The economist John Kay wrote in a paper on “Robust and Resilient Finance” that while “many aspects of the modern financial system are designed to give an impression of overwhelming urgency… only its most boring part – the payments system – is an essential utility on whose continuous functioning the modern economy depends”. His choice of word — utility — is interesting. Just like the electricity network or the water system, not only are payments a utility but they are also critical infrastructure: If the stock market shuts down for a day, life goes on, but if salary payments stop because of a bank failure, customers cannot access their money because of bug-ridden software update or debit cards stop working in supermarkets because of misplaced cost-saving on testing, there is chaos. Perhaps we need to think again about how the payments system works.
Money Utilities
Matthew Klein says that banks are speculative investment funds grafted on top of that critical infrastructure and goes on to suggest that the public sector should embrace the role because money and the payments system are public goods. As he sees it, banks could focus on (what should be) their core competency of identifying creditworthy borrowers and making profitable loans. I think this is a very interesting perspective that is brought into focus because of two imminent developments in that critical infrastructure: FedNow, which is coming along in the summer, and the Digital Dollar, which could well be coming along soon.
I mention both of these because I am a payments nerd, so I distinguish between the implementations of electronic money that lives in bank accounts and flows around banking networks and the implementation of electronic cash that lives in devices and flows over the Internet, Bluetooth, WiFi and other forms of communications network. They are chalk and cheese, apples and oranges. But in both cases, the idea that the underlying Federal Reserve product (money) could be delivered into the mass market by regulated organisations other than commercial banks is worth exploring.
How could this work? Matt Stoller provides a robust criticism of the Fed in his newsletter “Fire the Fed”, noting that the The Fed sees banking as ‘innovative,’ which he says is “ridiculous and means we will always structure banks, and our economy, in unfair ways”. Maybe we do not want innovative banks. Maybe as Matt says banking is a “public utility service” and we should start treating it that way.
But how? Well, Mihir Desai and Sumit Rajpal, writing in the Harvard Business Review, suggest that the U.S. should create a special class of bank called a “payment bank” that does nothing more than process payments and earn a safe return by holding deposits with the Fed at the federal funds rate or charging customers clients a very small fee for facilitating these large payments. Now, ideas of narrow banking and “flow accounts” are not new but in a post-Silicon Valley Bank world of embedded finance, tokens and digital dollars it seems they may be reinvigorated. Why couldn’t fintechs or techfins hold customer money in accounts at the Fed to create a risk-free payments layer for the wider economy?
Suppose, for example, that the Fed gave settlement accounts to properly-regulated fintechs so that they could exchange electronic money directly without having to go through banks. Crazy? Well, no. That’s what the economist George Selgin, Director of the Cato Institute’s Center for Monetary and Financial Alternatives, and others have long argued for. This was the approach taken in the U.K., for example, when the Bank of England decided a few years ago to give accounts to fintechs. The fintechs who took advantage of this opportunity used it deliver a better and cheaper service to customers: They range from my favourite fintech Wise (which I use all the time) to the open banking startup Modulr (which counts PayPal Ventures amongst its investors).
Similarly, suppose the Fed allowed anyone with an approved, security-certified wallet in their phone, car, USB stick or whatever else to hold digital dollars and send them to any other such wallet: Who knows what innovative new services might be built on top of this simple, device-to-device robust form of electronic cash!.
Public Services
Banks as we know them are built on top of three “transfer functions”. These are transfers in space (payments), transfers in time (savings and loans) and transfers in scale (investments). But it is not a law of nature that these functions should sit inside the same institutions: Indeed, they could be implemented in entirely different organisations. Perhaps it is time to be more radical in our rethinking of the infrastructure for the online age: provide digital fiat as a public good and allow non-banks to implement the transfers in space as a utility using the two together (electronic money and electronic cash) to put in place robust, inclusive and sustainable pipes for the rest of the economy to use.
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