Why Central Banks Should Offer Bank Accounts to Everyone

Central banking disrupted for the 21st century

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By Nicholas Gruen

As the financial crisis continued to wreak its havoc in late 2010, Mervyn King, then Governor of Britain’s central bank, the Bank of England publicly mused that “of all the many ways of organising banking, the worst is the one we have today”. He was speaking of fractional reserve banking whereby almost all the money circulating in our economy represents claims against commercial banks like Citibank, ING or Barclays even though the deposits they hold constitute a tiny fraction of all the loans they make.

There have subsequently been any number of proposals to solve the resulting problem – which is that bank runs can be so damaging that we’re forced to bail out our banks. But economists can’t agree on a model.

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However, it turns out that modern technology – most particularly the internet – enables our most pressing problems in banking to be solved, not with arcane disputes over banking theory but just by unleashing the digital disruption that would occur in the wake of some simple reform from the deregulation playbook.

Let me explain.

As much as your bank presents itself as the very essence of competitive, private enterprise, it’s actually part of a public private partnership. The central bank – in the US the Fed, in the UK the Bank of England, in Europe the European Central Bank ECB) – sits at the apex of the banking system providing two fundamental services to your bank.

First each bank is connected to the monetary system with an ‘exchange settlement account’ with the central bank. So if you want to pay me, you get your bank to pay mine, with the net difference between all payments to and from each bank at the end of the day being squared up via counterbalancing payments between each commercial bank’s exchange settlement account with the central bank.

Secondly, because the deposits banks hold are such a tiny fraction of the loans they write, the central bank goes ‘lender of last resort’ to banks if they can’t meet withdrawals.

So the central bank is essentially the wholesaler of banking services with the commercial banks like Citibank retailing those services to all. But in other industries, wholesalers have been disrupting retailers by retailing themselves directly to consumers over the internet. Thus you can still buy your newspaper from your newsagent or a plane ticket from your travel-agent as was common last century, but today you can also buy it direct online from the wholesaler – the airline or the publisher.

One central principle of economic reform is ‘competitive neutrality’ which requires that those in the market compete on a ‘level playing field’, that is on their ability to attract customers, and not on any special favours they receive. But we’ve mostly heard about competitive neutrality from businesses complaining that government competitors get special favours. The principle works the other way. Your bank shouldn’t get government favours that you can’t get.

Before the advent of the internet this proposition was largely academic as it would have required central banks to directly provide personal service to customers which would have also required the establishment of central bank branches throughout the land. But in the age of the internet, all citizens and businesses could be provided with lightweight online central bank exchange settlement account at minimal cost. After paying any cost-reflective account keeping fees, your deposits with the central bank would earn the same overnight cash rate it pays commercial banks. And money in your account could be paid to anyone else’s exchange settlement account.

The central bank could also provide liquidity in a more competitively neutral way. It couldn’t practicably assess everyone’s creditworthiness, but it could specify a set of super-safe assets against which it would automatically lend as a matter of right. I’d propose that you could borrow to fund your housing loan up to – say – 65 percent of its value or against prime commercial property up to say 45 percent of its value (though these numbers might vary through the cycle for ‘macro-prudential’ reasons). This would entail far lower risks for central banks than the lending they currently advance to highly leveraged commercial banks.

Given their extraordinary degree of independence and well funded research departments, you might expect such ideas to be explored by central banks themselves. As we’ve seen, the Bank of England has been prepared to rock the boat and through the crisis it regularly published estimates of the eye watering extent of the implicit subsidies banks receive because their creditors expect them to be bailed out if they get into trouble. In 2012 the Bank of England calculated the implicit subsidy to the 29 institutions deemed by the Financial Stability Board to be the world’s most systemically-important to be running at over $400 billion per annum, down from $700 billion in 2009.

But elsewhere central bankers seem inured to the role of bureaucrat.

The arrangements I’m proposing would generate much fairer, more efficient banking.

