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Economics, Governance

Regulate Banks or Go for the Two Account System?

There are two basic ways of minimising taxpayers’ exposure to banks. One is regulation of the Glass-Steagall or Vickers type. The other is the two account system advocated by Positive Money and others. The crucial flaw in the former, i.e. regulation, is first that it is inherently so complicated that regulators are clearly out of their depth. Second, and as a result of the complexity, banks can eat away at those regulations via lobbying. That is exactly what banks have repeatedly done in the past.

Reforming banks has one basic objective: minimising taxpayer subsidies for banks. It could be argued that there is another basic objective, namely making the system safer. However the basic problem with an unsafe system is that the taxpayer has to come to the rescue periodically. So the ultimate objective in making the system safer is to minimise taxpayer liabilities.

Moreover, there is no big merit in making banks safe. That is, there is no harm in letting banks go bust, as long as the country’s stock of money and the money transfer system is not damaged in the process. Thus the central objective is to minimise taxpayer subsidies for banks.

To attain the latter objective, there are two possibilities. One is better regulation of the Glass-Steagall or Vickers type: for example insisting that banks are better capitalised.

The second possibility is to go for the two account system advocated by Positive Money, Prof Richard Werner and the New Economics Foundation in their joint submission to the Vickers commission.

The fact is that banks managed to have Glass-Steagall removed. That is a historical fact. Another historical fact is that Spanish banks managed to have bank regulations watered down between 2000 and 2005. Come 2011/12, and the results are plain to see. (FT article about Spanish bank regulation)

Moreover, the regulations are inherently so complicated that regulators are just not able to design a set of regulations that minimises taxpayer exposure to banks. For example, according to Mervyn King, a few months before the collapse of Northern Rock, the best capitalised bank, according to the regulations then in force was . . . . . wait for it . . . . . Northern Rock! Thus the regulations were clearly a load of rubbish. And things have not improved much since then.

In 2011, the European Banking Association, plus the European Central Bank and the European Systemic Risk Board supervised stress tests on all major European banks, and what do you know? Bankia, the shambolic Spanish bank passed with flying colours.

Now Bankia needs twenty billion Euros and counting. Incompetence isn’t the word for it.

The emperor has no clothes! Regulators are just not up to the job.

As for our dear old Vickers commission, it claims to have designed a “ring fence” which supposedly stops banks using money from grandma’s savings account to invest in businesses. Unfortunately, the Vickers final report EXPLICITLY ALLOWS retail deposit money to be loaned to businesses.*

Now “lending” to a business is not, admittedly, the same as investing (i.e. buying shares). But the two can be very close if the terms of the loan make the lender about the last in line for compensation if the business fails.

In short, the much vaunted ring fence does not really achieve the above mentioned objective: minimising taxpayer liabilities.

To summarise, regulation is hopeless, first because those designing the regulations are according to all the evidence, are not up the job. Second, the mere fact that regulations are complex, means that banks can and do eat away at the regulations.

So what we need is much simpler system: a system where it is obvious when banks are trying to “cross the Rubicon”: and there it is 100% certain that they WILL TRY to cross it.

The two account system.

Enter the two account system. The basic rule here is that if depositors want their bank to LEND ON or invest some of their money, then the taxpayer does not underwrite that money: depositors may not get their money back. We’ll call the relevant accounts “investment accounts” for want of a better phrase.

In contrast, where depositors want their money to be 100% safe, the taxpayer DOES underwrite the money. But the money is lodged in a 100% safe manner (e.g. it could be deposited at the central bank, where it will earn little or no interest).

As to achieving the two objectives with which we started above, this system certainly reduces taxpayer liabilities to a minimum. First, and regarding investment accounts, there is no undertaking by taxpayers to reimburse those with these accounts, so there is no taxpayer liability there.

As to ensuring the stability of the country’s stock of money and money transfer system. And it might seem that if those with investment accounts lose their money, a significant proportion of the country’s stock of money has vanished. That argument is flawed and for a reason that has to do with the distinction between a debt which is not a form of money and a debt WHICH IS a form of money.

Where (as under our existing system) the main form of money is monetised debt, there is distinction between a debt which the relevant debtor and creditor intend as a long term arrangement between the two parties, and in contrast, a debt which the creditor has the right to shift the debt at a moment’s notice to another creditor: that is what happens when you write a cheque or make a payment with a credit card, for example.

Now investment account money is money that is loaned to whoever borrows from the bank for a relatively long period.  That in turn means that this debt is more in the nature of a PERMANENT DEBT than money. It’s not much different to a bond.

In contrast, instant access IS ALLOWED to safe accounts. This is genuine money. And this is underwritten by the taxpayer.

Thus in the event of a bank collapse, government could temporarily take over the bank and continue running the “current” or “safe” accounts (or another bank might be willing to do a take-over relatively quickly). In either case, there’d be little effect on day to day transactions. And where depositors had taken the precaution of making sure they had enough in their safe accounts to meet their cash requirements for the next few months, there’d be no effect on demand for goods and services.

Of course a proportion of depositors might not take the latter precaution, but that’s their look out. Likewise, a proportion of households and businesses do not look after their cash flow under the CURRENT system. They get into difficulties of course, but the sky does not fall in. And no one has ever suggested it’s the taxpayers’ job to bail them out.

* See the ICB final report, 2nd last para, p. 11, or left hand column of p.54.




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