PositiveMoneyUK is a website dedicated to solving the debt crisis. It has some very good ideas as well as some influential and knowledgeable members. I have been aware of this movement for some time – please pay them a visit.

We have recently had some constructive comments on my article on the Vickers proposals and on other suggestions made here.  Rather than write yet another long essay hidden in the comments, I address some of the fundamentals here in a two Special Posts, both where I agree with the PM proposals and where I differ. So it’s a good news, bad news story.

Let’s start with the good news! There are two particular ideas that I like. The first is the proposal to reform the financial reporting standards. The International Financial Reporting Standard, endorsed by the European Union,

  1. allows the improper recording of assets by the up-front loading of loans,
  2. permits unrealised gains to be considered as profits,
  3. recognises losses only when they are incurred and
  4. allows staff compensation to be ignored in profits.

To me – and the team at Positive Money – this seems to be a scandal. Amazed that the EU should mandate these? I’m not. But Boards take decisions based on accounts. If the accounts are false, is it any surprise that wrong decisions are taken?

The Financial Services (Regulation of Derivatives) Bill by Steve Baker MP attempts to rectify this. This bill has had its second reading in the House of Commons but it depends on government support to get further. I hope it does and I support it completely. We need to return probity and prudence to the banking sector.  We would need parallel reporting for EU reasons but in so doing, questions would be raised about any institution that did not report in this way. Thus it would diffuse out driven by market expectations and demands.

The second proposal is to establish Custodial accounts where deposits would not be allowed to be invested or lent. The bank would act as a true custodian of the money. This is the subject of a second Private Members’ Bill before Parliament at the moment, the Financial Services (Regulation of Deposits and Lending) Bill by Douglas Carswell MP.

My query here is that if everyone adopted a Custodial account for their money, it would indeed mean a return to full reserve banking and would be very deflationary. As I have argued, we need fractional reserve banking in order to create money that is the engine for growth and progress. When banks are allowed unfettered reign, it is also the engine for disaster.

The true cost of banking would also have to be reflected in substantial account charges for custodial accounts. These costs are currently hidden by the massive yields banks make on creating new money, as I showed in Why Banks love to lend. By being more visible, attention would turn to the internal efficiency of their business processes – not a bad thing.

At the moment accounts in the UK are guaranteed by the taxpayer up to a certain limit. Some people need a guarantee on their deposits – pensioners for example or a business that needs to have money to pay critical bills. But others are not so risk-averse. So my suggestion is to put power in the hands of the consumer with a quid pro quo return.

The Bill includes the facility for lending intermediary services but why would anyone want to allow the bank to use their money to lend?  The answer must be that in return for lending and not having a guarantee, the depositor would share in the yields currently enjoyed by the bank.  It is not clear in the Bill that this is the intention.  But if the depositor could say that some fraction – up to  80% to meet the Vickers’ requirements – could be used to lend and create other money and they were to share in this highly profitable exercise, many would leave their money in such Yield Sharing accounts because the interest paid on those would be substantial.

If the bank and the depositor shared the benefit and risk equally just to create money for mortgages for example, and a Vickers’ fraction of 20% was used, then the bank would make 18% per annum and the depositor would also make 18% on a 4% 20 year mortgage; both would make 72% pa on a 4 year car loan and so on. This sort of return has hitherto only been available to banks and would come with no guarantee and in particular no taxpayer bail-out should the bank fail.

At the moment the Bill envisages having to give the lender information as to the borrower, the possibility of default etc.  I think this will be far too bureaucratic and a better way would be for the lending intermediary to be able to package up potential loans into groups – for example mortgages, secured loans, unsecured loans etc.  Otherwise there is too much information for the depositor to have to process and they may as well use Zopa.

The effect of these Yield Sharing accounts would be dramatic. Investors would move to such accounts and banks that did not offer such terms would eventually have to follow suit. It would break the artificial link (based on full reserve concepts) between savings and borrowing and make saving worth while again.  As the depositor could specify what proportion of their money is used in this way, he or she could set the limit so that if the worst happens they would not lose all their money. Of course banks may not be able to lend ie create the money so it may be that the fraction available to the depositor would be less than a half but even so, it would represent a large improvement in the savings environment than 0.5% base rate and paltry savings. Most importantly, as such Yield Sharing accounts would not lead to a contraction in lending, they would not be deflationary.

There are other benefits that the legislators may like to note. Such returns would of course be taxable. So a substantial chunk of the higher interest paid would end up with the Exchequer – rather more than if all the profit were taken by the banks which employ an army of lawyers and accountants to off-shore it and otherwise hide it from the taxman. In addition, the taxpayer would have no liability for the non-custodial component of bank deposits.

One downside to this suggestion is that a mechanism would need to be set up to avoid roundabouts where someone borrows from Bank A at say 10% (or less) and deposits it in a non-custodial account in Bank B at 20% (or more) return. Each of these accounts will need to be registered and authorised by the Inland Revenue who will take a snapshot of the borrowings when the account was opened. I realise that this will be a bit bureaucratic but no more so than is undertaken when someone opens an ISA – Individual Savings Account – which is a tax-free haven for investments with an annual limit.

The second downside is that it may attract a lot of investments from overseas which would result in Sterling rising to an unhealthy level. But if the whole thing was controlled by requiring Inland Revenue approval, only UK taxpayers would be entitled to use it – a neat way of avoiding EU objections.  Of course this would still mean some rise as UK taxpayers who have hitherto been investing overseas would repatriate their money.

So I like two of the Positive Money proposals, the second subject to an interesting sharing of benefit with depositors. The bad news I will reserve for the next post – this one has already got too long!