  • We can all access a payments system with much lower costs and risks than the electronic cobweb of bank systems that constitutes the payments system today.
  • Even where it’s performing relatively simple and safe tasks, the financial system involves complex supply chains matching suppliers and receivers of funds. That involves custodians, aggregators, auditors, lawyers, marketers, advertisers and so on with ‘due diligence’ required on each relationship at each stage if not each transaction with virtually all of it heavily regulated and large economic rents being earned by incumbents which are then passed onto their senior managers.
  • Under these proposals, funding of super-safe assets is moved from the financial system to the monetary system. By contrast with the financial system the central bank is an integrated entity and the issuer of fiat money so it can simply issue liquidity against an asset, up to the point at which it judges risk becomes appreciable. The economic efficiency gains are thus large. Interest margins on the commercial financing of super-safe assets like a partially paid off mortgage are around three percent. It is hard to imagine the equivalent funding costing the central bank more than about a sixth of that or half a percent for the administration of mortgage management and account keeping and the very low risk involved.
  • These lower margins are particularly important for macro-economic management when the central bank’s principal lending rate approaches zero in a depressed economy. In such circumstances under these proposals, almost all the monetary easing gets through to borrowers who’d be paying around half a percent in interest to the central bank when, if they were borrowing from a commercial bank, they’d be paying around six times as much.
  • While margins would collapse on central bank provided utility products, they would rise for other lending as commercial banks lost their monopoly on savings and transaction accounts which currently forces us all to subsidise them with our deposits. Rents would drain out of commercial utility banking. To attract depositors or other sources of funding and to sell what would have to be more expensive loans, commercial banks would need to innovate and build their skills in servicing particular financial needs and assessing credit risks. That’s what they should be doing already, but they don’t need to given their current privileged position. Those wishing to gear up their mortgage above – say 80 percent of mortgage valuation might well find this ‘second mortgage’ more expensive and difficult to come by than their ‘first mortgage’ with the central bank.
  • The result would produce ‘narrow banking’ most efficiently delivered and guaranteed by the central bank, alongside a commercial banking system that was far more focused on taking and managing risk and managing with far less government support and the consequent regulation.
  • With deposits leaking from commercial banks and the central bank providing valuable savings and payments services to all comers, the state’s cost of borrowing would fall.
  • Currently, commercial banks create over 95 percent of the economy’s money on which they charge interest. Nice work if you can get it. (The rest is issued by the central bank as bank-notes). But the money supply is a public good. For each dollar the central bank lent its businesses and citizens, it would earn the net interest paid each year, creating a major source of government revenue to fund additional public services or tax cuts. Just as governments generate revenue by auctioning off the public good of scarce radio spectrum, or mineral rights or development rights, capturing this seigniorage-like recurrent rent on money creation would become a major source of revenue.

As economist Robert Shiller points out, the centrality of government to banking has meant that most beneficial financial innovations in modern banking – like long-term lending to fund your home loan – have been engineered by governments.

Amongst many innovations in the evolution of modern banking, one offers the perfect precedent for what I’m proposing. Despite some politicians’ dire warnings about allowing central banks to compete on a level playing field with commercial banks, over the second half of the nineteenth century and into the twentieth, central banks became the principal, and then effectively the monopoly issuer of physical bank-notes in virtually all developed countries.

Involving parties other than the central bank in issuing bank notes simply injected additional complexity and counterparty risk into everyday transactions without any gain – just as our the commercial bank based payments system we’re forced to use does today. Today, extraordinarily, citizens can make payments to each other instantly and without risk of loss, but only by physically taking possession and then exchanging central bank-notes. What’s being proposed here is no more nor less than enabling us all to do the same using the technology of the internet.

None of what I’ve proposed would involve the central bank directly staffing branches or providing personal retail services. Rather, it would provide the internet resources for retail users to access utility central banking as banks already can rather as internet giants like Facebook and Google syndicate their services through application programming interfaces. The provision of branch services, property valuation and, indeed, IT systems to service retail clients and the ‘packaging’ of central bank services with additional services would be provided competitively and efficiently by competing private firms. No doubt banks would compete to provide such business but so too could other businesses like telcos, supermarket chains, internet giants like Google or local ‘FinTech’ start-ups as their appetites and capabilities allowed.

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The end result is no less than a reconfiguration of the monetary architecture for the internet age. The central bank would undoubtedly capture dominant market share of utility or ‘narrow banking’, but only because the public sector is the least cost provider of the service. Without any subsidies, implicit or otherwise, the central bank is the cheapest, safest provider of these services in the market.

Not only would the resulting banking system have much lower costs and greater efficiency, not only would it throw off tens of billions of dollars in revenue to government, it would be a safer, more rational system playing much better to the respective strengths of public and private sectors. Though it may not obviate the need for further reform, on its own these changes could make a substantial down-payment on the aspirations of those who would urge upon us a more comprehensive redesign of the banking system.

