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.
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.