Yesterday I wrote a post pointing out that the banks actually set saving and borrowing interest rates according to market demands and the needs of their business, not according to the base rate - despite what people think and the media say. And I identified the real cause of the increased spread between borrowing and savings rates as being the introduction of higher capital and liquidity requirements to make banks "safer". Safety comes at a price, and that price is less lending, higher rates to borrowers and lower rates to savers.
Having capital requirements for banks at all is direct government interference in the market, which creates distortions and gives certain categories of customer a raw deal. The question we have to ask ourselves is whether additional regulation is needed to protect the customers disadvantaged by the regulations we have already introduced. Regulation tends to beget regulation, as each time another regulation is added the commercial organisations react to it in ways that disadvantage other consumer groups. The "red tape strangles business" we hear from politicians of right-wing persuasion arises from this tussle between regulator and regulated. These politicians tend to try to persuade rather than regulate, but the effect is still the same.
Here are some of the current distortions in the retail banking market. Note how many are "sacred cows"!
- Unlimited taxpayer guarantee of retail deposits
- Capital reserve requirements
- Liquidity requirements
- Bank of England funding support for payments
- Interbank lending rate (why is there only one LIBOR rate?)
- Bank of England base rate (why doesn't the BoE charge different rates according to institutional risk?)
- Single fiat currency issued only by the Bank of England
- The Bank of England (why do we have a "lender of last resort" at all?)
- Project Merlin (why should the banks lend more to SMEs just to "get the economy growing"?)
- Tax relief on pension savings
- Tax relief on other forms of savings such as ISAs
- Requirements for pension funds to invest highly in "safe" securities such as government debt
- Bans on short selling of CDS and government debt in EU, US and other countries
A free market in banking would look very different from what we currently have:
- No government guarantee of retail deposits, or anything else for that matter. A bank that failed would not be bailed out by taxpayers, however large and important it was. Savers would lose all money not covered by voluntary bank insurance schemes
- Savers would be charged by banks for insurance to protect their savings in the event of bank failure. They would of course be free to refuse this insurance and take the risk. There would be a growth of private-sector insurance schemes protecting savers - and of course an attendent risk of mis-selling (nobody ever said that a free market couldn't be corrupt!)
- No free banking. Banks would charge for every bank transaction
- Banks could lend unlimited amounts of fictional money. They would have no need to hold reserves except for funding. But they actually might increase their reserves - read on.....
- All bank funding would come from the interbank market. There would be no lender of last resort. If the markets stop lending banks would fail. Banks would be forced to put in place longer-term funding strategies: their current practice of lending long and borrowing VERY short would have to end. Because of this, banks would be likely to hold reserves voluntarily because of the risk of losing short-term funding. There would be a greater need for them to attract retail deposits, particularly longer-term notice deposits, and savings rates would rise due to the increased competition.
- Banks of varying sizes would face different funding rates depending on the interbank market's view of their risk. Smaller banks would either charge more for borrowing or suffer margin reduction. They would be likely to become niche players - offering very high savings rates to sophisticated investors who don't mind risk, or focusing lending on high risk individuals and businesses at very high rates. We are seeing some of this developing already (companies specialising in payday lending, for example).
- There might be more differentiation in the market - more players specialising in different things.
It's an interesting model, isn't it? Note that savers would be likely to do VERY much better under such a model, but borrowers would have to pay more. So it is fair to say that the present regulated banking system systematically discriminates against savers in favour of borrowers. If the government prefers to maintain a regulated system, then this is an area that needs addressing through additional regulation. It is not reasonable to expect banks to offer a better deal to savers voluntarily. There is no reason for them to do so.