2016 December 16

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  • geonomist

    Why should central banks even exist? Let consensual (or local) currencies enjoy legal tender. Let currencies compete. Since others would have to pay for your ideas, it’s easy to come up with them. Since so many don’t want to pay for your ideas, just let people open accounts in the public treasury. You can even get rid of deposit insurnce that way, which protects bigs more than littles, if you admire efficiency and fairness. Bigger picture, the symbol money matters much less than the referent wealth. Especially surplus values, the byproduct of economies, socially-generated values of locations and natural resources. Share that, and you can forget about money, banking, debt — even lock the hood on the economy.

    • Ian Tompkins

      To be fair, local currencies are already able to exist under the Bit Coin ruling. There are plenty of digital cryptocurrencies that could exist, and Ethereum could be popularized eventually, but the fact is the dollar is valuable because it is universally accepted, and alternate currencies have not built that reputation, and are failing due to market entry barriers, and a lack of need.

      That said, banking being a public good is not a bad thing. It would give banks the second claim on property, and would prevent over pricing since the bank would no longer be able to scrape off they way over value the propery and it’s foreclosed on (HUD would take the first 65% of the property’s value, and the bank would get the next 15%, if they valued the property way too high and it foreclosed for <65% the bank would get nothing, so they now would almost never inflate more than 20% over market value, or THEY would lose)

      • geonomist

        Public treasuries — central and local — should allow individual accounts. Any so-called insurance won’t be needed. Allow competition, oppose monopolies.

        • Ian Tompkins

          I think you’re missing my point, and you can’t have your own currency that only you use, that wouldn’t even make any sense.

          • geonomist

            No, you can’t. Yet so what? Reality offers more than (alpha) you having our own currency and (omega) you forcing everybody to use your own currency. Currencies can be as democratic as credit cards — even more so.

          • Ian Tompkins

            My point was that you’re right, everybody already *can* do that, but nobody chooses to because it’s easier and more useful to use the universal currency.

          • geonomist

            You’re right of course, just like driving downtown is easier than bussing since the former is more greatly subsidized and its costs hidden. Anyway, any currency that is universal need not have the force of the state behind it, it need not be the only legal tender. It could allow competition and still keep its status if it were truly more useful and not inflating.

          • Ian Tompkins

            What I was saying it that it DOES allow competition in the digital forum, AND it still keeps it’s dominant status, precisely because it’s already so much more useful due to mass adoption (except to ideological bitcoin users) but that inherently smart-money like Ethereum will probably out compete it, and that that will probably adopted as a national currency by either democratic takeover, or by direct competition.

          • geonomist

            Adding “in the digital forum” makes all clear. That’s what should’ve been in CAPS. Still, let’s de-politicize central bank currency. Make it a fair fight outside the digital forum, too.

          • geonomist

            Nobody’s missing any points here. They’re quite obvious. Point is, you need not worry about competition, need not monopolize the status of legal tender. If people choose not to use a currency, they won’t and it dies. If people choose to use a currency, they will and it lives. Everyone benefits. No need to monopolize or centralize or arrest people or tax one currency, not another, etc.

    • Nicholas Gruen

      Central banks exist because the quantity of money is a public good and economies are not self-stabilising at full employment.

      • geonomist

        They exist because the elite exists. Centralizing the issuance (and destruction) of money is centralized to benefit a few not the many. Those most sensitive to the needs of buyers and seller are not cloistered bureaucrats looking at data from distant sources. Instead, local consensual currencies could do a much better job — accurate and equitable. Full employment is fine for robots. You go do the stinky work. Don’t impose it on human beings, each one a miracle. I like your last name.

  • Derryl Hermanutz

    Great idea! Seems to me the B of E suggested this same thing a few months ago. CBs could offer 100% safe deposit and payments accounts: no need for deposit insurance; no threat of having your deposits bailed in to bail out your failed bank; no threat of your bank not being able to payout its deposit liabilities in banknotes or in deposit transfers to payees. Deposits and payments could be made electronically via everybody’s online central bank accounts.

    CBs could also offer debit cards, so people could spend their central bank deposit balances at retailers and other businesses who accept debit card payments. There would be a smartphone debit card reader app, rather than a wired connection, to electronically transfer balances from payer to payee accounts at the central bank. Retailers would pay a small fraction of the transacation fees they are charged by commercial banks for payments system services.

