Michael overheard me pontificating with a friend at my local café and we got talking. After lengthy emails on various topics including universal basic income, I invited him to post on Troppo — with this being the result. Michael has had 40+ years in senior management and consulting roles (including at CEO and board level), across: government, telecommunications, brewing, construction, consumer goods, car manufacturing, transport and logistics. He was a Board Member of Australian Logistics Council and Chair of its ICT Committee, as well as Member of Austroads Intelligent Transport Industry Reference Group. In 2011, he established VANZI, a ‘not-for-profit’ Initiative in collaboration with a range of national stakeholders to broker development of the Digital Built Environment. In 2016, he led the team that wrote the Road Map for 3D Queensland.
To fix the financial system, nationalise money, not the banks: Guest post by Michael Haines
This post outlines a novel way to stabilize the banking system by:- a) converting all bank deposits AND loans to ‘Central Bank Money’, and b) appointing each bank as ‘Agent for the Central Bank’.
At present, only 3-4% of our money is ‘risk-free national money’ (cash).
Most is in the form of deposits, created when loans are made by commercial banks, other deposit-taking institutions, and ‘fintechs’ that have a banking licence (together called ‘banks’).
This Bank of England paper explains the process in detail.
The deposits are liabilities of the banks; placing our money ‘at risk’ if our bank fails.
As banks underpin the financial system, it is generally agreed that they have a responsibility to lend only at the ‘low risk’ end. Risky ventures are seen as the preserve of equity
Unfortunately, banks often abrogate their social responsibilities by taking on unreasonable risks.
This is largely a ‘system problem’, that requires a system solution.
The system shields bankers from the consequences of their decisions, resulting in ‘moral hazard’.
We see it as some banks increase their risk profile to get more business, pulling other banks into the vortex to stay competitive; knowing deposits are guaranteed by the government.
While formal deposit guarantees are limited to a set amount, in practice, governments are forced to underwrite the solvency and liquidity of all the major banks, to prevent system collapse.
The system places the Central Banks in a dilemma. They need to support the banks, while also deciding when to pull the plug against many powerful interests. In practice, some banks may be shuttered, while the broad system is underpinned via massive bailouts, reinforcing ‘moral hazard’.
Essentially, the problem is how to put banks on the same footing as any business, so that instead of the Central Bank having the main role in insolvency; the directors and auditors have principal responsibility under corporate law for deciding when to call in an Administrator and/or stop trading -without impacting depositors or anyone else.
I suggest appointing all banks as Agents for the Central Bank.
We can have the Central Bank buy all outstanding loans from the banks, with the money used to pay out deposits and inter-bank loans; all redeposited with the Central Bank. This can be achieved by having a ‘round robin’.
The result would be that the loans and deposits would shift from the banks’ books to ‘subsidiary ledgers’ of the Central Bank. This would have no effect on the net assets or profits of the banks.
Each bank would continue to manage the deposits of their customers, as Agent for the Central Bank.
Banks would also continue to assess borrowers. However, instead of making the loans as principal, they would do so on behalf of the Central Bank, with the right to earn the interest and fees, as now.
In consideration for the profits earned in the process, the banks would be required to guarantee the repayment of any loans to the Central Bank, effectively reversing the guarantee that is now in place.
Faced with the realization that the risk environment had changed, some banks may feel suddenly ‘overly exposed’. To mitigate the impact, we could provide a lead-in of (say) 5 years to enable them to alter their capital ratios, just as they must do now when the Central Bank believes there is a need to reduce risk across the whole sector.
Once in place, it would mean that if any bank loaned unwisely, so that its capital was lost, it would be wound up like any insolvent business.
This could be done without impact on depositors, or on any borrowers who were not in default.
Importantly, by taking inter-bank liabilities and deposits off the banks’ balance sheet, it would eliminate any possible flow-on effects because of any single bank failure.
In the event of a failure, all deposits and loans would remain on the books of the Central Bank, managed by the Administrator using the failed bank’s operational staff and systems, until they and the remaining business could be sold as a ‘going concern’ to another viable bank.
The bank officers would lose their jobs, the shareholders would lose their investment, and the defaulting borrowers would be chased for recovery.
Everyone else would carry on as normal.
What does not Change
- the bank’s relations with its customers
- the banks basic business model: hold deposits, operate the payments system, make loans
- the bank’s net assets
- the bank’s net profit (though profits could be boosted when the switch is made, as a sweetener)
- Loans and deposits move from the books of the banks onto the books of the Central Bank.
This change is key to stabilizing the banking system:
- no deposits at risk
- no loans that are not in default at risk of being called in if a bank fails
- no need for interbank loans, eliminating flow-on effects from a single bank failure
- no more liquidity concerns, as the deposits and loans would not be on the bank’s books
- no more bank runs
- The ‘guarantee’ would be ‘reversed’. Instead of the Central Bank guaranteeing deposits. The banks would guarantee repayment of the loans to the Central Bank.This change is key to reducing risk across the banking system
– eliminates ‘moral hazard’
– eliminates any need for Central Bank intervention in the case of a bank insolvency
– ensures directors alone are responsible under corporate law to halt trading if insolvent
This reversal of the guarantee places banks in the same situation as all other businesses.
- It opens the opportunity to create a Central Bank Digital Currency, turning ‘deposits’ into ‘digital cash’ with instant settlement, while maintaining the current levels of privacy.
- The ability to offer instant settlement, with deposits and loans free of the risk of bank failure, would provide the banks with a competitive advantage
- It would enable more detailed real-time analysis of the money flows in the economy.