FM on Money (8) Narrow Banking

Felix Martin describes a proposal for 100% Money made by the American Economist Irving Fisher in the 1930s. He calls it simple and radical.

Fishers proposal was to require that any deposit that could be withdrawn or used to make a payment on demand be backed by sovereign money – and banks which offered such deposits be permitted to do no other business. “The checking deposit department of the bank”, Fisher wrote, “would become a mere storage warehouse for bearer money belonging to its depositors and would be given a separate corporate existence as a Check Bank. As for the rest of what banks now do – whether client facing or not, whether wholesale business or retail – these things would be treated like all other capital market activities, and the institutions that undertake them would neither enjoy special sovereign support, nor suffer special sovereign supervision.

The market would decide what products would be offered, and what institutions would offer them. Outside the realm of “Check Banks”, even the dodgy promise of liquidity transformation would be permitted. If investors wanted to gamble on an intermediary’s ability to synchronise payments in and out of its balance sheet, they would be quite at liberty to do so – because there would no longer be any illusion on any side that such investors would be bailed out if the promise was not met.

Fisher's proposal was taken up into the 1930s by economists at the University of Chicago, after which it became popularly known as the “Chicago Plan”. Today under the banner of “Narrow Banking", it is being advocated once again by some the world leading regulatory economists. It has been the subject of a new study by the International Monetary Fund, which found that test its consequence suing a forma mathematical model strongly corroborates Fisher’s argument that it would lead to great macroeconomic and financial stability.

Fisher’s plan to separate money transactions from debt and credit is a valid one. Felix Martin believes that governments might do it, but they will not, because they want to keep the benefits they get from inflating the currency. I describe a better way in sound banking system. I describe them as transaction banks.