The end of banking? Not like this please

I recently read Jonathan McMillan’s The End of Banking, which I first heard of through FT Alphaville here (McMillan is actually a pseudonym to cover it two authors: an academic and a banker). I have mixed feelings about this book. I really wanted to agree with it. And I do, to some extent. But I simply cannot agree with a number of other points they make.

The End of Banking

Their proposal to reform banking is as follows (see the book for details): lending can be disintermediated through P2P lending platforms (and equivalent), which both monitor potential borrowers through credit scoring and allocate savers’ funds to minimise the probability of losses. Marketplaces set up by platforms would enable savers to sell their investments to generate cash if needed. What about the payment system? Their solution is for non-bank FIs to continuously provide market liquidity a number of financial instruments using algorithmic trading. Current accounts would in fact be invested like mutual funds, which would instantly convert those investments into cash when required for payment. They also propose accounting rule changes to prevent corporations from creating money-like instruments.

As such, they propose to end banks’ inside money and have a financial system exclusively based on digital outside money controlled by a monetary authority. While they don’t classify it this way, it does seem to me to be some sort of 100%-reserve banking proposal: the money supply is fixed in the very-short term and exogenously-defined by the monetary authority.

What I agree with:

  • The main thesis of the book is completely valid and is something I have also argued for a little while: technological disruptions are now allowing us to go beyond banking and disintermediate it. P2P lending, non-banking payment systems, decentralised payment frameworks and currencies, algorithm-driven credit scoring… In many areas, banks have almost become redundant. I totally adhere to the authors’ thesis (although credit scoring does have real limitations).
  • Technological developments have facilitated regulatory arbitrage, if not enabled it. Computing power now allow banks to optimise their capital requirements through the use of complex models which, it is important to point out, are validated by regulators.

What I disagree with:

  • The authors seem to believe that banking regulation is usually a good thing and cannot seem to understand the various distortions, bubbles and inefficiencies those regulations create. According to them, if only technology hadn’t boomed over the past three decades, the banking system would be more stable. I strongly disagree.
  • I dislike the top-down banking reform approach taken by their thesis. Free markets, driven by technology, should decide under what form the next iteration of banking should arise.
  • I also see weaknesses in their proposal. First, I cannot agree with their view that money belongs to the public sphere, and that IOUs must benefit from a state guarantee to qualify as money. This has been disproved by history over and over again. Second, I see their proposal to have algorithmic trading manage the payment system as not only unworkable, but also dangerous. As already witnessed, algorithmic trading is imperfect and can amplify crashes rather than prevent them. How their payment system would react during a crisis, when everyone tries to exit most investments and pile into a few others, is anyone’s guess. Mine is that the payment system would suddenly be down, paralysing the entire economy. To be fair, their treatment of cash is unclear: could we maintain a custody account comprising only digital cash in their framework?
  • Their 100%-reserve banking reform does not address fluctuations in the demand for money. Centralised monetary authorities do neither have access to the right information, nor within the right timeframe, to accurately provide extra media of exchange when needed by the public. Private entities, in direct contact with the public, can.
  • Finally, though this is a minor point, I disagree with their monetary policy stance. It is inaccurate to present price stability as ideal to avoid economic distortions: productivity increases should lead to mild deflation in a growing economy (see Selgin’s Less than Zero or any market monetarist or Austrian blog and research paper). I also reject their physical cash ban, from a libertarian standpoint: people should be able to withdraw cash if ever they wish to*. This would seriously limit their negative interest rates policy proposal.

Overall, it is a thought-provoking and interesting book, which also quite accurately describes our current banking system in its first part (mostly aimed at people who don’t know that much about banking). Its two authors are also right to point out the defects of regulation in an IT-intensive era. But, in my opinion, they draw the wrong conclusions and the wrong reform proposals from their original assessment.


* Here again, their treatment of cash is unclear: can cash be withdrawn in a digital form and maintain in a digital wallet outside the financial system? I doesn’t look so from their book but I cannot say for sure.


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7 responses to “The end of banking? Not like this please”

  1. Roger McKinney says :

    Isn’t “shadow” banking P2P? Investment banks like GS lent directly to large customers. Yet, the latest crisis emanated from that form of banking. Also, money market funds loan directly to large firms in another form of P2P, yet they suffered as well in the latest crisis.

    • Julien Noizet says :

      When you mean ‘that form of banking’, do you mean shadow banking or lending to large companies?

      Yes the authors mention money market funds. They consider money market shares as money and their accounting/bankruptcy proposals try to prevent any private entity from issuing money-like instruments. I haven’t deeply analysed this proposal but don’t really believe it can work.

