A future with fewer banks

Imagining a world without banks

It is hard to conceive of a world without banks, partly because they are so visible. 

Picture the horizon of any big city, and the skyscrapers in view are usually banks. 

Commuters emerge from Grand Central station in New York in the shadow of the Park Avenue base of JPMorgan Chase.

Morgan Stanley looms over Times Square; Bank of America over Bryant Park. 

In London the skyline is dominated by odd-shaped towers in the City and Canary Wharf. 

In Singapore the top floors of the offices of Standard Chartered and uob house rooftop bars looking out over the entire city. 

Even in places like Auckland, Mexico City or Jakarta, the logos adorning the tallest buildings are those of anz, bbva or hsbc.

The physical dominance of banks symbolises their importance. 

Most people interact with their banks for such mundane transactions as buying groceries. 

Companies pay their workers, suppliers and landlords through banks. 

Banks are also there for bigger decisions, such as buying a house or getting a student loan.

For almost as long as there has been money (whether cowrie shells, gold, banknotes or digital deposits),there have been institutions providing safe storage for it. 

And for as long as deposit-taking institutions have existed, their managers have realised how in normal times not all depositors will demand their money back at once. 

That means they do not have to keep cash on hand for every deposit—instead they can use the money to make loans. 

Thus bankers provide funding for private investment and earn interest for themselves. 

This was a marvel to classical economists. 

“We have entirely lost the idea that any undertaking likely to pay, and seen to be likely, can perish for want of money,” wrote Walter Bagehot, then editor of The Economist, in his 1873 book “Lombard Street”. 

“Yet no idea was more familiar to our ancestors.”

The “fractional reserves” that banks hold against their deposits have another effect, however: to make them inherently unstable institutions. 

The history of capitalism and of money is thus one of relentless economic enrichment, pockmarked by the scars of frequent bank runs and financial crises.

Much has changed about banking since Bagehot’s day. 

Then the biggest banks were in London; now they are in New York, Beijing and Tokyo. 

Technological change means nearly all payments are settled digitally, rather than with notes or cheques. 

The banks are also far bigger. 

The total assets of the world’s biggest 1,000 banks were worth some $128trn in 2020, dwarfing annual global gross product of $84.5trn.

And yet a world without banks is also visible on the horizon. 

As never before, their role is under threat from new technology, capital markets and even the public sector. 

Central bankers have seen tech giants develop quicker and easier payments systems that could pull transactions out of the banking system. 

They worry that digital payments may bring about the end of cash. 

Financial regulation and monetary policy have traditionally operated through banks. 

If this mechanism is lost, they may have to create digital central-bank money instead.

Because technology has disrupted so many industries, its impact on banking may seem like one more example of a stodgy, uncompetitive business made obsolete by slick tech firms. 

But money and banking aren’t like taxis or newspapers. 

They make up the interface between the state and the economy. 

“The deep architecture of the money-credit system, better known as banking, hasn’t changed since the 18th century, when Francis Baring began writing about the lender-of-last-resort,” says Sir Paul Tucker, formerly deputy governor of the Bank of England and now at Harvard. 

“Which means it has not, so far, depended on technology at all, because Francis Baring was writing about it with a quill pen.”

Now a new architecture is emerging that promises a reckoning. 

“Economic action cannot, at least in capitalist society, be explained without taking account of money, and practically all economic propositions are relative to the modus operandi of a given monetary system,” wrote Joseph Schumpeter in 1939. 

Yet it is possible to see a future in which banks play a smaller role, or even none at all, with digital money and deposits provided by central banks, financial transactions carried out by tech firms and capital markets providing credit.

Bad change or good?

The question is whether such a world is desirable. 

Banks have many flaws. 

Scores of the unbanked are too poor to afford them. 

They can be slow and expensive. 

They often make more money from trading and fees, not normal banking. 

Negligent banks can create boom-and-bust cycles that inflict economic hardship. 

