Business

Why Central Banks Should Offer Bank Accounts to Everyone

Central banking disrupted for the 21st century

Share with your friends










Submit
More share buttons
Share on Pinterest

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.

Get Evonomics in your inbox

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.

Get Evonomics in your inbox

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


Donating = Changing Economics. And Changing the World.

Evonomics is free, it’s a labor of love, and it's an expense. We spend hundreds of hours and lots of dollars each month creating, curating, and promoting content that drives the next evolution of economics. If you're like us — if you think there’s a key leverage point here for making the world a better place — please consider donating. We’ll use your donation to deliver even more game-changing content, and to spread the word about that content to influential thinkers far and wide.

MONTHLY DONATION
 $3 / month
 $7 / month
 $10 / month
 $25 / month

ONE-TIME DONATION
You can also become a one-time patron with a single donation in any amount.

If you liked this article, you'll also like these other Evonomics articles...




BE INVOLVED

We welcome you to take part in the next evolution of economics. Sign up now to be kept in the loop!

  • 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

    http://dividendsforall.net/potential-revenue-sources/ 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.

    • Nicholas Gruen

      There is some very encouraging modelling by the Bank of England of a proposal which is similar to mine in that it involves the central bank issuing a substantial portion of the money which is used for payments – in this case in the form of a central bank backed digital currency. http://www.bankofengland.co.uk/research/Pages/workingpapers/2016/swp605.aspx

    • Nicholas Gruen

      ..

  • I have a few questions:
    1. Using an API approach, is there any verification of the end user? For example, if a putative EzyBanking company provided me with a 65% LVR home loan, would the RBA verify my identify or leave that to EzyBanking?
    2. Presumably the RBA would take a mortgage over properties provided as security. Is there a proposal to do this in a way that bypasses lawyers (maybe the LPI can provide an API as well?)
    3. Linked to 1 and 2 are there additional utilities (potentially government provided) that would be ideal (perhaps even necessary) to make the proposal work – for example a central identity verification agency (beefing up DVS), enhancing the online management of land title, valuation, etc?
    4. Would the parties using the RBA API that originate a loan be responsible for servicing the debt (e.g. providing statements, etc) or would that be part of the RBA’s API offering?
    5. Who would be responsible for chasing up borrowers that fall behind in their payments?
    6. Would customers be free to transfer their relationships between providers, moving the same deposit or loan account between providers?
    7. How would the valuation be performed to ensure that the LVRs were within the maximum level?
    8. Would the RBA be responsible for managing transfers at the back-end between accounts?
    Sean.

    • Nicholas Gruen

      Generally speaking I’d leave the answers to many of these questions to the stage of detailed design, but in the spirit of working through one possible example of the system I’ll have a go at your questions.

      1. The central bank satisfies itself that EzyBanking is handing over an unencumbered mortgage with a 65% LVR or LTV – that is there is no fraud on the central bank. Other questions are a matter for EzyBanking.
      2. Because the RBA (this is the central bank for Australia for others’ information) would write mortgages en masse, there may well be opportunities to standardise and reduce costs and in the process remove lawyers. Already in Australia title deeds can be transferred by licenced conveyancing clerks and without lawyers. Mortgages should be similar. What I’m proposing would also be a good opportunity to standardise mortgages so as to make them much more tradeable which would generate substantial efficiency gains.
      3. Indeed. When Geoff Mulgan initially commissioned the piece this article was based on – see below – he was keen to include discussion of this – which was nevertheless held over to subsequent elaboration. http://www.nesta.org.uk/publications/central-banking-all-modest-case-radical-reform.
      4. Not sure quite sure what you’re asking here or why. Whatever minimises transaction costs.
      5. My way of thinking of this is that the central bank provides a facility to all comers with minimising cost and efficiency being the key drivers. It would certainly be possible for banks and other service providers to package up central bank lending and resell it to customers with or without their own products and with or without their own margins. But I’m wary of assuming that the central bank should settle for that – because though economists assume that margins will fall to commoditised levels, they rarely to in finance for a variety of reasons. Accordingly at every point I’m keen to allow people to access the central bank directly – or as directly as possible – should they wish. Accordingly I’d propose that anyone can use the API as a basic banking service – involving online accounts and the right to borrow up to 65% LTV. They must pay up, and if they don’t they get auto-emails up to the point at which some trigger is reached – say 3 months arrears – and then their case is sent onto a service provider who adds a margin and manages the loan.
      6. Indeed they would and as you’ll have gathered from my earlier comment, I see the opportunity to standardise a lot of things as an important sub-benefit of what I’m proposing.
      7. Valuation would be done as banks currently get valuations done – by registered valuers subject to various integrity checks both in general and on a spot basis.
      8. Not sure what you mean. I am thinking that you could give customers the right to having their money in a large number of accounts – ie that once set up this should be at negligible additional transactions costs for the central bank, but it’s not an important thing and it could be an add on service provided after the API if I’m wrong. If you’re asking about the payments system, the answer is yes. The central bank runs a giro-bank which I think would become the heart of the payments system very quickly.

