Select Committee on Treasury Appendices to the Minutes of Evidence


Memorandum submitted by Mr James Robertson[17]


  Recent discussion about competition in the banking industry has not included the possibility that the way new money is now created may affect the cost structure of banking services so as to give a competitive advantage to the bigger banks. This Note suggests that the Select Committee might wish to ask for the Treasury's advice on this possibility.

  The Select Committee touched on the question of cost structure in paragraphs 42 and 45 of its Fifth Report on "Banking and the Consumer" of March 2001, as an "issue which arose in connection with payment systems, and also more generally". In particular, the Select Committee was concerned with "the extent to which different banking activities are cross-subsidised, or more generally the relation between the cost to banks of a particular service and the charges made to customers". It pointed out that regulation should be based on "access to both bank charges and their internal cost details" in order to ensure that the market for banking services is operating competitively.

  The present arrangement for creating new money and putting it into circulation as an addition to the money supply allows the UK commercial banks to create about 95 per cent of it by simply printing it into their customers' bank accounts as interest-bearing, profit-making loans. In a report published by the New Economics Foundation in 2000 my co-author and I estimated that the privilege of creating this public resource gives the UK banking industry a hidden subsidy of over £20 billion a year.[18] (We also proposed an alternative way of creating new money, which we estimated might bring in over £40 billion a year in public revenue—making it possible to reduce taxes or increase public spending or pay off public debt or a mixture of all three, up to that total. That could have many beneficial effects throughout the economy—eg as a less costly alternative to PFI—which are not in themselves directly relevant to banking competition.)

  The relevance to banking competition reflects the assumption that the bigger the bank, in terms of its lending to current account customers, the bigger the share it will receive of the aggregate annual subsidy stemming from the creation of new money—so giving it a competitive advantage against smaller banks. In other words the present way of creating new money skews the playing-field in favour of bigger against smaller banks—not only making it more difficult for smaller banks to compete but also making it more difficult for potential new players to get into the game.

  How new money is now created, and what the consequences are, is not widely understood—even within government itself. Sometimes, as in a written House of Lords answer on 23 November 2000, the government says that the funds that banks lend to customers "must either be obtained from depositors or the sterling money market, both of which usually require the payment of interest"— thus appearing to deny that banks are allowed to create new money and to profit from doing so.

  More often (eg in a letter of 18 October 2000 from a Treasury Minister to an MP) the government seems to accept the view that, if banks had to borrow all the funds they lend (as most other financial intermediaries do), their costs would rise significantly. The impact "on the cost of borrowing would be significant, adversely affecting business investment, especially of small and medium-sized firms... At present the banks are able to create money by making loans on which they charge interest, while having reserves which cover only a small proportion of total liabilities. This is the sense in which banks earn revenue from their participation in the creation of the money supply. If banks were obliged to bid for funds from lenders in order to make loans to their customers, the costs to banks of extending credit would rise significantly."

  In the particular context of banking competition the Select Committee will presumably not wish to consider the question, in all its important ramifications, whether the commercial banks should continue to be allowed to create over 95 per cent of all new money. But, in the context of banking competition, the previous paragraph seems to make it clear that the present arrangement distorts the market for credit—and the market for other bank services, the costs of which are "bundled" with the costs of bank-provided credit[19]—in a way that favours the bigger banks.

  In the first instance, the Select Committee might wish to seek further information and advice on this question. For example, they might like to ask the Treasury:

    —   to confirm that commercial banks are allowed to create money to lend to their customers, instead of borrowing it in the free competitive market for credit;

    —   to estimate broadly the total annual cost reduction (or hidden subsidy) this provides for the banking industry as a whole;

    —   to advise how this hidden subsidy is likely to be distributed between different types of banks, in terms of their size and the various features of their business; and

    —   to advise whether this is likely to favour the bigger banks and so impair free competition in the banking industry.

  In the light of the Treasury's response to that request, the Select Committee might then want to consider further what could be done to deal with whatever impediment to banking competition arises in this way.

25 April 2002

17   James Robertson is an independent writer and lecturer. His past experience includes working in the Cabinet Office, directing an Inter-Bank Research Organisation, and advising a House of Commons Select Committee on parliamentary control of public expenditure. Back

18   Joseph Huber and James Robertson, "Creating New Money: A monetary reform for the Information Age", New Economics Foundation, June 2000-a 92-page report. Back

19   The government's decision in March this year to force the big four banks either to pay interest on small business current account balances or to offer free banking is not designed to make the cost structure of banking services more transparent; and Halifax / Bank of Scotland (HBOS) has questioned whether that decision will redress the competitive balance between the big four and the smaller banks. Back

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