The central bank payment system would survive any crisis: My letter to the FT

The first time I’ve ever had something published with the graphic being a cockroach. And hopefully not the last. From the FT.

Bob Sleeper (Letters, June 15) is concerned that if central banks embraced competitive neutrality and extended to us all the utility banking they provide commercial banks, that would leave high-risk loans to the private sector. For me that’s a feature, not a bug.

He claims it would make the system more crisis prone. Why? Currently bank depositors are forced to cross subsidise both low- and high-risk lending. Central bank lending against super-collateralised mortgages (at no more than 60 per cent of the value of mortgages) would slash the resource cost of low-risk lending.

It effectively transfers it from the financial system, in which each link in the supply chain does “due diligence” on the previous one, to the monetary system which is adapted to minimise transactions costs. High-risk debt would then be (properly) repriced — with a little more “due diligence” going on. Borrowers would substitute towards more equity funding and lower spending.

There would still be the usual mistakes and herd behaviour, but it would be on a smaller scale and with lower leverage against collateral. And the central bank payments system would survive any crisis, just as we are told cockroaches will survive a nuclear winter.

That removes one central driver of bailouts. So wouldn’t asset bubbles, and the crises to which they can lead, be rarer? And milder? If existing prudential regulation of systematically important players — banks, insurers and pension funds — works now, it would work in this new world.

If it’s defective, we should fix what we can. And to the extent that we can’t, there would be less to go wrong, not more.

Nicholas Gruen Port Melbourne, VIC,
Australia Visiting Professor, King’s College London Policy Institute

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5 years ago

Hi, I have a question. As I understand it, consumer deposits will be held by the central bank, and in exchange, the CB will make long term loans to commercial banks. Is this your expectation? Or do u think commercial bank liabilities will shrink substantially, and so lending will also shrink?

If the CB lends to commercial banks, then in effect the CB assumes the risk previously faced by depositors although with deposit insurance, that risk is not high.

If instead commercial bank liabilities shrink substantially, wouldn’t lending also shrink? Or perhaps would the CB itself buy mortgages and other securities?

Could u give us your thoughts on these questions?

5 years ago

I assume that the “financial system” must somehow convert consumer deposits into mortgages (home loans). At present, this conversion is done by commercial banks. If deposits are held by the CB, then either the CB must itself provide home loans, or buy mortgages, or lend to commercial banks.

Further, the corporate sector’s liquidity requirements needs funding from non-corporate sources. Jean Tirole argues that unless corporate sector defaults are uncorrelated (or negatively corrrelated), the corporate sector as a whole cannot come up with sufficient liquidity. The liquidity has to come from outside the corporate sector.

Again, please do give us your thoughts on these matters!

Kien Choong
Kien Choong
5 years ago

Hi, thank you for replying and answering my queries!

Your proposal for the public to have the same access to central banking facilities as the access that commercial banks enjoy is admirably egalitarian.

It occurs to me that if such public access to central bank facilities could be supplied over the mobile network, it could be a way to extend banking services to rural/remote areas of countries such as Papua New Guinea.

I hope you succeed in persuading a central bank to take up your proposal!

5 years ago

Ha, ha. It seems even Ben Bernanke (the academic) didn’t have much success with Ben Bernanke (the central banker). The central banker ignored the academic’s advice to the central bank of Japan!

Paul Krugman commented in 2015 ( on an apparent split between “insiders” and “outsiders” over their respective interpretation of the risk of hiking interest rates too soon. And speculates it may have something to do with “incestuous amplification”.

If you ever find yourself on the board of the RBA, beware!