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Features
Banking
Do we still need banks?
Frances Coppola discusses whether banks need to be made safer, or even if they are still needed, but says the alternative solutions appear to be much worse
Only 15 years after the fall of Lehman Brothers, two banks, Silicon Valley Bank (SVB) and Credit Suisse, have created fresh angst about bank stability and the need for state support. Then, when it was reported in early October that Metro Bank in the UK was looking to raise £600m, its shares plunged. So, do we need to make banks safer?
Underlying this question are deeper concerns. Banks now dominate the payments landscape even more than they did 15 years ago. It’s virtually impossible to be involved in the western economic system without a bank account. Should banking now be regarded as an essential public utility, like water, energy and telecommunications? And as fintech disrupts the financial landscape, do we even need banks to do banking?
Born to run
Born to run
All banks that take deposits and make loans face the threat of a run, but deposit insurance has long been known to reduce or eliminate that risk. Had the large corporate deposits that fled SVB been insured, the bank might still be standing today – hence calls for deposit insurance to be made unlimited.
But insured deposits are effectively liabilities of the deposit insurance fund – the Federal Deposit Insurance Corporation (FDIC) in the US and the Financial Services Compensation Scheme (FSCS) in the UK. The FDIC and FSCS are both funded by a levy on banks and financial institutions. The higher the deposit insurance limit, the larger the levy must be.
The cost is an issue, but there is also moral hazard. If all deposits were insured, and effectively the liabilities of other banks, there would be a perverse incentive for individual banks to act recklessly. If it all went wrong, someone else would pay.
The price of this unlimited deposit insurance would be much tighter regulation of banks, but this would fundamentally change their nature. With no liability for deposits, and little responsibility for risk management, banks would arguably merely be arms of the state.
Regulators are looking at deposit insurance reforms that stop short of unlimited insurance. The Bank of England is considering raising the current deposit insurance limit from £85,000, shortening the payout period for insurance claims (currently up to seven days) and increasing the size of the insurance fund.
The FDIC has recommended higher deposit insurance limits for business transaction accounts, which typically have large balances at certain times (such as close to payroll dates) and for which losses due to bank failure can be disastrous, not only for the business itself but for employees, suppliers and the wider community.
There’s a strong argument that transaction banking should now be regarded as a public service
But these reforms would not be without cost. They would be paid for by bank customers in the form of lower interest rates on savings and higher rates on loans. It’s not clear why ordinary savers and borrowers should pay to protect large deposits. Perhaps a better approach would be to offer larger depositors the opportunity to insure their deposits in full for a premium charged to their account.
Larger capital buffers could be an alternative to more deposit insurance. They would help prevent bank failures and make it less likely that uninsured depositors would take losses in the event of a bank failure. But they might not prevent runs. The depositors who ran from SVB neither knew nor cared about the bank’s capital. They had been frightened by powerful influencers and just wanted their money.
Are banks a public service?
Are banks a public service?
There’s a strong argument that transaction banking should now be regarded as a public service. This doesn’t mean that all banks must provide accounts to all comers. A bank is a commercial enterprise and a bank account is a legal contract. Commercial enterprises can choose who they do business with, subject to the provisions of equality law, and it would be odd to have a legal contract in which one side can terminate the contract but the other cannot.
The nine largest high-street banks are required to offer basic personal accounts, which ensures that no one needs to be unbanked. But even basic accounts have conditions, such as identity checks. The Financial Conduct Authority’s (FCA) recent report into bank account closures found that some 35% of basic bank account applications were declined, mostly because the applicants could not prove their identity.
When it comes to organisations, there’s currently no basic bank account, but it’s extremely difficult to run any sort of organisation without a bank account. One solution might be to extend the right to a basic bank account to organisations, subject to identity and financial crime checks. But the FCA found that the most common reason for a bank to close a business account or reject an application is suspected financial crime. Watering down financial crime checks to make it easier for organisations to qualify for basic accounts could be counterproductive.
The replacement system would be subject to catastrophic systemic runs and collapses
There have been calls for all individuals and businesses to have the right to a basic bank account regardless of status, via a government service such as a Post Office Bank. But as a public bank would have to operate the same identity and financial crime checks as high-street banks, it’s difficult to see how this would significantly improve financial inclusion.
Do we even need banks?
Do we even need banks?
The traditional business model of banks is to accept deposits, lend at risk and profit from the interest rate spread. But the proliferation of online lenders, funds and payment services providers creates the prospect of a ‘deconstructed’ banking system.
However, lending is still predominantly long term and saving (except for pensions) predominantly short term. And because lenders need funding, and savings institutions need to generate returns for depositors, and both need payment services, there would inevitably be strong links between lenders, funds and payment services providers. Some might even be housed under the same corporate roof, creating a bank in all but name.
The proliferation of unregulated banks in the ‘decentralised’ crypto ecosystem suggests that a ‘deconstructed’ banking system would not remain deconstructed for long. The need for liquidity and returns drives the creation of institutions to pool savings and intermediate them into loans.
Even if online lenders, funds and payment services providers replaced traditional banks, there would still be duration and liquidity risk in the system and within institutions. And because the risks would neither be clearly visible nor easily managed, such a system would be subject to catastrophic systemic runs and collapses.
Is banking fit for purpose?
Is banking fit for purpose?
It’s understandable that with the return of bank collapses and depositor risk, people are once again questioning whether the current model of banking is fit for purpose. But measures to make banks safer for depositors come with significant costs and create perverse incentives. Although a universal right to a bank account sounds attractive, in practice it cannot be delivered without eliminating the checks that protect the banking system from identity fraud and financial crime. Nor would replacing traditional banks with a panoply of fintech firms and funds make the system safer – instead it seems likely to increase the risks to ordinary people and businesses.
The present banking system has evolved over centuries of ‘muddling through’. For all its many flaws, the alternatives being mooted appear to be worse.
Frances Coppola
Frances Coppola writes and speaks on finance and economics, following a 17-year career in banking. She is the author of The Case for People’s Quantitative Easing, published by Polity Books in June 2019, and is writing The Absolute Essentials of Banking for Routledge
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