The banking commission report doesn’t go far enough


4:18 pm - April 11th 2011

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contribution by Ben Curtis

The battle between the government, the financial sector, and the public interest over banking reform reached a pivotal moment today with the release by the Independent Commission on Banking’s interim report.

The clear winners in this round seem to be the banks: this morning shares in Barclays were up 3.28%, for RBS 2.49%, and for Lloyds slightly less, at 0.72%. We expect this is due to the less-than-radical reform being suggested by the Commission.

It advocates splitting up the investment and deposit-taking activities of banks, but not in the form of a full-scale breakup. The proposals essentially suggest that retail (high-street, deposit-taking) banking activities should be ‘ring-fenced’ from the riskier investment banking activities.

Much of the media is reporting that the two arms of a universal bank would be isolated, but closer analysis suggests this is not necessarily the case. The two arms of a bank would still be able to bail each other out in difficult times, but neither would be able to bring the other half down in a crisis.

This opens the doorway to the enormously difficult task of designing new rules to govern exactly how much and how often these “isolated” institutions could transfer money to each other, and prevent the best rule-benders in the world from abusing the regulatory system.

Just a few days before the financial crisis brought down Lehman Brothers and Bear Stearns the ratings agencies were convinced the firms were watertight, and our regulators were happy with banks regulating themselves!

But increasing the capacity of the banks to absorb losses does not equate to taking the taxpayer off the hook.

A pseudo-break-up of separate banking activities will not in practice prevent them from failing all at once, will not remove the need for deposits to be insured by the government, and will not remove the “too big to fail” problem.

But the Commission was tasked with the wrong investigation. Of particular interest is the following passage:

…even before the crisis banks enjoyed various kinds of state support, including the effective right to create money, and access to lender-of-last-resort facilities at the central bank. Comprehensive state support was given to banks in the crisis, for fear of what would otherwise happen, and continues to benefit banks directly and indirectly on a large scale, especially those seen as being systemically important. (p98)

Would it not be better for the Commission to ask whether these privileges should benefit bankers, or the taxpayers who provide them? Given the track record of the banks, are they really the right people to trust with the ‘effective right to create money’, as the Commission puts it?

I for one am hoping that voters will demand that the right question is asked of the government – “does providing banks with the effective right to create money serve me better than taking it away from them?”

Given the instability that has underlined the growth of the financial sector, that doesn’t sound like a great return on investment to me.


Ben Curtis is a campaigner at Positive Money – calling for a fair, stable, and sustainable banking system.

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Reader comments


Lehman Brothers and Bear Stearns…

Neither of which would have been affected by any sort of Glass-Steagal-style reform since both were exclusively investment banks.

From your website:

“The business model that banks use to create money is so unstable that it requires taxpayer-funded safety nets such as deposit insurance. However, the ability to create money also produces a massive subsidy for the banks every year. This subsidy is around £30bn every year, being the interest on the debt that would not even exist if banks did not have a monopoly on supplying the economy’s money as debt.”

Ah, yes, you’re one of the nutters who is confused about “seignorage” then, aren’t you?

The £20-£30 billion a year that the banks make out of fractional reserve banking is not because they’re the people who create the money. It’s because there are large balances upon which they pay no interest but which they lend out at interest. For example, my UK current account has a couple of £thousand flowing through it each month. So an average of £1,000 over time as the balance. They pay me no interest on that. But they do indeed lend it out at interest.

It’s not seignorage they make money from, it’s the float.

Tim the point was that regulators and credit ratings agencies believed both to be more or less safe just a few days before they imploded, so a regulated pseudo-separation of this kind doesn’t fill me with confidence.

The banking divisions will still be able to provide each other with liquidity and bail-outs, and therefore the incentive is to take as much risk on as possible, knowing that one side can bail out the other. There will information asymmetries between banks and regulators, and between firewalled banking divisons.

@Tim W – Seignorage and money created from fractional reserve banking are different things.

