
The Fed stalls the creation of a bank with a novel business model - known
https://www.economist.com/finance-and-economics/2018/09/22/the-fed-stalls-the-creation-of-a-bank-with-a-novel-business-model
======
dannyw
In a competitive market, if the Fed is paying out 1.95% to bank reserves,
there is no reason why my savings account shouldn't pay me that figure minus a
spread for expenses and a profit spread.

~~~
pankajdoharey
Well nothing stops you from investing abroad, For instance Investing in Indian
Bank as a depositor will get you a guaranteed 6-7% return per annum depending
on the bank. Long term deposits have even higher return rates, some smaller
private banks even give as high as 8-9% on deposits.

~~~
deepGem
Holds true only if you convert your currency to INR. The dollar denominated
deposits (FCNR) have far lower yield around 3.4% still better than what the US
banks offer.

[https://www.icicibank.com/nri-
banking/RHStemp/rates.page](https://www.icicibank.com/nri-
banking/RHStemp/rates.page)

But I think you need to hold an Indian passport to open these deposits. I am
not sure though.

~~~
pankajdoharey
Actually even i am not sure about that. There should be some route though,
Foreign Institutional Investors do invest so there should be some legal route
to circumvent this.

------
User23
There is the usual misinformation in this article. Banks don’t loan out
deposits. Originating loans expands their balance sheet. Deposits are useful
to satisfy reserve requirements, when they exist[1], but if the loan is
profitable the bank can always borrow the reserves at a lower rate on the
interbank market.

[1][https://www.federalreserve.gov/monetarypolicy/reservereq.htm](https://www.federalreserve.gov/monetarypolicy/reservereq.htm)

~~~
UncleEntity
Banks have always loaned out deposits, that's just what they do elsewise
they'd be money warehousing operations and there'd be no fractional-reserve
banking cartel.

~~~
klodolph
I think there's a bit of a subtlety in the parent comment that you may be
missing, because the "banks don't loan out deposits" is a reference to
fractional-reserve banking.

~~~
UncleEntity
That's the whole basis of fractional-reserve banking, banks loan out deposits
while keeping a small percentage on hand (last I cared to check it was 10%) to
meet their reserve requirements.

Without deposits banks couldn't loan out anything since they couldn't meet
their reserve requirements and they'd basically be insolvent.

So, true, banks don't loan out 100% of deposits but they certainly do loan out
deposits.

~~~
didgeoridoo
Edit: my comment was misleading and confusing and I’m too tired to fix it
right now so into the bin it goes :)

~~~
klodolph
No, that's not correct at all. It does mean that the back loans out an amount
of money equal to 90% of its deposits. In some sense it's not the "same" money
because the deposit amount is counted as money in its own right... both the
amount of money in the loan and the amount of money in the deposit is counted
as "money supply".

The 1000% figure comes from the fact that the money that the bank loans out is
in turn held in another deposit account somewhere, and so it has a cascading
effect... I deposit $100, my bank loans out $90 to person B, that money gets
saved in a bank which can then loan out $81, then $72.9 gets created somewhere
else. 1000% is just the limit of the sum 1 + 0.9 + 0.81 + ...

~~~
Dylan16807
And to put that all together, it means the bank is responsible for $1000 in
deposits, has $900 owed to it in loans, and has $100 of cash in the vault.

------
stephen_g
This article has a surprising misunderstanding of the way banks work for a
publication called “The Economist”. It is unintuitive, but banks _do not_ and
_can not_ lend out deposits. Banks lever their _capital_ (that is, paid up
shares and retained profits) to lend, and that lending creates new deposits.
Existing deposits and debt funding (money markets etc.) are useful as
liquidity so they can settle interbank transfers, but they aren’t allowed to
lend out of them, both out of regulations like the Basel framework, but also
because it would violate accountancy rules (deposits are liabilities, and you
can’t back a liability with a liability. In reality they create the loan
(asset) with a corresponding liability (the deposit).

The Bank of England (basically the UK federal bank) has published a good
article on this - [https://www.bankofengland.co.uk/quarterly-
bulletin/2014/q1/m...](https://www.bankofengland.co.uk/quarterly-
bulletin/2014/q1/money-creation-in-the-modern-economy)

~~~
zeroxfe
> In reality they create the loan (asset) with a corresponding liability (the
> deposit).

Isn't that just a book-keeping technicality? Fundamentally, the bank is still
using deposits to leverage a loan. Or am I misunderstanding your point?

~~~
empath75
So basically I deposit $1000.

Someone else goes to the bank and says ‘I want to borrow $1000’

Great the bank says, approved. And they set up a bank account for you that
says you have $1000 in it.

Now they’ve got $1000 in reserves and 2 accounts that claim to have $1000 in
it.

Now when you withdraw $500 where does that money come from? I can assure you
it’s not from the banker’s wallet. That’s coming out of my deposit. Not from
my account because my account still says they have $1000 on hold for me, it
comes from the actual cash I deposited. (Which of course isn’t actually cash
in most cases)

None of that matters in practice because unless everyone tries to withdraw all
the money at once there’s plenty to cover all the withdrawals, but they are
definitely using money from deposits to cover withdrawals.

