Tag Archives: Volcker Rule

Mervyn King: prevent fractional reserve banking to address the divergence between private benefits and social costs

On Monday, 25 October 2010, Mervyn King, the Governor of the Bank of England, gave this 25-page speech in New York City, at The Buttonwood Gathering: Fixing Finance.

This Gathering was organised by The Economist and cost $3,495.

The speech covered:

  1. Introduction – the importance of a resilient and robust banking system
  2. The practice of banking – an extraordinary rate of expansion by banks
  3. The theory of banking – “financial alchemy” requires the implicit support of the tax payer, and its Achilles heel remains the absurd levels of leverage by relying on short-term debt; the results that follow from a banking system “too large relative to national output” (Iceland and Ireland) without having first solved the “too important to fail” problem
  4. Finding a Solution – to address the divergence between private benefits and social costs:
  5. Why Basel III is not a complete answer – there is merit in having a basket of different measures to rein in excessive risk-taking
  6. Large Institutions – led by the Financial Stability Board – an extra layer of either equity or other loss-absorbing capital
  7. More radical reforms – “limited purpose banking” (Kotlikoff, 2010), Volcker Rule, divorce the payment system from risky lending activity – to prevent fractional rserve banking (Fisher, 1936; Friedman, 1960; Tobin, 1987; Kay, 2009); genuinely safe deposits must not coexist with risky assets. Creditors should know that they will bear losses in the event of failure; the Financial Policy Committee will provide clarity about the regulatory perimeter; banks should be financed much more heavily by equity rather than short-term debt
  8. Page 18: Of all the many ways of organising banking, the worst is the one we have today.

    The Independent Commission on Banking will lead us to the right solution

  9. Conclusions
  10. A market economy has proved to be the most reliable means for a society to expand its standard of living. Change is, I believe, inevitable. The question is whether we can think our way through to a better outcome before the next generation is damaged by a future and bigger crisis. This crisis has already left a legacy of debt to the next generation. We must not leave them the legacy of a fragile banking system, too.