Friday, 6 July 2012

I am a bank

I am a bank.

Honest, I really am. This is not a joke.

You see, I lend people money. Or, more accurately, I allow them to run lines of credit, which I create for them out of thin air.

Let me explain. My day job is teaching singing, much of it to teenagers in secondary schools. These teenagers' lessons are paid for by their parents. I invoice them for 10 lessons at a time and they are supposed to pay for the whole series of lessons before the series starts.

In practice, hardly anyone does. About half will have paid by the 5th lesson and the remainder have to be chased. The vast majority do pay by the end of the series of lessons, but there are a small minority who have to be cajoled, threatened or even sued. Some negotiate with me for payment in instalments and then forget to make those payments.

No doubt because of their own financial difficulties, the proportion of people who pay late is rising, as is the proportion of people who don't pay at all. In the last year I have sued two people at the County Court for non-payment of fees, one of whom didn't reply and has had default judgement served against them - but I still haven't been paid. The other has offered to pay off the fees and associated charges at £20 per month, which is all she reckons she can afford.....but if that is true then she couldn't afford the lessons in the first place, because the fees for 10 lessons between January and March were £135. In effect she is expecting me to extend her an interest-free loan.

But she is not the only one. In fact every single one of the parents who pays late is effectively expecting me to lend them the money to pay my fees.

Which is why I say I am a bank. But unlike a normal bank, I am expected to lend to them interest-free - parents get very angry if I start imposing interest on late payments, although the law does allow me to do this and even recommends a rate. If I upset parents, they may take their business elsewhere - and student numbers are falling at the moment because poorer parents are finding it difficult to maintain their childrens' musical activities at the moment. So I could end up even worse off if I insist that parents have to pay up front.

I am by no means alone in this. Most small businesses are forced to extend lines of credit interest-free to customers, particularly large and rich ones who have the leverage to squeeze them out of business if they complain. Most small businesses, therefore, are unofficially acting as banks.

And they do it at considerable cost. Like most micro businesses, I rely on the fees from my singing lessons to meet my personal living expenses. Because parents routinely breach my terms and conditions that clearly state that payment must be made in full within 14 days of the invoice, which is sent at the start of term, I have no idea when I will be paid - but my own bills still have to be paid. Unlike parents, I have no access to interest-free credit: I can only borrow from the bank, and if I go over my overdraft limit that funding is at a penalty rate. And as I said above, it is difficult for me to pass these costs on to my customers.

There has been considerable discussion recently about trust in banking. People are understandably angry that banks have betrayed their trust and behaved disgracefully. I have no doubt that the parents who fail to pay my bills on time (or at all) are among those who are angry at the fraudulent behaviour of banks. What a pity they can't see that their own behaviour is just as bad.

Businesses like mine depend absolutely on trust - trust from the parents, that their child will be properly taught: and trust from me, that parents will pay in accordance with agreed terms and conditions. If one side fails to abide by their obligations, that trust is broken. I already feel as if I should, for my family's sake, seek employment with a steady income, but I resist that pressure because I love the work I do and believe that I deliver real value to my students. But if the present trend - increasing volumes of late and failed payments - continues it will not be possible for me to continue.

Now, instead of being negative about this, I could treat it as a business opportunity. Currently my business  overdraft rate is 6%, and the rate that I can charge on bad debts that are going to the County Court is 8%. It may be that the reason parents get cross if I charge them interest is that they don't realise that I'm lending them money. Suppose I were to make it explicit in my terms and conditions? I could say "A credit account will be opened for you when you book your first course of lessons. To avoid interest charges, you must pay the account in full by ..... date. After that interest will be charged at 8%". I would need to send out statements of account, of course, and I would still have bad debts. But I would be making money on the credit I extend to my customers. I would be borrowing short (overdraft) at 6% and lending long (3-month credit line) at 8%.  This is credit intermediation and maturity transformation.

And note that credit creation is involved. I only have to borrow when I have a bill to pay, which may be some time after I've extended lines of credit to my customers. The line of credit is a stream of future payments plus interest and I would borrow on the strength of those future cash flows. But my customers in effect have borrowed money from me to pay my bill, even though I don't actually have that money until I borrow from the bank to meet my expenses (money that I wouldn't have had to borrow if they ACTUALLY paid upfront - I hope that is clear). In this way I have effectively created money. 

