2009-09-19

The BORING BANK

Can a public sector utility bank be a solution to the banking crisis

Most articles you read on current financial crisis today point the figure of blame squarely at bankers and their greed with low respect for risk. It may or may not be 100% accurate accusation but the root of this issue points to the uncomfortable marriage of public deposits and investment banking industry. We loath banks for their greed and bonuses and at the same time we cannot function without them. This create the vicious circle where banks end up becoming too big to fail, and end up taking tax payer bailouts. If the come out stronger after bailout – they receive the wrath of anti capitalists for making money on account of tax payers and if they end up failing further, more tax payer bailouts are required as they are “too big to fail”.

Many would point to separation of Investment bank/retail bank or more and stringent regulation etc but I feel that it could be a papering over the cracks. The fact is as that as long as deposits are guaranteed by the tax payers/governments it implicitly puts a floor under a bank failing and therefore it will inevitably promote excessive risk taking as the cycle progresses and we will remain in this cycle of boom and bust.

Can there be a simpler solution?

Just as protecting the country’s borders is public sector enterprise (army/navy/air force), protecting public is public sector enterprise (police and fire brigade and in most of Europe – health care). Why can't protecting the public’s savings be a public sector enterprise. I can think of the following outline of a bare minimum “BORING BANK”

  • Ability to deposit money (branch, electronic)
  • Ability to withdraw money (branch, ATM, debit card)
  • Ability to make and receive payments (electronic, cheque, branch)
  • Ability to receive monthly account statement (postal or electronic)
  • Peace of mind on safety of money by an absolute government guarantee.

I propose that such BORING BANK can be placed in a public ownership. All the deposits to this bank would be backed by 100% guarantee of the government. A typical private sector bank uses the deposits to make further loans and that is how, using fractional reserves, they can leverage the depositors money and earn profits. And that is where the risk lies for a bank.

The BORING BANK would pay depositors interest at some discount to prevailing short term benchmark rates (which in today’s world would be close to zero if not zero).

The BORING BANK will not make any risky investments – not even overdraft facility on the deposit account, will not offer mortgages to public and will not do anything remotely similar to an investment bank. It will be a bare minimum, no frill deposit bank not even offering foreign currency transactions. The deposits will count towards borrowing by the Government.

Or in other words, deposit with BORING BANK is akin to buying a Government Bond, which anyone can do today, just that it will be much simpler with wider access and can be part of day to day life of people.

BUT, the key change after introduction of BORING BANK would be that there would not be any guarantee on deposits with private sector banks and no tax payer funded bailout. Also the regulation on the banks could become lighter and they would be allowed to take as much risk as their internal risk control (and depositors) allow.

Private Sector banks would still operate but without explicit government guarantee. They will still be able to take deposits from willing customer but in full knowledge that the deposit is not guaranteed by government. This would increase the deposit rates paid on such deposits with private sector banks. Customer would still rely on private sector for credit cards, mortgage, foreign currency transaction, insurance, investments and other risky transactions and any other borrowings the customer would need to go to such private sector banks.

I think such a move will ensure that the cost of capital for the private sector bank would move to a reasonable risk adjusted level and since private sector banks would be competing for capital, it will ensure that excessive risk taking would be curbed.

Government would be spared the huge cost and risk of providing the deposit guarantee and future bailouts. If a private sector bank fails it will be similar to any other private sector company failing.

so how much such BORING BANK will cost

I did a back of the envelope calculation

Adult population of UK who will be the likely account holder = 50,893,318

Assuming 1 employee per 1,000 account holder = 51,000 employees Appox.

Assuming average cost per employee = £100,000 per year (on generous estimate considering average household income is only £30,000)

Total Personnel Cost = £5.1 bln

Assuming all other costs = 2 * personnel cost gives TOTAL COST FOR BORING BANK = £15.3 bln per year.

I would say this is much better deal to tax payers compared to the £1.4 trln bailout money already on hook and will be money well spent. Considering that this BORING BANK is providing a bare minimum services, I am sure the cost can be much lower. Someone with experience of running a bank can comment on this aspect.

Conclusion

What I am talking is not unique. The process is already in place. If you want absolute security on your money, you have the option of buying government bonds from Debt Management Office (DMO). Just that the process is not easy for every one and cannot be used for day to day purposes. What I am proposing is a radical change to extend remit of DMO to convert into providing the services required by the BORING BANK and extend its reach to all population and at the same time remove the costly government guarantees on private sector bank.

Make no mistake, I am not calling the end of private sector banks or investment banks. I am merely asking them to operate on pure private sector basis – paying the true cost of capital for funds they play with. After that, if someone earns a bonus of £100 mln good luck to them! They deserve it.

Can this solution work? I think it can. It is not about removing competition but promoting competition. Just like we have National Health Service does not mean that private sector insurance/health care is dead in UK. And just because we have police does not mean some one with extra security requirements and money to pay for that cannot hire a private security company.

Same way with the BORING BANK, any one who needs better returns on their capital will turn towards the private sector banks with full knowledge that they are taking risk with their capital. Same way people invest in stock market or even start a business. Rest of us who just want to sleep well without worrying about their savings or unnecessary tax payer bailout wastage can leave the money in the BORING BANK.

I would like to know what you think on this and also why such an idea cannot fly?