The Economist: How the state could take control of the banking system
Banks are inherently unstable.
By May 1st the Federal Deposit Insurance Corporation (fdic) will produce a menu of options for Congress about how to reform or expand the backstop the regulator provides, which is currently capped at $250,000 per depositor. Many blame the limit for the run which brought down Silicon Valley Bank (svb).
Banks are inherently unstable. They offer deposits that are instantaneously redeemable while holding long-dated, illiquid assets such as mortgages and business loans.
The mismatch means even well-managed institutions are vulnerable to a run that might be sparked by a misunderstanding. The fragility of banks is matched by severe consequences if they fail: runs tend to be contagious events that can cause credit crunches and recessions.
Despite the danger banks pose, governments tolerate their existence. The transformation of liquidity and maturity is thought to enable a greater provision of credit and faster economic growth than would be possible under the alternative: a system of “narrow banks” in which deposits are fully backed by only the safest assets.
In a crisis, central bankers follow a dictum attributed to Walter Bagehot, a former editor of The Economist, to lend freely, secured by good collateral and at a penalty rate of interest.
The Fed’s latest facilities barely seem Bagehotian at all, valuing long-term securities at par even when the market has heavily discounted them, and imposing an interest penalty of a mere tenth of a percentage point.
The prospect of banks becoming de facto government-funded should alarm anyone who values the role of the private sector in judging risk. Yet the difference between deposit financing underwritten by multiple layers of the state and funding that is provided directly by the state itself is getting harder to distinguish.
The Economist 12 April 2023
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