Steve Baker MP Explains What Is Wrong With Banking

Steve Baker MP (Conservative, Wycombe), writing in the Wall Street Journal Europe explains what’s wrong with the current banking system. You may need to subscribe to read the full article (try it) but here’s some choice quotes:

“If you borrow a friend’s painting and promise that you will give it back on demand, and you then lend that same painting to somebody else, you have committed a fraud. The same rules do not apply, however, to bankers. British parliamentarians have an opportunity to change that today, and I hope they do.

“Today, banks enjoy the legal privilege of fractional reserve banking, meaning they may lend out what they already owe depositors. By lending and investing on-demand deposits, banks create money by extending credit. When the bank’s investments turn sour—and investments often turn sour at some point—the bank cannot pay back the deposits and goes bust. Unless it manages to convince politicians that it is too large to fail, in which case it will be bailed out by taxpayers.

Steve then goes on to make a huge announcement, and something that we fully support:

“Today I will be supporting my colleague Douglas Carswell, member of Parliament for Clacton, as he introduces a bill to phase out fractional reserve banking. Our friends in the U.S. and Europe are watching closely, for the same crony capitalism afflicts the world. […] Our Regulation of Deposits and Lending bill would allow you, Britons, to choose how your money is used. You would have the choice either to deposit your money for safe-keeping, or to save it for a term to be invested further by the bank. If safe-keeping is your choice, you can have your money back on demand. Your property rights would be intact—you would remain the owner of your deposit. You would probably not earn interest; in fact you may have to pay for the privilege of direct access through branches and cash machines. If, however, you want a yield, you may choose to deposit your money for a term instead. The bank can then invest it further, potentially earning you an income.”

But what about making sure the economy has enough credit? Steve goes on:

“Credit would continue to exist, backed by real savings. The saver would be fully aware of the benefits and risks when choosing between depositing money and saving it for a term.

That sounds good – much better than the current system, whereby all bank depositors are exposed to the same risk, and then, because they were unaware of the risks, have to have those risks negated by tax-payer funded deposit insurance and other bailouts.

But why has this system not been fixed before now? Here’s a suggestion:

“Is it outrageous to suggest that bankers rather like the socialization of risk and easy access to others’ money, and that their success in this system requires the ears of the right politicians?

There are also issues with corporate structures and the effect that has on incentives:

“Executives who, in another age, would have lost everything as partners with open liability, have instead retired wealthy.

But surely fractional reserve banking is a natural product of free market principles? Surely capitalism is the root of the issue? I – personally – don’t think so, and neither does Steve Baker:

“In reality markets do not grant legal privileges such as fractional reserve banking—politicians do. The legal privilege of fractional reserve banking destroys the sound capitalist mechanisms of property and contract law. Today we hope to end it.”

Positive Money will do what we can to support this bill. It doesn’t matter if you’re pro-free-market, like Steve Baker MP, or you think that free markets don’t work – fractional reserve banking works against the interests of everyone, no matter what side of the political spectrum, and now is the time for us to bring this practice to an end and move to a better banking system.