Making the central bank a people’s bank

Some of you will have seen my article in the Saturday Paper. I can only tease you with 150 words from it here. Then you’ll need to read it on the Saturday Paper’s site.

As the financial crisis continued wreaking its havoc in late 2010, Mervyn King, who, as Governor of the Bank of England, sat at the apex of the banking system, made this observation: “Of all the many ways of organising banking, the worst is the one we have today.”

He was speaking of “fractional reserve banking”, the pea-and-thimble trick by which banks accept your deposits and assure you of access to them at all times while they’re actually lent out to others for lengthy periods.

This alchemy works so long as depositors don’t all withdraw their money at once. If they do, governments bail out banks. The alternative – the entire banking system seizing up and with it the commercial life by which we earn our daily bread – is too horrible to contemplate.

Greens leader Richard Di Natale recently floated the idea of a “people’s bank”. In the absence of further detail, pundits assume he means something like New Zealand’s government-owned Kiwibank. Adding another competitor to the four major and many minor banks in our market might win some applause on Q&A, but it doesn’t even try to address the structural problems of banking to which King referred.

In fact, we already have a “people’s bank”. Rethinking it for the internet age, using nothing more radical than the principle of competitive neutrality, could address King’s concerns while putting thousands of dollars each year into the pockets of most Australian households and into the economy.

Let me explain.

OK – that was a bit more than 150 words, but not much more, and got you up to the cliffhanger. How will it end? Will Dr Gruen be rounded up by the authorities for being unAustralian? What will Pauline Hanson think? How would it look with five big pipes from the Snowy behind the announcer? And what part of the text above is subtly different to the version on in the Saturday Paper? All these questions are answered in ways you WONT BELIEVE on this page of the website of The Saturday Paper.

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8 Responses to Making the central bank a people’s bank

  1. I am and will always be Not Trampis says:

    This article is full of interest!

  2. Paul Frijters says:

    I see you still like the idea of getting your 65% mortgage at Woolworths. Seems a bit of an odd construction if Woolworths has to intermediate between two banks (the people’s bank and the bank where you would receive the loan). Easier to indeed have Woolworth offer you loans and an account with the peoples bank, bypassing the other bank entirely.

    Having actual accounts with this peoples bank has real advantages. In deposit banking too, the RBA can be seen as the wholesaler and the commercial banks as the intermediaries. There is something to be said for commercial banks staying out of deposit accounting altogether, focusing on investment banking: the task of assessing what investments are worthwhile.

    • Nicholas Gruen says:

      Thanks Paul,

      I’m not sure what you mean. What I intend is that the facilities by which the RBA lends the money can be ‘White labelled’ as it’s called in the trade. After all, it’s largely an IT service to supply the account keeping. A bank or anyone else can also sell you a loan for – say – 80% of the value of your property which is composed of 65% from the RBA and the next 15% from their own balance sheet or the balance sheet of some other lender.

      I’m thinking there may be some misunderstanding here.

      • paul frijters says:

        Yes, probably some misunderstanding on the process. Perhaps it’s handy if you walk me/us through the process you have in mind for a woolworth’s people’s bank scheme.

        A prospective entrepreneur who has some premises in mind walks into the woolworths to get a loan for a million to help buy a premise costing 1.5 million. He fills in a brochure, sets up a meeting with a Woollies financial checker, walks in with lots of identity cards and his big-4 bank statements. Then what? Woollies sells you an RBA-guarantee which he then takes elsewhere (that would not be a people’s bank, more a replica of the Canadian system)? Or does the RBA create new money that is passed directly onto the bank of the owner of the premise?

        If Woollies acts like the bank tellers of old, why not to directly set up accounts and have loans go from one RBA account to the other (rather than involving another bank).

        • Nicholas Gruen says:

          The model I’m thinking of can be described as follows.
          1. I’d like to see 65% LVR loans provided by the RBA as of right – no other tests like income being imposed.
          2. If governments want to impose further regulation that income must be acceptable then it would be useful to do it in a way that the cost of this was transparently itemised and competitively determined. That’s where one would hope for competition between service providers – though they will have to be regulated sufficiently to ensure they deliver the service policy intends with integrity.
          3. If a person is just after a loan of more than 65% LVR a bank could ‘package’ the RBA loan up to 65% with its own loan and add whatever markup it can get away with. For this reason I’d want there to be plenty of ways to access the 65% loan from the RBA including directly – unless it seemed clear that the market was competitive enough not to require it.
          4. Woolies could package up services a la level 2 and/or 3 above.

  3. Liam says:

    Did someone say Fractional Reserve Banking?

  4. Chris Lloyd says:

    I am out of my depth here, but I wonder about the effects of having the RBA taking all the safe part of the loan and the banks taking the risky part. Presumably the RBA are first in line in the event of default. So the banks would charge quite a high interest for this wouldn’t they? And is there any reason to think that the overall rate would be much lower. Also, banks have to limit their total risk so if all their home loans were only the risky part, they would have to get their low risk loans from somewhere else. Where?

    BTW: I just settled on an apartment for k$780. The bank values it at $640 (even though 150 people settled at the higher market price over the a pat month) and then would only lend me 70% of that, which worked out at a leverage of about 57%. So I think the banks are already very focussed on limiting their risk . And contrary to popular commentary they are not lending at high ratios (in my experience anyway).

    • Nicholas Gruen says:

      Thanks Chris,

      I agree that margins would go up on the second mortgages – over 65% that banks and other financiers would offer. Would it be cheaper. It certainly would for more than half of outstanding loans which have LVRs of less than 65%. And it would be so much cheaper that margins would have to be enormous on the next 15% of the value of the property for the total not to be a lot cheaper.

      The fact is that there’s massive rent and inefficiency in the super-safe house lending. To give you an idea, you can insure a 65% LVR loan in Canada via the CMHC – a government underwritten commercial insurer – which gives it the credit risk of a government bond – for a one-off premium of 0.5%. I’m further arguing that the margins on the loan management are about 0.5% per annum. So you’re about 2.5% per annum ahead.

      If we had a half-way competitive market this safety would be priced differently to the higher LVR loans. But it’s not. Most of the margin isn’t economic/monopoly rent. Some is, but a lot is simple inefficiency as the private provider of funds must square off all the funds, track them, guarantee credit quality, liquidity, legals, marketing, advertising, regulation etc. The central bank suffers none of this – just issues the loan and effectively transfers the super safe part of residential lending from the financial to the monetary sector which is optimised to minimise transactions costs.

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