Funding money-creating banks: Cash funding, balance sheet funding and the moral hazard of currency elasticity

Abstract

Once banks are viewed as money creators rather than financial intermediaries, a distinction between their cash funding and balance sheet funding can be made. This distinction opens up various insights. It allows for a fuller explanation of the cash needs of banks with reference to the pattern of their cash gains and losses. It facilitates an understanding of the central bank as not only a cash lender of last resort (LOLR) for some banks some of the time, but also as a cash lender of continual and only resort (LOCOR) for all banks all of the time. It leads to novel insights into the sources of banks' balance sheet funding. The paper investigates the various implications of the central bank's elastic currency policy in its role as LOCOR, particularly how it thereby incites considerably more moral hazard than conventionally acknowledged. This realisation opens up a better understanding of the banking sector's proneness to excess and the economy's susceptibility to financial cycles. The paper concludes by weighing the merits of the only two policy strategies by which banking excess can be checked.