Friday, February 06, 2009

A bunch of bankers

A couple of weeks ago, your humble Devil was sitting in the pub, having a few lunchtime pints with Pater Devil. It was he who said something like...
I see that the government are planning to instigate a "bad bank" to buy up all of the toxic loans. And my immediate thought was "why doesn't someone set up a good bank instead."

The tagline could be something along the lines of "deposit your money with us: we don't have any debts, toxic or otherwise."

It is, I think, a very good idea: it is unfortunate that setting up a bank requires such massive amounts of box-ticking in order to gain the licence from the government.

But it shouldn't be that difficult, I thought: after all, the infrastructure—the ATMs and suchlike—is all there. Why not?

I never seriously investigated setting up The Bank Of Hell, but it seems that others have been a bit more pro-active, as this LaunchLab article shows.
It’s what entrepreneurs do: find something that’s wrong with the world, fix it, and make some money along the way.

So while most of us complained about small business’ lack of access to finance; a group of entrepreneurs decided to take affirmative action.

Cambridge-based telecoms entrepreneur Dr David Cleevely is leading a team researching the potential for a new bank that would focus on giving “fairer” funding options for small businesses.

He tells The Independent: "We are sick to death of the way the banks are operating. They are offering people almost nothing for deposits but charging small businesses up to 15 per cent for their credit facilities. There is something fundamentally wrong."

"Quite apart from the social issues, there is an arbitrage opportunity here to set up a bank because of the huge disparity between borrowing and lending," Dr Cleevely said.

"Talk of their being no money around is nonsense. There is tons of money but no one wants to put it in the banks earning next to nothing."

Nigel Brown of NW Brown, the Cambridge-based corporate finance business, and Dr Alan Goodman, a biotech entrepreneur who has founded more than 30 companies, are also involved in the project.

The group is in talks with Cambridge University, Cambridge City Council and the Treasury to see whether or not their scheme is a goer.

It sounds like a good idea to me. After all, if you wanted to set up a new bank, you could hardly pick a better time than now. Only one thing slightly worries me about this endeavour—and that's the involvement of someone who says something like this...

“We need to change this and it could be that commercial and investment banking must be separated by law."

Um... So, tell me, how is lending capital to businesses so that they can expand, in return for interest on the capital, substantially different to buying up shares in businesses so that they can get capital to expand, in return for a dividend?

Still, one to watch, I think; although I wonder how easy they will find to get a licence: after all, if they did very well and started to take massive numbers of depositors from the big banks, they could precipitate another capitalisation crisis. And that, of course, is something that the government simply cannot afford...


Jock Coats said...

Whilst they probably have a better chance than me at actually achieving it, the *are* a little bit behind the curve...

Jock Coats said...

...and yes, you are absolutely right, the hardest thing is going to be getting approved by the people who approved the lot who have just broken the current system so spectacularly - the FSA. And we, unlike this Cambridge lot are not really in a position to find £10m just like that. And it's a catch-22 - you can't advertise or tout for investors until you are. So, any HNWIs in Oxfordshire reading this...

John East said...

If a "good" bank were to be set up today there would be a run on all the other banks as people transferred all of their money to the good bank. It would never be allowed to happen because we have to look after the interests of all of the poor bankers who have suffered so much over the last year.

Jock Coats said...

To be honest though neither the Cambridge group nor mine here in Oxford are looking at much more than a local thing - perhaps, ultimately, replicatable as a series of local structures elsehwere but initially at least quite a local thing.

More like a WIR Economic Co-operative Circle in our case than a Nat West.

So it may be a threat in terms of competition for some savings money belonging to Oxfordshire based people currently in bad banks, but I'd personally not be too worried about that!

Gareth said...

The Ascent of Money had a bit about credit unions in South America. Seemed to be working very well. Local lending for local people. Time was when lots of UK towns had them. Same too Building Societies.

Better to not be approved by the FSA I would have thought (as a number of foreign banks are not IIRC) - then you're not going to be dragged into and be hobbled by the banking compensation scheme if any other banks go under.

Jock Coats said...

If I understand the 4,673 pages (or whatever) of regulation, you cannot basically sell or promote the vast majority of financial services (including credit unions by the way) without being regulated *somewhere*. Most of the overeas banks operating in Britain or touting for business in britain do have their UK offices regulated by the FSA, but some are allowed to trade with their overseas regulation (eg SEC or Fed accreditation).

