Reserve banking

Full bank reserve | openDemocracy

From Irish woes to student protests, the grim fallout from the banking crisis once again dominated the news this month. But behind the scenes, a radical solution has also quietly gained traction, with growing support from a few unlikely bedfellows.

Conservative MPs, leftist and libertarian think tanks and even Muslim Shariah bankers have lent their support to fundamental reform of the banking system. Their idea is simple but radical: banks should only be able to lend money from our accounts if we give them explicit permission.

Before the financial crisis, most mainstream economists and politicians would have dismissed this idea outright. But this month, two Tory MPs released a private member’s bill on the subject and, perhaps more importantly, it caught the attention of the new Independent Banking Commission and the Governor of the Bank of England.

How to make money from nothing

In modern commercial banking, banks hold in reserve only a fraction of the money we deposit with them and lend the rest out again and again. This is called fractional reserve banking. Before the crisis, on average, for every £1 issued by the Bank of England, the banking system was able to create around £80 of new bank money (the numbers in your bank account). As Martin Wolf, chief economics commentator for the FT says: “The essence of the contemporary monetary system is the creation of money, out of thin air, by the often foolish lending of private banks.

In this system, we can access our money whenever we want without having to pay for banking services or take risks. Even if the money we deposited has been invested elsewhere, when we want our money back, we will be reimbursed. Banks profit from lending out most of this money multiple times – essentially creating new money and charging interest on it.

But what if the bank uses our money to invest in risky assets and loses everything? To deal with this, the UK government has introduced a deposit insurance scheme, whereby the state guarantees that anyone who deposits money – up to £50,000 – into an eligible account will get it back. even if a bank goes bankrupt, thus eliminating the risk for the customer.

This is not good news for the taxpayer, because as Mervyn King explained in a recent speech, the use of short-term debt (our bank deposits) to finance risky long-term investments makes banks “inherently fragile”. “Many [people] treat loans to banks as if they were risk free,” he says. “Taken in isolation, this would be akin to a belief in alchemy – risk-free deposits can never be backed by long-term risky investments in isolation. To work, financial alchemy requires the implicit support of the taxpayer. In 2008-09, this taxpayer support amounted to £18.9 billion.

Boom and bust

According to monetary reformers, this system of “alchemy” is one of the root causes of economic booms and busts, and nothing less than a fundamental overhaul will be able to prevent deeper crises from occurring at the future.

Ben Curtis of Positive Money, a campaign group coordinating the burgeoning currency reform movement, says: “It’s pretty embarrassing to have a financial system that crashes every 7 to 10 years, but instead of it fix it, we patch it up and resume business as usual. We have a banking system that is inherently unstable and triggers these recessions that put millions out of work and destroy otherwise healthy businesses. He also argues that the current system “privatizes profits and socializes losses” because banks are able to charge interest on newly created money while taxpayers foot the bill if something goes wrong.

Steve Baker, one of the two Conservative MPs behind the recent private member’s bill, goes even further. He argues that current banking practices would be “considered a disgusting crime” in other industries, and would amount to “collusion between the state and the private sector”.

Possible solutions

In September, Conservative MPs Douglas Carswell and Steve Baker introduced a private member’s bill in Parliament which they said offered a solution to this problem. The bill would “assert strong property rights over money,” Carswell said, allowing us to choose how banks use the money we deposit. Baker explains how this would work:

“For new accounts, people should either choose to have a custodial account where the money belongs to them and is safe and ready to go, or they choose to have that money lent to them, [for a set period of time, at their own risk], to someone who wants to borrow it. These would be the only two types of accounts.

This would mean that banks would always have to have enough money in reserve to reimburse their current account customers, and that people with loan accounts could only get their money back at the end of a fixed period, thus eliminating the risk of bank runs.

Although the bill would never have been signed into law (backbench bills like this very rarely are), it was released this month and Baker is setting up a new all-party caucus. on Money, Banking and Economics to discuss such issues, which he will chair. Baker is also promoting the idea with the libertarian think tank Cobden Centre, where he is an adviser.

For Baker, this is a decidedly conservative issue of too much state interference in markets. “The state ended up underwriting and privileging a particular section of the economy,” he says. He argues that this not only hurts his constituents, who must bear the cost of costly bailouts, but also distorts loan markets. His conviction that the problem is largely one of the state and not of the markets should help him attract other Conservative MPs to the cause.

Fair and sustainable

Further to the left in a completely different area of ​​public life, another group of people have come to a very similar solution, but for different reasons. The think tank nef (new economic foundation), the campaign group Positive Money and Professor Richard Werner of the University of Southampton have put forward a proposal for a full reserve banking system, which is very similar to the bill of Carswell and Baker. Earlier this month they took the idea to the Independent Commission on Banking (ICB), which was set up in June 2010 to study how the banking system can be made more stable and competitive.

But in addition to working for a stable and productive economy, these groups prioritize the creation of an environmentally sustainable and equitable economy; the nave exists to promote the economy “as if people and the planet matter” and Werner is a professor at the Center for Banking, Finance and Sustainable Development in Southampton

They argue that because banks can charge interest on the money they create through loans, and because most of that interest goes to bankers rather than savers, the system is currently very unfair. Through interest, money flows from the poor to the rich, from the ‘real economy’ to the financial sector, and from the rest of the country to the City of London and the South East, they say.

They argue that a 100% reserve banking system, where customers have a choice of two accounts as outlined in the Carswell/Baker bill, would be much fairer, more stable, more productive and sustainable.

A full-reserve bank could also put an end to credit-fueled consumer booms. This would help curb the overexploitation of natural resources and the emission of greenhouse gases that cause climate change.

Problems with full-reserve banks

To many economists, however, much of this sounds like heresy. “[Full reserve banking] would be a major shift in business models,” says Dr Alistair Milne, of Cass Business School at City University London. “What the Independent Banking Commission is more likely to say is that deposits should be held in safe bank subsidiaries which have much stricter regulations and cannot engage in certain types of activities. It’s much more achievable practically.

Moving to a full-reserve bank would raise many questions. According to Dr Michael McMahon, LSE associate researcher and assistant professor at the University of Warwick, the “big unknown” is how much money people would put in these “super safe accounts”, and how much we would choose to lend. as this affects the amount of credit available and the impact on the system.

There is also a question, he says, about the ripple effect on the cost of regular banking services for customers. “Banks may decide that providing accounts to households was suddenly a very unprofitable business because of the way they are allowed to use the money” [i.e. they can’t lend it out], he says. “So they may decide to stop offering personal accounts altogether… We could move to a system where the cost of having a bank account is very high, where you are charged transaction fees every time you use your debit card.”

There are also disagreements among proponents of the full reserve bank as to exactly how the alternative system would work. While Tory MPs Baker and Carswell agree with more left-leaning groups such as the Nave on a surprising number of issues, they disagree on issues such as who should control the money supply if the banks don’t – the state (nave) or the free market (Baker and Carswell)?

The Future of Currency Reform

Positive Money’s Ben Curtis says the campaign he and colleague Ben Dyson launched two months ago will kick into high gear over the coming year. “We are trying to mainstream the issue, get media coverage, reach the public through organizations such as the Federation of Islamic Student Societies, work with more MPs and listen to the Independent Commission on Banking. ,” he says.

So for now, it looks like the unlikely union of left, right, green and Muslim interests will continue. This is vital, argues Curtis, if the banking lobby is to be countered.

“There are no interest groups working on the other side of the banks,” he says. “Banks will obviously push for the system that allows them to make the most profit. There is no one who represents society’s point of view, that’s why we are here, to create the best monetary system for those who use money.