Thursday, May 30, 2019

Fed Nixes Narrow Banks Redux

J. P. Koning at AEIR writes well on the Fed's efforts to quash narrow banks, more clearly than my previous efforts here here and here

As a quick review: Narrow banks take your money and invest it 100% in interest-paying reserves at the Fed. They are completely immune from runs, failures, and financial crises. You would get a lot higher interest than the big banks currently pay.  The Fed should be giving them a non-systemic medal. Instead, the Fed is fighting them tooth and nail.
the Fed is floating the idea of destroying the narrow-bank business model before it can ever be tested in the market.
J.P. clearly goes through the Fed's proffered objections, demolishing each in turn.  The financial stability concern makes no sense -- after all, they can buy treasury bills directly or buy treasury - backed money market funds. Reserves are that, with instant rather than one day settlement, or money market funds that now are allowed to invest in reserves.

J.P is, I think, a little too polite. He writes,

..the Fed worries that narrow banks could unfairly undercut traditional banks by “avoiding regulatory costs,” specifically capital requirements. 
...the Fed worries that narrow banks could reshape the financial system by drawing large quantities of deposits away from traditional banks.... banks could be forced to respond by raising rates on loans to households and businesses.
He responds to each on its merits. Capital requirements are supposed to be a buffer to prevent failure and runs. If you come up with a bank that cannot fail and cannot run, it is not "unfair" to not have any capital requirements, it is only common sense.  If you buy solar panels it's not "unfair" that you no longer pay the electric bill. In fact it is the big banks who are "unfairly" subsidized by implicit and implicit bailout guarantees. And no, banks are not so magnanimous to turn protected deposits into low-cost loans rather than profits.

We can go one step further. I think. J.P is a bit too polite here. What is the Fed doing deciding what is "unfair" competition? The Fed should be worried about consumers and the economy, not the profits of traditional vs. new banks.

And, put these two quotes together: Whatever its motives, The Fed sure is acting and talking as if its goal is to preserve big bank's oligopoly power to pay us low interest rates, in return for banks lending as the Fed sees fit they should lend. The result is traditional financial repression pure and simple.

The Fed seems to be heading to a bewildering variety of interest rates to different institutions according to how it favors or disfavors them. Big banks get one rate, money market funds get another lower rate, narrow banks get a lower rate still. This favoritism will only expand. Surely Congress and the President, seeing this, will demand higher rates for community banks, lower rates for foreign-owned banks and so on. The best defense against politicization is simple rules -- one rate for all financial institutions, period.

JP thinks narrow banks, if allowed, will remain limited, offering an alternative to overnight repo to large corporations. That's already a big advance in financial stability. I have greater hopes. Central banks cannot operate retail digital currencies. Who do you call when you forgot your password? But narrow banks are the ideal institutions to provide the retail-facing end of digital currencies. The sooner the better. Unless we can persuade the Treasury to offer reserves first and take this all away from the Fed.


  1. I think this post makes a very strong case that the Federal Reserve, like all regulatory agencies, is prone to "regulatory capture"---that is, the industry that it regulates is calling the shots.

    How could it be otherwise? As a citizen, or earnest taxpayer, have I time to carefully peruse the actions of the various regulatory agencies? My mechanisms for citizen oversight of the regulatory agencies are 1) the R-Party or 2) the D-Party.


    Okay, add to regulatory capture the clarion calls for "Fed independence".

    We should want an independent and also captured Federal Reserve?

    My advice: Dudes, we have to give up. The best option here to attach yourselves to the (legalized) gravy-corruption train in one way or the other. Build up a big nest-egg stashed in the Cayman Islands.

  2. Money in the economy consists of commercial bank deposits backed by banks assets, with the Fed facilitating transactions between banks, and so having the public hold Fed accounts would be putting the cart before the horse.
    In the ultimate case of deposits held at the fed, the banks would have no assets and the Fed would have to scrutinise every mortgage and loan in the economy, which it does not have the resources or objectivity to do, and the banks would only be credit brokers.

    1. There's enough Federal Debt outstanding for the Fed to back all of the deposits it receives from the public with treasury securities. Banks could make loans from capital raised by issuing stock.

    2. If the Fed purchased those Treasuries it would create more deposits ,the treasuries would then be backing the new Fed deposits held by the banks of the previous holders of the treasuries and so they would not be available to back any deposits held by the public from transfers from banks.

    3. Banks would need to use those reserves to pay off the depositors withdrawing from their accounts to put their money at the Fed.

    4. The banks would not be able to use those reserves to '"pay off depositors withdrawing from their accounts to put their money in the fed"" because they would need those reserves to back the new commercial bank deposits created by the Fed purchasing the treasuries.
      the only assets the banks could offer The Fed to facilitate the transfer would be mortgages and loan contracts which the Fed does not have the resources or objectivity to scrutinise as I wrote before.

  3. John, what do you think of this idea to have the Federal Reserve directly offer accounts to the public?
    It's essentially narrow banking, but it cuts out the middle man by having the Fed be a giant narrow bank.

  4. Why is a single agency conducting both a very technocratic monetary policy and a less technocratic banking regulation? It seems to me that the ordinary reason for that is the role of Fed as the lender of the last resort. Since it bails out banks it has to regulate the riskiness of their assets (and the Fed knows better than anyone how much risk is tolerable). However, during normal times a lender of the last resort is not necessary. During the last crisis, on the other hand, Treasury did a lot of the bailouts. Wouldn't it be better to make a Treasury bailout a normal course of action, and strip the Fed of their regulatory powers?

  5. I am suffering from the stupids. I do not see a difference between a narrow bank and a money market fund that invests solely in T-bills. Right now, that is what I am putting spare cash in.
    Kernals: Right now you can invest in T-bills through treasury direct. It is kind of a pain and I don't see many people doing it. Most investors prefer the MMFs. They are cheap and easy.

    1. MMFs come with restrictions. Accounts at the Federal Reserve could offer all of the convenience of a checking account.

  6. I expect that the Fed already uses the money it gets from reserves to buy Treasuries.

  7. If the banks cannot compete with interest on reserves then the Fed is setting the rate it is paying on reserves too high.

  8. Kernals:

    What restrictions on MMFs are you referring to? The only one I am aware of is that non-individuals are no longer allowed to invest in MMFs that own investments other than Federal government securities. However, I was referring to MMFs that so limit their investments. see: download the statutory prospectus, the rules are explained beginning at p. 15.

    Running a customer facing system requires enormous investments in people, systems, and technology. I cannot believe that the Fed would make those investments even if they had the statutory authority to do so, which they do not: I also believe that existing commercial banks would scream bloody murder to Congress if the Fed were to ask for the authority.

    One of the latest political idiocies is the idea that the Post Office should run a banking business with ATMs, credit and debit cards, and checking accounts. Never mind that the institution is basically insolvent, and that it is having a devil of a time running its traditional delivery business.

  9. I see today in the that Sanders and O-Cortez are proposing the USPS should offer expanded financial services, beyond postal money orders. The classic European giro system, with a twist. Yet, it could be structured as a pure Narrow Bank. Many Social Security pensioners will hold all their surplus there, instead of investments that pay fees to managers.
    Plus, it puts one more nail in the coffin of classical "central management" banking, in contrast to what markets can do. (In spite of being the post office; a passive bureaucracy in this concept.)


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