Sunday, 23 March 2014

Reforming the Banking System

Monetary reform has to deal with a number of issues. There are a number of things that need to change. These include stopping banks creating money but it also involves implementing new ways to ensure the money supply matches demand. I would also argue that we need to change attitudes of people toward money and chasing wealth. However, not everything can change at once so changing the way money is created by stopping banks from creating money is a starting point. This is the focus of chapter 6 of “Modernising Money” (Jackson & Dyson, 2012).

There are quite a few issues that need to be addressed if depositors are to have confidence that they will not lose their money or they are aware of the degree of risk in their investment. It is also preferable that banks can fail rather than being bailed out by the government. How can you set up a banking system so that banks really do become intermediaries and not creators of money.

Positive Money's proposals as outlined in this chapter is through changing the banking system so that there are two types of accounts. These are Transaction Account and the Investment Account.

The Transaction Account

The Transaction Account replaces the current Current Account with the major difference being that instead of the money deposited in a Transaction Account becoming owned by the bank, it remains the property of the depositor. The bank simply manages the transactions for the depositor but otherwise it cannot use these funds. They are deposited with the bank of England.

Under this strategy, banks no longer hold reserves for settling interbank transactions. This isn't needed as the money is already held in the Bank of England. Also if the bank fails then the depositor still has access to their money and can transfer their account to another bank of their choosing. This sounds positive so what are the drawbacks? Banks will not pay interest on these money held in current accounts (no change really) and may decide to charge for transactions. There would be no savings accounts offered as current accounts.

Each bank will hold an account, their Customer Funds Account, at the Bank of England that represents the funds held by depositors in their Transaction aAccounts with the banks. The balance held in this account will not appear on the banks balance sheet.

The Investment Account

The Investment Account is where investors would place their money if the are seeking a return. However, the investor gets to choose the risk that they are prepared to take. The bank may offer some guarantees but these would not be backed by the government. The banking would be from the banks own operational funds. The money becomes the property of the bank and it is able to use it to offer loans to borrowers. The bank can lend money that has been placed with it for investment or from its own operational money that it has placed into the investment pool. The bank is not able to loan money that it doesn't possess.

There is another restriction in that investors are not able to use investment accounts to conduct transactions. They either have to wait for maturity of the investment or if allowed by the nature of the investment give notice of their intention to withdraw investment funds.

To manage the amount of money that the bank has available for lending holds an Investment Pool account with the Bank of England. This account represents the total of the investor investment accounts minus the current loans that the bank has made. The bank needs to manage the funds in this account to ensure that it is able to meet its obligations in repaying investors as their investments mature. If they bank were to fail then investors would become creditors of the bank and have to wait for the completion of liquidation proceedings. Preference in the liquidation proceedings should go to the investors who took the lowest risk.

Other Details

The book chapter discusses the accounts that banks would hold with the Bank of England and the way that these would be used to settle payments and to manage investments. I am not going to deal with these in this blog. If you really want the underlying technical details then I would suggest getting a copy of the book and reading the details.

Does this solve the problems?

The development of the current banking system came about through trying to meet a perceived need for funds to exact business transactions. To ensure that banks and other financial institutions do not generate new forms of money after these reforms there is a need to ensure that mechanisms in place to ensure that adequate money is maintained in the system. Insufficient money in the system would mean that businesses and individuals would look for alternative mechanisms to obtain the necessary funds for business. Excess money would put inflationary pressure on the system.

Consequently, just reforming the banking system is not enough. There needs to be a new mechanism form managing the money supply enabling new money to be created if required and money to be destroyed if excess money is in the system. The next chapter of the book deals with these issues.


Andrew Jackson and Ben Dyson (2012) Modernising Money: Why our monetary system is broken and how it can be fixed. London: Positive Money.

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