Seignorage is earned by the Bank of England and is the difference between the exchange value of a note or a coin and the cost of production. Money created from fractional reserve banking is in existence until it is paid back and is created when a loan is issued.

There are numerous quotes confirming that banks create money in the Commission report, from the Bank of England and others on our website. Here is one…

2007 Q3 Quarterly Bulletin – “When banks make loans, they create additional deposits for those that have borrowed the money”

When somebody borrows from a bank, the deposits of another do not become unavailable. If banks were lending out the money everybody had in their current accounts, people with current accounts wouldn’t be able to spend.

You can find out exactly how banking works at our website.

No surprise to see the two Timmy trolls spinning for the banks.

And no surprise that the establishment review has not demanded the break up of the industry. Too big to fail is still the name of the game. The banks and the their bail outs across the western world show that the free market that is trumpeted by these same casino houses is just meaningless rhetoric.

When these arrogant institutions suddenly face the edge of the cliff, they want govt support. Privatise the profits and socialise the losses, is the new mantra of the masters of the universe. Capitalism for the poor and socialism for the rich.

The commission being tasked with the wrong enquiry reminds me of all economics discussion in the media. Wholly irrelevant concepts are gone into at great depth while the principle issue, that of the ability of the (privately-owned for the most part) banks to create money while the rest of us have to juggle solely with the money already in circulation, simply isn’t ever aired or referred to. The Establishment seem to be doing their best to preserve the status quo but one wonders how long so momentous a secret can be kept in this, the information age.

BB

These recommendations are a farce. As Duncan Weldon pointed out on Twitter too, Lehman brothers had more than 10% reserves before they went bust

@ Sunny

These recommendations are a farce.

Agreed absolutely. An establishment fix to ensure they can continue to rip us off.

Quite pathetic.

We need to storm the bastille- get UK uncut onto it.

I agree with pagar, for once!

UKUncut need to move on this, the report has been unduly weak.

Martin Wolf has disappointed me, I’m sure he’ll be gutted at that news.

@4. But I went to your site as you can see from the way that I quoted it.

“Seignorage and money created from fractional reserve banking are different things. ”

Well, depends what you mean. Profit made from money creation is seignorage. That’s what the word means. And this is where I think your error lies. Yes, the banks create credit (M4 money if you wish) but this doesn’t mean that they enjoy seignorage profits from having done so.

And that £30 billion number that you quote is very close to the number that it is claimed that they do in fact earn in seignorage profits from credit (or money) creation. Now it could be that I’ve misunderstood you (cue Sunny stating “well, that’s new isn’t it?”) but could you please explain to me how it is that the banks profit from this credit creation that they do?

For I fear that you’ve grossly misunderstood someone who got it wrong in the first place.

Fractional reserve banking does indeed offer a point at which the banks profit hugely. That we bank with them and gain no interest while they lend out our cumulative deposits (“the float”) at interest. But that’s not a profit from credit creation, it’s not seignorage. It’s the float.

And yes, this is important. Because if these profits are flowing from the float, then insisting that the Government should have the monopoly on money creation (as the likes of Anne Pettifor insist) won’t solve it, will they?

“UKUncut need to move on this, the report has been unduly weak.”

Most amusing. Uncut protested that BoA hadn’t paid tax. But BoA had made a loss, so what profit tax was there to pay?

It’s sorta required to understand a point before you protest against it……

12. Charlieman

@10 Tim Worstall: “That we bank with them and gain no interest while they lend out our cumulative deposits (“the float”) at interest.”

From idiots like me who procrastinate about where the money in the current account should go next, banks earn a bit. But I was a bad customer (for them) for years; I wrote dozens of cheques each month, payed nought (nowt, by my vernacular) and had two pounds left before pay day. I used their services for years and payed nought.

The banks, surprise, do not tell us sufficient to know whether current account income covers banking costs. When retail outlets, by the mechanism of cash back, became pseudo bank outlets, who gained?

