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Economics

Are Carswell and Baker Really So Wrong?

As reported by Gordon Kerr, the Independent Commission on Banking issued its Interim Report last Monday. The Commission’s mission is to propose structural and other reforms of the UK banking sector. The objective being that big bank failures (rescued with taxpayers’ money) and the near collapse of the UK financial system we saw in late 2008 (eventually prevented with taxpayers backing) will not happen again. However, the Commission’s Interim Report in fact seems oriented towards ensuring that everything in the banking sector will basically remain the same.

On reforms in the way banks do business, the Commission has opted for ring-fencing economically essential retail banking activities from risky, privately profitable but socially useless banking activities. In this way, the Commission hopes that future taxpayers’ rescues will not be so expensive. We would like to congratulate the Commission. Realising that structural changes are needed to make a safe and sound banking sector is a baby step in the right direction. However, the Commission has bluntly rejected structural reforms that would imply a serious commitment to really ensure that taxpayers’ money will not be used again to rescue banks – namely, narrow banking and, even better, full reserve banking. On the latter, the Commission dismissed Carswell and Baker’s Bill for full reserve banking in the following terms:

“4.121. Some have argued that full reserve banking should be mandated as an option for all deposits, so that depositors could choose whether or not their money was lent on. It is important to find safe deposit options and having these options might help to reduce the need for a government guarantee applicable to all deposits. However, safer deposit options than bank deposits do already exist (such as National Savings & Investments or safety deposit boxes), although these do not offer the same transactional capabilities as a current account. There is no prohibition on the establishment of a full reserve bank (or a narrow bank) which could provide such capabilities, though it would likely have to charge for them. In light of deposit insurance, mandating that all depositors have such an option appears unnecessary

(page 98, emphasis added).

Is Carswell and Baker’s Bill really so ill-conceived as the Commission argues? Unfortunately it is, provided UK taxpayers remain content to back bankers’ profitable business of borrowing short and lending long, creating money out of thin air to grant to whomever they choose, and inducing huge malinvestments and creating cycles of boom and burst in the process. That is, as the Commission rightly points out, as long as there is deposit insurance backed by the UK government, a Bank of England ready to flood banks with liquidity at favourable rates, and a UK Government ready to recapitalise failed institutions, then we agree with the Commission that Carswell and Baker’s Bill is the crankiest idea you have ever heard.

However, if one day UK taxpayers decide to remove State backing from the banking sector — a thought that the Commission has no intention of considering — then, Carswell and Baker’s ideas for full reserve banking would be the only way most people would accept holding bank accounts. Carswell and Baker’s Bill is, therefore, a legislative initiative that will help smooth transition from the current full State support of the banking sector to a truly free market. Their Bill will also avoid many depositors’ big losses on the way. We hope the Commission may wish to reconsider Carswell and Baker’s proposals.