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A future with fewer banks

A future with fewer banks

IT IS HARD to conceive of a world without banks, partly because they are so visible. Picture the horizon of any big city, and the skyscrapers in view are usually banks. Commuters emerge from Grand Central station in New York in the shadow of the Park Avenue base of JPMorgan Chase. Morgan Stanley looms over Times Square; Bank of America over Bryant Park. In London the skyline is dominated by odd-shaped towers in the City and Canary Wharf. In Singapore the top floors of the offices of Standard Chartered and UOB house rooftop bars looking out over the entire city. Even in places like Auckland, Mexico City or Jakarta, the logos adorning the tallest buildings are those of ANZ, BBVA or HSBC.

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The physical dominance of banks symbolises their importance. Most people interact with their banks for such mundane transactions as buying groceries. Companies pay their workers, suppliers and landlords through banks. Banks are also there for bigger decisions, such as buying a house or getting a student loan.

For almost as long as there has been money (whether cowrie shells, gold, banknotes or digital deposits),there have been institutions providing safe storage for it. And for as long as deposit-taking institutions have existed, their managers have realised how in normal times not all depositors will demand their money back at once. That means they do not have to keep cash on hand for every deposit—instead they can use the money to make loans. Thus bankers provide funding for private investment and earn interest for themselves. This was a marvel to classical economists. “We have entirely lost the idea that any undertaking likely to pay, and seen to be likely, can perish for want of money,” wrote Walter Bagehot, then editor of The Economist, in his 1873 book “Lombard Street”. “Yet no idea was more familiar to our ancestors.”

The “fractional reserves” that banks hold against their deposits have another effect, however: to make them inherently unstable institutions. The history of capitalism and of money is thus one of relentless economic enrichment, pockmarked by the scars of frequent bank runs and financial crises.

Much has changed about banking since Bagehot’s day. Then the biggest banks were in London; now they are in New York, Beijing and Tokyo. Technological change means nearly all payments are settled digitally, rather than with notes or cheques. The banks are also far bigger. The total assets of the world’s biggest 1,000 banks were worth some $128trn in 2020, dwarfing annual global gross product of $84.5trn.

And yet a world without banks is also visible on the horizon. As never before, their role is under threat from new technology, capital markets and even the public sector. Central bankers have seen tech giants develop quicker and easier payments systems that could pull transactions out of the banking system. They worry that digital payments may bring about the end of cash. Financial regulation and monetary policy have traditionally operated through banks. If this mechanism is lost, they may have to create digital central-bank money instead.

Because technology has disrupted so many industries, its impact on banking may seem like one more example of a stodgy, uncompetitive business made obsolete by slick tech firms. But money and banking aren’t like taxis or newspapers. They make up the interface between the state and the economy. “The deep architecture of the money-credit system, better known as banking, hasn’t changed since the 18th century, when Francis Baring began writing about the lender-of-last-resort,” says Sir Paul Tucker, formerly deputy governor of the Bank of England and now at Harvard. “Which means it has not, so far, depended on technology at all, because Francis Baring was writing about it with a quill pen.”

Now a new architecture is emerging that promises a reckoning. “Economic action cannot, at least in capitalist society, be explained without taking account of money, and practically all economic propositions are relative to the modus operandi of a given monetary system,” wrote Joseph Schumpeter in 1939. Yet it is possible to see a future in which banks play a smaller role, or even none at all, with digital money and deposits provided by central banks, financial transactions carried out by tech firms and capital markets providing credit.

Bad change or good?

The question is whether such a world is desirable. Banks have many flaws. Scores of the unbanked are too poor to afford them. They can be slow and expensive. They often make more money from trading and fees, not normal banking. Negligent banks can create boom-and-bust cycles that inflict economic hardship. So it is easy to assume that the sidelining of banks might be just another shackle broken by technological advance.

Yet a world without banks poses some problems. Today central banks provide very little to economies. Around 90% of the broad money supply is in bank deposits, underpinned by small reserves held with the central bank and an implicit central-bank guarantee. This makes it easier for central banks to instil confidence in the system while still keeping at arm’s length from credit. Widely used central-bank money would bring them nearer the action, causing their balance-sheets to balloon. This creates risks.

Banking and capitalism are closely linked. Economists still debate why Britain industrialised first, but it is hard to read Bagehot and not conclude that the alchemy of banks turning idle deposits into engines for investment played a part. The question is what happens if central banks play a bigger role instead. It might be possible for them to avoid actually distributing loans, but it is hard to see how they could avoid some interference in credit markets.

There are broader social risks as well. Banking is fragmented, with three or four big banks in most countries, plus lots of smaller ones. But state-issued digital currencies and private payments platforms benefit from network effects, potentially concentrating power in one or two institutions. This could give governments, or a few private bosses, a wealth of information about citizens.It would also make the institutions a lot more vulnerable. A cyber-attack on the American financial system that closed JPMorgan Chase for a time would be distressing. A similar attack that shut down a Federal Reserve digital currency could be devastating. And there is the potential use of money for social control. Cash is not traceable, but digital money leaves a trail. Exclusively digital money can be programmed, restricting its use. This has benign implications: food stamps could be better targeted or stimulus spending made more effective. But it also has worrying ones: digital money could be programmed to stop it being used to pay for abortions or to buy books from abroad.

The scope of the issues this special report will consider is vast. It includes the role of the state in credit provision, the concentration of power in tech firms or governments, the potential for social control and the risk of new forms of warfare. A world without banks may sound to many like a dream. But it could turn out to be more like a nightmare.

This article appeared in the Special report section of the print edition under the headline “Fewer—or even none?”

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