Credit Union law is extremely restrictive and would not, for example enable the organization I'm planning at the moment to provide any "home purchase schemes" (even if not strictly mortgages in the common usage).

Building Societies similarly are heavily regulated as to what they can and cannot finance - basically house purchases and savings but not, for example, business lending - which appears to be the prime concern of the Cambridge lot and one of our prime concerns here too in Oxfordshire.

There *are* a few ways around it and this is where the Cambridge lot may be more successful - if they operate as a "private equity" fund and take money only from high net worth exempt ("sophisticated") investors who have signed away their right to protection under FSA for example. But that too prevents retail investors and in our case "house purchase scheme" investees.

It really is a nightmare. You can understand why of course, but it is definitely stifling right now those of us who have what we think are viable business plans for helping *right now*. Unfortunatelym since the whole idea is that our mechanisms will be slightly different - our "mortgage" offer is really a "property investment partnership" not a loan for example - it is likely to take even longer to get approval because the FSA won't have an existing "template" for the type of product we are trying to promote!


Anonymous said...

I wonder whether ZOPA could be developed into something along these lines.

Jock Coats said...

Zopa, a bit like a Building Society of old, operates its retail accounts through RBS, so they have access to the FSCS for example.

As I understand it the £10m thing that the Cambridge lot say they need is for capital requirements because they are going to be acting as a principal. We are trying to create a structure which, a little like Zopa, will not involve us in a principal's position. So yes, it is a possibility.

Revolution Harry said...

DK, if you were allowed to create a new bank would you operate using the fractional reserve banking system so favoured by current banks?

Budgie said...

This is very interesting, from Jeff Randall (Telegraph 06-02-2009):
" ... onlookers discovered that Michael Fallon MP (Conservative, Sevenoaks) suspects that John Kingman, the government official who now heads UK Financial Investments, the body created to oversee state shareholdings in commercial banks, was the source of Robert Peston's BBC scoop about the banks' pleas to Downing Street for emergency assistance. Mr Kingman and Mr Peston used to work together at the Financial Times.

This allegation, made in the form of a question to Mr Peston (which Mr Fallon knew very well would not be answered), is a serious one. It invites us to infer that ministers deliberately weakened the banks' bargaining position by leaking details which would provoke sharp falls in their share prices. In effect, far from shoring up confidence in the banks, the Government plotted to ensure that it could take control without unseemly resistance."

Gareth said...

Ed Balls used to work at the FT as well. I wonder if he was there when Kingman and Pesto were...

richard allan said...

I can't speak for DK, but if I were to set up a bank I would certainly keep a fractional reserve, because otherwise it wouldn't be a "bank", it would be a safety deposit box that you would have to pay to use (rather than the bank paying you for the privilege of investing your money).

People already have the right to do this, but they don't, because that would be dumb. They're dumb for leaving their money in bad banks, too, but it's really difficult to open good banks because of over-regulation, so they're stuck between two bad options: cash, easily stolen/destroyed, cumbersome; and deposits, convenient, but easily lost in a bank run.

Mark Wadsworth said...

DK, others have already suggested that we ought to start again with New Banks - depositors can move across at the drop of a hat, 'good' borrowers will have no problem remortgaging, so the old banks automatically become bad banks.

Loads of proper official economists have said this. Closer to home, Cityunslicker was the first to get round to actually saying it, and I did a nice summary here.

If it weren't for the morons bailing out the existing banks with taxpayers' money, instead of allowing them to fail, then the free markets would see new banks springing up left right and centre (or small banks with relatively few bad investments in absolute terms just getting bigger, taking over the branches and ATMs and so on).

Revolution Harry said...

Richard, this is how I see it. There's absolutely nothing stopping banks that didn't operate a fractional reserve system lending your money out at a certain rate of interest, then paying you a share of that interest and keeping the remaining interest as a profit to them. In the fractional reserve system they can lend money they don't have. Using your deposit they can lend up to (usually) 9 times that amount. As William Paterson, writing in the Bank of England's charter in 1694 put it: “The bank hath benefit of interest on all moneys which it creates out of nothing.” Not only do they create money out of thin air in this process but they don't, at the same time, create the interest they require you to pay back. A situation best summed up by former Belgian central banker Bernard Lietaer who said: 'Money is created when banks lend it into existence. When a bank provides you with a $100,000 mortgage, it creates only the principal, which you spend and which then circulates in the economy. The bank expects you to pay back $200,000 over the next 20 years, but it doesn't create the second $100,000 - the interest. Instead, the bank sends you out into the tough world to battle against everybody else to bring back the second $100,000." Hence the clamour for economic growth.

