Pennacchi on Narrow Banking

Monday, August 21, 2017

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I stumbled across this prissy article , "Narrow Banking" yesteryear George Pennacchi. The get-go component subdivision has a informative capsule history of U.S. of A. banking.

George defines a spectrum of "narrow" banks. For instance he includes prime number coin marketplace funds -- borrow coin , hope fixed value instant withdrawal , purchase Greek banking concern commercial paper. But that is "narrower" than traditional lending , every bit the assets are brusque term too normally marketable.

Some interesting tidbits:

Prior to the twentieth century , British too American commercial banks lent close entirely for brusque maturities. Primarily , loans financed working upper-case alphabetic quality too provided merchandise credit for borrowers who were expected to obtain cash for repayment inward the close future

Therefore ,

... the typical construction of these early on banks contrasts amongst the modern sentiment of banks , according to which the received wisdom is that “[t]he original business office of a banking concern is that of maturity transformation---coming from the fact that lenders prefer deposits to hold upwardly of a shorter maturity than borrowers , who typically require loans for longer periods” (Noeth & Sengupta 2011 , p.8)....maturity transformation was often considered a violation of prudent banking.

On the nature of assets:

Following the the States Civil War , many banks ... invested inward commercial paper... With the institution of the Federal Reserve System inward 1913 , commercial newspaper became specially desired because it was eligible collateral for borrowing from the Fed’s Discount Window. According to Foulke (1931) , prior to the 1930s , banks too trust companies held to a greater extent than than 99% of commercial paper....In contrast , banks today concur real niggling commercial paper

so "bank" so = "prime coin marketplace fund" today -- precisely , after 1913 , amongst discount window liquidity support. Some disintermediation makes a lot of sense. In 1830 , you lot could non hope to sell commerical newspaper inward 10 milliseconds on an electronic central , so the "liquidity creation" yesteryear banks was to a greater extent than necessary.  The struggles the SEC is having amongst prime number funds today has deep roots.

Credit lines:

One credit service of banks that is ubiquitous today precisely was completely absent from banks inward the nineteenth too early-twentieth centuries was the loan commitment. In recent years , to a greater extent than than 70% of concern lending was from loan-commitment drawdowns.

This was an specially interesting resultant inward the crisis. Chari ,  Christiano , too Kehoe noticed banking concern lending going upwardly inward autumn 2008. Lending freeze , what lending freeze?  Scharfstein too Ivashina argued increased lending was mostly companies grabbing cash promised nether existing lines of credit.

Prior to the 1930s , banks often had long-term relationships amongst detail borrowers: Banks would lend repeatedly for brusque damage to the same borrower....During the fiscal panic catamenia of 1857--1858 , the [Black River] Bank’s number of borrowers declined yesteryear nearly 75% ,..early banks made virtually no formal loan commitments.

so rolling over loans without commitment is a means to save the selection non to lend inward a crisis. Perhaps Fed liquidity back upwardly is what changed rolling over to promising to exercise so.

Narrow deposit creation too the viability of equity-backed banking:

...[the] Louisiana Banking Act of 1842. ...required a banking concern to concur specie (gold) too bills of central too promissory notes maturing inward xc days or less inward amounts at to the lowest degree equal to its deposits too notes issued. Moreover , the ratio of specie to the full of deposits addition notes had to hold upwardly at to the lowest degree one-third. The banking concern could brand loans amongst maturities greater than xc days , such every bit mortgages , too concur existent estate too other fixed assets precisely they must hold upwardly funded amongst equity upper-case alphabetic quality , non deposits or notes.

Hammond (1957 , p.683) states , “The available testify is that the organization operated amongst distinguished success…Although the banks of New Orleans were good known throughout the province for their clit too integrity , the constabulary governing them was non mostly emulated.” Sumner (1896 , pp. 387 , 389) is to a greater extent than enthusiastic , calling the deed “the most remarkable constabulary to regulate banks , which was produced inward this catamenia , inward whatever State…"

We seem doomed to constantly reinvent the steam engine , so to forget how it worked.

In summary , prior to the early-twentieth century , many the States banks functioned similarly to narrow banks yesteryear belongings primarily short-maturity assets to agree their brusque maturity liabilities. Despite the several episodes of banking panics , it may hold upwardly argued that panics occurred primarily at banks that deviated from the narrow-banking ideal. 

H5N1 novel form of moral hazard:

H5N1 to a greater extent than of import reply to the 1907 panic was the institution inward 1913 of a authorities lender of concluding resort too cardinal banking concern inward the cast of the Federal Reserve System. Access to the Fed’s Discount Window made it less costly for banks to concur longer-term too to a greater extent than illiquid loans. Indeed , Friedman & Schwartz (1963) debate that the Fed’s beingness changed banks’ guide inward ways that led to to a greater extent than banking concern failures during the early on 1930s. Banks shifted to higher credit-risk loans too felt less ask to lend to each other during times of stress because that was forthwith considered the Fed’s responsibleness (which the Fed failed to perform adequately).

...bank capital-asset ratios were trending downward since the 1840s (when they were over 50%) , precisely the refuse accelerated next the founding of the Fed too the FDIC. The upper-case alphabetic quality ratio so stabilized inward the make of 6%–8% starting inward the early on 1940s

too one-half of that at the start of the fiscal crisis inward 2007.

As amongst other proposed banking concern reforms , recommendations for narrow banks look most ofttimes next major fiscal crises. With the exception of the Louisiana Banking Act of 1842 , too maybe the U.S. of A. Postal Savings System , proposals involving narrow banks accept non been implemented.

Well , non yet!

The residuum of the newspaper has a prissy summary of narrow banking proposals , too theoretical analysis.

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