So it is easy to assume that the sidelining of banks might be just another shackle broken by technological advance.

Yet a world without banks poses some problems. 

Today central banks provide very little to economies. 

Around 90% of the broad money supply is in bank deposits, underpinned by small reserves held with the central bank and an implicit central-bank guarantee. 

This makes it easier for central banks to instil confidence in the system while still keeping at arm’s length from credit. 

Widely used central-bank money would bring them nearer the action, causing their balance-sheets to balloon. 

This creates risks.

Banking and capitalism are closely linked. 

Economists still debate why Britain industrialised first, but it is hard to read Bagehot and not conclude that the alchemy of banks turning idle deposits into engines for investment played a part. 

The question is what happens if central banks play a bigger role instead. 

It might be possible for them to avoid actually distributing loans, but it is hard to see how they could avoid some interference in credit markets.

There are broader social risks as well. 

Banking is fragmented, with three or four big banks in most countries, plus lots of smaller ones. 

But state-issued digital currencies and private payments platforms benefit from network effects, potentially concentrating power in one or two institutions. 

This could give governments, or a few private bosses, a wealth of information about citizens.

It would also make the institutions a lot more vulnerable. 

A cyber-attack on the American financial system that closed JPMorgan Chase for a time would be distressing. 

A similar attack that shut down a Federal Reserve digital currency could be devastating. 

And there is the potential use of money for social control. 

Cash is not traceable, but digital money leaves a trail. 

Exclusively digital money can be programmed, restricting its use. 

This has benign implications: food stamps could be better targeted or stimulus spending made more effective. 

But it also has worrying ones: digital money could be programmed to stop it being used to pay for abortions or to buy books from abroad.

The scope of the issues this special report will consider is vast. 

It includes the role of the state in credit provision, the concentration of power in tech firms or governments, the potential for social control and the risk of new forms of warfare. 

A world without banks may sound to many like a dream. 

But it could turn out to be more like a nightmare.

The Fed and Schrödinger’s Phillips curve

Central banks have gone quantum: here’s why

Guest writer 

     © AFP via Getty Images

Confused about why the Fed is committed to higher inflation despite mixed signs of recovery in the US economy? 


Edward Price, a former British economic official and current teacher of political economy at New York University’s Center for Global Affairs, explains the paradox at the heart of the US central bank’s new monetary framework.

Erwin Schrödinger, a physicist, studied the tiniest of things. 

And he discovered something bizarre. 

If observed, the atomic world will change its state. 

Schrödinger illustrated this idea with an imagined cat. 

In an irradiated box, and as long as this cat remains unseen, it can remain both dead and alive. 

Only when the box is opened will its actual fate occur.

Which is ludicrous. 

Schrödinger himself admitted as much. 

He hoped his thought experiment would illustrate the absurdity of other quantum scientists’ views. 

But, as a theory, it’s no more or less ridiculous than some mainstream economics.

That includes ideas that lie at the heart of monetary policymakers’ models.

Take the Phillips curve. 

It posits an inverse relationship between inflation and unemployment. 

Simply put, the more people with jobs, the more money there is in the system. 

That, in turn, should mean a higher rate of inflation. 

For many years, the Phillips curve was considered economic science. 

But then, in the late 1960s, Milton Friedman treated the curve to a savage takedown. 

He showed policymakers can’t rely on the trade-off between wages and prices — injecting inflation to lower unemployment — because workers will notice what they’re up to and demand better pay as a result. 

Eventually, he argued, inflation will outpace job gains, something which occurred in the 1970s. 

Moreover, the Phillips curve doesn’t explain situations when both inflation and unemployment are low, for example during the first quarter of 2020.

Yet, none of these flaws, it seems, has truly knocked the inflation-employment trade off from its golden pedestal. 

The theory is still referenced today, especially by central banks. 

Today, for instance, markets’ attention has been focused on the non-farm payrolls figures. 

These figures were dreadful, with the US economy only adding about a quarter of expected job gains.

