A “narrow bank” is a bank that takes deposits like any other bank, but instead of lending them out to businesses or homebuyers, it invests all of its deposits in safe, liquid government bonds. If narrow banking were to prevail, customer demand for deposits could be accommodated with (virtually) no risk of bank failure while other institutions handled making loans.
First popularized during the Great Depression with the “Chicago Plan,” narrow banking was in the news again after the failed Vollgeld (“sovereign money”) initiative in Switzerland this summer.
Markets, as they are wont to do, have supplied the demand for this safer financial institution. The Narrow Bank USA Inc. (TNB), founded by 28-year Fed veteran James Mcandrews would, “accept deposits from the most financially secure institutions” and place that money in an interest-bearing Fed account, “permitting depositors to earn higher rates of interest than are currently available to nonfinancial companies and consumers.’”
Unfortunately, the New York Federal Reserve denied TNB’s application for an account, preventing it from earning interest on its deposits and making its business model unworkable. TNB has sued the Fed in response, and while the reasons for the Fed’s decision are unclear, John Cochrane has a few theories.
The Fed may worry about controlling the size of its balance sheet — how many reserves banks have at the Fed, and how many treasuries the Fed correspondingly buys. If narrow banks get really popular, the Fed might have to buy more treasuries to meet the need. Alternatively, the Fed might have to discriminate, paying narrow banks less interest than it pays “real” banks, in order to keep down the size of the narrow banking industry. It would then face hard questions about why it is discriminating and paying traditional banks more than it pays everyone else. (It’s already a bit of a puzzle that it often pays interest on reserves larger than what banks can get anywhere else, even treasuries.)…
The Fed’s efforts to downsize its balance sheet could be complicated by the growth of narrow banking (if it catches on), but Cochrane also offers a more cynical theory.
Banks are making a tidy profit on their current activities. JP Morgan Chase pays me 1 basis point on my deposits, as it has forever, and now earns 1.95% on excess reserves. The “pass through” from interest earned to interest paid to depositors is very slow. This is a clear sign of lack of competition in the banking system. The Fed’s reverse RP program was put in place, in part, to pressure banks to act a bit more competitively, by allowing an almost-narrow bank to take investor money and put it in reserves. The Fed is now scaling that program back.
That the Fed, which is a banker’s bank, protects the profits of the big banks system against competition, would be the natural public-choice speculation.
It’s too early to tell if TNB will prevail in court, but if it prevails, it would offer many businesses (and potentially consumers) the option save their money in a safer financial institution and increase interest-rate competition in the banking industry.