Jeremy Warner writes,
A simple transactional, online bank, where all deposits are placed as reserves with the central bank, making them completely safe, free of costly capital requirements, and immune to loss and panic, cries out to be invented.
Let’s assume that the main cost of the bank is upfront software development. It recovers that cost (and other expenses) with a monthly service charge to each customer.
Each customer will have a companion institution, call it a mutual fund, that pays a return on deposits. When you want to earn more interest, you shift money from the transactional bank to the mutual fund. When you want to have more money available for transactions, you shift it from the mutual fund to the transactional bank. As the cost of moving funds between institutions approaches zero, your average balance at the transactional bank will approach zero.
If they took away deposit insurance, would the system evolve toward this? If they keep deposit insurance, are you ensuring that the system cannot evolve toward this?
In any case, the safety of the transactional bank does not mean that risk goes away, or maturity mismatching goes away. It goes to other institutions, and I’m not convinced that those institutions won’t have a cozy relationship with the government.
Simple (https://www.simple.com/) is pretty close. Granted they sweep their deposits into a larger bank (Wells, I think) to get deposit insurance, but still. I think Simple has something like a dozen employees.
I don’t see a reason they’d need to charge to make up for software development costs. Deposits at the Fed provide 25 basis points. They could pay 10 on deposits and still net a nice spread given that there’d be minimal marginal costs.
Anyway, is a system in which the Fed effectively holds all the nations’ deposits really that much better than one with deposit insurance? Either way, all the liabilities are belong to us.
Even if you took away deposit insurance, it’s not clear to me that people would choose the transactional, safe bank. The transactional bank will have to charge fees to cover operating costs and generate profits, will it not? If I can move money around quickly and cheaply, thus allowing me to minimize the amount of cash I need on hand for my operating expenses, that means I’m paying pretty hefty fees relative to my account balance to bank with Transaction Bank. If the choice is between banking for free but losing my deposit entirely if PNC goes bust or getting nickel and dimed by Transaction Bank forever, I think the risk of PNC going bust-o could climb pretty high before I chose the latter.
But deposit insurance is funded with taxes, nickels and dimes, much the same way. It sure seems popular.
Banks pay for deposit insurance out of their net interest margin (ie, the difference between what they earn in interest on the assets they hold less what they pay in interest on deposits and other borrowings), so for customers, in a sense it’s not really a fee they pay, but more like an opportunity cost in that interest rates for deposits would be higher, absent FDIC insurance. The purely transactional bank, since it earns nothing or almost nothing on the assets it holds, will have to pass virtually all of its operating costs along to its deposit customers in the form of fees.
A purely transactional bank, if transaction costs are very small and markets for a wide variety of property made very liquid (as they would be if combined with a generic virtual transaction platform like Ripple), could be augmented with algorithms that do optimal diversified wealth management, and only go into cash for the purpose of transactions – instantaneously selling some assets for the buyer, transferring the cash, and then buying the optimal portfolio of assets for the seller.
This is pretty much what already happens when you make a purchase overseas in dollars-for-you and foreign-currency-for-them.
But in this way, people could ‘name your price’ and pick whatever form of money (as either a medium of exchange or account) they felt more appropriate and secure given their particular needs, and they could even use shares of a hedge or mutual fund, or fractions of a debt portfolio.
The demand to hold actual currency balances could evaporate so long as a global Ripple network with maximum ability to keep cheaply and quickly reassignable assets ‘on deposit’ would greatly expand the liquidity of other stores of value.