Band 8, Heft 2 - The Money Problem. Perspectives on Money, Banking and Financial Regulation

Contemporaneous banking theories appear to understand financial institutions as intermediaries, relegating bank money creation through money multiplication outside the core of banking activity. This article takes a different systemic perspective, pointing to the dynamic and collective features that generate a banking system within and across financial institutions. Classic features such as bank credit creation, as well as classic issues such as bank runs, are reconsidered under the notion of a ‘banking system’ requiring coordination over time and circumstances. Our conceptual framework develops a heuristic model of the basic mechanisms on which bank money creation lays upon. This model disentangles the link between functional and institutional dimensions of the money system, aiming to include minimal institutions in economic theory and economic analysis of money. These basic mechanisms include: monetary financial institutions (bank entities) issue claims which function as money; they facilitate payments across agents in the economy over time and space; they increase the money base through credit creation; they hold fractional reserves and lend to each other. Ongoing bank activity involves cash and non-cash (accrual) processes occurring within each bank entity and across them. Each bank keeps currency money in bank deposits on behalf of other agents. But the bank activity is further characterised by the capacity or privilege to use these deposits, although the latter remain available for payment and redemption at will and at par. Moreover, the bank can create deposit by granting a loan to, or buy a security from a borrower. This bank capacity or privilege involves money generation that enables the bank credit manufacturing process. In this way, all the banks become interdependent on the flow of payments that are performed across them, generating the ‘banking system’. Since each bank is structurally unbalanced due to money generation, inter-bank coordination is required to maintain the banking system in operation over time and circumstances. Both inter-bank clearing and credit arrangements provide this coordination at the inter-bank level, which is effectuated through central bank intervention, clearing houses and the money market. From this systemic perspective, ‘systemic risk’ and ‘macro-prudential’ management and regulation are new labels for recurrent concerns of systemic coordination. A careful combination of design and policy is therefore required to reach coordination in view to prevent or respond to local and systemic crises. Drawing upon this conceptual framework, this article develops institutional economic analysis and implications for shadow banking; systemic risk, interdependency and interconnectedness; the relationship between money and credit and the real economy; and the systemic consistency between functions and institutions in monetary regimes.

The financial crisis of 2007–2009 left scholars and policy analysts scrambling to explain what went wrong. While a variety of stories have been told, none have seemed like they could account for the magnitude of the collapse in securities values, or the devastation the collapse caused to the performance of whole economies around the globe, nor could they offer a clear path to reform. Legislation passed to reform the financial system in the U.S. is extraordinarily complex, and still very controversial. Now, however, Morgan Ricks’ new book, The Money Problem: Rethinking Financial Regulation , cuts through the complexity to offer a relatively simple but compelling explanation – the crisis was a consequence of an old-fashioned run on the “bank”, which, in this case, was the shadow banking system rather than regular banks. The solution is the same as the solution that prevented major financial crises in the U.S. from the 1930s to 2007 – government insurance of “money claims” and stricter regulation of firms that are allowed to issue money-like claims.

Should money issuance be a licensed privilege, and if so, who should issue money? Morgan Ricks argues that free-wheeling money issuance by non-licensed shadow banks was a major factor behind the global financial crisis. Still, the regulatory reform agenda after the crisis has mostly been directed at banks (with a few exceptions). This has led to an enormously complex body of regulations that threatens to bring traditional banking to its knees. Ricks would instead restore money issuance as a privilege and leave other financial institutions with a lighter regulatory regime. He is not, however, in favor of narrow banking – as favored by Irving Fisher – but would leave credit allocation with the private banking sector. In this way his proposals are both radical and conservative. He brings a refreshing look to the regulatory debate, and the book is full of novel insights. His discussion of banks and deposit regulations should be required reading for all bank regulators, although his proposal may fall on barren ground in the current political environment. Nevertheless, the book should serve both as a primer for future monetary reform proposals, but also as a starting point for a pragmatic bipartisan debate about financial reform today.

A brief reflection on this issue’s contributions on The Money Problem.