Because 97% of the money supply has been created by commercial banks through the ‘multiplier effect’ of fractional reserve banking, the commercial banking sector is effectively charging interest on 97% of all the money supply in existence. The money supply in the US is around $14.6 trillion, and around £1.8trillion in the UK. Assuming that the average overall interest rate is 8% per annum, then the permitting the banking sector to create money allows them to collect around $1.16 trillion and £144 billion each year respectively.
Post-reform, the money supply will be created and injected into the economy via the government, and the banking sector will be unable to create money. The banks will simply act as brokers, distributing ‘spare money’ in the economy from those who have too much to those who have too little. As a result, the banking sector will only be able to charge interest on a portion of the money supply – that portion will be the money which customers have put into savings accounts, depending on the ‘savings ratio’. If the savings ratio is 50% overall, then the banking sector will only be charging interest on 50% of the money supply.
Profitability
A common mistake here is to assume that, if the banking sector is only charging interest on half as much money, its profit margin will be halved and therefore banking per se will become unprofitable (the argument that ‘You’ll bankrupt the banks!’). To be blunt, this is just poor logic.
In reality, the profit margin will stay the same: it will be the difference between the interest rate paid to savers, and the interest rate charged to borrowers (the interest rate ‘spread’). From the perspective of a single bank, nothing will change.
However, from the perspective of the sector as a whole, the market for ‘money brokering’ has just halved. In other words, the market for commercial banking has halved in size (or reduced in line with the savings ratio).
Every individual bank can remain as profitable as it was before the reform, but in a small market, it will need to fight to increase its market share, or otherwise reduce the size of its operations by about half. Either every bank will reduce its size (in terms of staff and revenue), or some banks will maintain their current business while others will get ‘shaken out’ of the market and leave the industry. (Note that this doesn’t mean that any banks will go bust – they will just gradually lose market share).
Deflating the Sector
It needs to be recognized that the banking industry has only become as large as it has due to its power to inflate the money supply and simultaneously increase the public’s dependency on debt. The demand for their services (lending) is created by their activities, rather than any natural need for credit in the economy. In other words, if they didn’t lend so much, we wouldn’t need to borrow so much (since price would not be inflated to the same extent). If there is a debt-free money supply, injected into the economy by the government, then our need to borrow should gradually fall to a fraction of its current level.
False Profits
To those who argue that the banking sector contributes a significant proportion of GDP, and contribute significant tax revenues, it needs to be shown that the banking sector’s “contribution” is really our contribution, through the ever-increasing amount that we need to pay in interest charges on debt. To put it simply, their profits are at our expense. In fact, the more than the banking sector profits, the more the real economy (shops and businesses) suffer.
Key Impacts
- The size of the banking sector will be reduced
- Each bank will find that its ‘slice of the pie’ has shrunk
- Each bank can either:
- fight for a bigger slice of the pie (and push other banks out of the game) to get back to their original position
- be satisfied with what they’ve got (and reduce staffing levels accordingly)
- leave the game (selling their customer base to another bank and exiting the market)
- Bank profit margins should not be affected.
In summary, the reform will restore the banking industry to healthy size relative to the economy. Good banks will be able to do as well after the reform as they do now, but bad banks will be thrown out of the market.