  2. Jonathan McMillan says :

    Dear Julien,

    Many thanks for reading our book and taking the time to write down your thoughts. We are excited to bounce arguments with others who are exploring the digital frontiers of finance. We do have some comments on the points you disagree with.

    We do not consider banking regulation per se good or bad. Deposit insurance and central banks acting as a LOLR make banking regulation inevitable to counter excessive risk taking. So, if you consider banking regulation per se as something undesirable, you also consequently have to speak in favor of abolishing central banks as a lender of last resort and deposit insurance. What is your position here?

    To the second point: If you note that free markets should drive changes, are you propagating that the regulatory framework (i.e. deposit insurance, LOLR & banking regulation) should stay the same? Or do you propose to remove elements from this framework? The form of the financial system is not only the result of market forces, it has always and everywhere been a matter of politics. Both technological developments and “top down” political decisions shape our financial system. What is your “top down” view on regulating the financial system?

    We have presented our arguments in favor of public money in chapter 10. Money has public good and network good characteristics. We have not argued that it is impossible for private entities to issue money without sovereign backing.

    Outside money continues to exist in our proposal. Individuals can maintain a custody account with cash. We have described that individuals will continue to hold (digital) cash (see p. 127). You are right that technological issues can lead to frictions in markets, and that this risk needs to be taken seriously. But a payment system built on outside money and market liquidity is much more resilient than one built on inside money and contractual liquidity.

    The argument you raise that a financial system without inside money cannot address fluctuations in money demand has been repeatedly raised in connection with narrow banking proposals. We think it is fundamentally flawed. Millions of excess housing units in the U.S., Spain, Ireland and other countries are evidence that the elastic inside money supply by unconstrained banking institutions create heavy distortions. When credit can be created out of money and losses arising from this activity can be passed on to taxpayers, interest rates are no longer sending valid signals.

    In our envisioned system, the interest rate regains that ability to effectively balance the demand and supply for money and credit so that the financial system incorporates information from the real economy. The monetary authority only needs to know the overall price level to maintain long term price stability.

    I am looking forward continuing this debate


    Jontahan McMillan

    • Julien Noizet says :

      Thanks Jon for passing by.

      As you can see in most of my writings on this blog, I am in favour of free banking, meaning a banking system that indeed is not ‘backed’ by either a central bank or deposit insurance, with competitive currency issuance and no special banking regulation (closest examples in history are Scotland, Canada, Sweden… from the late 18th to the early 20th century). A less ideal compromise could be found in some specific rule-based central banking frameworks such as NGDP targeting or a productivity norm.
      An interesting example is modern Panama, which has no central bank, no deposit insurance, and yet one of the most stable and liquid banking systems nowadays.

      In free banking systems in history, the only ‘top down’ approach taken by politicians was to ensure a stable institutional framework that allowed contract enforcement. There was little actual design, if none at all in the likes of Scotland. Those banking systems have regularly proved to be much more stable than regulated ones.
      See the track record here:

      I believe innovators and market actor preferences should design our future banking system, and that the state should not intervene to favour or protect or regulate any new or old institution. This does not imply that no firm could ever collapse. But I see collapses as part of the learning process that eventually lead to an ‘antifragile’ system (one that can experience the collapse of any one institution without leading to a systemic collapse, which is clearly not what we have at the moment).

      I am unsure why you advocate a discredited monetary policy such as price level targeting though. Alternatives exist that are more likely to maintain economic stability.
      See this paper by Beckworth that highlights all the flaws with inflation targeting:
      A productivity norm is possibly the best policy in my opinion (see Selgin’s work), in the absence of free banking.<

      Regarding your point on the excess housing units, I believe this has less to do with the elastic property of inside money and more to do with the combination of (1) excess outside money creation by central banks in an inflation targeting framework and (2) banking regulation that naturally incentivises banks to channel this excess liquidity into real estate. This has been the main topic of this blog since its inception.

      Even if I cannot agree on a number of things, I appreciate your contribution to the debate, light years away from the very poor analyses (and this is a euphemism) we often see out there.
      Thank you again.


      • Jonathan McMillan says :

        Hi Julien

        I think it makes sense to structure our discussions along the lines of money and credit. This may help to find some common ground, and specify where our views deviate from each other.

        With regards to the “how to organize credit”, we are aligned. Our book argues in favor of a decentralized credit market where private actors get full autonomy to price interest rate and credit risk. We also want to abstain from any credit or liquidity guarantees on any forms of credit in any way. We even go one step further and propose a credible separation of monetary and fiscal policy. Even the threat of government default should not trigger any monetary intervention. People who take credit and liquidity risk should carry credit and liquidity risk, and only pass them on in voluntary agreements (i.e. by buying and selling loans).

