Banks, private money creation, and regulatory reform
| Pages | 20-34 |
| Published date | 12 February 2018 |
| DOI | https://doi.org/10.1108/JFRC-06-2016-0046 |
| Date | 12 February 2018 |
| Author | Gerry Cross |
| Subject Matter | Accounting & Finance,Financial risk/company failure,Financial compliance/regulation |
Banks, private money creation,
and regulatory reform
Gerry Cross
Policy and Risk Directorate, Central Bank of Ireland, Dublin, Ireland
Abstract
Purpose –This paper aims to consider recent arguments that post-crisis regulatory reform has
misunderstood the nature of banks’activities. These arguments suggest that a bank’s role is not that of
intermediationbetween savers and borrowers but the systemicallyriskier one of private money creation.
Design/methodology/approach –The paper assesses whetherbanks’activities are best understood as
private money creationrather than intermediation. It considers the argument thatregulatory reform has not
gone far enoughto prevent a recurrence of future credit spiralsending in financial crises.
Findings –This paper analysesbanks’activities and finds that it is incorrect to considerthat they engage in
relatively unfettered money creation.While fractional reserve banking does create flows of money through
the economy, theseflows are tethered to banks’funding requirements. Multipleuse of that money, rather than
representing an ill-understoodrisk, simply reflects the nature of maturity transformation.This has not been
missed in designing the post-crisis regulatory framework. The revised framework contains many features
that are not fully recognisedby proponents of the money creation critiqueand goes significantly further than
they allow. Once completed,it will address many of the concerns they raise. They are right to call for further
considerationof whether the countercyclical features of the new frameworkare sufficiently developed.
Originality/value –The paper provides an early detailed response to recent criticism of the post-crisis
regulatoryreform programme coming from a money creationperspective of banks’role in the economy.
Keywords European union, Basel, Financial crisis, Credit, Banking regulation
Paper type Conceptual paper
Introduction
The period of intense financial regulatory reform that followedthe global financial crisis of
2007-2009 is reaching its end. Recently, pressing demands for economic growth and
increasing distance from the crisis have led to a noticeable softening in the political
environment.
Some policymakers believe that there is a risk that the reforms may be having
unintended consequences,at least when considered cumulatively (Hill, 2015).More widely, it
is held that it is timely to embark on an effort to fully understand the separate and
cumulative impact of post-crisis regulatory reforms. Noteworthy in this context is the
European Commission’s call for evidence on the economic impact and unintended
consequences of thereforms (European Commission, 2015).
At the same time, a different perspective has emerged. Some commentators argue that
regulatory reform has not properly understood how banks’activities impact the economy
(Turner, 2016;Wolf, 2015). These arguments suggest that banks’role is not that of
intermediation between savers and borrowers but rather the systemically riskier one of
private money creation.
This article analysesbanks’activities in light of this critique. It finds that it is incorrect to
consider that they engage in relatively unfettered money creation. While fractional reserve
Thanks to Valerie Herzberg and Gina Fitzgerald for their comments.
JFRC
26,1
20
Received11 June 2016
Revised17 September 2016
14January 2017
Accepted30 January 2017
Journalof Financial Regulation
andCompliance
Vol.26 No. 1, 2018
pp. 20-34
© Emerald Publishing Limited
1358-1988
DOI 10.1108/JFRC-06-2016-0046
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