Banks: Do we need them?

People who believe the good times will soon return are harder to find these days. It’s not just the loss of trust in our institutions and the political class but a more deep-seated scepticism as to whether the suggested remedies will work.

The laws of economics are not immutable. Many are mere transient beliefs that may provide a reasonable explanation of current machinations, but when a black swan event occurs, like the Global Financial Crisis, something outside previous experiences, the old ways of thinking are of little help.

Likewise, our treasured institutions have failed us. As part of the reported proceedings of the Royal Commission into Banking, investment banker UBS estimated $500 billion out of $1.7 trillion in mortgages across Australia, that’s one third of the total mortgage debt, could be ‘liar loans’, based on dodgy documentation.

With residential mortgages growing faster than the rest of the economy, our economy is out of balance. Everyone knows it. We shuffle existing assets amongst ourselves at ever increasing prices using borrowed funds under the mistaken belief we are growing the economy when the reality is we are involved in a giant Ponzi scheme. Now we discover that up to one third of the mortgage loans may be based on suspect if not fraudulent documentation.

Banks have a very privileged position. They are permitted to create money. They are not simply passive intermediaries between lenders and borrowers. Banks don’t require existing deposits before lending. Loans create deposits. Deposits are money. Deposits are required not to lend but to balance the bank’s balance sheet after lending. It’s a subtle but very significant difference.

Banks may have created $500 billion in money out of thin air using dodgy documentation to buy existing assets, putting houses beyond the reach of many including all those workers who must service the cities where the increasingly expensive houses are located. It’s an utterly crazy system. Everyone knows it.

The real economy where actual production and distribution of goods and services occurs operates alongside the financial economy. It provides services to the real economy, but its size and importance is more a reflection of how much it extracts from the real economy rather than how much it contributes.

Now, more than ever, is the time to question what banks do.

Apart from lending money banks provide settlement services. Almost everyone uses banks to settle payments on their behalf. Banks have been granted this right by the Reserve Bank. Settlement accounts at the Reserve Bank are used to settle on our behalf when we pay someone with an account at another bank. But technology now makes it possible for everyone to be able directly settle with whomever they wish. We don’t need banks as intermediaries.

As economist Nicholas Gruen observed, newspapers are sold directly by newspaper publishers bypassing newsagents, airlines now bypass travel agents.  We can bypass banks by having a settlement accounts at the Reserve Bank. Non-bank institutions can easily assist, like internet providers say. Banks have abused their position of trust and privilege. Technology now makes it possible to bypass them and to allow others access into the protected market.

Level the playing field and provide everyone with the same facility at the Reserve Bank as major banks have. Uber drivers have been given the same access to passengers as the taxi industry, Airbnb competes with hotels. Let’s extend the sharing economy a little further? We don’t need banks to settle for us.

That would take away banks’ captive market for funds, all those funds held in client accounts, unsecured amounts guaranteed by the government, earning little interest, but used to balance banks’ balance sheets, enabling more profits to be made and higher bonuses paid.

Returning to banks’ other function, that of making loans, there is growing acceptance of the truism publicised by the Bank of England in 2014 that bank lending creates deposits, rather than the reverse. For too long economic orthodoxy has led us to believe than deposits are prerequisites to lending.

Nor are government borrowing via bond issues or taxes a prerequisite for government spending. The Reserve Bank can provide any amount desired by the government with just the click of a mouse. Create a loan and a corresponding deposit just like banks do.

Governments should be able to better spend loan proceeds than by forcing up house prices and allowing the banking monster unfettered access to a fee smorgasbord.

We have unemployed and underemployed resources everywhere. We have the knowhow to do most things. There is no shortage of demand for many vital government services.

But when it comes to public economic policy we are stuck in a time warp. Almost all money is created by private banks and most of that is used to speculate. The tax system encourages it. Banks and the property lobby demands it.

Cheering accompanies rising house prices. But servicing higher loans drains more resources from the real economy especially if principle repayments coincide with stagnant wages.

Our much acclaimed superannuation system also has its downside as funds leave the real economy and are almost exclusively used by fund managers to speculate in existing assets, again largely to the benefit of banks and others in the finance industry.

The banking system is at the heart of our problems. However, greed dishonesty fraud and lack of process as revealed by the current Royal Commission, are the least of those.

More serious is the way banks have stunted the real economy and hijacked policy making. So much policy is designed around banks’ needs, from first home buyers’ grants which assist homeowners onto the treadmill, to child care assistance which enables breadwinners a return to work ASAP to service the loans bankers have created to maximise their profits and bonuses.

It won’t be sufficient to force banks to divest their funds management operations. Settlement services should be divested or at least open to non-bank competition.

But who can create money, how much and for what purpose are the crucial questions which need answers if we are to move forward.   
(Published in The Mercury 27th April 2018)