Reserve banking

P2P as a full reserve bank | Financial Time

FT Alphaville had the pleasure of moderating the “Future of Banking” sign at OuishareFest, a collaborative economy gathering, earlier this month.

During this discussion, an interesting point was raised by François Carbone, CEO of an equity crowdfunding company. Anaxago. Namely, when you think about it, every peer-to-peer (P2P) initiative proposed today is truly representative of an evolution towards a private sector version of full reserve banking.

This is whether P2P businesses are equity-based (as in the case of Anaxago), reward-driven, donation-based, or even focus on traditional interest-based lending.

And that’s, of course, because most peer-to-peer lenders operate almost exclusively in the world of existing money. They do not get involved, unlike conventional lenders, in the business of money creation, parallel currencies or seigniorage.

They simply redirect what is already available.

To explain this a bit, it’s worth revisiting John Maynard Kenyes’ famous graphic representation of the monetary universe from his Treaty of Money:

In any economy, there is, according to Keynes, a root common to all money, which revolves around a social consensus on what is the “money of account” in this economy, namely the unit in which all debts can be adjusted. In primitive human economies, it could be either seashells or feathers (although they vary in size and quality). In the first societies, it was a question of standardized part or merchandise weights. In today’s more complex economy, these are more abstract and standardized concepts like the dollar.

Account currency in this sense is the description or title of the currency that any society collectively agrees to have the power to cancel social commitments. It forms, one might say, the “monetary consensus” of the Emperor’s New Clothes.

If we all believe unity matters, it is.

Money itself, meanwhile, is the thing that fits this description.

According to Keynes, this real form of money can then be subdivided into two forms: “own money” and, separately, money which is representative of an “acknowledgment of debt” within the system, which is itself. – even a type of money that tends to bleed into “bank money”.

Further down the trunk we encounter other types of money.

Finally, among them is “Commodity Money”, which is changing very significantly. out of State (or social) currency, the value of which is entirely determined by its relative position and its placement in the monetary sphere representative of a particular economy.

The “representative currency” itself is made up of a mixture of “managed currency”, “fiat currency” and “bank money”. Its defining characteristic is simply that the state (aka the collective) believes that these forms of money are acceptable when it comes to fulfilling a responsibility in the system.

But what is interesting about bank money in particular is that it resides in a domain largely independent of the state. If the state has control over bank money, it is either by influencing the supply of “state money” on a relative basis, or by its power to dictate what counts as representative money and what does not. ‘is not.

It can, for example, declare at any time that the money issued by Bank X no longer counts as real money. It is the equivalent of a bank losing its banking license, or – perhaps during a crisis – failing to match its liabilities with assets that actually count as government currency, failing to meet reserve requirements. mandatory and not being able to convince the state to create new volumes of state money to fill the gap on its behalf.

As Keynes himself noted:

Bank Money is simply an acknowledgment of a private debt, expressed in account currency, which is used by passing from one hand to the other, alternatively with Money-Proper, to settle a transaction. We therefore have side by side the State-Money or the Own-Money and the Bank-Money or Acknowledgment-of-debt.

As a consequence of this parallel monetary characteristic of bank money, the monetary universe actually evolves like this:

As can be seen from the graph, bank money is only fully fungible with state money due to its interaction with the reserve system of the central bank. So while banks can create as much money out of thin air as they want (over there on the right), they are in theory limited to more do so because of their ultimate need to meet the minimum reserve requirement.

When the minimum reserve requirement is zero, the bank is ultimately constrained by the need to pay government money to depositors on demand. This means managing the risk of asset and liability mismatches so that the bank can always provide money from the state to meet such claims.

Failure to meet these demands creates a crisis of confidence in the banks’ own parallel currency units, which are actually a sub-category of the bank’s equity, as in all respects they now appear to have been largely overissued.

The state can either bail out the bank, printing state money the bank lacks, or decide to point out that that particular bank is – in the emperor’s new language of clothing – naked.

