Americans Want an "Ultra Safe Bank." It's Time to Ask Why They Can't Have It.
Back in the 1950s, the bank was the primary means by which individuals and businesses got capital to fund themselves. If you needed a mortgage, you went to the bank. If you needed a business loan, you went to the bank.
The bank was also the primary means at which people earned a return on investment. If you wanted to earn interest, you put money in a savings account. If you wanted to earn more interest, you purchased a certificate of deposit. If you wanted the safety of a federal government guarantee, you bought a savings bond. And for almost all individuals and small business, those were almost the only investment options that you considered. In 1952, only 5% of Americans owned shares of stock.
In other words, for most Americans and businesses, the bank was where you did almost all your financial transactions. And more importantly, the bank played an essential role in allocating capital from savers to borrowers, because most savers and borrowers had few practical alternatives other than the bank. Only large corporations, banks themselves and other large entities could access a broader array of capital markets.
Obviously, things are quite different today. Consumers have access to pretty much every asset class under the sun through a simple click of the mouse. Both consumer and business borrowers also have a large number of options for getting access to loan capital. And banks' role in the economic system has gradually transitioned from being a holder of debt to increasingly being an originator of borrowings and quickly offloading much of that risk via securitization to someone else or to the federal government (e.g., agency-backed mortgages, SBA loans, etc.).
Yet much of the world (including a lot of the finance world) still thinks that this thing called a "bank" is an essential piece of capitalism without which capital would not be able to be optimally allocated.
My question is: why do people think that when a lot of the evidence points to the contrary?
There has never been a broader array of capital markets with tremendous liquidity, and it's not likely that this trend of capital moving from banks to capital markets is going to stop anytime soon.
Moreover, it's clear that the American public and a lot of American businesses do not want banks to take risks.
What the SVB debacle demonstrated is that first and foremost people and organizations depend on banks to provide two things: (1) an ultra-safe place in which to store cash that can be withdrawn at a moment's notice and (2) services to process and report on transactions through bank accounts in a highly secure manner.
That's it, and in today's world, those services are indeed essential and valuable.
What most American consumers and businesses aren't using banks for is to earn a decent return on investment. And that is because people and businesses generally invest their money in other places that earn a better return. In fact, part of the reason Congress enabled deferred-contribution retirement plans like 401(k)s was so Americans could get used to investing on their own. And it worked! Now lots of American do investing on their own.
But Americans consumers and businesses still need a safe place through which to process day-to-day transactions, and banks are pretty much unequaled in being able to do that effectively. Some bank industry experts speculate that if a bank came along that promised to only store cash, process transactions and invest deposits only in ultra-short, ultra-safe investments like Treasury Bills, many people and businesses would be attracted to that business model.
In fact, in 2018, a proposed bank called TNB ("the Narrow Bank") filed an application to open a master account with the Federal Reserve. To be clear, TNB's business model was to serve very large institutions, not small potatoes depositors, and to serve as a Passthrough Investment Entity ("PTIE") to access more favorable interest rates provided through Federal Reserve master accounts than they could access through open market transactions.
That being said, the Fed hated the idea not just because it seemed like it was solely a cheating mechanism to get large institutions access to higher returns, but also because such a bank would essentially be "too popular," especially in a crisis. Specifically, the Federal Reserve said:
“Deposits at PTIEs could significantly reduce financial stability by providing a nearly unlimited supply of very attractive safe-haven assets during periods of financial market stress. PTIE deposits could be seen as more attractive than Treasury bills, because they would provide instantaneous liquidity, could be available in very large quantities, and would earn interest at an administered rate that would not necessarily fall as demand surges. As a result, in times of stress, investors that would otherwise provide short-term funding to nonfinancial firms, financial institutions, and state and local governments could rapidly withdraw that funding from those borrowers and instead deposit those funds at PTIEs. The sudden withdrawal of funding from these borrowers could greatly amplify systemic stress.”
From <https://www.bloomberg.com/opinion/articles/2019-03-08/the-fed-versus-the-narrow-bank>
What is true for PTIEs is probably also true for a "ultra-safe store / ultra-secure processor" bank. In times of stress, a regular bank's depositors could rapidly withdraw that funding from shaky traditional banks and deposit those funds at ultra-safe banks. And that sudden withdrawal could indeed amplify any crisis.
In fact, we saw exactly that dynamic in the SVB crisis: customers took their money from SVB and plowed it into the large "safe" money-center banks, like Chase, Bank of America, etc., that have an implicit Fed guarantee on all deposits. And with the SVB crisis, we saw just how fast a bank run can happen these days. It literally took 36 hours for the 16th-largest bank in the country to go belly up and to spook regulators into crisis management mode.
No one likes this: Consumers want a lower-risk banking model. Regulators want a banking model that doesn't lead to crises. But we're stuck in this system that isn't getting us what we want.
And that's why I ask the question:
In practice, the reasons why the U.S. financial system hasn't yet enabled "ultra safe banks" to come into existence are:
This "ultra-safe" business model would be too popular (which is a weird reason in a capitalist economy).
The Federal Reserve thinks that this system would make it harder for the Federal Reserve to manage monetary policy (maybe true).
A narrow banking system could also lead to making the financial system harder for the Federal Reserve and Treasury to manage in a crisis (very possibly true). Here's why: even if ownership of loans moves to non-bank entities, that doesn't mean that the financial system is necessarily safe - that loan capital will simply move to less regulated non-bank entities. In fact, non-banks have been a significant source of potential systemic risk, such as with the Long Term Capital Management crisis. Regulators currently have much less insight into non-bank lenders. The benefit of the current system is that regulators can use their oversight of large banks' capital structures to monitor risk-taking and to use large banks capital structures to provide a ballast in a crisis. It’s harder to do this with non-bank lenders.
The existing large banks are very powerful politically and can probably scare elected officials and regulators into believing that the collapse of their business model would lead to economic calamity (definitely true).
I'm not saying that there aren't any risks in introducing "ultra safe banks" to the financial system.
In fact, a very rapid introduction of "ultra-safe banks" could indeed be very destabilizing to the overall financial system. There could also be significant longer-term effects on capital markets, and the cost of capital in many debt capital markets could increase materially if banks cease to hold loans and long-term bonds on their books. These are important concerns that require some research.
But it seems weird not to really think more broadly about alternatives to our existing banking model given that it's not 1952 anymore and a lot of people hate the current system. Many American consumers and businesses clearly want an "ultra safe store / ultra secure processing" bank.
In the wake of the SVB crisis, we need to step back and ask if it's reasonable to deny customers such a service as an ultra-safe bank.
I'd love to see some real experts on the banking system (not me) asking if banks are indeed still essential as capital allocators, and also thinking about not just the pros and cons of introducing an "ultra safe" model into the banking system, but also how such business models can be safely integrated into that system, especially if they are indeed "too popular."