    Cash is physical, and requires a physical network of ATMs and armored trucks stocking ATMs with cash. Maybe CBs could provide ATMs, so people could convert their deposits into cash withdrawals. Modified ATMs might also offer cash deposit services for retail businesses who are paid a lot of cash. There’s still a role for cash in the modern economy.

    In the narrowest banking, CBs would not pay interest on deposits nor make any loans: not even the low ratio mortgage loans suggested by Mr. Gruen. CBs would be deposits and payments banks — pure monetary utilities, with no retail banking services at all. Loans require bankers personally meeting borrowers and underwriting the loans, which requires a national network of bank branches, which commercial banks already have in place.

    If savers want to earn some interest on their deposits, commercial banking could be changed so that banks lend out their depositors’ savings, rather than commercial banks creating new deposits to fund every loan. Commercial banks would become financial intermediaries between savers and borrowers, which most people mistakenly believe is what banks do now.

    The downside of earning interest on your loaned-out deposits is that you cannot withdraw your money on demand. You “loaned out” your money. You don’t get it back until the borrower makes the loan payments. The upside is that you and the bank share in the interest money that the borrower pays. You provide the funding; the bank provides the loan underwriting and payments collection services.

    Mr. Gruen points out that over 95% of the world’s total money supply is commercial bank-created credit-money (deposit account balances). The other 3-5% is government/central bank-issued cash money. Banks create deposit account balances — brand new credit-money — to fund their lending. Borrowers spend the credits, and payees earn the new money. 95% of all the money that people and businesses have earned and presently own, was created as a bank loan (or a bank purchase of a government bond-debt). All of that money is owed “back” to the lending banks by the debtors who borrowed and spent the new money.

    Making a bank loan creates a new deposit in the amount of the loan principal. Repaying the bank loan destroys (“extinguishes”: cancels out) the deposit, in the amount of the principal repayment. 95% of all money is created as commercial bank credit-debt. 95% of all money only “exists” as long as debtors’ debts to banks remain unpaid.

    For debtors to earn back the money and repay their bank loans, savers have to “spend” their savings, not “lend” them. But savers don’t spend the money they earn. They save it as their long term deposit account balances in bank accounts (including offshore banks). And they transfer it to their brokerage accounts and invest it buying stocks (ownership shares in businesses) and bonds (mainly government debt).

    Money that is being “saved” and “invested” is not being “spent”. Money that is not being spent cannot be “earned”. About 75% of the existing money supply is being saved in bank accounts as dead numbers; and being invested in the capital markets financial system via brokerage accounts. None of this money is accessible to the debtors who need to earn it back. So debtors can’t earn back the money, and debtors can’t repay their bank loans.

    The people who earned and how “have” all the bank-created credit-money; and the people who borrowed, spent and now “owe” all the loan account balances and bond debt: are two different sets of people. As long as savers keep or invest their money, debtors can’t earn it back (or tax it back) and extinguish it by repaying their bank loans and bond debts.

    Savers and investors have accumulated trillions of dollars, pounds, euro, yen, and every other currency. Banks created, and debtors borrowed and spent, virtually all of that money into existence. Debtors owe it all back out of existence, as their unpaid but still “owing” loan account balances and bond debts. But debtors can’t pay, so banks can’t collect.

    This is the unresolved fatal flaw in the commercial bank credit-debt money system that the whole world has been using for at least the past century. 1929 and 2008 exposed the flaw, but it was there all along.

    It is a simple arithmetic problem. The simple solution is for governments to issue debt-free money and pay it to everyone as a universal basic income, which debtors must use to repay their bank loans. This insulates savers’ deposit account savings from debtors’ loan account debts, by using the new government money to paydown debt, rather than using the bank-created credit-money (that was earned and is now owned by savers) to paydown the debts.

    Solvency is restored to the banking system, by deleveraging the banks who are holding trillions of “distressed” debt on the asset side of their balance sheets at full “collectable” value. Those loan account debts cannot be paid, because deposit account savers have all the money and are keeping it, not spending it. All those trillions of savers’ deposit account balances are on the “deposit liability” side of bank balance sheets.

    But banks can’t pay their deposit liabilities, because banks can’t collect their “earning assets” — debtors’ interest-bearing but unpayable loan account and bond debts. Depositors are the banks’ largest class of “unsecured” creditors. Which is why regulators are “bailing in” depositors’ account balances, to convert banks’ payable deposit liabilities (customers’ deposit account balances) into non-payable shareholder liabilities. Depositors are being robbed to bail out an impossibly insolvent balance sheet arithmetic equation.

