Theory, Evidence, and Policy
Chapter 5: Banking, Financial Markets and the Narrow Banking Idea
The recommendations in this report aim to create a more stable and competitive basis for UK banking in the longer term. That means much more than greater resilience against future ﬁnancial crises and removing risks from banks to the public ﬁnances. It also means a banking system that is eﬀective and eﬃcient at providing the basic banking services of safeguarding retail deposits, operating secure payments systems, eﬃciently channelling savings to productive investments, and managing ﬁnancial risk. To those ends there should be vigorous competition among banks to deliver the services required by well-informed customers. Independent Commission on Banking (2011, p.7) 5.1 Introduction In this chapter1 we model the problematic role of modern banking – besides their traditional role as credit institutions – when banks are also acting as investment banks, by concentrating speciﬁcally on their stock market activities as a possible substitute for credit creation. We show that such a mixed orientation of the activities of commercial banks is endangered by unstable feedback structures which can imply that the steady state of the economy becomes repelling, if ‘Minsky Drifts’ are at work which drive crucial ﬁnancial parameters beyond certain critical values. In contrast to such a situation of broad banking we will then provide a model of narrow banking and of Fisher’s (1935) 100% money idea where such tendencies towards real-ﬁnancial market instability are eliminated through legal restraints. Moreover, this model will also show that such a narrow banking system (where trade in equities is excluded from...
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