29 Sep 2013

Changing Banking for good?

In June 2013, the UK's Parliamentary Commission on Banking Standards published a major investigation into the Banking system  called "Changing Banking for Good".

I looked for any discussion of the way that money is created in the current system, by searching through all nine volumes - a total of over 4400 pages. There was nothing at all in the first three volumes.

But in volume four, page Ev 956 ("Written Evidence to the Commission"), there is the following, which was submitted by the "Christian Council for Monetary Justice".
The Christian Council for Monetary Justice.... has advocated, for the UK, ending usury—and fractional reserve banking—by getting the Bank of England to take away from commercial banks the creation of most of the money in use.
This can be achieved in a single step when government instructs The Bank to issue, free of interest, all the money needed for the real economy as repayable debt. Any willing existing agency, such as high street banks, mortgage lenders, or credit unions, could administer the distribution of this interest-free credit for an administrative fee. This single step could be expected to crowd out undesirable features of the current system and to hugely benefit people engaged in healthy economic activity."
Hear, Hear!!

In volume 5 page 1595, Paul Moore, the former Head of Group Regulatory Risk at HBOS, gave a spirited defense of the positions held by Positive Money
14. The Inadequacy of our Monetary System and the need to Investigate what is called “Full Reserve Banking” but which is, in fact, a Wholly New Monetary System

14.1 I have to say, at this point in my paper, that I really do not think we have got anywhere near solving the problem of banking in this country (or the world) or the excessive power the big 4 banks have over our monetary system, economy and lives.

14.2 Over time, I have come to the very firm conclusion that ring-fencing, more capital, stronger corporate governance and regulation simply will not do the trick and that, to solve the huge economic problems we face, the entire monetary system and banking needs fundamental reform by the introduction of a system of “Full Reserve Banking” as proposed by Positive Money.

14.3 The whole idea that 97% of our money supply is created, and its use in the economy is directed, by private commercial banks when they make loans is wrong. It bases pretty much everything we do economically on debt which banks are incentivised to oversell to make interest for themselves. It directly causes a constant transfer of wealth (through interest—about £160 billion per annum) from society as a whole (and particularly the poor) to the banks and so is a direct cause of the inequalities and associated social problems discussed in the great book called The Spirit Level. It means that asset bubbles (property) and boom and busts are inevitable and, most importantly, it cedes far too much power over our economy, our society and our lives directly to the banks and a tiny group of executive directors who are incentivised (and required by Company Law) to generate short-term profit. Of course, only around 10% or so of bank lending is made to the productive economy ie the SMEs with the vast majority going to residential and commercial mortgages and financial intermediation. Indeed, SME's deposit more with banks than they ever borrow. Finally, the big 4 banks control well over 80% of the money supply which means that something like 25 executive directors, with no public duties whatsoever, to a very large extent control our monetary system and economy.

14.4 Even Mervyn King has commented that this way of organising our monetary system and banking is not the best way to do it. Martin Wolf summed it up perfectly when he said—“The essence of the contemporary monetary system is the creation of money out of nothing, by private banks' often foolish lending.”

14.5 Positive Money which was set up and is run by a remarkable young guy called Ben Dyson makes the case for reform of the monetary system through the introduction of Full Reserve Banking very powerfully indeed in their new book “Modernising Money”. You can check out what they say on their website here http://www.positivemoney.org/ . I am on the Advisory Committee of Positive Money.

14.6 Policymakers need to look very carefully at introducing “Full Reserve Banking” (see Positive Money about all this) as this will completely remove the need for the State ever to stand behind banks again. The ICB simply ignored the idea of full reserve banking and its recommendations do not achieve this. It is wrong that the taxpayer has to provide a guarantee of £85,000 to each account holder in each bank. Full reserve banking is the best way to resolve this problem and the best way to ensure that banking is carried out in the interests of customers and society as a whole. It means that there can never be a run on current accounts and customers choose savings accounts with the level of lending risk with which they are comfortable just like collective investment schemes and the saver/investor bears the risk.
Hear, Hear!!

In Volume 6 page 185, the New Economics Foundation has this to say
The Credit Creation Function of Banks
5. There is no recognition within the ICB Final Report or the draft Bill of the role played by retail banks in supplying sterling bank deposits through the extension of credit and purchase of assets, and hence creating the bulk of the UK's money supply. Instead reference is made to deposit-taking, which is an established phrase in regulation and describes part of what retail banks do. The far more significant role of banks is the creation of new bank deposits. A full explanation of this process is beyond the scope of this submission, but the selection of quotes below establish that this description is fully supported by central bankers and monetary economists:

By far the largest role in creating broad money is played by the banking sector… When banks make loans they create additional deposits for those that have borrowed. Bank of England (2007)
Given the near identity of deposits and bank lending, Money and Credit are often used almost inseparably, even interchangeably… Bank of England (2008)
Each and every time a bank makes a loan, new bank credit is created—new deposits—brand new money.  Graham Towers (1939), former Governor of the Bank of Canada
Over time… Banknotes and commercial bank money became fully interchangeable payment media that customers could use according to their needs. European Central Bank (2000)
The actual process of money creation takes place primarily in banks. Federal Reserve Bank of Chicago (1961)
In the Eurosystem, money is primarily created through the extension of bank credit… The commercial banks can create money themselves. Bundesbank (2009)
When banks extend loans to their customers, they create money by crediting their customers' accounts. Mervyn King (2012)
Banks do not have to wait for depositors to appear and make funds available before they can onlend, or intermediate, those funds. Rather, they create their own funds, deposits, in the act of lending. This fact can be verified in the description of the money creation system in many central bank tatements, and it is obvious to anybody who has ever lent money and created the resulting book entries. IMF (2012)
6. It is relevant to note that this credit creation function does not feature in most general equilibrium models of the economy used by orthodox economists. Recent academic debate, for example within the Institute of New Economic Thinking, has begun to consider whether this was a factor in the seeming inability of many economists and economic models to predict the financial crisis, and is investigating the role of unconstrained or poorly managed credit creation in maintaining, or rather upsetting, financial stability.

7. The draft Bill would therefore appear to be built on an analytical framework that is incomplete at best, and flawed at worst. We argue that in this key respect the theoretical understanding of banking that underlies he Bill will come to be seen as obsolete. This has implications for, inter alia, arguments for splitting retail from investment banking, stability of the banking system (and indeed broader macro-economic stability) and distortions in the retail banking market that prevent fair and effective competition.
In other words, they were told!

So that's it. 4400+ pages on the Banking System and how to reform it, and just three mentions of the key problem - that of how money is created.

There's clearly a serious need to get the truth out.

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