    This unresolved fatal flaw in the credit-debt money system is the root problem of our time. Fixing it is simple. I described the problem in more detail, and the solution, and the consequences, in a little book with a long title: A Basic Income Alternative to the Slow-Motion Train Wreck of Global Finance.

    • Nicholas Gruen

      Thanks Derryl,

      I don’t think there’s any need to separate savings and transactions accounts with the central bank. There’s no distinction made of that kind regarding banks exchange settlement accounts to my knowledge. After all, the central bank doesn’t have to take any steps on the demand side to maintain liquidity.

      There are any number of alternative plans – which people are emailing me at a great rate since the publication of this article – but I see it as a feature rather than a bug that this article argues for a single change to the existing system. That’s for two reasons.

      1) it involves a single change which has strongly positive characteristics. It should drain a lot of the rent out of the existing system which would then start specialising in the kinds of things that it’s supposed to do – relationship banking etc. It’s deposits would also be understood by the community to be higher risk than deposits with the central bank, and, so, given the availability of the central bank accounts there’s no need for the state to get involved in rescuing those who’ve gone for higher returns in the event of a bank run on those deposits.

      2) The principle of competitive neutrality is simple, well understood and compelling politically – it’s transparently ‘fair’ that, as far as practicable, we all receive the same treatment.

  • Kevin O’Leary

    Cool, now if my money is in the central back the can just directly debit my account to pay my income ta… oh wait.

  • remmals WHY OUR MIDDLE CLASS NEEDS DIVIDENDS: “Every American knows our middle class is in decline. But in a globalized, increasingly automated economy, what can we do about this? In the past, good-paying jobs were the bedrock of America’s middle class. But we must face the fact that jobs alone won’t sustain a large middle class in the future—there just aren’t, and won’t be, enough good-paying jobs to do that. That means we need broadly shared streams of non-labor income.

    “Where might such non-labor income come from? One possibility is higher taxes. But there’s another and better source: wealth we own together. Consider the Alaska Permanent Fund, which uses revenue from the state’s oil resources to pay dividends to every Alaskan.

    “A similar fund based on several co-owned assets could be established nationwide. Dividends from co-owned wealth make political as well as economic sense. They’re not welfare but rather legitimate property income. They rest on conservative as well as liberal principles and can unite our country rather than divide it.”

  • Dr. Mohinder Kumar

    When all money is credit and a social construct for enumerating transactions among individuals/institutions in society, then not only commercial banks but also money itself has long served its purpose in human history, especially when internet can better connect their transactions and exchanges. Even central bank is not needed. What society in the coming days may require is a web-linked centralized account-keeping institution to record all transactions.

    Hitherto commercial banks are losing relevance, particularly after the invent of Microfinance Institutions which themselves are nothing but reincarnations of banks. Banks have hitherto acquired sort of autonomous power to rule over society and its economic activities. With exponentially enhancing automation, banks with autonomous financial power are also becoming automatic drivers of the economy and society to subdue these entities.

    Autonomous banks are to society just as uncontrolled artificial intelligence in robots is to humanity. Banks think that society exists as an instrument of multiplying finance. The goal of society is money/ finance/ banks. It’s society and its overlord state which have to ensure that banks survive and sustain for eternity. This ideology (not science) nourishes unfair and inefficient modes of existence of banks nestling in state’s subsidies.

    In any case, commercial banks have no social purpose or relevance whose function of credit creation could immediately be taken over by central banks. After some time, automation shall make central banks and many other organs of the state also useless to the society. When humans’ inter-personal relations, social relations of production and institutions created out of that process could not ensure emancipation of humanity then force of automation shall complete the as yet unfinished task of human society: human welfare and human emancipation.

  • Ian Tompkins

    I love this idea of banking as a public good, essentially gutting the financial sector for public gain. I also think that this would correct the market’s mega-inflation of the FIRE sector. See the below example:

    Now, If I need to purchase a home, I would have it privately surveyed for value, but now, instead of the bank owning 100% of the value in the home they would only have the value remaining after the public bank took their 1st claim after foreclosure (the super safe value). It would no longer be profitable for private banks to dramatically inflate the market since they stand to lose everything if the share owned by the public bank, and they do not make such astronomical interest off their portion of the mortgage that it doesn’t matter if they have to foreclose after 5 years at a “loss.”

    I see a lot of positive externalities are possible with public banking, I’d love to see some modeling done to prove the benefits.