13. AnotherTom

Given that the media and opinion-formers have for the last 2-3 years been playing populist politics with finance, which they seem never to have bothered to have understood, is it much of a surprise that the IBC doesn’t give the answer that is sought?

The left, the state, the regulators and the banks got it wrong during the credit boom. And the media didn’t care. Come the crunch, the state, the regulators and the media turned around and found a scapegoat. At that point understanding stopped. The OP is by most standards a crank who is seeking the entire system to be unravelled because they have found the magic bullet to cure all ills (“And it’s the major (but hidden) contributor to problems like poverty, debt, environmental breakdown, economic instability and a load of other ‘bad things’.”)

Please. I know it’s fashionable but why does this website keep publishing the outpourings of cranks?

14. AnotherTom

“Just a few days before the financial crisis brought down Lehman Brothers and Bear Stearns the ratings agencies were convinced the firms were watertight, and our regulators were happy with banks regulating themselves!”

This is simply untrue and misunderstands how credit rating agencies work. They don’t monitor credit on a minute-by-minute basis and can’t encapsulate all potential risks, however unlikely into their rating. And they can’t downgrade credits from investment grade to junk overnight without running some form of detailed evaluation.

The sudden collapse of companies and banks that were once rated investment grade in exceptional circumstances doesn’t “prove” much about rating agencies occasionally get it wrong, often because something that no-one expects occurs (Lehman Brothers being allowed to collapse by the US financial system). Overall, the statistics for credit rating agencies is actually very supportive of their ability to rate accurately; that a couple of examples can be found that shows otherwise is nothing more than a statistical inevitability.

15. Charlieman

@13 AnotherTom: “The left, the state, the regulators and the banks got it wrong during the credit boom.”

So it was the other people that got it wrong?

If those people had made the right decisions, according to your terms, you would be a rich man.

Thanks for the explanation.

AnotherTom, you are not supposed to say people are ‘ cranks ‘ heterodox views is the acceptable term.

17. AnotherTom

“If those people had made the right decisions, according to your terms, you would be a rich man.”

There was a period in which I had an investment strategy which was based on buying shares on days when the media panicked. That helped fund the deposit for the house I’ve just bought.

“The clear winners in this round seem to be the banks”

Umm, no. The winners are the banks shareholders, which in this case are mostly UK pensioners.

@7 Sunny.

Lehmans wasn’t a retail bank and was sunk because of the money markets totally freezing up rather than any bad bets. Once again you are confusing retail and investment banking.

It was the retail banks loaded with crappy mortgages that fell over, breaking the money markets and as a function of that pulling the rest of the banking system with it.

@Tim W – no 10…

If the banks earned £30bn in seignorage profits, it would be from selling £30bn worth of currency and producing it for £0, this would be counterfeiting, only the UK government is allowed to profit from seignorage.

Money created as credit is not seignorage, it is in existence until such time as the loan is repaid, and the banks earn roughly £30bn annually in profits from adding, in 2007 for instance, £200bn to the money supply. Banks can profit from money creation because they hold BofE reserve accounts, used to operate the payments and clearing and settlement systems, where small pools of bank reserves are used to issue very large quantities of loans.

This ability to, as a system, increase the money supply and simultaneously issue credit and fund payments far beyond the level of reserves held – guaranteed by the government, is how banks are able to “create money”.

I’m afraid although you have quoted from the first page of the website, you’ll need to read more, I don’t have time to give a full description here!

I would be happy to continue an explanation over email if anything on our website is not clear.

@AnotherTom – no 13…

An unfortunate choice of words, “a” major but hidden cause is what should be there, and it’s now been changed. Our proposals are simply a modernised version of those put forward by Irving Fisher and numerous others in the 1930’s and have been worked on by NEF and Richard Werner.

no 14…

As I explained above the point here was that regulators tended to rely on ratings agencies and banks themselves to manage their own risk – see –

http://www.positivemoney.org.uk/2011/03/the-contradiction-at-the-heart-of-the-financial-services-authority-fsa/

– for the specifics of how the FSA failed in its regulatory approach. Financial markets rely on information, often imperfect and asymmetric, relying on regulators to reduce risk by controlling the flow of capital between the arms of a bank will produce a high chance of the same failings that caused the financial crisis reappearing.