Given concerns over the US economy’s ability to recover, Jay Powell, the Fed chair, has made clear that the Fed will provide support for “as long as it takes” to achieve a buoyant job market and, with it, inflation. 

At first glance, there’s nothing wrong with that. 

Under the Fed’s contract with the government, it must produce two things: stable prices and full employment. 

But, at a second glance, that mandate appears at odds with Friedman’s description of the Phillips curve. 

Full employment is supposed to forfeit stable prices and vice versa.

To get round this, the Fed has concocted two conceptual hacks.

The first is the non-accelerating inflation rate of unemployment, or NAIRU. 

A mouthful, NAIRU simply refers to the idea that, in any stable monetary system, some people naturally won’t have jobs. 

In turn, there’s no need to pursue literal full employment.

The other leeway comes from an equally playful definition of stable prices. 

The Fed, and other central banks, can’t pursue nominal price stability. 

That would require an entirely static monetary system in equilibrium with an entirely static economic system. 

Which is impossible. 

Instead, a gentle reminder to go out and spend — the loss of real purchasing power, which comes about with a little inflation — is preferred.

That loss of real purchasing power has largely eluded central banks of late, however. 

That’s despite U3, the most commonly used measure of unemployment, falling to levels consistent with NAIRU.

Which explains why the Fed last year abandoned its old framework and adopted a flexible average inflation target (FAIT), under which it can tolerate inflation above its goal of 2 per cent for (an unspecified) period. 

The aim is twofold, and simple. 

More inflation and, with that, more jobs. In other words, if inflation is so persistently low, the notion of NAIRU has got to go.

This is where things get weird.

The proposed mechanics of FAIT are an affirmation of Phillips curve theology. 

In other words, FAIT assumes the curve is alive and well. 

More inflation will result in more jobs. 

But, at the same time, it’s only possible to adopt FAIT because the Phillips curve is very much dead. 

And monetary policymakers killed it. 

Without the persistently low inflation monetary authorities have achieved, no central banker would dare embark on a bout of deliberate and sustained inflation.

So, which is it? Is the Phillips curve alive or dead?

On the one hand, alive. 

In combination with actual and proposed US fiscal stimulus, which amasses to almost a quarter of US GDP, the central bank might have a pretty good shot at producing an upward tick in prices. On the other hand, dead. 

Today’s nonfarm numbers were woeful. 

If the conclusion is we’ve been measuring unemployment wrong this whole time, and for whatever reason inflation remains low, we can indeed kiss goodbye to NAIRU.

This is the conundrum at hand. 

The Fed’s stance only makes sense because the natural rate of unemployment is at once known and unknown.

Economists have long been accused of physics envy, or the desire to predict the macroeconomy as reliably as physicists predict natural phenomena. 

But the most compelling parts of both physics and economics have nothing to do with Newtonian mechanics. 

Instead, people are like atoms. 

Interact with them, and things invariably get strange. 

The macro cannot be extrapolated from the microscopic, at least not until after the event. 

For mainstream equilibrium theory, this is a bitter red pill. 

But it seems the Fed has swallowed it, waking up from the slumber of dismal science to a far stranger reality.

Welcome to the weird and wonderful world of quantum central banks.

Chinese Property Bonds Are Hot, Defaults Aside

Investors find more appetite for risk as they hunt for yields in a challenging market

By Xie Yu

China’s property bond sales are up, despite market challenges. Pictured: Guangzhou, in the southern province of Guangdong. / PHOTO: NOEL CELIS/AGENCE FRANCE-PRESSE/GETTY IMAGES

Yield-hungry investors are still snapping up Chinese property bonds, despite a recent string of defaults, tighter regulation and market unease about one of the country’s biggest developers.

As of June 2, real-estate companies from China had sold $20.3 billion of dollar bonds this year, according to Refinitiv, a 16% increase over the same period last year.

Heavy bond issuance from Chinese developers is “completely contrary” to market expectations for a decline in deals, said Owen Gallimore, head of credit-trading strategy at ANZ. 