Effectively, I would be an unregulated and unlicensed bank - a "shadow bank", making money on the spread between borrowing and lending. And you will note that I would be borrowing from real banks - which are supported by the taxpayer - to fund my shadow banking activity. If I went bust, the real bank would lose money and the taxpayer would be on the hook. I am hopeful that those taxpayers would include the parents whose failure to pay caused my business to fail - but if they cheated me, perhaps they cheat the government too?

The thing is, though, I don't want to run a bank. I don't want to make money by borrowing short and lending long. I want to teach singing and be fairly paid, on time, for what I do. Is that too much to ask?

A shorter version of this article is cross-posted at


  1. Hmmm. I wonder whether you could apply for charitable status. Bursaries / scholarships could then be awarded by your charity to struggling families.

    1. As I benefit financially from giving these lessons, no I couldn't. I would need to set up a trust fund or something similar with independent trustees.

      In my experience most of the families who pay late or don't pay wouldn't meet the criteria for assistance anyway. They aren't that poor, they just have a skewed set of priorities.

    2. and a lack of respect for you...

  2. Are you regulated by the FSA?

    1. There is no need for Frances to be FSA regulated as she is selling real (as distinct from financial) goods and services.

  3. You could offer a massive discount to those who pay in full in advance (an early settlement discount). You could set this early settlement price to the price you would normally charge. Those requiring credit terms would be charged the (much higher) full price to compensate you for default risk. You could still advertise at the early settlement price by quoting prices as "from....".

    I wonder whether you could approach local schools to offer your services as a sessional teacher?

    1. I currently apply a surcharge for payments outstanding after the half term break, and I impose administration charges for all communications after the first reminder. I could increase the surcharge a lot more.

      I already work in local schools. It's mostly school-based work that I describe in this post.

      However, the point of this post is that people who treat the terms and conditions of small businesses in such a cavalier manner are as untrustworthy as the banks they castigate. The behaviour of the banks and of people who rip off small businesses is the same - it is symptomatic of a "me first" attitude in society. We need to change fundamentally the way we behave towards each other.

  4. It'll be interesting to see how someone else's bank works.

  5. Frances, Re you claim “I am a bank”, Simon and Garfunkel produced a song called “I am a rock”, so why can’t we have “I am a bank” from you?

    As for the technicalities of your claim to be a bank, I suggest you perform one of the basic functions of a bank, but not another one. You extend credit, i.e. lend. However the debt your customers owe you is not widely accepted in payment for goods and services, i.e. it is not a form of money. That is, you don’t create money in the same way as private banks do.

    As to shadow banks, I’m not 100% clued up on what shadow banks do (and I think you said a few months ago you were going to write an article about them). But I think their basic activity is connecting large borrowers with large lenders. I.e. they do what you do, but they don’t create money, in the same way as high street banks do. Am I right there?

    More possibilities for bank related songs: “I stole one bit at a time” sung by Bernie Madoff. “One of these days these boots are going to walk all over you” sung by Lloyd Blankfein and the Goldman Sachs mobsters.

    1. Ralph,

      Not so. In lending them money (which is what delaying payment amounts to) I am providing them with the means to obtain other goods and services from other suppliers. The money I provide is therefore WIDELY accepted. So yes, I do create money in exactly the same way as private banks.

      A shadow bank is simply an unregulated financial institution. And they do create money in exactly the same way as private banks - as I explained in my post "The Money Machine".

    2. Frances

      Interesting analogy, but if you must be absolutely correct about the process, then your acceptance of the parents deferred payments amounts to two transactions. One is them actually paying you. The second then is you lending them money.

      You haven't created money ex-nihilo.

      The excess money (relative to what they should have had) in their account is matched by a corresponding deficit in your account. There is an increase in money supply only when you actually borrow from an overdraft account, for which you need a *bank* bank, not a Frances bank.

      Still, interesting post.

    3. You're not a bank because you don't take deposits. Banks lend other people's money, not their own.

    4. You need to think of "me" as two separate things - Frances the Singing Teacher, and Frances the Bank. Correctly, the process is that the customer pays Frances the singing teacher, and Frances the Bank borrows that money from Frances the Singing Teacher and lends it back to the same customer. Of course no money has actually moved at all, but that's the implied process and that's how it should be accounted for.

      If Frances the Singing Teacher doesn't want to lend that money to Frances the Bank - because there are personal bills to be paid - then Frances the Bank has to borrow money from a commercial bank, or failing that a relative or friend (yes, that has happened) in order to fund the customer's borrowing. That is EXACTLY how commercial banks work. If depositors remove their money commercial banks have to find money from somewhere else to cover expenses - which is why a bank run can cause a bank to fail. Bank "creation of money from nothing" is simply an accounting construct and a reflection of the way we measure money.

