On Banking as an institution - Reflections on week 3

On Banking as an institution - Reflections on week 3

by Johnna Montgomerie

The business of making money

The all-important context for understanding how banks as institutions act as drivers of financialisation need only look at the case clearly outlined in the Bank of England’s QuarterlyBulletin (2014) ‘Money in the Modern Economy’, which explicitly outlines that (a) private banks create money by issuing loans, and in doing so, they make an asset on their balance sheet linked to the anticipated revenue from interest on repayments; (b) the Bank of England controls the money supply through interest rates and QE, not through base reserves or by printing more money and (c) when new debt-money is created, the central bank expands its own balance sheet to reflect the change in the money supply (pp. 16–19). 

From this description it becomes clear how banks are the drivers of financialised growth: they are the only institutions with a license to create sterling by issuing loans (debt deposits) with the unregulated ability to charge interest on the loans they issue and with the legally enforceable right to collect interest revenue from those loans.

The ‘originate and distribute’ business model means banks that issue loans can also make considerable profits from bundling together debt deposit accounts and transferring them to offshore investment vehicles in order to trade products and services based on these debt contracts many times over. Private credit creation is not new; banks have long exercised the ability to create money from nothing (see Mellor, 2010). The fractional reserve system allows banks to issue more loans than they have as savings or cash deposits; however, when banks acted as intermediaries between savers and borrowers the accepted convention was to extend the asset base by extending lending (assets) with reference to liabilities (savings/cash deposits). 

However, this is not the case for the financialised banking system in the present day. Banks originate loans (creating debt deposits, as described by the Bank of England) and then bundle them together and sell them on global financial markets first through securitisation, then sliced and diced with every manner of derivative product to be sold and re-sold across global financial markets.

Conventional accounts of disintermediated banking remained blind to the relevance of the households within financialisation, that is until the subprime market revealed a fatal flaw of debt-led financialised expansion - the risks associated with non-performing loans. Without a steady stream of interest payments (fixed-income) on debt assets, the subsequent series of claims against these ‘paper’ assets are illiquid and can quickly become difficult to value. The 2007 credit crunch was triggered when pools of financial assets linked to US subprime mortgages could no longer be accurately valued because of rising default rates. The non-performing subprime mortgages were a mere fraction of total bank lending but still set off a firestorm that ripped through financial markets throughout 2008 to become the global financial crisis. At the time, the lesson seemed clear: banks can create assets at the stroke of a keyboard, but these assets are only made real by the revenues received as repayments; financial fragility is thus intimately linked to the risk of non-repayment, or default, of even small-scale borrowers.

However, virtually nothing has been done to redress this fatal flaw. Instead, banks continue to use their ability to create money by issuing debt deposits as well as unregulated interest rates to create financial products to be traded on secondary markets. For example, private banks licensed to trade in the ‘discount window facility’ have the ability to borrow at near zero or even negative real interest rates and access financial support from the government through QE. According to the Bank of England (2012), only the top 5% of households in wealth and income percentiles benefited from the QE programme. Even a cursory acknowledgement of the gender distribution of costs and benefits of QE points to how public debt shores-up financialisation in such a way that it redistributes the gains of stimulus to the financial sector, perpetuating gendered economic inequalities in wealth and income distribution; while directing the costs of crisis down on to the household sector in ways that also perpetuate established gender inequalities of welfare provision. 

An in-depth analysis of the UK by Jeremy Green and Scott Lavery (2015) explains how this ‘regressive recovery’ is enacted across two policymaking axes: monetary policy, using Quantitative Easing, drives asset-price inflation for the wealthy, and regressive labour reforms, which drive wage-growth for the majority. These dynamics, it is argued, will ultimately ‘further entrench structural weaknesses in Britain's economy in the years ahead’ (p. 896). As such, monetary policy is gendered in the same way fiscal policy is, by unequally apportioning the costs and benefits of policy in ways that rely on, and perpetuate, established gender hierarchies. Being attune to these power dynamics is essential to understanding why, as Craig Berry (2016) convincingly argues, Austerity is a political narrative that has become a form of common sense that policymakers rely on to actually prevent change in the way the UK economy operates (my emphasis added , p. 4).