    • Nicholas Gruen

      I’d leave the answers to many of these questions to the stage of detailed design, but in the spirit of working through one possible example of the system I’ll have a go at your questions.

      1. The central bank satisfies itself that EzyBanking is handing over an unencumbered mortgage with a 65% LVR or LTV – that is there is no fraud on the central bank. Other questions are a matter for EzyBanking.
      2. Because the RBA (this is the central bank for Australia for others’ information) would write mortgages en masse, there may well be opportunities to standardise and reduce costs and in the process remove lawyers. Already in Australia title deeds can be transferred by licenced conveyancing clerks and without lawyers. Mortgages should be similar. What I’m proposing would also be a good opportunity to standardise mortgages so as to make them much more tradeable which would generate substantial efficiency gains.
      3. Indeed. When Geoff Mulgan initially commissioned the piece this article was based on – see below – he was keen to include discussion of this – which was nevertheless held over to subsequent elaboration. http://www.nesta.org.uk/publications/central-banking-all-modest-case-radical-reform.
      4. Not sure quite sure what you’re asking here or why. Whatever minimises transaction costs.
      5. My way of thinking of this is that the central bank provides a facility to all comers with minimising cost and efficiency being the key drivers. It would certainly be possible for banks and other service providers to package up central bank lending and resell it to customers with or without their own products and with or without their own margins. But I’m wary of assuming that the central bank should settle for that – because though economists assume that margins will fall to commoditised levels, they rarely to in finance for a variety of reasons. Accordingly at every point I’m keen to allow people to access the central bank directly – or as directly as possible – should they wish. Accordingly I’d propose that anyone can use the API as a basic banking service – involving online accounts and the right to borrow up to 65% LTV. They must pay up, and if they don’t they get auto-emails up to the point at which some trigger is reached – say 3 months arrears – and then their case is sent onto a service provider who adds a margin and manages the loan.
      6. Indeed they would and as you’ll have gathered from my earlier comment, I see the opportunity to standardise a lot of things as an important sub-benefit of what I’m proposing.
      7. Valuation would be done as banks currently get valuations done – by registered valuers subject to various integrity checks both in general and on a spot basis.
      8. Not sure what you mean. I am thinking that you could give customers the right to having their money in a large number of accounts – ie that once set up this should be at negligible additional transactions costs for the central bank, but it’s not an important thing and it could be an add on service provided after the API if I’m wrong. If you’re asking about the payments system, the answer is yes. The central bank runs a giro-bank which I think would become the heart of the payments system very quickly.

      • Thanks Nicholas,

        A few thoughts in response:

        1. I think this is a bit more complicated than you suggest. First it doesn’t really make sense to talk about an unencumbered mortgage: it is the property that is encumbered and the mortgage is the means of encumbrance. For the RBA to have a secured loan, it would have to be the mortgagee rather than EzyBank (and, as an aside, in NSW taking a mortgage requires a lawyer to act for the RBA, but not necessarily for the borrower http://rgdirections.lpi.nsw.gov.au/land_dealings/dealing_requirements/mortgages/mortgage). It would be possible for EzyBank to initially take a mortgage over the property and then transfer it to the RBA, although then there would have to be a settlement at that when taking the mortgage which either means that EzyBank would have to fund that for an interim period of time or, if the RBA provided these fund, there would be an initial (short) period where the RBA was lending unsecured. So, that probably means that the RBA would have to participate in the initial settlement. Second, I’m not sure that under current legislation that it would be possible for the RBA to provide the loan without undertaking some due diligence to know its customer (the borrower). Under current anti-money laundering (AML) legislation, if the RBA were to become involved in retail banking it would be providing a “designated service” and would be responsible for maintaining an AML program, including adequate customer identification. While the legislation could be amended to carve the RBA out of these obligations, if that happened and it turned out that an RBA account was used for money laundering, it would not be a good look! http://www.austrac.gov.au/definitions-and-examples-common-designated-services#financial

