totally safe as it’s possible to get. That’s in contrast to commercial bank created money, billions of dollars of which vanished into thin air in the 1930s.

Re Neipelt ‘s claim that a “reserve only” system “could undermine deposit-financed credit creation..” that’s a popular and flawed objection to FR. Under FR, anyone is free to have their money loaned on to whoever they wish (NINJA mortgagors, safe mortgagors, or whatever). The big difference as compared to the existing system is that those making the latter choice carry ALL THE RISKS, as opposed to the existing system where the taxpayer carries some of the risk (e.g. via TBTF).

So FR does “undermine deposit financed credit creation” in that it increases costs for borrowers: but only because the latter (TBTF etc) subsidy of lenders is removed. What’s wrong with that? Subsidies misallocate resources.

Deposit insurance.

Re his claim that “As a by-product, public ‘insurance’ of bank deposits could be scaled down..”, actually “public insurance” of banks can be removed altogether. At least if lending entities are funded just by shares rather than by money, then it’s impossible for lending entities / banks to go insolvent. Though the value of their shares can decline to the point where they become takeover targets. (Entities funded just by shares cannot go insolvent because they owe nothing to anyone - certainly not to shareholders. In contrast, money is liability of a bank which is more or less fixed in value.)

Loans granted by CBs.

Neipelt also raises this question: “Would central banks lend funds only to financial institutions or also to the broader public, and at the same policy rates?”

My answer that is that there’s no excuse for central banks to lend to anyone. Certainly CBs shouldn’t get involved in COMMERCIAL loans of any sort, i.e. loans to “the broader public”.

As to CB loans to commercial banks, the only generally accepted excuse for those sort of loans arises where commercial banks are in trouble, and CBs lend according to Walter Bagehot’s criteria, namely at penalty rates and in exchange for decent collateral. But the latter policy involves problems.

First, once you allow “Bagehot” type lending, political pressures ensure that the lending is at rates well below the “penalty” rate. And second, the collateral can be nearer junk than first class. That’s exactly what happened in the recent crisis. And that amounts to a subsidy of commercial banks.

Second, if lending entities / banks are funded just by shares rather than deposits, it’s impossible for those lenders to go insolvent. So the need for Bagehot type lending just doesn’t arise!

Funding for lending.

Having said just above that the “only generally accepted” excuse for CB lending is the Bagehot excuse, there have of course been various exceptions, e.g. the UK’s so called “Funding for Lending” scheme. However, for most of the last century, the only widely accepted excuse for CB lending has been the Bagehot excuse, while schemes like Funding for Lending have been small scale and temporary.

Completely ban private money creation?

Neipelt seems to envisage letting everyone have an account at the CB, while letting commercial banks continue with private money creation. So should we do that, or aim for a straight ban on privately created money?

Certainly the bulk of the advantages in cutting down on private money and boosting CB money come with doing just that (i.e. insisting on a big rise in commercial bank capital ratios). I.e. raising lending entities’ capital ratios from roughly 30% to 100% (which equals a total ban on private money) does not bring huge benefits. However, I favour the 100% figure, and for several reasons, as follows.

1. 100%, to repeat, does bring finite benefits.

2. 100% is a nice clear line in the sand. Anything less, and the banking lobby will just bribe and cajole regulators and politicians into a gradual relaxation of capital ratios, till we’re back with the ridiculously risky ratios that existed prior to the crunch. Indeed, the bank lobby in the US is currently proving highly adept at dismembering Dodd-Frank.

3. Resources are optimally allocated where there are no subsidies. A total removal of bank subsidies means that depositors are in line for hair-cuts when things go seriously wrong (as in Cyprus recently). But a stake in a bank which involves sharing in profits and losses is what’s known as a “share”. Or at least it’s getting near to being a share.

So to that extent and by definition, a total removal of bank subsidies (aka optimally allocating resources) means a total ban on private money.

(H/t to Mike Norman.)


PS ( 22nd Jan 2015). Also (No.4), anything less than 100% means banks can engage in a trick allegedly employed by Barclays during the crisis, which is to lend large sums to a borrower on condition the latter use some of the money to buy shares in the bank. To the extent that that trick works, a hefty capital ratio (say 30 to 50%) means that sub 100% capital ratios are no sort of constraint on bank expansion.

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