~~~
stephen_g
I think part of the problem to understanding is that you’re assuming that
banks are places that store money. They aren’t really, they are places that
hold various types of assets and manage IOUs between themselves and other
parties (other Banks, the Government/Fed, and customers etc.) in either
direction.

Banks don’t really store money, you give them money and they give you bank
credit, and then later on you exchange that credit back for money or transfer
credit to someone at another bank and the two banks settle that with some
asset (could be reserves etc.).

I think this is the main confusion, of course the physical cash the bank gives
you for a withdraw might have been given to the bank during a deposit
transaction, but in terms of the transactions on the balance sheet it did not
come from there.

------
spectrum1234
I don't understand why banks would give this bank their money. Shouldn't they
be getting this same rate from the Fed? Something is left out.

~~~
dmurray
I think their target customers are not banks. The article says it would "take
deposits from financial institutions" but this could mean insurance companies,
pension funds, credit unions, securities exchanges, etc. Anyone who might have
substantial cash reserves as an integral part of their business, but who does
not actually have a banking license.

Edit: from the Matt Levine piece linked further down the comments, the target
customers are "money-market funds and foreign central banks".

------
captainmuon
Unless I'm missing something, why doesn't every bank have an "internal narrow
bank" that takes deposits and puts them at the central bank?

Actually, I thought that is exactly how banks have to operate right now... All
deposits are settled in the interbank system or ultimately with the central
bank. You can't just deposit money in a bank, because "depositing" $100 means
telling an upstream bank that your bank now owes you $100.

~~~
incompatible
They can do, quite a lot of money is on deposit at the Fed. But they may find
it more profitable to lend the money elsewhere. All true government issued
money is either in the form of banknotes and coins or deposits held at the
central bank.

~~~
pas
What is gov issued money? The money created by the fed is gov issued too, no?
And it sits on the Fed's balance sheet as liability, debt, but not as deposit.

~~~
incompatible
For simplicity I'm taking the Fed as part of the government. I know the setup
in the USA is a bit strange. A government can create as much money as it
likes, debt on a balance sheet is an optional accounting detail.

~~~
thelasthuman
So the federal reserve isn't part of the government?

------
apo
_... The central bank may worry that narrow banks, which lend to neither
companies nor individuals, could hamper the effectiveness of monetary policy.
Their business model may also risk unsettling incumbent banks, which could
have large economic consequences. ..._

This is almost certainly a big reason for the opposition. The Federal reserve
wants to keep people from "hoarding" (saving) money at all costs. Driving down
interest rates and causing inflation is one tactic. Preventing the emergence
of banks who can out-compete the rest of the market on interest rates is
another.

------
cryptonector
> The Narrow Bank would take deposits but not make loans

That can't work, not if you scale it up across the industry. The Fed could not
continue to pay interest even on overnight deposits without it directly
turning into inflation. The economy could not function without loans.
Alternatively the Fed would have to become the one (and only) lender for
commercial (and muni, and...) purposes so that it could make the interest
income on those with which to service deposits from these "narrow banks". A
narrow bank is essentially free-loading, and politically untenable.

~~~
konschubert
Matt Levine writes about this in his newsletter:
[https://www.google.de/amp/s/www.bloomberg.com/amp/view/artic...](https://www.google.de/amp/s/www.bloomberg.com/amp/view/articles/2018-09-06/fed-
rejects-bank-for-being-too-safe)

BTW, it's a really great newsletter, always entertaining and has been teaching
me a lot about the world of finance. His take on the Tesla scandal is
hilarious.

~~~
sah2ed
> _His take on the Tesla scandal is hilarious._

If you are curious as I was, here is the link:

[https://www.bloomberg.com/view/articles/2018-08-13/funding-f...](https://www.bloomberg.com/view/articles/2018-08-13/funding-
for-elon-musk-s-tesla-buyout-wasn-t-so-secure)

~~~
konschubert
That's not the one I meant, he's also talking about Tesla in his newsletter.
Probably still worth reading.

------
twic
Why is it so crucial to their business model that the customers' deposits are
deposited directly with the Fed, rather than lent out to other banks on the
overnight Fed Funds market? The Fed Funds rate is typically lower than the
IOER rate paid on deposits with the Fed, but only by a small amount:

 _since early 2009 the fed funds rate has generally been 5 to 20 basis points
(one basis point is equal to 0.01 percentage points) lower than the IOER_ [1]

For example, money lent out on the Fed Funds market on thursday earned 1.92%
[2], while money deposited with the Fed earned 1.95% [3].

