Martin Wolf proposes the death of banking

Martin Wolf proposes the death of banking

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The distinguished economic journalist Martin Wolf has suggested (£) that banks should be stripped of their ability to create money when they lend. Endorsing “100% reserve banking” as outlined by, among others, the IMF, Lawrence Kotlikoff and Positive Money UK, he calls for all money to be created by the state and banks to be reduced to pure intermediaries. He explains how this would work thus:

First, the state, not banks, would create all transactions money, just as it creates cash today. Customers would own the money in transaction accounts, and would pay the banks a fee for managing them.

Second, banks could offer investment accounts, which would provide loans. But they could only loan money actually invested by customers. They would be stopped from creating such accounts out of thin air and so would become the intermediaries that many wrongly believe they now are. Holdings in such accounts could not be reassigned as a means of payment. Holders of investment accounts would be vulnerable to losses. Regulators might impose equity requirements and other prudential rules against such accounts.

Third, the central bank would create new money as needed to promote non-inflationary growth. Decisions on money creation would, as now, be taken by a committee independent of government.

Finally, the new money would be injected into the economy in four possible ways: to finance government spending, in place of taxes or borrowing; to make direct payments to citizens; to redeem outstanding debts, public or private; or to make new loans through banks or other intermediaries. All such mechanisms could (and should) be made as transparent as one might wish.

 The three proposals Wolf cites are actually very different from each other. The IMF’s paper “Chicago Plan Revisited” is a strict 100% reserve banking proposal, in which all deposits, irrespective of the risk appetite of the depositor, are backed by central bank reserves. It is accompanied by a full debt jubilee plan to eliminate household debt, leaving banks to lend only for business investment.

I’ve previously written a detailed critique of the IMF’s paper. To summarise, though, the paper does not give sufficient consideration to the implications for commercial banking. There are four principal problems:

·         banks would have to clear all lending decisions with the central bank in advance in order to obtain funding: lending decisions would therefore in reality be made by government (the IMF’s paper regards the central bank as part of government) .

·         banks would have to borrow from the central bank to fund lending – they could not borrow from each other, even though they would have large amounts of idle money lying around on their balance sheets earning nothing.

·         banks would have to pay fees to the central bank for the reserves required to back deposits, even though deposits are a cost for them (the IMF in effect proposes permanently negative interest on REQUIRED reserves).

·         margins on what little lending remained after the debt jubilee would be painfully low, because the paper assumes that businesses would alternatively be able to obtain finance in the capital markets at similar rates to the yield on government bonds.

This cannot in any way be considered a profitable business model.  In my critique I concluded that this proposal would mean the death of commercial banking:

As far as I can see, in this model it is virtually impossible for private banks to be profitable. In which case they would soon cease to exist, and government would be forced to create state banking facilities to replace them. The question is, why did the authors stop short of recommending full nationalisation of the banking system, since that is the only way the model could work in the longer term? The authors think that private banks funding long-term investment projects is a Good Thing, but they offer no explanation for this belief. Could it be that they have retained private banks in their model because recommending a move to a wholly state-owned system would not be taken seriously by most economists and politicians?

But such a strict 100% reserve banking approach is not actually what Wolf is suggesting, despite his comment that the IMF researchers' approach “could work well”. His idea is much closer to the other two proposals, both of which I have also written about.

Kotlikoff envisages a disintermediated banking system in which banks “market” various types of funds but do not themselves do credit intermediation or maturity transformation. Depositors who want no risk would place their money in money funds fully backed by safe assets (government debt): they would have guaranteed safety but very little return on their investment. Depositors wanting higher returns would have a range of funds to choose from representing varying amounts of risk: capital allocation (lending) would be done by the funds in accordance with their portfolio management strategies. The US banking system is already well down the disintermediation road anyway, so to an American customer base it would make complete sense for banks simply to market funds rather than compete with them.

But there is a problem. The functions that distinguish “banks” from other financial institutions are credit intermediation (deposit-taking and lending) and maturity transformation (borrowing short, lending long). Once banks no longer do either of these, they cannot be regarded as banks. They are simply shops. Once again, we are faced with the death of commercial banking.

The third proposal, from Positive Money UK, is actually the closest to Wolf’s ideas. Though there are differences. Rather than backing deposits with central bank reserves as Wolf suggests, Positive Money UK simply cut out the middleman. They propose that transaction accounts should be on the books of the central bank. Commercial banks would only hold risk-bearing investment accounts, from which they could lend. It’s a neat idea, and unlike the other two proposals – both of which completely ignore the crucial role of banks in facilitating payments - it does recognise that transaction accounts and interest-bearing time or sight deposits serve very different purposes. Both Wolf and Positive Money UK envisage banks charging customers fees for payments and account management. This does, of course, mean the end of “free while in credit” banking.