      It is NOT correct to regard that borrowing as funding Frances the Singing Teacher. Frances the Singing Teacher has been paid. Frances the Bank is the one out of pocket.

      If there were no Frances the Bank, those customers would have to borrow from commercial banks to pay Frances the Singing Teacher. The lending process would be EXACTLY the same, but because they were borrowing from a commercial bank rather than from Frances the Bank, the implied deposit would show up in measures of money, whereas if they borrow from Frances the Bank it does not. That is because the way we measure money does not include implied deposits from non-bank credit, but it does include implied deposits from bank credit. This is really pretty illogical, and has nothing to do with the actual lending process which is the same in both cases.


      Frances the Bank is taking deposits, actually - from Frances the Singing Teacher - and lending that money to customers.

  6. I had music lessons as a child (clarinet) as did a lot of kids in my school. And extra tuition, private lessons out of school hours (evenings) was the only way to progress adequately and get through the grade examinations in a reasonable time. Those private lessons were always payment per lesson, in advance (at the start of the lesson). Then the only problem the tutor has is with cancellations (and that was fixed by charging the lesson fee if cancelled with less than 24 hours notice).

    AFAIK all the music teachers (string, brass as well as my woodwind teacher) operataed the same way. OK, some kids dropped out as their parents couldn't pay, but I'd suggest they would have dropped out any way. And none of the music teachers ran the same payment risks that you're running.

    It may be worth trying an A/B test with your students - keep half on the existing payment model, and move half to a pay-per-lesson model, and see which has the better results for your cashflow.

    1. Private lessons out of school are on cash-per-lesson basis. Several problems with it:
      1) I operate a 24-hour notice for cancellation rule, as you suggest, but it's virtually impossible to extract payment the following week for on-the-day cancellations
      2) what do you do with kids who forget their money? If you refuse to give the lesson you lose the money.
      3) with cash-per-lesson no-one EVER gives notice of termination. They just disappear - even though my terms & conditions specify 4 or 5 lessons' notice.
      I've tried it both ways and a tariff is slightly better in my view, but I have to get tougher with late payments and try to get as many parents as possible paying directly into my account rather than by cheque or cash (which kids can lose).

    2. I think my music teachers were a lot tougher! Cancellations in <24 hrs and no money the following week = no lesson (if the student turns up with the money for that week's lesson, give them one week's grace to pay the missing money, otherwise no lesson). Forgetting the money = no lesson! If you give the lesson, you're doing so for free and at risk again. If you don't give the lesson, then the student learns not to forget it next time.

      As for point 3) as a student I was on the wrong side of the student-teacher relationship to understand that one. Most students (or at least most that I remember) were involved in various bands and orchestras in their schools or around the county - if you dropped out of lessons, you came under pressure next time you met your music teacher at band/orchestra practice (so there was a social aspect to keeping the lessons up as well).

      Payment directly into your account is an ace idea. I'd suggest offering payment by Paypal as well (as it's practically the same, and if the parents have ever bought anything on eBay they may prefer to pay that way).

      The Anonymous commenter below (10:59h 09-Jul-2012) has a good point too, an early-bird-style discount could work well, a fiver off amounts to just over a 3.7% discount, but use it as an incentive to pay electronically. It could be introduced at the same time you put through an inflation/etc... increase: "Fees up by x% due to inflation, but payment by direct debit/standing order, Paypal at current prices." And if anyone asks why: bank charges for handling cash and cheques. Everyone uses that excuse!

  7. As a marketeer I know that the carrot (discount) works better than the stick (interest etc.). Have you tried an early-bird discount etc.?

  8. What you describe is mercantile credit not bank credit - as no money is created. All money is credit, not all credit is money.

    1. The nature of money will be the subject of another post...but I would refer you to my reply to Ralph Musgrave on the subject of whether or not money is created, and whether the money that I "lend" is real money.

