The Case for a Single National Depository

Banks play two distinct roles: They serve as depositories in the payment system, and they compete with other financial service companies to seek profits through financial investments. Their investments include loans, which create new deposits without a corresponding increase in bank reserves. Private banks thus hold the privilege of creating most of the public's money supply. The net amount issued depends on the demand for credit as well as on the willingness of banks to lend.

Proposal for a National Depository

Suppose the government established a national depository to take over the depository role of private banks. As sole depository, it could be called The National Bank. It would accept deposits, execute payment orders, and provide cash in exchange for funds on deposit. However it would neither lend nor borrow money, and therefore would not offer time deposits. All deposits would be transaction deposits and earn no interest since they are the equivalent of cash.

Payment orders would be executed simply by transferring funds between the accounts of depositors. Orders would only be accepted by electronic means, e.g. plastic cards, the Internet, or the Fed wire. Paper checks would be phased out. Deposit insurance would be eliminated since all deposits are base money created by the Fed, on which there is no credit risk.

With a single national depository, all accounts would be kept on the same computer system. Verifying balances and making payments could be done in real time, thereby eliminating checking system float and its associated costs. Without a depository role, private banks would evolve into non-bank financial intermediaries, which we will call financial service companies (FSCs).

One should not confuse the twelve Federal Reserve Banks with the proposed National Bank. However the Reserve Banks would provide facilities and operate the National Bank. Relatively few local branches would not be needed because many retail stores now offer "cash back" to customers who make purchases with their debit cards.

Monetary Policy Implementation

The National Bank would be the dollar-denominated depository for the U.S. Treasury as well as the entire private sector. Since the only deposits of direct concern to the economy are those held by the private sector, we define the money supply to exclude the deposits held by all government entities, including the Treasury and foreign central banks.

The concept of reserves loses its meaning in the absence of private banks. Rather than managing the supply of bank reserves to control the Fed funds rate, the Fed would manage the supply of loanable funds to control the money market rate. The money market rate could be defined as the average interest rate that major FSCs lend to each other on a short-term basis, say 30 days. Alternatively it could be the London Inter-Bank Offer Rate (LIBOR) on 30-day eurodollar placements.

When the interest rate in the money market rose above the target rate, the Fed would purchase securities in the open market to increase deposits in the National Bank. Conversely when the interest rate fell below the target rate, the Fed would sell securities from its own portfolio. In this way the Fed would continually adjust the supply of loanable funds to meet the demand at its target rate.

The Treasury would deposit all receipts from taxes and the sale of bonds in its account at the National Bank. Treasury payments move deposits into the accounts of the private sector and thus increase the money supply. Since that would impact the Fed’s ability to implement monetary policy, the Treasury would balance its inflows against outflows, on average. It would do so just as it does now through the net sale of bonds to cover the difference between its spending and tax revenues.

The Importance of Financial Service Companies

FSCs pool the savings of investors and make them available to borrowers. They buy and sell financial instruments as diverse as bonds, mortgages, mutual fund shares, and insurance policies. FSCs today issue most of the credit on which the economy runs. In the proposed system, they would issue essentially all of it.

Those seeking a return on their liquid assets have a variety of investment options. For example they could purchase money market mutual funds, Treasury bills, or make short term loans to FSCs. None of these are deposits and none are insured, although T-bills are free of credit risk.

The two-tier system of base money and bank-issued credit money would no longer exist. The only type of money would be base money, all of which is created by the Fed. That means the Fed would have direct control of the aggregate money supply. As in the fractional reserve system, an FSC could lend but only by transferring funds from its own account to the borrower's account.

An FSC in good standing could borrow from the Fed, just as private banks do now. The interest rate on Fed loans would be set 100 basis points above the money market target rate. With that large a spread, the lending facility would be used for short term cash flow problems, and not as a source of funds to invest. The borrower would have to pledge Treasury securities as collateral. The loan could be rolled over indefinitely as long as the borrower had sufficient funds on deposit to pay the interest and to cover any change in the market value of the collateral.

Minimizing Systemic Risk

FSCs differ widely in the degree to which they mismatch the maturity of their assets and liabilities. Mismatching creates a potential cash flow problem. The main concern is a systemic failure in which a major default by one FSC could bring down many others due to the cascading of liabilities among them.

A single depository system would not automatically end excessive risk-taking by FSCs. Therefore capital adequacy requirements should be imposed on all FSCs. For those designated as "too large to fail" because of the chaos such failure would create, the required ratio of capital to risk-adjusted assets should be an increasing function of the mismatch in their maturities.

Government insurance should not be provided on the financial instruments offered by the FSCs. Bond rating agencies could expand their domain to rate the credit worthiness of FSCs as institutions. That would be of great value to investors, but more importantly FSCs would tend to avoid practices that reflect badly on their portfolios in the competitive business of lending for profit.

Comments

[bosun.j:]

BAD IDEA! Big brother issues far outweigh and *possible* benefits. IMHO.

Jan 07 08:25 AM

[William Hum...:]

If there are any big brother issues, they are no different from the existing system.


On Jan 07 08:25 AM bosun.j wrote:

> BAD IDEA! Big brother issues far outweigh and *possible* benefits.
> IMHO.

Jan 09 05:39 PM