‘The End of Banking’ – is it as appealing as it sounds?

I attended a talk based around an interesting book, ‘The End of Banking’ by Jonathan McMillan (in fact a made up name from two authors –  one of whom works in finance so wanted to remain anonymous). The book defines banking as “the creation of money out of credit,” which nails the unspoken truth in one, but they admit that they use this narrow definition because that is actually the style of banking they want to end.

The book considers that originally the economy was just not interconnected enough for ‘systemic risk’ to be of much relevance. For a long time, the failure of banking institutions did not wreak sufficiently strong havoc on the rest of society to force governments into action. But with the industrial revolution, the economy became increasingly capital-intensive and interconnected. The modern economy could no longer operate without a functioning financial system. Banking failures could not be ignored anymore, which is why in the 19th and 20th century governments started to bail out banking stakeholders.With the digital revolution, however, the interconnectedness of the economy accelerated further.

On their blog page, ‘Why today’s monetary reformists ask for too little‘, the authors state:

Banking can no longer be fixed. In the digital age, banks will always find ways to circumvent banking regulation. Once one considers the development of shadow banking, it becomes hard to deny that banking got out of control with the rise of information technology.

(I’m sure this is a salient point, but also contributory, at the very least, are the disappearance of the partial gold standard in 1971 and then the real liberation in credit creation that came with ‘the City big bang’ of the 1980s. Now many banks, especially in the UK with the mergers of the recent past, are literally, too big to fail.)

Still, it is easy to see that while the balance sheets of banks were relatively straightforward to oversee and understand in the industrial age, the digital age brought about a whole lot of new complications. Monitoring of the financial system has been habitually so light-touch that properly operating a regulatory regime seems to be an insurmountable task. The authors then go on to outline how the unregulated sector of shadow banking works – this is financial engineering whose workings are not always easy to grasp, but its transactions do have the effect of creating additional money using a few, specific, financial ploys. This is where we encounter: Asset Backed Securities (ABS), Collateralised Debt Obligations (CDO’s) and Money Market Mutual Fund (MMF’s) shares.

The appeal of shadow banking is that lending banks, by bundling a part of their loans into what are, in effect, bonds, are able to move a large part of them on to third parties – or sometimes just to each other – and thus issue yet more loans, whilst all the time staying within their Basel capital requirements. In doing this they actually create money but ironically sell on only the safer parts of their loan portfolios, keeping the more doubtful parts for themselves and thus of course increase financial instability as a price for the opportunity to create more loans. The processes of shadow banking themselves are completely outside any banking regulation, so banks can engage at will. Meanwhile other financial institutions such as hedge funds which do not have banking licences, are able to use the same methods to create additional money, potentially creating further risks in the system. This shadow banking ruse is widely prevalent in the US and accounts for almost as much money creation as lending does in the first place. In Britain, although significant, it is much less widely practised. Presumably the UK’s tax havens are more rewarding?

All these activities have given rise, thinks Jonathan McMillan, to the notion that today’s banking is out of control (which is rather a quaint understatement). Anyway this is something the authors seek to change. The anonymous, London based author says:I could not say that bankers are in a desolate state. Actually, those of us who kept their jobs are still doing very well. The thing is that financial professionals – bankers and regulators, are not interested in real solutions. They would rather keep the deeply dysfunctional system we have today and enjoy the perks as long as possible.”  Although I rather think he spoilt it by adding “Many outsiders – Occupy Wall Street or the Tea Party – want radical change, but they resort [to] ideological responses and lack a genuine interest in the workings of a financial system. This is not helpful either.” Nonetheless we are going to see equally ideological solutions from the authors. (Could any solution fail to be ideological?)

And their first solution surrounds the amendment of the concept of limited liability. They suggest that financial liabilities should not be able to exceed the non-financial assets of companies (where a financial asset, as distinct from any other kind, is a liability of someone else – ie. an asset that appears on the liability side of someone else’s balance sheet). This puts paid to most of the money creation of the shadow banking sector.

Their second idea is to issue to every citizen, a Unconditional Income (they are specific that it would not be enough to live on, so Unconditional but not Basic) as a way of ‘improving’ the economy, which seems to be a response to the current economic stagnation and probably a nod to poor man’s QE. And to encourage spending, savings would be taxed.

These first two ideas provide practical if rather limited and parsimonious, solutions but their third idea is where I part company with both Jonathan and McMillan and the title of their book. They propose that an overall monetary authority, run at arms length from the government but still reponsible to it, should be the monopoly supplier of money. This central authority would also issue the Unconditional Income, which, from my perspective seems rather like a bribe to love your bankers. Private banks then become simply intermediaries between savers and lenders. Today’s private banking would be over but central banking would be running the show. This is putting the bankers in charge, and when bankers propose a monopoly you know to be on your guard!

It seems remarkably similar to the ‘Positive Money’ scheme with exactly the same drawbacks. Once any government farms out control of its money system to a committee of the great and good, it loses control of its own money. That is a shortcut back to tax and spend.

Spend and tax requires that the government has control of the money supply. As it rightly should. It is not the monopoly bank’s authority to issue the money that legitimises it, but the government’s requirement to receive it in payment of taxes, which makes it a legitimate currency acceptable to every taxpayer.

And whilst amendment of the concept of limited liabilty is overdue in more ways than the book suggests, to use its reform for banking control is unnecessarily complicated and might have unintended consequences: where companies might find borrowing for, say, Research and Development more difficult because they might easily fall foul of the rule for financial liabilities being greater than the non financial assets.

A much simpler solution is for banking legislation to be based around the idea that anything that is not specifically permitted is forbidden – and the penalty would be that any loans found to be illegal would not be legally enforceable.

That puts the boot on the other foot. Instead of borrowers worrying about how the banks are deceiving them, the banks themselves might have to worry that they had a long line of borrowers trying to catch them out.

The book might propose the End of Banking as we know it but it is very far from the actual End of Banking, and even further from the Ends of Banking – the purpose – that societies need.




  1. Graham -

    “banks will always find ways to circumvent banking regulation”. I’m sure that’s true, but I suspect there are more potent reasons, as you allude to in your comment on this – such as regulatory, government and ideological capture. Finance as a whole has spread its tentacles into so many aspects of government that the master/servant role has been reversed, or so it would seem.

  2. Peter May -

    It has indeed – that’s why we need to limit the individual amounts donated to political parties for a start. The Tories particularly have virtually no members but a few really big donors. HSBC is notable amoung them…

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