A New Banking System

Scarab80

I originally posted this in the Irish Economy section, but wanted to post it here to get peoples impressions on whether a system like this could work. IMO the technology has not existed previously to be able to implement the system outlined below, however now that it does is it time to change the way we manage our money?

IMO the only way to ensure that the state is never again required to intervene in another bank bailout is to recognise the reality of the banking system. So long as you have long term loans funded by short term or indeed on demand funding the possibility of another bank run is always possible and given enough time inevitable.

Consider this proposal,

(1) Separate banks lending and retail/business services sections.

- Retail and business services will include all demand deposits as liabilities and cash as it's assets, the cash will not be invested but will be held by the banks as custodian. The banks will charge the demand depositers for the costs associated with holding this cash, i.e. security costs, insurance costs and will charge customers for services provided such as an ATM network. Money held on demand deposit will therefore have a negative rate of return.

- Banks will no longer engage in direct lending but will instead act as ratings agencies. If you want a loan you go to your local bank and go through the loan application procedures as normal however instead of being approved for a loan you are issued with a credit rating for that loan.

- Banks can also act as debt recovery agencies.

(2) Create a primary and secondary market for lending along the lines of Zopa. As a prospective borrower you take your credit rating received from the bank and place an offer on the primary market, prospective lenders looking for a return will also bid on this market. Once funds are matched a bond is issued for the term of the loan at a particular interest rate (fixed or floating). To spread the effect of possible bad debt losses, bonds could be issued in batches - for example AA Residential Mortgage bond maturing September 2030. Similarly lenders can manage the risk/return they want to receive by diversifying and buying bonds relating to specific sectors with specfic maturities and credit rating.

Now not too many people would be prepared to drop their capital on a mortgage with no access to it for 30 years, so a secondary market must be created where the bonds issued on the primary market can be bought and sold. This further allows investors to invest in whatever part of the yield curve they desire.

With money held on demand producing a negative rate of return, customers will be incentivised to keep their money in bonds, and sell bonds on the secondary markets and transfer to their demand account as it is needed.

(3) The banks would now compete on the basis of value and cost of services provided in the retail sector and on the basis of their ability to correctly price risk and provide an effective marketplace and bond products in the lending sector.

(4) Problems with this kind of system are
- How to transfer from our current system to this maturity matched system
- If too much money continues to be held on demand this can have a deflationary effect on the economy.
- Is the time and cost involved in managing money worth it or is it better to let the banks manage your money as per current system*
- Are Joe and Mary Bloggs knowledgeable or interested enough to operate such a system*

*I believe these concerns could be addressed by the emergence of companies who would manage your money on your behalf.

(5) In the event of another asset bubble with high levels of default the cost would be borne by those who took the decision to lend and the world would just keep rolling on.

Any thoughts?

Slippers 2

I started a thread about a similar plan in the U.K.
www.boards.ie/vbulletin/showthread.php?t=2055931872

The two main differences from this plan are:

Instead of holding cash for customers the banks would hold the customers' money as the other form of base money - numbers in accounts at the central bank. This cuts down on printing and transportation. A number in a computer system at the central bank is the same as a number printed onto a banknote by the central bank. (This money would not be counted as an asset of the high street bank but as an asset of the customer of the bank, and the customer's account would not be a liability of the bank, just a record of how much money the customer had in the central bank.)

Instead of lending directly to borrowers people lend to banks by purchasing savings accounts (essentialy corporate bonds issued by the bank). This moves the money from the pool of money at the central bank belonging to customers to the bank's own account at the CB from which the bank lends it to borrowers (in the plan they actually give each bank two accounts for its own money but I wouldn't). If a bank becomes insolvent savings account holders get first claim on the assets of the bank but there is no government or central bank guarantee of savings accounts.

FISMA

There's no way to regulate good behaviour, nor is there a way to remove greed.

Also, without the desire to enforce existing regulations, what good are more?

It doesn't take a genius to avoid situations like the one in which we are in now. It just takes some will. But when times are good and we're on a roll, who will be the one to step up and cool things down? The govt? Not a hope, gov't runs on taxes and debt. Don't expect them to try and control bubbles.

Even in a poker game, you have to bring something to the table to cash in. The govt's cheap money policy, allowing individuals to borrow 100%+ was just a disaster. People's thinking that the Celtic Tiger and housing boom would continue forever was just greed masquerading as wishful thinking.