        2. Whether or not the RBA were to become involved in retail banking, modernising the activities of the LPI would be a good step forward in this internet world, so I think we are agreed here. Without this sort of modification, I do think that, as per point 1, even the origination of the loans would involve significant activity for which the RBA is currently not resourced.

        3. Again agreed here (and I’ll read the more detailed paper too). It’s worth noting that maintaining an AML program is a significant undertaking for banks today, which maintain dedicated teams to run the programs. Again, without an AUSTRAC-sanctioned third party service providing much of this program, this again would involve going significantly beyond current RBA capability and infrastructure. http://www.austrac.gov.au/chapter-6-amlctf-programs

        4. The reason I ask is that, as any bank or telco will attest, there is a lot of work involved in providing any service to a large retail customer base. Even with a sophisticated automated system for maintaining customer accounts, statements, etc (which the RBA does not currently have – the operation of wholesale exchange settlement accounts is a very different undertaking), it is still necessary to have staff in call centres and the like to respond to customer queries (email, phone, etc). This can be outsourced (for an ongoing fee), of course, but then that involves ongoing due diligence by the RBA on the outsourced provided and, most likely, maintaining what is known as a “stand-by servicer” to step in should the primary servicer fail. It would also be possible to leave this to each intermediary (such as EzyBank to continue that hypothetical), but the ongoing due diligence would be even more complex and would make customer transferability more complicated as fees would have to be moved from one provider to another (and they may not all charge the same rates – unless the RBA insisted on a flat rate, which would make sense).

        5. I think you are underestimating how important managing collections is in ensuring the performance of lending portfolios, even where initial loan to value ratios are low. Currently in Australia there is a market for buying defaulted (i.e. more than 3 months in arrears) debt, but typically this market is for credit cards, personal loans and auto loans. I am not aware of any debt sales market for home loans, but I’m sure there would be takers. This would involve selling the debt at a price less than 100 cents in the dollar. Given the good security, this price would be fairly high – probably around 90c in the dollar – but it would certainly not be 100 cents in the dollar. This would mean that even by focusing on very low LVR mortgages, the RBA could easily find itself losing about as much on this portfolio as banks lose on theirs (typical default rates at the moment for Aussie banks are around 0.5% or so, with lower risk portfolios the RBA’s portfolio may be closer to 0.2% – even low LVR borrowers lose their jobs, get sick, etc – and loss rates of around 10% in a debt sale would result in 0.02% in losses which is about what the large banks lose). Alternatively, instead of a sale, there could be some kind of outsourced collections arrangement for a fee. This does not exist today in Australia as far as I know, but to get into this business the fee would have to be quite high and, as it would not really be possible to charge the borrower this fee, it would also result in losses for the RBA. Overall, the importance of collections management should not be underestimated!

        6. I thought this was the intent – the relevance of the question goes back to the importance of setting up the servicing arrangements cleanly, as per 4.

        7. You may not be aware that a valuation by a valuer has not been standard for a long time. Particularly for low LVRs, there is extensive reliance on “e-valuations” based on models developed by the likes of Core Logic. These models have an inherent uncertainty so, in setting the maximum of 65%, it’s important to be aware that some of the loans originated make actually have higher LVRs. It would be possible to insist on a full valuation, but this would add to costs and time involved.

        8. What I was referring to here is that there is currently significant investment under way by numerous banks at the direction of the RBA to develop the “New Payments Platform” http://www.apca.com.au/about-payments/future-of-payments/new-payments-platform-phases-1-2. This will facilitate near real-time transfers between banks using aliases (i.e. I can pay you only knowing your mobile number or email address not your BSB and account number). It will also provide richer metadata than the current “pay anyone” transfer messages can provide. I don’t think that the RBA would want to have an inferior offering for payments between accounts, but that would mean that the RBA would have to invest in the sort of infrastructure that the banks themselves are currently building. Even if the RBA was content with something more basic, to work online there would still be development required: it’s not infrastructure that the RBA has today.