The fractional reserve system is inherently inflationary as the creation of money happens much faster than any consequent economic growth. This is by far the largest driver of inflation, which in itself is a hidden tax.

Runs on banks would be far less likely if their assets were the same as their liabilities. As I understand it this was the situation with Building Societies until deregulation.

At present the money supply in britain is approximately 3% notes and coins and 97% debt (but not the money to pay the interest on that debt) supplied by banks and other financial institutions. Our economy needs people, businesses and government to go into debt in order for it to function at all, let alone to the benefit of the people rather than bankers.

"In the Colonies, we issue our own paper money. It is called 'Colonial Scrip.' We issue it in proper proportion to make the goods pass easily from the producers to the consumers. In this manner, creating ourselves our own paper money, we control its purchasing power and we have no interest to pay to no one. You see, a legitimate government can both spend and lend money into circulation, while banks can only lend significant amounts of their promissory bank notes, for they can neither give away nor spend but a tiny fraction of the money the people need. Thus, when your bankers here in England place money in circulation, there is always a debt principal to be returned and usury to be paid. The result is that you have always too little credit in circulation to give the workers full employment. You do not have too many workers, you have too little money in circulation, and that which circulates, all bears the endless burden of unpayable debt and usury."

Benjamin Franklin in his autobiography.

richard allan said...

Thanks Harry, but as I see it there's no difference between FRB and on-lending, because they lead to the same result. If the bank lends out your money to a business, that business is going to stash it in a bank, which will on-lend a part of these deposits, and so on. You get back to the situation where the money supply = (monetary base * reserve ratio), as my economics professors have assured me! There's little difference in terms of money supply between on-lending and creation of deposits. Each individual bank ends up in a position where its reserves are 1/10th of its deposits, or whatever ratio they pick. The only difference is that collectively, the new deposits are concentrated in the original bank rather than being spread throughout the other banks in the system.

Also, I hear this a lot, so I'll point out again that you claim the FRB system creates too much money, causing inflation, then go on to quote Franklin, who claims there's too little money in circulation.

Roger Thornhill said...


Remember that banks always ALWAYS insist that the interest is paid off first before any principal.

Think about that.

Interest is profit. It pays wages, granite lobbies, mercs, advertising, lunches, bonuses. It goes right back into the economy except for extra capital which is the same for any company selling services or value add.

This means that the interest is recirculated and thus does exist in the economy so it can be earned back. The principal is already spent, no?, so that will have been floating around also for about a decade before it is repaid. This meme about interest being "evil" because the amount of moeny "out there" is too small to ever pay it back is disingenuous at best and often hokum put out by the Social Creditors focusing on "the gap". Douglas was flawed. He was wrong. He even thought depreciation created "a gap" and could not understand that wages paid to workers enter the economy to provide the money to buy the goods made by those workers. Even his own examples are flawed and rely on sleight of hand smoother than any card-sharp. He never blinked because even he was nto aware at the beginning, but I suspect he realised later but it was too late to fess up.

WV: poofisp IKYN

Revolution Harry said...

Franklin was talking about a specific time when there may have been too little money in circulation; much like our current situation. FRB can create plenty of money when it wants to and earn lots of interest in the process. It can also restrict the money supply, just as it's doing now. Why do we have a system that requires a sufficient number of people going into debt in order for the economy to have enough money to operate? Why do we give private banks, responsible to their shareholders, a monopoly on money creation and such power over our economy? The present system has failed continuously yet still we persist with it.

Interest may or may not be evil, that wasn't the point I was making. If such a large part of our money supply is debt then those debts must have interest that needs paying. The money to pay the debt isn't created at the same time, which means that at any given moment there isn't enough money in the economy to pay off all the debts and the interest due. The only way to keep the whole charade going is 'economic growth'.

The UK money supply doubled from around £750 billion in 1996 to nearly £1,500 billion in 2006. Where did all the new money come from? Who created it? How much interest was earned thanks to this monopoly on money creation? How did this affect the inflation rate?

I'm on a learning curve and I'm keen to understand. I have no problem with free markets but it seems to me the way our economy operates, particularly our banking system, is flawed and could be greatly improved.

richard allan said...

Banks don't have a monopoly on money creation, bank deposits are not legal tender and only function as money because the public chooses to accept them in exchange. The fact that there isn't enough money in circulation to pay all the debts is irrelevant because they don't all come due at once.