20. Luis Enrique

Jesus what is all this fuss about banks creating money? it’s an extremely well understood process, taught in every undergraduate economics course, but to put to talk about banks profiting from the ability to create money is rather silly. I mean, profits are determined by things like competition or collusion, market power etc. You could have a fractional reserve banking system in which banks make small profits (highly competitive) or one in which they make hugh profits from the business of taking deposits and making loans, it all depends on the spread between the interest they charge for loans and pay on deposits and their costs.

If banks were not able to “create money”, if you’re talking about deposits just sitting in the vaults mouldering, or perhaps being held as government bonds, banks would have to do things like charge us for current account services (payments, use of ATMs etc.) and would make profits of some size or other, depending on market power etc., under that alternative system, plus the interest rate charged on loans would rise because loans would have to be equity financed or something (like mutual funds).

21. AnotherTom

A couple of years ago there were lots of scare stories about the creation of money and the scary “shadow banking system”. Previous to that it was the “mass destruction” of derivatives (which Gillian Tett wrote a hilariously bad book about). Now it’s banks. It’s sortta funny but kinda sad.

@Luis,

One could argue that profits are largely determined by regulation and state support, and to a much lesser extent by competition.

The nature of the reserve accounts and clearing systems mean that banks have a natural tendency to conglomerate, as the larger the market share the more loans can be financed with reserve money. In this sense large market share and oligopoly provide higher net benefits than in most other industries.

Deposit insurance and the range of implicit and explicit taxpayer subsidies enable banks to take greater risks, and is estimated by bankers to be worth around £6-7bn a year, and by the Bank of England to be worth up to £100bn a year in 2009, for instance.

Many of the 1 million extra unemployed people might have been prepared to pay for current accounts if they still had their jobs, had the commission been tasked with investigating structural system reforms such as Limited Purpose Banking or Irving Fishers 100% money, which could remove the exposure of taxpayers and the real economy to failures in finance.

Without investigation into the return to the taxpayer on providing the various subsidies and guarantees the state does in fact provide, as stated by the Commission, how can we expect the suggested reforms to be in the real interest of the public?

23. Luis Enrique

Ben – ah yes, I’d love to see Limited Purpose Banking too (just not because I object to banks “creating money”) – I’m not sure what you mean by “had the commission been tasked with investigating .. LPB” – have you read the report? It’s in there (open the pdf and search for “Kotlikoff”)

@Luis

I have seen the section on Limited Purpose Banking and the proposals we put forward with NEF and Richard Werner are also covered under the section above it on Full Reserve Banking – we would argue that both systems represent the kind of goals we feel are appropriate when considering banking reform.

This is my primary gripe, that the Commission have not been tasked with investigating the nature of the various subsidies afforded to the banking system, whether the taxpayer benefits or is harmed (in all the various forms) in providing these subsidies.

The Commission was tasked with promoting competition and stability, I feel that as well as not being optimally stable, the proposals reflect this narrow mandate, and so the proposals do not go “far enough” – admittedly as a campaigner on banking reform my views are naturally in favour of more radical reforms!

“we put forward with NEF”

Ah, OK, with nef….so yes, you’re loons. By definition.

“If the banks earned £30bn in seignorage profits, it would be from selling £30bn worth of currency and producing it for £0, this would be counterfeiting, only the UK government is allowed to profit from seignorage. ”

Umm, no. Seignorage is profit from the creation of money. I think we all agree that banks create credit….but is credit the same thing as money?

“Money created as credit is not seignorage, it is in existence until such time as the loan is repaid, and the banks earn roughly £30bn annually in profits from adding, in 2007 for instance, £200bn to the money supply. Banks can profit from money creation because they hold BofE reserve accounts, used to operate the payments and clearing and settlement systems, where small pools of bank reserves are used to issue very large quantities of loans.