The Not-Quite-So-Narrow Bank wouldn't be able to pay as high a rate of
interest to depositors as the true Narrow Bank, but it also wouldn't be
dependent on the cooperation of the Fed, and Congress's authorization to the
Fed, in collecting the IOER rate.

While looking up those numbers, i came across a nice detailed series of posts
by George Selgin on IOER [4] and the Narrow Bank in particular [5] [6] - well
worth a read.

[1] [https://www.stlouisfed.org/publications/regional-
economist/a...](https://www.stlouisfed.org/publications/regional-
economist/april-2016/interest-rate-control-is-more-complicated-than-you-
thought)

[2]
[https://apps.newyorkfed.org/markets/autorates/fed%20funds](https://apps.newyorkfed.org/markets/autorates/fed%20funds)

[3]
[https://www.federalreserve.gov/monetarypolicy/reqresbalances...](https://www.federalreserve.gov/monetarypolicy/reqresbalances.htm)

[4] [https://www.alt-m.org/2017/06/01/ioer-and-banks-demand-
for-r...](https://www.alt-m.org/2017/06/01/ioer-and-banks-demand-for-reserves-
yet-again/)

[5] [https://www.alt-m.org/2018/09/10/the-skinny-on-the-narrow-
ba...](https://www.alt-m.org/2018/09/10/the-skinny-on-the-narrow-bank/)

[6] [https://www.alt-m.org/2018/09/14/the-narrow-bank-a-follow-
up...](https://www.alt-m.org/2018/09/14/the-narrow-bank-a-follow-up/)

~~~
srgseg
Because then you have counterparty risk, which means you then have greater
regulatory/compliance costs and have to pay up to 0.4% on assets for FDIC
insurance.

~~~
twic
Counterparty risk on Fed Funds loans, which are for one day only and to solid,
highly regulated financial institutions, is negligible - that's why it's
treated as the risk-free rate.

Would you need FDIC insurance if you only took deposits from financial
institutions?

~~~
srgseg
> Why is it so crucial to their business model that the customers' deposits
> are deposited directly with the Fed

Note that whether interest was earned via IOER or via the Fed Funds market,
the funds would be deposited with the Fed either way (whether in the bank's
own Fed account or overnight in the Fed account of the counterparty of a Fed
funds loan).

It wouldn't be possible to accept transfers from other banks, to send funds to
other banks or to participate in the Fed Funds market unless the bank had an
account with the Fed.

On the point of "risk-free", the TED spread was north of 1% for much of the 20
months between August 2007 and April 2009, and peaked at over 4%. So it's not
always what I'd call negligible risk.
[https://fred.stlouisfed.org/series/TEDRATE](https://fred.stlouisfed.org/series/TEDRATE)

------
ttul
The Fed is probably concerned that, if the idea catches on, trillions in
deposits could be vacuumed out of the fractional reserve banking system,
leaving less available for lending.

If that were to happen, the Fed would lose considerable influence over
liquidity. Its only lever on narrow banks would be to adjust the deposit rate
encouraging savers to go elsewhere.

------
known
[https://archive.st/archive/2018/9/www.economist.com/w316/](https://archive.st/archive/2018/9/www.economist.com/w316/)

------
lesserknowndan
Debt is created not money. You can’t pay the ferryman with an IOU from a bank.

~~~
goodcanadian
Actually, that is pretty much exactly how it works. Banknotes (i.e. cash), are
explicitly IOUs from a bank. Usually, it is a central bank, such as the Bank
of England, but sometimes, it could be another bank. There are three retail
banks in Scotland that are authorised to issue banknotes:
[https://en.m.wikipedia.org/wiki/Banknotes_of_Scotland](https://en.m.wikipedia.org/wiki/Banknotes_of_Scotland)

------
seibelj
I'm sure this is an interesting article, but not only is my "article limit"
reached, but I even can't login to read it.[0] Which is strange, given the
hundreds of dollars per year I give The Economist to support them.

If you want to stop people from stealing your articles, maybe give the paying
readers access would be a start.

[0] [https://imgur.com/a/2uo4hnE](https://imgur.com/a/2uo4hnE)

~~~
topmonk
I will set you free: [http://archive.is/JYM3P](http://archive.is/JYM3P)

~~~
seibelj
That's fine and all, but I am happy to pay for top-notch journalism. But even
me, the paying customer, is locked out.

------
comboy
A good starting point for those who want to learn something about the FED:
[https://www.youtube.com/watch?v=mQUhJTxK5mA](https://www.youtube.com/watch?v=mQUhJTxK5mA)

Just the basics, but I doubt these are obvious to everybody.

