Narrow banking
Encyclopedia
Narrow banking is a proposed type of bank called a narrow bank also called a safe bank. Ultimately, if adopted widely, this could lead to an entirely new banking system. Narrow banks can, by risk reduction measures designed into the narrow bank, significantly reduce potential bank run
s and the need for a deposit insurance provided by the central bank
. It is sometimes suggested as an improvement upon fractional reserve banking.
Narrow banking would restrict banks to holding liquid and safe government bonds. Loans would instead be made by other financial intermediaries. That is, the deposit taking and payment activities have been separated from financial intermediation activities. Two different types of banks (financial companies) are needed, one for each activity.
1. no lending of deposits (reducing a key risk materially but constraining return on investment for depositors and shareholders alike)
2. extremely high liquidity (typically short-term assets e.g. bonds)
3. extremely high asset security (typically government bonds)
4. lower interest rates paid to depositors (as a function of the no lending and other constraints)
5. possibly specific regulatory framework with higher level of scrutiny and operational/investing restrictions
Additional criteria applied to safe banks include -
1. no derivatives
2. no off balance sheet assets
3. high degree of institutional transparency (e.g. continuous real-time disclosure of financial records)
4. capped executive salaries
5. low risk jurisdictions
1. Satyajit Das from the University of Illinois who published an early paper on the topic of narrow banking.
2. Mike Denoma who advocated the case for it early in his career (circa 2000)
3. Kevin James from the Bank of England who presented very early on in this debate
More recent references include the consideration of safe banks or narrows banks in the next round of Bretton Woods
and the Feb 2009 World Economic Forum agenda titled The Future Of The Global Financial System.
Lenders have to become investors (cases PS, PL). The table below shows four different cases of narrow banking.
Bank run
A bank run occurs when a large number of bank customers withdraw their deposits because they believe the bank is, or might become, insolvent...
s and the need for a deposit insurance provided by the central bank
Central bank
A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...
. It is sometimes suggested as an improvement upon fractional reserve banking.
Narrow banking would restrict banks to holding liquid and safe government bonds. Loans would instead be made by other financial intermediaries. That is, the deposit taking and payment activities have been separated from financial intermediation activities. Two different types of banks (financial companies) are needed, one for each activity.
Attributes
Key attributes of narrow banks include -1. no lending of deposits (reducing a key risk materially but constraining return on investment for depositors and shareholders alike)
2. extremely high liquidity (typically short-term assets e.g. bonds)
3. extremely high asset security (typically government bonds)
4. lower interest rates paid to depositors (as a function of the no lending and other constraints)
5. possibly specific regulatory framework with higher level of scrutiny and operational/investing restrictions
Additional criteria applied to safe banks include -
1. no derivatives
2. no off balance sheet assets
3. high degree of institutional transparency (e.g. continuous real-time disclosure of financial records)
4. capped executive salaries
5. low risk jurisdictions
Background
Some early thought leaders in narrow/safe banking include -1. Satyajit Das from the University of Illinois who published an early paper on the topic of narrow banking.
2. Mike Denoma who advocated the case for it early in his career (circa 2000)
3. Kevin James from the Bank of England who presented very early on in this debate
More recent references include the consideration of safe banks or narrows banks in the next round of Bretton Woods
Bretton Woods system
The Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states in the mid 20th century...
and the Feb 2009 World Economic Forum agenda titled The Future Of The Global Financial System.
Classifications
Each writer tends to apply their own classification system for defining types of narrow banks. Here is one classification system, though there are others defined by the leaders listed above.Lenders have to become investors (cases PS, PL). The table below shows four different cases of narrow banking.
| Permitted to possess short-term safe assets (S) | Permitted to possess long-term safe assets (L) as well as short-term assets |
|
|---|---|---|
| Prohibited from conducting lending activity (P) | PS Full-reserve banking Full-reserve banking Full-reserve banking, also known as 100% reserve banking, is a banking practice in which the full amount of each depositor's funds are kept in reserve, as cash or other highly liquid assets... |
PL |
| Permitted to conduct lending activity (L) | LS This case advocaded by Kobayakawa and Nakamura has a synergy effect between deposit taking and lending |
LL This case shows some similarities with fractional-reserve banking Fractional-reserve banking Fractional-reserve banking is a form of banking where banks maintain reserves that are only a fraction of the customer's deposits. Funds deposited into a bank are mostly lent out, and a bank keeps only a fraction of the quantity of deposits as reserves... but is still more restricted |