  9. When you extend credit (or lend) to your clients this implies that repayment will be coming from the future. Thus you wait for to-morrow to become to- day when payment materialises. As such there is no money creation. When the bank system as a whole lends money it converts “future” money into “to-day’s “money. It serves as a conduit for you to manufacture or print your own money legitimately, as opposed to “counterfeit” money if you were to do so yourself. So banks are licenced by the Central Bank/Government to manufacture money on your behalf. Whenever you see the banking system’s total assets (inclusive of loans) being on an increasing trend, you should know that money creation is also going upwards. Why? Because proceeds of all loans come initially into existence as deposits and when spent and circulated, will find their way back as deposits. To make it simpler, let us say you have a credit line with your supermarket. You make purchases on credit and the supermarket records you as its debtor until such time that you refund the debt .No money creation. If you have a credit card issued by banks what happens when you pay by this method? The banks just input a debit to your account (as an overdraft) and credit the supermarket’s bank account. So there is instantaneous money creation because that money did not exist prior to your purchase. Mind you, should the supermarket also have overdraft facilities then that money will decrease its debt towards the banks so that new money creation destroys previously created money. This dynamic process occurs on a daily basis giving rise to funds’ flows on the asset and liability sides of the whole banking system which interacts with the Central Bank which is the apex of money creation as the issuer of currency notes and coins and lender of last resort…

    1. You are missing the point. If I extend credit to someone, I am lending them money that I don't have. That is real money that they can use to buy goods and services in the real economy - in other words, a deposit. This is no different from the lending activity of commercial banks. The only reason that commercial bank loans inflate the money supply is that they actually account for the implied deposit, whereas generally in mercantile credit we do not. It is the implied deposit that inflates measures of money, not the loan itself.

      You could of course argue that the money creation doesn't occur until I borrow from a bank to cover my expenses because I haven't been paid. But when I do this I am simply the other side of the transaction - the bank has lent me money it doesn't have and funds it by borrowing (customer deposits, wholesale borrowing, bond issuance).

      People need to appreciate that bank "money creation" is simply a consequence of double-entry loan accounting, and that if non-banks accounted for lines of credit in the same way as banks do, they would also "create money".

    2. Umm, not quite true. Consider your virtual balance sheet. A deferred payment adds an Accounts Receivable entry to your assets, and a corresponding increase in net worth to you liabilities. Nothing happens to a bank's net worth when it creates credit.

      You are lending them *money* you *already* have.

    3. Ritwik,

      That's not true. A bank's net worth is increased when it creates credit. The loan (asset) has an associated deposit (liability) and both together inflate the balance sheet. When the loan is spent it creates a liability gap which must be funded by borrowing if it can't be met from capital.

    4. Frances

      The increase in the bank's balance sheet does nothing to its net worth. The requirement of liability gap funding illustrates precisely this point. When *you* make a loan to the parent, your net worth has gone up in lockstep. There is no liability gap. When a bank makes a loan, its balance sheet goes up, but not its net worth - had the net worth gone up, the bank would not have had a liability gap when the loan was spent. The bank can match the the liability gap by borrowing - which keeps the net worth constant. (I'm assuming zero NII throughout, positive NII increases the net worth in both cases, of course.)

      However, the solution to this is your reply to my earlier comment, which is that I'm implicitly combining Frances the singing teacher with Frances the bank. So actually, nothing happens to the net worth of Frances the bank, only the net worth of the singing teacher goes up. This is absolutely true. Accepted. Frances the bank does look like a bank.

      I think that Ralph's point about wide acceptance of your liabilities is now important. Let's solve this using the analogy you presented - Frances the bank (F-B)can be seen as accepting deposits from Frances the singing teacher (F-S).

      So say F-S has an initial deposit of 100 at F-B. Parent X has a deposit of 100 at F-B (could be any other bank, but let's simplify). Now in conventional accounting, when the parent does not pay, both deposits stay at 100. However, in the new *true* accounting, F-S's account is credited by 50, X's account is debited by 50, and a new loan account for X is created and credited by 50. So now F-S has 150, and X has 50 in current account and 50 in loan account. The money supply has indeed gone up from 200 to 250, and X can indeed spend the full 100 that they have, so it seems like F-B's credit is widely circulated as money.

      But, can F-S spend the full 150 she has, without any help from a bank bank? If the money supply has gone up, why hasn't F-S's purchasing power gone up? Can F-S go to a merchandise store and say that look my account only says 100, but I have a virtual accounts receivable of 50, so you should let me spend 150 without hesitation?

      Can F-B create purchasing power for X without suppressing the true purchasing power of F-S? If not, then Ralph's point stands.

    5. Yes, it's fair to say that banks' net worth only increases because of the future value of interest payments.

      Whether or not I can spend on the basis of a "future promise" depends on the willingness of retailers to accept credit risk. Effectively I would be transferring my credit risk to my supplier. That is no different from the parent who says "I'll pay you when I get paid".

