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.

Postscript: Central banking for all: The Interview

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I am and will always be Not Trampis
I am and will always be Not Trampis
4 years ago

This article is full of interest!

Paul Frijters
Paul Frijters
4 years ago

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.

paul frijters
paul frijters
4 years ago
Reply to  Nicholas Gruen

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).

Liam
4 years ago

Did someone say Fractional Reserve Banking?

Chris Lloyd
Chris Lloyd
4 years ago

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).

Chris Lloyd
Chris Lloyd
4 years ago

OK. So the core of your argument is that the banks are inefficient and there is a lack of competition which is why the spread is so high. Otherwise I was expecting that it would ultimately not matter much whether you divided a loan up into more risky and less risky tranches. The evidence of inefficiency is pretty clear in my own case: 57% leverage at standard commercial premium. I’m suitably outraged.

Interestingly, your reply seems to indicate the Canada have already done just this – maybe not with the central bank but with a government underwritten commercial insurer. So basically it is underwritten by the central bank. I assume the govt also set the premium?

What about the issue of where the banks would get their very safe borrowers so that they can be within their prudential constraints?

BTW: If this idea ever looks like getting legs, can you let me know asap so I can sell my ANZ shares?

Mikhail Chodorov
Mikhail Chodorov
4 years ago

A brilliant idea really. Transferring value from the banks to the public.

Jon Symons
Jon Symons
4 years ago

I heard the longer version of this argument in your excellent Ockham’s Razor on central banking; I hope the concept finds the ear of policy-makers, as it seems fairly clear you’ve identified a smart way to achieve some efficiencies and to capture the benefits for the public good.

Your segment has prompted me to run the following rather left-field idea concerning helicopter money past you. I should stress, I have zero training in economics, so I’m sure there’ll be some obvious flaws.

The idea is this – what if a group of major central banks were to collaborate to distribute helicopter money to the ‘bottom billion’, to create something like a global social protection floor? Selection and delivery would be a major challenge, but the Give Directly approach might provide a model that could be scaled up in stable countries.

As the governor of the Indian Reserve Bank notes here, the key problem with the helicopter money idea is not a fundamental issue of economics, but the confidence crisis that would occur if governments started giving away money.

But what if helicopter money were directed only at impoverished people in the developing world and thus were conceptualised as an aid initiative rather than an economic one? (I realise this conflicts with the key purpose of central banks) This would still have a positive effect on global demand (albeit only a small one because only very modest sums need be involved to have a significant impact on the lives of the very poor), it shouldn’t cause a confidence problem, and (my hunch as a non-economist) might not create an inflation problem because it would be bringing new people into the formal economy.

Recent studies have also shown that giving cash to the very poor is a very effective way of addressing extreme poverty; so the idea aligns with both the movement toward ‘effective altruism’ and with the labor movement’s ‘social protection floor’ concept.

I know this is a very stray idea – but it seems to have enough going for it that I thought it worth running past someone with expertise.