See here for an explanation why the share price of a bank must always be higher than 1 dollar, euro, pound, franc (or other) to remain solvent.

In any case, it is for this reason that a bank is prevented from over-issuing its own currency, unless all other banks also issue too much money, which means that there are other forms of bank money that a troubled bank can borrow (and which are considered reserve money. , or the type of money a depositor would accept) to avoid being caught bare.

Or as Keynes noted:

… It must keep pace with other banks and cannot raise its own deposits in relation to the total deposits out of proportion to its share of the country’s banking activity.

In a world of full reserve banking, however, there is no chance for banks to go ahead (or over-issue) unless the state creates first (through currency managed) additional money for the system. Control of the money supply is therefore returned to the State (or to the collective authority).

The problem now, of course, is slightly different. Banks have already been taken “naked”. They received the state money needed to plug the hole, but are not creating enough money to meet the needs of the system because they fear that if they continue to create money at their previous rate. , they risk ending up with a liability mismatch everywhere. again.

Therefore, the responsibility for money creation lies with the state.

Except in the current context, the reserve system prevents more money from flowing into the real economy. This is because money is created as reserves held by member banks, rather than reserves held by the public. (In our view, this is one of the reasons why the state should seriously consider issuing official electronic money.)

In view of the above, the velocity of money is dying on the banking side. Not only are banks reluctant to take credit risks, but, as Anat Admati argues, they have no interest in financing themselves directly because they can now count on the State’s excess money reserves to guarantee their low capitalization.

Reserves should not, as she always notes, be confused with capital. Just because the banking system has excess reserves does not mean that banks are fully capitalized. Rather, the capital (or state money) that the system possesses has been diluted (by the state) to satisfy the existing demands of the banking system.

However, this was done disproportionately to the capital held by the public.

So kind of like owing Peter five apples, but since you’re a bank, being allowed to settle the claim with five apple slices while everyone still has to provide Peter with the original number of apples.

In this sense, QE has changed the nature of the game for banks, but not for everyone. And since the banks, having settled their debts, are now dealing with apple slices rather than apples – in fungible terms with apples – they now rightly want to swap those slices for safe apples (especially those that have already been turned into “income money” in terms of old apples) as quickly as possible.

All of this actually reduces the number of apples (state money) in the investment sphere and causes an excessive amount of apple slices to crowd out the last remaining safe apple opportunities. The reason why slices are not passed on to the real economy is mainly because the chances of creating similar income streams with apple slices, compared to those that already exist under old apple conditions, are weak.

This is where the P2P loan boom comes in – fully funded from the start:

P2P turns out to be the safest way for the private sector to increase the speed of money in the “Publicly owned” section of the graph – speed that is needed to make up for all the money in the state. sucked from the hands of the private to the member bank. or financial hands instead.

Of course, if and when, the social consensus decides that money totally disintermediated – that is, not bank money, or crown money – can be used to settle claims, then we would have a change in the system that looks like this:

The demand for virtual / disintermediated money would be understandable given the lack of state money in state hands relative to need.

The only problem with such a change, however, is that there really wouldn’t be any restriction on issuance. Nor would there be any obvious convergence with the reserve system or the legal unit of account; no social authority to specify when the issuer is naked or not; no lender of last resort; no stability due to insufficient management of the money supply (especially in relation to a price target) and last but not least: no guarantee that the social consensus around the virtual unit will prevail.

In short, there could be monetary chaos.

Greater adoption of P2P, however, has the advantage of increasing the speed of money in private hands under the existing system. And also with continued responsibility to the state.

Related links:
Guest article: The case of digital legal tender – FT Alphaville
A digital solution for the repo squeeze? – FT Alphaville
Learn more about M-pesa and electronic money – FT Alphaville
M-euro, a money supply lesson from Kenya – FT Alphaville
Why central banks should take charge of their digital currencies – FT Alphaville

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