      However, the process is exactly the same as a depositor who makes a card transaction from her current account. F-S has a real deposit (not a future one) with F-B, which F-B has lent out - this is 100% reserve banking, of course, not fractional reserve. If F-S draws that deposit, it leaves a gap which F-B has to fund by borrowing either from other banks or from other sources (Wonga??). The only difference is that it is MUCH easier for a real bank to borrow.

      If a real bank had the same difficulties borrowing as a small business does, depositors would not be able to use their money. Liquidity problems for banks are potentially catastrophic for depositors - which is why we have a lender of last resort for banks. A small business failing because of cash flow problems doesn't put the economy at risk. A large bank failing on the same issue does.

  10. You need to look at the experience of the day-care centre in Israel that started to charge a fee for late pickups of children, and saw the rate of late pickups increase. That was because parents didn't have to feel guilty about picking up late any more -- it was a commercial service that they were paying for. If you write an interest rate for late payment into your contract, you should similarly expect more late payments -- your customers won't have to feel guilty about not paying on time, just pay you a little interest.

    1. Yes, I agree with you. Some customers may simply choose to pay late and accept the cost. From my point of view that's fine provided the interest covers the cost to me of receiving the money late. The issue is customers who want the flexibility to pay late but don't want to bear the cost.

  11. Surely the best approach is to calculate the total direct and indirect cost you incur from delayed payments, halve it and divide by hours taught, then offer that as an hourly discount to parents who set up a monthly Direct Debit?

  12. [A bank's net worth is increased when it creates credit. The loan (asset) has an associated deposit (liability) and both together inflate the balance sheet. When the loan is spent it creates a liability gap which must be funded by borrowing if it can't be met from capital.]
    Net worth is defined as the surplus of assets over liabilities at a certain point of time. If, as you say, both sides of the balance sheet are inflated whenever a bank creates credit, the net worth may increase due to interest spreads but may also decrease if the credit turns sour…There is no liability gap if you look at the whole banking system because when loans are spent they return to the system as deposits, unless hoarded in mattresses…It is only when loans are not repaid that capital is eroded.

  13. Frances,

    The trick is to make it easy to pay. When you send invoices you're asking for people to carve out the time to login to their banking systems and pay you or to cut a cheque and put it in the post. Its not that either of those tasks takes very long, its just that that task has to arrive at the top of a person's priority before they'll do it. Even when you send reminders, it won't get done, because there's always something else to think about.

    The answer is to create a process whereby your reminder can create an immediate response that completes the transaction, the best way to do this is to take card payments. Once you can take a card payment you can call up and say "You owe £135, I can take the payment over the phone if you like". It also means that if anyone is in arrears, then you can call them before the next lesson and ask for payment, you can also store a clients card details for regular use to auto bill them (there are very strict rules for storing card details though).

    Taking card payments moves you from a bank back to a service provider, one that is considerate enough to not only teach their kids how to sing, but also to make their lives easy by making it easy to pay.

    My wife uses card payments for her teaching services and it has made a huge difference, we used to get a deal and hire a terminal.

    Good luck

    1. Thanks Ian - that's really helpful. I shall look into that!

    2. Just one warning, it isn't an easy process to get set up, as there's the rate you have to agree, and then you have to chose the technology, and then you have to get it all linked to the bank account. Despite what anyone says, no one really makes it painless, BUT it is worth the effort.

      We've now got a terminal at home, so when a kid is dropped off or collected, Ruth just asks for the card to process the payment. If you work in other people's houses you can get a portable terminal that will work anywhere, but these are more expensive.

      We've found that people weren't choosing not to pay us, they just saw the act of paying as something irritating and time consuming. Making it easier for them to pay has really worked and in a weird way increased customer loyalty - they like that Ruth is making it easier for them and now they don't want to go back to a teacher that sends them invoices.

  14. I get your point here. Very simple principle.

  15. Positive Money's response is here:

  16. Well, ok.
    If a gunman breaks into a bank branch and says "Nobody move! This is a mortgage application!" and the staff comply, then you might choose to say that the gunman has the power to create money in this scenario rather than the bank.
    In the scenario where the withholder of payments and extender of credit leads to money creation, we similarly might want to say that it's the withholder of payments who is the one with the power to create money.
    Not that either creation of money would be advisable in either scenario- as ever, the final arbiter of property disputes is the state. In the long run, money creation of this sort is costly, so you wouldn't expect it to become widespread, unless something was going very badly wrong with the amount of money available in the society.

    Would be interested to know if you followed Ian M's tip, & whether this was something that's cleared up or getting worse, if that's not being too nosey.