He said alongside debt sales by Chinese tech firms, this was offsetting subdued supply from state-backed companies. 

“When deals come, the investor demand is enormous,” Mr. Gallimore said.

Last week, Times China Holdings Ltd. got more than $4.8 billion of orders for a $400 million, three-year junk-bond deal yielding 5.55%, according to a notice from one of the underwriting banks. 

The bonds from Times China, which is based in the Southeastern province of Guangdong, were rated 3-4 notches below investment-grade.

The robust bond sales are surprising because the sector is contending with a series of official moves intended to calm the property market and reduce indebtedness among real-estate companies. 

Among other measures, regulators have told banks to cap property lending, and a system of “three red lines,” widely reported in local media, essentially requires financially weak players to reduce their debts.

However, much of the new debt is simply replacing maturing bonds, meaning that it doesn’t worsen company debt levels, while housing sales are growing rapidly. 

So analysts still expect most companies in the sector to come into compliance with the government’s deleveraging push.

Jefferies analysts forecast major developers are likely to grow sales by 20% for all of 2021.

The creditworthiness of most Chinese developers is likely to improve this year, said Luther Chai, a senior credit analyst at CreditSights in Singapore. 

“Even though most developers may still record a growth in total debt, we expect the pace of year-on-year debt growth to slow,” he said.

Official approvals for bond sales, both on and offshore, have largely been granted for refinancing existing debts, Mr. Chai said. 

In addition, Mr. Chai said strong so-called “contracted sales” in previous years implied developers were likely to enjoy robust revenue growth from this year onward.

A developer records a contracted sale when it finds a buyer for an apartment, but doesn’t recognize the revenue until it completes the unit. 

He said in turn, the revenue growth would help lower widely watched ratios such as debt to earnings before interest, tax, depreciation and amortization, or Ebitda.

The red lines might hinder growth but also served to make real-estate firms financially stronger, by letting them spend more on paying down debts, said Chris Yip, senior director at S&P Global Ratings.

S&P estimates at least half of the real-estate firms it rates won’t be in breach of any of the red lines by the end of 2021, up from roughly 10% in June 2020. 

Mr. Yip said some bonds were also issued with maturities of just less than one year to avoid the regulatory review they would otherwise face.

In effect, a gulf has opened up between the industry’s stronger players and the laggards.

Shares and bonds in China Evergrande Group, one of China’s largest property companies, have sold off recently, with its stock nearing lows hit in the March 2020 market panic. 

A report from Caixin, a Chinese news outlet, stoked investor concerns that it could face fresh regulatory scrutiny.

At the same time, Sunshine 100 China Holdings, Oceanwide Holdings and China Fortune Land Development have all defaulted on debts this year. 

China Fortune Land, whose primary business is developing industrial parks, has some $4.6 billion of dollar debt outstanding.

The defaulters were either relatively small or not typical residential developers, Mr. Yip at S&P , helping limit the damage to broader investor sentiment. 

“But obviously if we’re talking about a much larger company, or a typical residential developer, that could change the story quite drastically,” he said. 

Central-Bank Independence Comes to Brazil

Central-bank independence is a democratic choice that enables the separation of money creation from government financing, laying the foundation for sustainable economic growth. The recently adopted Brazilian autonomy law is therefore a historic achievement to be celebrated – and handled with care.

Juliana B. Bolzani, Marcelo M. Prates, Flávio J. Roman, Marcel M. dos Santos

BRASÍLIA – In late February, after 30 years of debate in the Brazilian Congress, 

Complementary Law No. 179 took effect, granting “technical, operational, administrative, and financial autonomy” to the Central Bank of Brazil (BCB). 

The issue has been so divisive that the traditional term “independence” had to be replaced by the less politically charged “autonomy.” 

Despite this and other compromises, the day after the bill was signed into law, two political parties filed a lawsuit at the Supreme Court challenging its constitutionality.