        But we deviate in “how to get there”. We argue that such principles cannot be implemented as long as inside money exists within the financial system. The systemic risks inherent to inside money always forces the government and the central bank to intervene, even if they ex ante commit to not intervene. We describe this time inconsistency problem in Chapter 9. This is where our systemic solvency rule comes into play as an instrument to prevent money creation out of credit and to end banking. Unfortunately, you missed this central building block of our idea in the review of our book.

        And this is where we criticize the Austrian school. Some Austrians think that the time inconsistency problem can be solved by committing “extra hard” to not intervene in a banking panic. History has proved this view repeatedly wrong (also in your Scotland example, see below). For instance, the money market mutual funds were explicitly carved out from deposit insurance, yet received full protection by the public sector once investors started to panic on these funds. The time inconsistency problem cannot be solved with commitment, because of the devastating consequences of bank runs and bank panics.

        Other Austrians like de Soto implicitly acknowledge the problems with inside money, and the time inconsistency problem when dealing with it. De Soto argues that the deposit contract is a violation of property rights. I do not want to discuss this view, because it has become outdated with the digital revolution. Shadow banking demonstrates that a deposit contract is not required to create inside money. Our solvency rule acknowledges this new environment (and is therefore not a 100% reserve requirement proposal. We even explicitly discard such rules in Chapter 9).

        Without addressing the time inconsistency problem, the Austrian school cannot offer a convincing answers to restore the stability of our financial system. While you personally do acknowledge this problem by saying that a failure today could lead to a systemic collapse, you do not take any position on it.

        On Scotland: Scotland was no “free banking”.. Scottish banks repeatedly ignited boom and bust cycles, just as their counterparts in England. In addition, Scottish banks suspended conversion to specie from 1797 to 1821 (see, which is clearly a violation of property rights and a government intervention to stop a banking panic. I do not have time to go through all your examples, but after viewing Scotland I am as skeptical as before that any “free banking” successfully dealt with the time inconsistency problem over a longer time period.

        On the money side, we have presented our arguments in favor of public money in chapter 10. You have not addressed these arguments in your reply. It is simply wrong that we advocate a discredited monetary policy. The monetary instruments we propose – unconditional income and liquidity fee – have never been implemented before. In fact, they have some similarities with the NGDP targeting you consider as better alternative and is designed so that it can be embedded in a rule based framework, without making it vulnerable to the pressure of political interests.

        I do appreciate this debate with you. We are aligned on many central points. I hope that it is now very clear where we deviate, and I am interested in your position on the time inconsistency problem and the monetary policy framework that we propose.


      • Julien Noizet says :

        Hi Jon,

        I think your points on ‘how to organise credit’ and monetary policies are linked.
        The organisation of credit cannot be ‘free’ if monetary policy intervenes to maintain prices stable when they should decrease due to productivity improvements. In this case, maintaining stable prices necessarily involves injecting extra money in the economy to generate hidden inflation and inherently distorts the interest rate and hence credit allocation/growth that would occur in a free market.

        It looks like you consider inside money as ‘inherently unstable’ due to your view of free banking and our contemporary experience. However your view seems at odds with all the historical accounts I have read of banking in Scotland at that time and other (relatively) free banking systems in history (see for a summary). Yes convertibility was sometimes suspended but this was a contractual agreement, and only a couple of banks failed without ever endangering the whole system. Some libertarians such as Rothbard have attacked Scotland’s track record, but were faced with rebuttals from White, Dowd, Selgin and others.
        There is also some evidence that free banking helped Scotland catch up with England in terms of economic growth (

        I believe that what you view as the bad effects of inside money creation merely reflects the problems that originate in the bad incentives that banking regulation creates, which is amplified by misguided monetary policy. You proposal would still lead to booms and busts if monetary policy remain misguided as it has been.
        I am a little confused though by your reply, which seems to imply that unconditional income and liquidity fee would offset the distortive effects of price level targeting. I see those policies as having completely different effects.

        I think where we fundamentally differ is in our view of entrepreneurship and market process. You seem to believe that a good financial system should be stable, with little or no failure and little or no innovation. I believe that, to the contrary, a good financial system should consistently be under threat of collapse. Innovations will inevitably lead to failures (as for money market funds) and this is part of the learning process inherent to free markets. This isn’t a bad thing in itself. It is necessary.
        However, I do believe that banking regulation has led to numerous innovations (ie regulatory arbitrage) that have made this learning process considerably more difficult and the whole system more opaque. But the blame here lies in regulation itself, not in innovation, failures and learning process per se.

        Thanks your replies. It is an interesting debate.

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