        Overall, the thrust of these points is that your proposition is that a move of the RBA from “wholesaling” to “retailing” could be done fairly easily using existing infrastructure. I think you are significantly underestimating the complexity of the idea in practice and the extent of new infrastructure that would be required.

        • Nicholas Gruen

          Thanks for all your detailed comments. I think you’re taking what is a large proposal and then subjecting it to a nuts and bolts due diligence, which the article wasn’t written to do. Nevertheless it’s a useful exercise to go through those things. I think there’s reasonable agreement between us, but you’ll see in my responses a keenness to take things back to first principles, rather than just accept existing inefficiencies as inevitable and simply to be funded by the RBA – though I accept that often the function will need to be carried out. Some further specific comments are below.

          1. In my proposal, in case it’s of interest, I’d allow people to access 65% of their property’s value as of right. Clearly if we want to regulate this there are more and less complex ways of doing it.

          2. I don’t know what LPI is – and don’t much care. I know there are lots of details, many of them can be streamlined to some extent and the proposal can help in spearheading that, but lots of details will remain and dealing with them will have to be funded. I have indicated I think it can be done on a 0.5% but I also did talk about meeting transactions costs and for those who were looking for more definition in my piece, I should also have indicated that I’d expect there to be an upfront cost of setting up a mortgage, as there is in the existing mortgage market.

          3. Fair point. I wonder what AML achieves. Looks to me like the classic kind of anti-baddie regulation which inconveniences all the goodies, and is easily got around by the baddies – but that’s just a hunch, not based on good evidence.

          4. All what I’d expect. One could also sell different grades of service. I’m really only interested in the RBA providing the basic service. Not sure I’d even have the RBA sub-contracting the customer call-centres etc. One might require that to be provided by third parties in a regulated, market well informed about service quality (using the kinds of tools I’ve argued for in the past)

          5. This points to the inefficiency of our legal system and we should address it. Given the slim chances of doing that I agree that it would impose costs on the system.

          6. No comment – and hopefully none needed

          7. Agree – with thanks for the additional detail

          8. I’m aware of the development. I also think that a giro-bank style payments system – all within the one system – ought to be a lot cheaper than the system currently being set up. But I’m no expert.

          • Thanks for the reply. As you say, I have dug into the nuts and bolts here. In doing so I don’t intend to suggest that there are not alternative approaches to many of the operational processes I’ve touched on. Also, I am not particularly concerned about the costs of these processes: after all, these costs are covered today by fees and margins associated with existing banking products, so they could equally be covered by fees levied by different providers, including the RBA. Rather the reason I raise all of these details is that the impression I took from reading the article was that you were arguing that, as the RBA is currently a wholesaler of banking services, in this internet enabled age it would be relatively straightforward for the RBA to move beyond wholesaling to retailing. While I don’t think this is impossible, I do think it would be an enormously challenging and complex transition which would require significant regulatory as well as operational changes. While you have the view that at least some of this regulation is unnecessary (anti-money laundering) and perhaps somewhat paternalistic (responsible lending), it is the regulation of the day and changing it is no mean feat. Likewise establishing new providers and processes for interacting with retail customers in financial products is a very significant undertaking. It’s not that it can’t be done, but the enormity of the challenge in this proposal should not be underestimated.

            Finally, I know you said you don’t want to know what the LPI is, but I can’t help telling you: it’s Land & Property Information – formerly known as the Land Titles Office. It has a very important role in any mortgage lending, so it’s actually worth knowing what it is, but apologies for assuming you were familiar with the shorthand.

          • Nicholas Gruen

            Thanks for that Sean.

            Always gratifying when comments help narrow and clarify differences – as they have here. I think there’s a fairly full meeting of minds – or at least accounting for differences if you know what I mean.

    • Nicholas Gruen

      Hi Sean,

      I’ve written answers to your question on several occasions and each time it’s disappeared from the platform. Not sure what’s going on.