The new autonomy law concludes a long-running institutional project that started with Brazil’s adoption of a new constitution in 1988. 

Article 164 of the Constitution established two pillars of central-bank independence: the BCB was granted sole authority to issue Brazil’s official currency and was prohibited from financing the Treasury or extending loans to non-financial institutions.

This framework was enhanced in 1999, when Brazil overhauled its monetary and exchange-rate policies, following a severe financial crisis. 

That year, the country abandoned its currency peg to the dollar and adopted a flexible exchange-rate system, which enabled the implementation of an inflation-targeting regime. 

This shift reinforced the perception that the BCB enjoyed de facto independence within the government.

The new law means that the BCB’s autonomy is now explicitly guaranteed by federal statute. 

Moreover, the legislation adds one missing piece to the legal framework supporting the central bank’s independence. 

Under the autonomy law, the BCB’s president and eight directors will be appointed by Brazil’s president and confirmed by the Senate, serve staggered four-year terms with the possibility of being reappointed once, and can be removed only for cause.

The autonomy law also dispels the myth that central-bank independence creates an unaccountable institutional superpower. 

Although the BCB will not have “ties or hierarchical subordination to any Ministry,” its actions will remain subject to judicial review and congressional oversight. 

For example, the law requires the BCB president to “present to the Federal Senate at public hearings to be held in the first and second semesters of each year an inflation report and a financial stability report explaining the decisions made in the previous semester.”

So, after three decades, Brazil’s constitutional plan for an independent, credible, and accountable central bank is complete. 

But has it come too late? 

Inflation currently is low in many countries, and the COVID-19 pandemic is showing that, without monetary support, governments may not have enough fiscal firepower to help those in need. 

Some therefore argue that the theoretical justification for central-bank independence is weaker than before.

We disagree. 

First, even when inflationary pressure is not a concern, central banks still must deal with other politically sensitive issues. 

From setting negative interest rates and managing international reserves to providing liquidity assistance or even letting a bank fail, many central banks’ decisions can become controversial and subject to political pressure. 

Mercurial leaders have often dismissed heads of central banks for reasons other than surging inflation and higher interest rates.

Central-bank independence is even more important when the institution receives a broader mandate, as has recently happened in Brazil. 

In addition to the BCB’s “fundamental objective” of ensuring price stability, the autonomy law adds three secondary objectives: “fostering the stability and efficiency of the financial system, smoothing fluctuations in the level of economic activity, and promoting full employment.” 

If the BCB were not independent, it could come under political pressure to use its wider authority to uphold partisan priorities, potentially preventing monetary policymakers from striking the right balance between their multiple objectives.

Second, the idea that any government in control of its sovereign currency can use the “money-printing machine” without worrying about trillion-dollar deficits or mounting national debt is highly misleading. 

Controlling the inflationary pressure created by endless money issuance may be relatively simple for a handful of countries that have a widely accepted international currency, structurally low interest rates, and a total debt (public and private) that is overwhelmingly denominated in their own currency.

For all other countries, Brazil included, creating money and supplying the economy with liquidity is easy, but withdrawing the excess liquidity later is much harder. 

Many central bankers might have the nerve to implement unpopular policy tightening in response to rising inflation. 

But they could end up losing their job if their institution is not independent enough.

Central-bank independence is a democratic choice that enables the separation of money creation from government financing, laying the foundation for sustainable economic growth. 

Without it, the collective interests and public values that central banks protect and advance are at risk. 

The Brazilian autonomy law is to be celebrated – and handled with care.

Juliana B. Bolzani is a senior expert in monetary and international affairs at the Legal Department of the Central Bank of Brazil.

Marcelo M. Prates is a senior expert in digital currencies and financial technology at the Legal Department of the Central Bank of Brazil.

Flávio J. Roman leads the litigation division at the Legal Department of the Central Bank of Brazil.

Marcel M. dos Santos leads the policy and regulation division at the Legal Department of the Central Bank of Brazil.