The banking system faces an existential threat  

Posted by Big Gav in ,

The Business Spectator has an interesting article from Stratfor on attempts to change the way the banking system works - The banking system faces an existential threat.

Christmas did not offer much good cheer to the world’s bankers, who have received a sustained kicking since the financial crisis erupted in 2008. In the latest blow, Switzerland announced that it would hold a referendum on a radical proposal that would strip commercial banks of the ability to create money, depriving them of a great deal of their profitmaking capabilities. If the Swiss proposal catches on around the world, it could shred core business assumptions that have underpinned the banking model over the past three centuries. ...

It is into this atmosphere that the idea of stripping banks of their money-creating abilities has gained currency (regained, in fact, since calls for it date back at least to the 1930s). According to its proponents, the way to root out the instability inherent to the system is to require banks to back their loans 100 per cent with reserves. This essentially would be a step back to the point where banks would again function as conduits rather than creators of capital.

Under the reformed system the creation of new money would instead be the prerogative of the central bank and the government. These national institutions would in theory be motivated by the needs of the state rather than by short-term profit and would keep the money supply growing at a fixed rate, doing away with the wild fluctuations of the credit cycle. (One challenge to overcome would be politicians attempting to hijack the money supply for short-term political gain.)

Proponents of such a system point to many expected benefits: Bank runs would be eliminated, the proceeds of money creation would go to the government and, thus, the taxpayer rather than to the banking elite, government debt would be a thing of the past, and private debt would be greatly reduced. (Indeed, the predominance of debt in today’s world is partly a product of it being required in the money creation process.)

But there also would be great risks involved, the main one being the fear of the evil unknown. Though the economic instabilities of the past 300 years appear to have resulted largely from the fractional reserve system, was it also responsible for the relatively breakneck growth over the same period? Moreover, the changeover from one system to the other would be extremely tricky, requiring vast quantities of central bank money-printing and debt buybacks. That would be a recipe for an extremely fraught period carrying immense risks of mismanagement. In truth, another full-blown financial crisis may have to take place before such a changeover could be made at the global level.

But the theoretical upsides are great, as are frustrations with the current system, and the idea has begun to gather momentum. In 2012, the International Monetary Fund published an influential research paper laying out the case for the proposed system, and in 2015 the Icelandic government commissioned a report on the prospect of undertaking the changes. In Switzerland, a law requiring a referendum to take place should 100,000 signatures be gathered has set the country on a course to possibly being first to undertake the great experiment.


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