This ability to, as a system, increase the money supply and simultaneously issue credit and fund payments far beyond the level of reserves held – guaranteed by the government, is how banks are able to “create money”.”

Your description here is so confusing as to make me think that you yourself are confued on the matter.

What? £30 billion from £220 billion in money supply? Eh? Are interest rates 15% or something?

Now, yes, I know that banks create credit. Or rather, the banking system as a whole does. But I really don’t understand the mechanism you are positing as to how they make profits from it.

I did once delve into hte details of onoe of these ideas…..one that was being put forward by the nef/Anne Petifor axis. And found that, in the end, they were mistaking the profits from the float (the zero interest deposits lent out at interest) with those money creation/seignorage profits.

And what I’m trying to work out is whether you’re making that old mistake, a new one, or actually have found something interesting.

So, please do explain it here. With references.

The simple truth is that we do not need to put legal constraints on bankers and others who deal in financial products. We just have to stop governments from bailing out those who fail.

If Vickers report had consisted of only those two sentences, he’d have covered it.

Sadly, it didn’t.

27. domestic extremist

Who, if anyone, would actually suffer if big banks were broken up?

The inability to understand the difference between money and credit is almost as common as the inability to understand tax incidence.

MV=PY

M is a measure of the money supply, V its velocity, and nominal GDP is the product of the overall price level (P) with real GDP (Y). If M does not grow then neither can Y, and the causation driver for the increase in M is from Y. Y is really just all the constituent parts who make up the economy. The banks are not creating money, they are creating credit. The Bank of England create money and if they do their job properly they can make M anything that they want. If the BoE do not grow M fast enough, nominal GDP will fall and real GDP (Y) will follow it. The result will be an increase in unemployment. If they grow M too fast in relation to Y, the result will be an increase in P, and possibly asset bubbles. NGDP will grow but most up will be an increase in P rather than Y. So, the BoE controls the creation of money and should strive to keep it consistent with UK trend RGDP. Agents in the real economy, commercial banks, firms and consumers determine credit.

@TimW the £30billion figure is an estimate – the rough amount of interest earned by being permitted to operate in a constant state of insolvency, being able to promise demand deposit repayments when in fact they are impossible – a privilege granted by the state guarantee, preventing bank runs.

“a constant state of insolvency”

They’re not insolvent, they’re illiquid. A bank that’s insolvent has to close down, just like any other insolvent business.

But OK, now I understand what you mean. And I’m not that much more impressed.

For the deposit guarantee is something the banks pay for. They pay the FSCS a fee every year for the deposit insurance the customers get.

One of the problems we had just recently was that that insurance was only available to retail customers….so we had runs on the wholesale financing of the banks operations.

This too has now been solved. The bank levy is specifically and exactly an insurance premium to provide deposit insurance to those deposits which are no already covered under other insurance schemes.

Just in case you answer is going to be “Yes, but they don’t pay enough” the rates in the UK are similar to what the FDIC in the US charges banks there.


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  1. Liberal Conspiracy

    The banking commission report doesn't go far enough http://bit.ly/dUtDIa

  2. John Symons

    The banking commission report doesn’t go far enough | Liberal Conspiracy http://t.co/pdQUaqX via @libcon

  3. One Good Cut

    RT @libcon – The banking commission report doesn't go far enough http://bit.ly/dUtDIa – guest post from @onegoodcut / @positivemoneyuk

  4. blogs of the world

    The battle between the government, the financial sector, and the public interest over bank… http://reduce.li/xgsvhk #commission

  5. Steve Baker MP

    RT @libcon: The banking commission report doesn't go far enough http://bit.ly/dUtDIa

  6. Stardust we are

    The banking commission report doesn’t go far enough | Liberal Conspiracy: http://bit.ly/hNbtSN





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