Fed Nixes Narrow Banks Redux - Barokong - Teknoiot

19 Jun 2020

Fed Nixes Narrow Banks Redux - Barokong

J. P. Koning at AEIR writes well on the Fed's efforts to quash narrow banks, more clearly than my previous efforts herehere and here.

As a quick review: Narrow banks take your money and invest it 100% in interest-paying reserves at the Fed. They are completely immune from runs, failures, and financial crises. You would get a lot higher interest than the big banks currently pay.  The Fed should be giving them a non-systemic medal. Instead, the Fed is fighting them tooth and nail.

the Fed is floating the idea of destroying the narrow-bank business model before it can ever be tested in the market.
J.P. clearly goes through the Fed's proffered objections, demolishing each in turn.  The financial stability concern makes no sense -- after all, they can buy treasury bills directly or buy treasury - backed money market funds. Reserves are that, with instant rather than one day settlement, or money market funds that now are allowed to invest in reserves.

J.P is, I think, a little too polite. He writes,

..the Fed worries that narrow banks could unfairly undercut traditional banks by “avoiding regulatory costs,” specifically capital requirements.
...the Fed worries that narrow banks could reshape the financial system by drawing large quantities of deposits away from traditional banks.... banks could be forced to respond by raising rates on loans to households and businesses.
He responds to each on its merits. Capital requirements are supposed to be a buffer to prevent failure and runs. If you come up with a bank that cannot fail and cannot run, it is not "unfair" to not have any capital requirements, it is only common sense.  If you buy solar panels it's not "unfair" that you no longer pay the electric bill. In fact it is the big banks who are "unfairly" subsidized by implicit and implicit bailout guarantees. And no, banks are not so magnanimous to turn protected deposits into low-cost loans rather than profits.

We can go one step further. I think. J.P is a bit too polite here. What is the Fed doing deciding what is "unfair" competition? The Fed should be worried about consumers and the economy, not the profits of traditional vs. new banks.

And, put these two quotes together: Whatever its motives, The Fed sure is acting and talking as if its goal is to preserve big bank's oligopoly power to pay us low interest rates, in return for banks lending as the Fed sees fit they should lend. The result is traditional financial repression pure and simple.

The Fed seems to be heading to a bewildering variety of interest rates to different institutions according to how it favors or disfavors them. Big banks get one rate, money market funds get another lower rate, narrow banks get a lower rate still. This favoritism will only expand. Surely Congress and the President, seeing this, will demand higher rates for community banks, lower rates for foreign-owned banks and so on. The best defense against politicization is simple rules -- one rate for all financial institutions, period.

JP thinks narrow banks, if allowed, will remain limited, offering an alternative to overnight repo to large corporations. That's already a big advance in financial stability. I have greater hopes. Central banks cannot operate retail digital currencies. Who do you call when you forgot your password? But narrow banks are the ideal institutions to provide the retail-facing end of digital currencies. The sooner the better. Unless we can persuade the Treasury to offer reserves first and take this all away from the Fed.

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