Keynes’ MegaBank

Following Deep T.‘s regular probing analysis on the Australian banking system, the crew here at MacroBusiness often refer to the big four banks MegaBank.  Yet we are not the first. I came across an enlightening passage from Keynes’s Treatise on Money that came very close to using the term MegaBank.

When introducing the concept of ‘bank money’ , the type of money created when banks write loans, Keynes notes:

It follows that the rate at which the bank can, with safety, actively create deposits by lending and investing has to be in a proper relation to the rate at which it is passively creating them against the receipt of liquid resources from its depositors.

For the latter increase the bank’s reserves even if only a part of them is ultimately retained by the bank, whereas the former diminish the reserves even if only a part of them is paid away to customers of other banks; indeed we might express out conclusion more strongly than this, since the borrowing customers generally borrow with the intention of paying away at once the deposits thus created in their favour, whereas the depositing customers often have no such intention.

If we suppose a closed banking system, which has no relations with the outside world, in a country where all payments are made by cheque and no cash is used, and if we assume further that the banks do not find it necessary in such circumstances to hold any cash reserves but settle inter-bank indebtedness by the transfer of other assets, it is evident that there is no limit to the amount of bank money which the banks can safely create provided they move forward in step.

The words italicised are the clue to the behaviour of the system. Every movement forward by an individual bank weakens it, but every such movement by one of its neighbour banks strengthens it; so that if all move forward together, no one is weakened on balance.

Thus the behaviour of each bank, though it cannot afford to move more than a step in advance of the others, will be governed by the average behaviour of the banks as a whole – to which average, however, it is able to contribute its quota small or large.

Each bank chairman sitting in his parlour may regard himself as the passive instrument of outside forces over which he has no control; yet the ‘outside forces’ may be nothing but himself and his fellow-chairmen, and certainly not his depositors.

Sounds like an apt description of MegaBank, and one reason that ‘competition in banking’ is not quite what economists imagined it might be. In addition to the benefits of promoting innovation in customer service functions, competition in banking simply encourages the average rate of lending to accelerate as each player seeks to improve their market share, with little regard the the effectiveness of that lending on investment in new capital.  Thus, a competitive banking sector, to fulfil its social role of providing funds for the expansion of capital, needs clever regulation to ensure that lending standards are maintained.

Comments

    • +1 Chrism. His magisterial poise and withering clarity come from an understanding of economics that humbles us all.

      This is a timely reminder our banks are bloated building societies and the CEOs parading on the parapets mere feather dusters.

      Four near identical firms control 80% of banking assets. They do not compete on price. They do not compete on service. They compete by… ADVERTISING!

      This bloated oligarchy imposes enormous costs on the rest of our economy. Evidence: they are among the most profitable banks in the world – which comes from your pocket and mine.

      Canada regards six big banks as the irreducible minimum. When I am Prime Minister I will split each neatly in two and invite them to earn their crust.

      • Well, we all have a choice, don’t we. I stopped using Megabank 5 years ago so they are not lining their pockets from my “hard earned”. Some Credit Unions provide similar services, better customer service and good online banking facilities – no need to deal with Megabank at all!

  1. Thus the real constraint is the demand for debt and not any real constraint on bank behaviour.

    Clearly manipulating the price of debt by fiddling with interest rates is something to be done only with great reluctance as demand should reflect the requirements of a healthy economy where investments are being made in productive assets.

    Any wonder that the use of interest rates as a key economic lever has resulted in ponzi economics and capital misallocation on a grand scale.

    Yet still many recommend more of the same – ZIRP.

      • What’s best in the long run is not always going to be popular in the short term for the unprepared public.

        I’d imagine the unsuspecting investors in Madoff’s fund were also unhappy when it was wound up (not only because it was a scam, but because it hadn’t been allowed to continue).

      • Who said let the system collapse.?

        More imagination in economic reform is all that is required, much of which you comment on on a regular basis.

        Letting go of the interest lever / crutch is an important part of the process not a reason to resort to hyperbole.

        On interest rates cognitive dissonance abounds.

      • Do you want the the interest rate to be decided by the market, just like the LIEBOR was fixed?

        There are no easy answers on the question of interest rates. Both have their +/-.

      • Definitely no easy answers at the end of a credit boom and it is logical that interest rates will be lower when the demand for debt is lower (providing of course that the roll over requirements of the debt mountain do not exert too much upward pressure).

        I am just concerned that framing the debate too readily about interest rates takes attention away from the critical micro reform involved in moving the economy from ponzi-nomics.

        Adjustment will take time and the investment discipline imposed by appropriate interest rates.

        I don’t see how 7% home loans help people make appropriate investments in housing.

  2. Great find and comparison Rumple.

    Keynes would not have been surprised by Australia’s Mega Bank.

    As per a number of previous posts, the brake on ponzi growth is adequate risk capital allocation which recognises the danger of creating systemic risk in what may be perceived as “low” risk assets, eg housing and sovereign debt

    I also think capital allocation should be turned on its head with an allocation to offshore liabilities due to the increase in system risk that source of funds creates

  3. Interesting find Rumplestatskin.

    “Every movement forward by an individual bank weakens it, but every such movement by one of its neighbour banks strengthens it; so that if all move forward together, no one is weakened on balance.”

    I suspect this will be the way forward for central banks as well, needing to move in lockstep with coordinated action on a global scale to avoid imbalance.

    • Rumplestatskin

      Yeah, I would say there is something to that idea. As DE points out below, when global imbalances exist, there is some benefit from shifting capital rapidly to another country when risk perceptions change.

      In the very long run, it does seem that the world must move lock step, although the process is more political, since the short term weakening of the system is usually a product of differing regulations (and culture) across countries.

  4. “If we suppose a closed banking system, which has no relations with the outside world, in a country where all payments are made by cheque and no cash is used, and if we assume further that the banks do not find it necessary in such circumstances to hold any cash reserves but settle inter-bank indebtedness by the transfer of other assets, it is evident that there is no limit to the amount of bank money which the banks can safely create provided they move forward in step.”

    Actually this is something I thought about in the past, specifically an example where there is only one bank.

    However, it is important to understand that MegaBank is not a “closed” system. Outflows of capital through the external sector above the rate of credit creation can easily create a crisis for MegaBank, which is why FuruteBoom! is so important to the Oz banking system.

    • Nice segue to the oft overlooked

      “…which is why FutureBoom! is so important”

      and not just to Oz banking…to the entire economy.

  5. Sounds exactly like what Murray Rothbard wrote in The Mystery of Banking.

    All banks can inflate together, because we have a central bank acting as a lender of last resort, plus a government imposing a fiat currency on us.

    Without those two props, the system would have crumbled decades ago. Fractional reserve is a form of fraud, where depositors do not have their balances backed up by actual reserves.

    The entire system is extremely prone to bank runs if not for the fact that there is a central bank ready and willing to debase our currency and print more dollars at the first sign of weakness.

  6. Great piece and a great comeback, Rumple.

    However, one of the Megabank directors seem to be on the road to redemption.

    http://www.perthnow.com.au/business/markets/gail-kelly-tells-of-need-for-ethical-leaders/story-fn7kjy2l-1226409369443

    “That’s because we, like in many parts of the world, we went on a little bit of a debt splurge, of a borrowing splurge, of a credit splurge through the late 1990s and into the early 2000s.

    “We were living in the era where house prices were going up, share prices were going up.

    “Now consumers are cautious.

    “From a banking point of view ….banks now can’t rely on credit growth or lending growth, particularly mortgage growth, those days are gone.