I agree with you that "we" place too much faith in the current system, but not so much that it needs radical change (eg. abolition of usury/on-lending of deposits - not that I'm saying you've called for these). People just need to be more careful about the reserve ratios of banks they deal with, just like shareholders need to be more careful about the directors they appoint.

Revolution Harry said...

I understand that money is 'created' when the Mint produces notes and coins who sell them to banks, with the proceeds then going to the Treasury. This is a very small amount of the money supply though. I understood the rest was 'created' by banks. Private companies responsible to their shareholders who serve their interests rather then what's best for the economy.

Surely the fact that there isn't enough money in circulation is a relevant point because the current system necessitates constant economic growth, with a subsequent increase in the money supply. Otherwise repayment would at some point be impossible for a significant number of people. A far more stable economy is therefore impossible.

Jock Coats said...

Yeah, that's what I used to believe too. And it is not far off, but the recent crunch should prove otherwise - the fact that when those loans all go bad, the banks do need to scramble and fight amongst themselves to get hold of the "high powered" money.

What they actually create is "purchasing power" and yes, some say that if it smells like money, looks like money and so on then it must be money.

However, I still agree that giving private interests the ability to create "fake money" if you like that then has to be guaranteed by the authroities that created the original, is not right.

In fact I go so far now as to say that national money is wrong in a globalized world. Governments will never properly control their money supply and give commerce, and individuals a stable grounding on which to base commercial decisions. Even with a gold standard we were not immune to devaluation and inflation. There is nothing in the world that can make a body with political objectives and spending plans stick to a monetary discipline.

We should not have a "monopoly" of currency, but competing commercial ones. Such an arrangement would mean that the entire reputation and financial performance of a bank issuing such currency would be dependent on it managing that money in such a way that its value was not eroded by inflation. They'd have an economic incentive to create good money that people wanted to use. They could do deals with local banks on convertibility of local and complementary currencies - so whilst the Bank of Togo may not be a global player, HSBC might make a reciprocal arrangement with them based on commercial due diligence that users of Togollars could use Honkers interchangeably. And so on.

Revolution Harry said...

Thanks for that Jock. Of course the problem with government's issuing money is, as you suggested, the temptation for them to abuse that power in some way. That raises another issue entirely which is that we don't appear to have properly accountable government, of the people and for the people. I shall do a bit of research and reflect on the idea of competing commercial currencies. It sounds interesting.

Regarding the current 'credit crunch', whatever *appears* to be happening may well be very different to the reality. I'm afraid I'm more than a little suspicious of the behaviour of the banking system and the government's collusion with it. There appears to be some sort of charade being played out. In particular the eagerness with which so many world leaders have seized on the problems to further their globalisation agenda. I'm sure more will follow as 'solutions' are found.

richard allan said...

"I still agree that giving private interests the ability to create "fake money" if you like that then has to be guaranteed by the authroities that created the original, is not right."


" many world leaders have seized on the problems to further their globalisation agenda."

I'll believe they have a globalisation agenda when they start actually dismantling protectionist barriers, and if they did, it would be a good thing. Talk about a "globalisation agenda" makes me uncomfortable, because it looks like you're just going for a "right on" from leftists and protectionists. Globalisation is good, and it's under threat.

"I'm afraid I'm more than a little suspicious of the behaviour of the banking system and the government's collusion with it."

Banks hold so much of their assets in the form of government debt* that the two are pretty much inseparable by now, and over-regulation makes "good banks" all but impossible. And winning the ideological battle by convincing people that banking is over-regulated also seems all but impossible. On that note, I quote Victor Aguilar:

"Decentralization is not the same thing as deregulation. The term "regulation" is meaningless without reference to the basic framework in which banks operate. A stable system can be governed by the usual laws against criminality that apply to all businesses, while an unstable system requires a vast regulatory bureaucracy and is still plagued with corruption. It is naïve for people who dislike big government to advocate deregulation in the latter case, but it is also wrong to assume that the existence of a central bank is part of the regulations which attempt to prevent corruption. Central banks and regulatory bureaucracies are associated with one another, not because they both oppose an inherent instability in banking, but because the existence of a central bank creates an unstable system that requires constant policing."

*does anyone have the figures on how much an "average bank" holds in terms of cash, private equity/debt, and public debt quickly to hand? I can dig them up if not, obviously. I'm guessing about a 3%/47%/50% split between the three respectively, going by the total volume of each in the economy.

Night Owl said...

We were 24Hours from global economic collapse