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World Banking: The Future of Money
Anonymous. The Economist. London: May 2, 1992.Vol.323, Iss. 7757; pg. S49, 2 pgs
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Abstract (Document Summary)
Nonbanks are doing more banking and banks are doing less. If this trend continues,
banks will not disappear, but traditional banking will decline. Money-market funds (MMF)
and nonbank lenders can do separately what banks bring under one roof. Together, they
may be the banks of the future. MMFs are a form of investment that looks just like a
deposit but carries no government insurance. Funds invest mainly in Treasury bills and
high-quality commercial paper, thus supplanting banks as suppliers of short-term credit
to blue-chip corporations. Financial companies are inherently less prone to runs than
banks. They are funded by investors who, unlike depositors and holders of MMFs,
accept that the value of their securities will fluctuate. Banks will remain even as the
business of banking shrivels, but they will themselves champion the new techniques that
will undermine old banking.
Full Text (986 words)
Copyright Economist Newspaper Group, Incorporated May 2, 1992
Does banking have a future? That is not an idle question. Banks are dangerously
opaque boxes to which savers entrust their wealth and from which borrowers take
satchels-full of money with the promise to repay. Massive bureaucracies peer into banks'
mysterious workings, hoping to sight trouble before deposits are put at risk. Lest
depositors lose faith, governments offer them nearly unlimited guarantees against loss.
Why bother? Other sorts of enterprise do the same job as banks more cheaply and with
less risk to depositors.
It does not take a visionary to imagine a world without banking. As this survey has
shown, nonbanks are doing more banking and banks are doing less. If the trend
continues (never, admittedly, a safe assumption), banks will not disappear, though
traditional banking will wither. What would take its place? Mr Gorton of the Wharton
School and Mr Pennacchi of the University of Indiana offer one version of the future.
Money-market funds (MMFS) and non-bank lenders do separately what banks bring
under one roof, they point out. The separation makes each activity easier and cheaper
for regulators and the markets to monitor. Together they may be "banks of the future".
Start with MMFS, a form of investment that looks just like a deposit but carries no
government insurance. Savers buy shares that are usually redeemable at their par value
of (in America) a dollar each, and receive income in the form of additional shares. Funds
invest mainly in treasury bills and high-quality commercial paper, thus supplanting banks
as suppliers of short-term credit to blue-chip corporations.
Most MMFS share a basic weakness with bank deposits: because they are normally
redeemable at par they are vulnerable to runs by panicked savers. Unlike banks, though,
MMFS do not guarantee savers redemption at face value. If the value of a fund's assets
falls below the par value of its shares by more than half a percentage point, the fund
must mark its shares to their lower market value. If such a mark-down looked imminent,
perhaps because of a default by a big issuer of commercial paper, investors could panic.
So far, they have not. America's SEC discourages runs with a few simple but apparently
effective rules. If an MMF'S assets fall sharply in value, its parent company must decide
"promptly" whether to reduce the value of its shares ("break the buck") or to top up the
fund by buying back the cut-price assets at their full value. So far every fund company
has protected investors from loss by buying the securities. Even so, the SEC tightened
investment standards after two commercial-paper issuers defaulted in 1989 and 1990.
Messrs Gorton and Pennacchi found no evidence that commercial-paper defaults
triggered runs on MMFS. That is not surprising, because MMFS hold diversified
portfolios of high-quality tradable debt. A default by one debtor should not trigger a
decline in the value of all commercial paper. In theory, the CP market could crash like
stockmarkets did in 1987. That would set off the sort of general panic that deposit
insurance was designed to prevent. In practice a collapse in the value of all MMF assets
is unlikely. It is hard to imagine an event that would suddenly jeopardise the ability of all
blue-chip companies to pay their short-term debt. In their relatively short history, MMFS
have been as stable as bank deposits without the prop of government-financed
insurance.
If MMFS can do the job of deposits, financial companies can take over from banks as
lenders. Such firms are inherently less prone to runs than banks. They are funded by
investors who, unlike depositors and holders of MMFS, accept that the value of their
securities will fluctuate. Though their assets are illiquid, improvements in financial
technology enable investors to monitor the credit-worthiness of non-bank lenders. Unlike
most banks in America, they have publicly traded shares and public credit ratings, both
casting light on their financial condition. That light is reassuring. According to Messrs
Gorton and Pennacchi, non-bank lenders are also immune to the panics that afflict
banks. They conclude that "these firms do not require government insurance or
regulation in the way that banks may require."
As securitisation conquers banks' balance sheets, lending itself could wither away.
When all debt is liquid and tradable, savers will store their wealth not in bank accounts
but in pools of securities that represent direct claims on companies, governments and
individuals. Portfolio managers, rather than bankers, will mind these stores of wealth
under the scrutiny of watchful but unobtrusive regulators. Some managers will build
portfolios of low-risk credit; others will drain the venom from higher-risk assets by
combining them in diversified portfolios. They will set more sensible prices for credit than
banks because their judgment will not be clouded by guarantees and restrictions.
Computers will banish the mystery that now obscures the real value of banks' debt
holdings. Demystified money is safer money; it is ignorance that causes banking panics.
NEW WINE, OLD BOTTLE
Banks will remain even as the business of banking shrivels. But they will be a different
breed. Where the law permits they will themselves champion the new techniques that
will undermine old banking. Deutsche Bank underwrites most of Germany's commercial
paper; Citibank securitises much of America's credit-card debt; and BNP cannibalises its
own deposits with SICAVS, the French version of money-market funds. The banks'
empires of branches will survive, for they are still the strongest link between banks and
their customers. Their main source of income, the spread between interest paid on
deposits and interest earned on loans, will diminish, at least as a share of the total.
Banks will earn fees as brokers of debt and managers of investment. They will leave the
job of monitoring credit to rating agencies or their more-advanced successors. The
adjustment will undoubtedly be painful. But savers, borrowers and regulators can look
forward to finance supplied more efficiently and at less risk to the public purse.