We need a publicly anchored safe payment and savings system, not depending on the commercial banks that need to provide risky credit to companies, argue professors Dirk Bezemer (Groningen University), Arnoud Boot (Amsterdam University) and  Mark Sanders (Maastricht University), all members of the Sustainable Finance Lab.

Can we enforce reforms in the financial sector this time? Problems at a small American bank with less than one percent market share prompted a swift declaration from US President Biden that the government guarantees the deposits of all Americans. The Swiss government meanwhile orchestrated the takeover of Credit Suisse by UBS, with the government guaranteeing astronomical amounts, with unrest spreading to Deutsche Bank.

Who are we fooling? The financial crisis of 2008 was supposed to be behind us, wasn’t it? Was our financial system not safer with the new regulations? Yes, there were many new rules, but  insiders have always understood that the foundations remain fragile.

It is still the case that (high) profits line private pockets while losses are socialized. Public guarantees keep the system afloat. This despite solemn promises after the financial crisis of 2008. We conclude the public sector is still held hostage by a fragile banking sector. Supervisors and policymakers cannot afford to let failing institutions go bankrupt. And after Silicon Valley Bank and Credit Suisse everybody now knows this.

Dependence on commerce

In 2008 we learned that it is unwise to depend on the financial health of commercial parties for essential public infrastructure, such as the payments system. This was the conclusion of a European High Level Expert Group under Liikanen and a Dutch parliamentary inquiry into the financial system, the De Wit committee. And yet it seems we have to learn that lesson again in March 2023.

There is no risk of major banking problems in the Netherlands in the short term. It appears that EU arrangements on supervision and regulations are stricter than those in the US and Switzerland. But we cannot be complacent.

One vulnerability is that banks are largely financed with demand deposits. In today’s digital world with apps on our smartphones, anyone can move their money at short notice. A rumor is enough to cause a ‘bank run’, in which deposits are collectively withdrawn and the bank is caught short of liquidity. With contagion risks across the entire banking landscape. Controlling this seems impossible, even with extensive deposit guarantees. The fundamental problem is that banks do not keep our money in their safe but owe us the balance on our checking account. In short, our money is their debt. And as such only worth anything as long as the bank is solvent and liquid.

Indeed, this problem cannot be solved with stricter supervision and harsher regulation. In addition, more and tighter rules cause collateral damage by limiting banks freedom to do what they exist for: finance risky business by lending to innovative, young firms and new projects (for example, financing the energy transition). Regulation is effectively shutting down entrepreneurial banks, without ever achieving a truly secure payment system.

Public payment and savings system

The lesson is that something fundamental has to change. In a publicly anchored payment and savings system, citizens will have accounts with the central bank (ECB). This so-called  central bank digital currencies (CBDC) is a digital alternative to cash (banknotes and coins). A public-sector bank account offers a safe environment for savings and payments and an anchor for the private-sector financial system.

This  can be implemented in various ways. For instance, the  payment interface can be separate from the  central bank. A public anchor could alternatively take the form of  a National Savings Bank or a money market fund that invests in short-term liquid government paper.

However it will be set up, we will have a system for settling transactions and store our savings securely in good times and bad. In the new system private banks can no longer rely on support and guarantees that will become superfluous.  This implies that they have to finance themselves more robustly, not because the supervisor obliges them to, but because the market says so. That means that, depending on their risk profile, they must fund their activities with less demand deposits and more long-term bonds and equity. A government can still decide to bail out  a bank if it chooses to, but its hand will no longer be forced by dependence on the private sector for a smooth operation of our payment system. The new state of affairs will strengthen  confidence in politics and public affairs, and ultimately it will strengthen banks and the economy.

Flourishing of private banks

A public anchor does not reduce the dynamism in the private financial sector, but instead  allows it to flourish. The private banks, now tightly regulated for fear of calamities that would bring the system to a standstill, can again support business and risk-taking. An efficient, robust and entrepreneurial banking sector is essential for an economy facing major challenges in uncertain times. The current situation in Europe certainly fits that description.

There will remain the need for supervision and guidance. That is also the case in other markets, e.g. for energy and food. And accidents may still happen. But we can significantly limit the damage they cause to the rest of the economy and thereby create room for maneuver when the shit does hit the fan. The plans, the technology and the resources are sitting on the shelf.  The urgency to implement a public payment system, which had receded into the background in recent years, is now back. It is time to act.

This op-ed was previously published in NRC Handelsblad, March 29 2023