BANKS AND MONETARY ALCHEMY
Ever since the financial crash of 2008, the banks have been at the heart of thorough debates. Undoubtedly, the banking crisis has revealed serious gaps with respect to certain risks (in American real estate, for instance). This crisis was incompatible with the careful management of popular savings.
Over the course of four years, numerous lessons have been learnt and financial sector public authority guardianship has become legitimately more severe.
Besides, the banks are henceforth reimbursing the State aid they received in 2008 whilst remunerating them for the guarantees. Moreover, they finance the States by canalizing depositor savings towards public debt financing.
Taking this into account, the bank management issue is extremely complex for it’s the commercial banks that create the money.
In other words, they are enterprises which produce their own raw materials. Indeed, contrary to a widely-spread opinion, rather than central banks, it’s the commercial banks that create our money.
Of course, central banks provide indications with respect to interest rates and allow commercial banks to refinance themselves, the reason for which they are being referred to as “lenders of last resort”. The central banks thus create the money, yet only on a supplementary basis. What is more, the monetary creation of these banks is minor to that of merchant banks.
Commercial bank monetary creation is working thanks to, what economists describe as the “deposit multiplier”. The English refer to it using the adagio “loans make deposits”. Through this mechanism, merchant bank deposits are being on-lent by the latter to another economic agent. He/she will in his/her turn use the borrowed money for transactions which will eventually become the deposits of other banks, after which the money will be on-lent to new entrepreneurs, etc.
This credit operation multiplication provokes an instantaneous cash flow, the velocity of which can be increased or slowed down by numerous regulatory demands. What is more, the role of central banks consists in – counter-intuitively – accelerating the de-hoarding of the money which has been conferred upon them.
If it wants to be operative, monetary creation needs a commercial bank community for it cannot be activated by one single bank. Each bank thus contributes to the monetary creation process, which results in some institutions to become systemic, i.e. playing an essential role in monetary creation. The bankruptcy of these systemic banks would lead to cash flow discontinuity, which would provoke immediate effects on real economy.
Commercial banks only exist through the network they set up. For this reason, we feel the importance to conserve sufficient competition in this sector, which is yet naturally oligopolistic. Should the number of banks shrink, this would lead to progressively relying monetary creation upon central banks. The latter would thus move on from their role of lenders of last resort to become the interbank market hub. This situation would result in credit nationalisation and monetary creation, which would no longer be tempered by market economy offer and credit demand regulations.
The monetary base depends on bank credit variation. One of the system’s obstacles is merchant bank equity level, which obliges them to freeze a share every time a credit is granted. However, since the banks don’t need to freeze public sector credit equity (i .e. when they hold State bonds), they have naturally become the extension of the States in the monetary creation context.
Moreover, the abusive monetary creation which we are facing could be the germ of this stolen nationalisation. Indeed, the States have recaptured monetary creation so as to finance their debts, at the risk of currency devaluation and jeopardising monetary standard sustainability.
Should this orientation be confirmed, public debt and monetary creation will converge towards a partial expropriation of private economy. Incidentally, this is one of the numerous reasons for which the nationalisation of banks (or long-term public shareholding) is extremely unhealthy: by demanding the banks to finance them, the States create money through monetising their loans whilst at the same time using credits to their benefit.
Private shareholders are vital for they amortise private sector credit losses. Moreover, they know that their true risk comprises the dilution of their shares following a nationalisation. As a consequence, a bank needs to possess sufficient equity to prevent savings being negatively impacted in case of major losses. Belonging to the shareholders, this equity acts as a monetary creation shock absorber.
In light of the above, it can be understood why the States have contributed to the recapitalisation of the banks so as to prevent cash flow discontinuity. Conversely, the bankruptcy of Lehman Brothers did not provoke disastrous effects for it was an investment bank which reaped a very limited part of deposits.
