Memorandum submitted by Mr James Robertson
Recent discussion about competition in the banking
industry has not included the possibility that the way new money
is now created may affect the cost structure of banking services
so as to give a competitive advantage to the bigger banks. This
Note suggests that the Select Committee might wish to ask for
the Treasury's advice on this possibility.
The Select Committee touched on the question
of cost structure in paragraphs 42 and 45 of its Fifth Report
on "Banking and the Consumer" of March 2001, as an "issue
which arose in connection with payment systems, and also more
generally". In particular, the Select Committee was concerned
with "the extent to which different banking activities are
cross-subsidised, or more generally the relation between the cost
to banks of a particular service and the charges made to customers".
It pointed out that regulation should be based on "access
to both bank charges and their internal cost details" in
order to ensure that the market for banking services is operating
The present arrangement for creating new money
and putting it into circulation as an addition to the money supply
allows the UK commercial banks to create about 95 per cent of
it by simply printing it into their customers' bank accounts as
interest-bearing, profit-making loans. In a report published by
the New Economics Foundation in 2000 my co-author and I estimated
that the privilege of creating this public resource gives the
UK banking industry a hidden subsidy of over £20 billion
(We also proposed an alternative way of creating new money, which
we estimated might bring in over £40 billion a year in public
revenuemaking it possible to reduce taxes or increase public
spending or pay off public debt or a mixture of all three, up
to that total. That could have many beneficial effects throughout
the economyeg as a less costly alternative to PFIwhich
are not in themselves directly relevant to banking competition.)
The relevance to banking competition reflects
the assumption that the bigger the bank, in terms of its lending
to current account customers, the bigger the share it will receive
of the aggregate annual subsidy stemming from the creation of
new moneyso giving it a competitive advantage against smaller
banks. In other words the present way of creating new money skews
the playing-field in favour of bigger against smaller banksnot
only making it more difficult for smaller banks to compete but
also making it more difficult for potential new players to get
into the game.
How new money is now created, and what the consequences
are, is not widely understoodeven within government itself.
Sometimes, as in a written House of Lords answer on 23 November
2000, the government says that the funds that banks lend to customers
"must either be obtained from depositors or the sterling
money market, both of which usually require the payment of interest"
thus appearing to deny that banks are allowed to create new money
and to profit from doing so.
More often (eg in a letter of 18 October 2000
from a Treasury Minister to an MP) the government seems to accept
the view that, if banks had to borrow all the funds they lend
(as most other financial intermediaries do), their costs would
rise significantly. The impact "on the cost of borrowing
would be significant, adversely affecting business investment,
especially of small and medium-sized firms... At present the banks
are able to create money by making loans on which they charge
interest, while having reserves which cover only a small proportion
of total liabilities. This is the sense in which banks earn revenue
from their participation in the creation of the money supply.
If banks were obliged to bid for funds from lenders in order to
make loans to their customers, the costs to banks of extending
credit would rise significantly."
In the particular context of banking competition
the Select Committee will presumably not wish to consider the
question, in all its important ramifications, whether the commercial
banks should continue to be allowed to create over 95 per cent
of all new money. But, in the context of banking competition,
the previous paragraph seems to make it clear that the present
arrangement distorts the market for creditand the market
for other bank services, the costs of which are "bundled"
with the costs of bank-provided creditin
a way that favours the bigger banks.
In the first instance, the Select Committee
might wish to seek further information and advice on this question.
For example, they might like to ask the Treasury:
to confirm that commercial banks
are allowed to create money to lend to their customers, instead
of borrowing it in the free competitive market for credit;
to estimate broadly the total annual
cost reduction (or hidden subsidy) this provides for the banking
industry as a whole;
to advise how this hidden subsidy
is likely to be distributed between different types of banks,
in terms of their size and the various features of their business;
to advise whether this is likely
to favour the bigger banks and so impair free competition in the
In the light of the Treasury's response to that
request, the Select Committee might then want to consider further
what could be done to deal with whatever impediment to banking
competition arises in this way.
25 April 2002
17 James Robertson is an independent writer and lecturer.
His past experience includes working in the Cabinet Office, directing
an Inter-Bank Research Organisation, and advising a House of Commons
Select Committee on parliamentary control of public expenditure. Back
Joseph Huber and James Robertson, "Creating New Money: A
monetary reform for the Information Age", New Economics Foundation,
June 2000-a 92-page report. Back
The government's decision in March this year to force the big
four banks either to pay interest on small business current account
balances or to offer free banking is not designed to make the
cost structure of banking services more transparent; and Halifax
/ Bank of Scotland (HBOS) has questioned whether that decision
will redress the competitive balance between the big four and
the smaller banks. Back