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BrackenJuly 4 2018

Swiss ‘no’ does not end international debate on monetary reform

It is up to academics and policy-makers to educate the public on the benefits of greater state control of money supply, says Martin Brown, professor of banking at the University of St Gallen.
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On June 10, voters in Switzerland rejected a popular initiative to fundamentally reform their monetary system. The Sovereign Money Initiative was intended to introduce a type of full-reserve banking: demand deposits would have been taken off the balance sheet of commercial banks. Henceforth, all money-like assets – cash and electronic deposits alike – would have been direct claims on the Swiss National Bank. Commercial banks would have still been able to manage sovereign money accounts for their customers, in the same way they manage cash in safety deposit boxes or securities in custody accounts. But they would no longer have been able to use these funds to refinance their lending activities.

Sovereign money is seen by its proponents as a simple, comprehensive solution to financial fragility. Consumers are better off, because their deposits are safer. Taxpayers are better off, because the government is less tempted to bail out failing banks. Bank lending and asset markets are more stable, because banks can no longer ‘create money’ at the stroke of a pen. On top of all this, the monetary system would be fairer as the central bank would reap more, and commercial banks less, seigniorage.

Sovereignty and stability

Few economists would disagree that financial stability is a number one policy concern. A decade after the global financial crisis, policy-makers and academics are still struggling to enhance the stability of the banking sector and mute its procyclical impact on financial and real asset markets. But our current understanding of the causes of bank failures, systemic risk and credit cycles suggest that sovereign money has little to offer in stabilising the financial system.

It seems obvious that sovereign money would make deposits safer for individual consumers. A claim on the central bank is arguably safer than a claim on most commercial banks. However, as long as sovereign money accounts are managed by commercial banks, consumers and firms are still likely to worry about (timely) access to their accounts. The recent financial crises demonstrated that even customers with fully insured deposits at banks considered too big to fail (such as UBS in Switzerland) withdrew funds when their bank got into trouble. To what extent sovereign money would strengthen the perceived safety of deposits is therefore debatable.

Sovereign money would thus hardly save taxpayers from costly bail-outs of too-big-to-fail banks. Banks are classified as too big to fail due to their market position in domestic credit markets and/or their centrality to payment and settlement services. Whether the related transaction accounts are on or off the balance sheet of a bank barely affects its systemic importance and therefore its propensity to be bailed out.

Finally, sovereign money is unlikely to mitigate the procyclicality of bank lending and its exacerbating effect on asset markets. Indeed, taking customer deposits off banks’ balance sheets may actually increase the procyclicality of bank funding. If we have learned anything from the recent financial crisis, then it is that (short-term) wholesale funding of bank loans is a recipe for fragility, not stability. Think of Northern Rock, the UK mortgage lender that collapsed because of a reliance on wholesale funding rather than customer deposits.

If financial fragility is our main policy concern, then sovereign money is not the answer. The current multi-instrument approach of regulators and monetary authorities seems more promising: deposit insurance strengthens consumer trust in the banking sector. Prudential capital and liquidity regulation mitigates the risk of costly bank failures. A bail-in resolution regime reduces the costs for taxpayers if banks do fail. And macroprudential policy should smooth lending cycles and pre-empt asset market bubbles. Multifaceted problems require multifaceted solutions.

Public backing

What, then, should we take away from the Swiss initiative on sovereign money? Although rejected by a majority, the initiative shows that there is significant public support for more state and less market control of money supply and financial intermediation. Academics and policy-makers therefore need to clarify the economic benefits and perils of stronger state intervention in the financial sector.

Take, for example, the proposal currently under debate in Sweden of an e-currency issued directly by the monetary authority. Could an e-currency replace bank deposits not just as a means of payment, but also as a storage of wealth? If so, what would this imply for the role of the central bank – as opposed to commercial banks – in allocating financial resources to the real economy? And what would an e-currency imply for the design of the financial safety net? Would the Swedes (not the Swiss) still need deposit insurance?

For all the intellectual effort put into fine-tuning our current framework, we definitely need to think harder about the fundamental pillars of our current market-based monetary system.

Martin Brown is professor of banking at the University of St Gallen in Switzerland.

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