Banks, private money creation, and regulatory reform

Abstract

PurposeThis paper aims to consider recent arguments that post-crisis regulatory reform has misunderstood the nature of banks’ activities. These arguments suggest that a bank’s role is not that of intermediation between savers and borrowers but the systemically riskier one of private money creation.Design/methodology/approachThe paper assesses whether banks’ activities are best understood as private money creation rather than intermediation. It considers the argument that regulatory reform has not gone far enough to prevent a recurrence of future credit spirals ending in financial crises.FindingsThis paper analyses banks’ activities and finds that it is incorrect to consider that they engage in relatively unfettered money creation. While fractional reserve banking does create flows of money through the economy, these flows are tethered to banks’ funding requirements. Multiple use of that money, rather than representing an ill-understood risk, simply reflects the nature of maturity transformation. This has not been missed in designing the post-crisis regulatory framework. The revised framework contains many features that are not fully recognised by proponents of the money creation critique and goes significantly further than they allow. Once completed, it will address many of the concerns they raise. They are right to call for further consideration of whether the countercyclical features of the new framework are sufficiently developed.Originality/valueThe paper provides an early detailed response to recent criticism of the post-crisis regulatory reform programme coming from a money creation perspective of banks’ role in the economy.