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Could Greater Deposit Transparency Improve Bank Lending?

Civitas, 14 September 2010

This week, Douglas Carswell MP and Steve Baker MP are putting an interesting proposal before the Commons in the form of their Financial Services (Regulation of Deposits and Lending) Bill. The proposal would clarify the relationship between banks and deposit holders by requiring banks to gain explicit permission to lend out money. Such a reform could play a key role in holding high-street banks to account.

Under current laws, high-street banks maintain a key advantage over other companies. They are allowed to treat money in current accounts both as an on-demand deposit (that can be withdrawn by the account holder at any time) and a loan that can be lent out indefinitely. This makes it much easier for them to lend out money in the good times. However, it also causes problems during a credit crunch or when a bank is considered unsafe for any reason. Then people realise that money cannot actually be in two places at once and deposits could potentially be lost, often requiring the Government to step in to restore confidence.

In a more transparent system, people would see the link between bank deposits and lending. They would appreciate that banks are only able to provide the services (and interest on accounts) that they do because they lent out a large proportion of all money deposited. With that comes a small measure of risk as well. Sometimes debts aren’t repaid on time or not at all. Customers could have the option to opt out of taking that risk, and pay a small fee for banking services instead, or select the level of risk they are prepared (how much of their deposit should be available on-demand at any one time).

The advantage to the rest of the economy would be to remove the excessive market power that major high-street banks have on lending to businesses. Currently, smaller scale alternatives (whether banks, mutual building societies, or co-operatives) might possess superior knowledge and interest in local businesses and other enterprises but are unable to attract investors on favourable terms. Reform could allow this knowledge to be unleashed and allow more small businesses to benefit. As the recent financial crisis has illustrated, it is not as if the big banks have proven particularly worthy of their (legally protected) superior market position.

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