But once again, there is a problem. Banks are not fund managers. People who want to put money at risk for a return don’t generally put it in banks: they invest it in funds or manage their own portfolio. People put money in banks for two reasons:

·         because they want safety AND a return

·         because they need liquidity (including access to payments systems)

Wolf recognises the second of these, but not the first. I fear that the “investment accounts” he and Positive Money UK envisage would disappear like the morning mist once the deposit insurance that time and sight deposit accounts currently enjoy is removed. Positive Money UK's proposal therefore probably means the end of commercial banking, unless they could find other sources of funding. In Wolf's world, commercial banks could survive for a while as pure deposit-takers, but as mobile money platforms reduced their fees to undercut the banks now forced to charge transaction fees, and quasi-banks offered supposedly safe liquid depositary services for a better return than the banks now unable to pay interest on safe deposits, they would eventually wither and die.

But it is perhaps more likely that commercial banks would find ways of lending without relying on customer deposits for funding. Since heavy reliance on wholesale funding is now penalised by regulators, asset-backed securities issuance seems the most obvious choice: Santander UK already funds quite a bit of its lending with covered bonds. But there is another possibility too – and that is a vast increase in the amount of equity that banks hold. Equity is funding: if banks are prevented from using debt to fund lending, they are forced to use equity. Weirdly, we might find banks choosing to adopt Admati & Hellwig’s proposal for much larger equity cushions, just so they can lend at all. After all, as Northern Rock discovered, relying on asset-backed securities issuance for funding has a very big problem: asset-backed securities are by nature illiquid and there is no guarantee that anyone will buy them anyway. At least shareholders’ funds are money you already have, rather than money you hope to receive. Though - returning to my definition of banks' distinguishing functions as being credit intermediation and maturity transformation - if banks only lend shareholders' funds, can they really be said to be banks at all?

This brings me to the heart of Wolf’s proposal. Wolf thinks banks should only be able to lend money they already have, not money they hope to receive: in the absence of loanable deposits, this tends to force banks down the equity funding route because of the inherent illiquidity of other forms of stable funding. But as I explained in my critique of the IMF paper, money creation through bank lending is an inevitable consequence of double entry accounting, and preventing it is by no means as simple as Wolf suggests. Completely eliminating fractional reserve lending means removing banks’ responsibility for lending decisions. Yet again, we face the death of commercial banking.

But my bigger concern is this. Wolf’s idea amounts to replacing a demand-driven money supply creation mechanism with central planning of the money supply by a committee.  Central banks’ record on producing accurate forecasts of the economy is dismal, and their response to economic indicators is at times highly questionable. Put bluntly, they get it wrong – very wrong, at times: consider the ECB raising interest rates into an oil price shock in 2011. Is the entire lifeblood of the economy to be dependent on the whims of such as these?

Some people suggest an algorithm-driven mechanism whereby the money supply automatically adjusts in response to economic indicators such as NGDP or money velocity. This is a neat idea, but it suffers from the problem of accuracy and timeliness of information. GDP is a flawed measure which is subject to constant revision. So is inflation. So is money velocity. And all of them are lagging indicators. How can the future money supply needs of the economy be accurately estimated using these?

Personally I would prefer the money supply to respond to demand rather than be decided by a committee, or an algorithm for that matter.  I don’t in theory have a problem with removing the link between bank lending and money creation: bank lending is by nature pro-cyclical, so the money supply does tend to expand when it really should contract and vice versa. But until someone can identify a better indicator of demand for money, bank lending – or perhaps better, lending activity in the financial system as a whole, including non-bank lending – is the best we have and certainly a lot better than the MPC. The system we have is undoubtedly flawed, but Wolf’s alternative is a whole lot worse.  

Related reading:

The shoebox swindle – Coppola Comment

The shoebox shortage – Coppola Comment

The nature of money – Coppola Comment

Do we really care who creates money? – Coppola Comment

The negative carry universe – FT Alphaville

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What used to work was money creation by the bank manager network, local people who knew their patch and loaned carefully with a view to making profit without over-risking insolvency. Why not re-introduce them, this time as overt autonomous money creators, guided only by their conscience and a grasp of the necessity of creating more money as necessary without devaluing it? Leave it up to them how much money's created, at least at local level. Wolf and Postive Money's committee could then worry about the national level. I'm not sure there'd be that much to worry about, if it comes to it...


I agree that interest rate targetting and money supply targetting are “closely related” as you put it. Certainly one cannot adjust one without influencing the other. But I think money supply targetting is better, first because interest rate adjustments are pretty ineffective according to two recent studies. See:

Second, given a recession, there is no prima facie reason to assume the cause is a drop in investment spending rather than consumer spending, and hence that more investment is the best cure.

Third, even to the extent that an interest rate cut DOES INCREASE investment spending, the duration of that effect is limited (as pointed out by Mervyn King). Reason is that an interest rate cut pulls investment forward in time, but there’s a limit to the amount of “pulling forward” that any business or household will do.

Fourth, the evidence is that base rate adjustments have no effect on rates charged by credit card operators.

Finally, re your claim that central bank “bear some responsibility” for the crunch, you haven’t actually specified what they did wrong.

Positive Money's response is here:


You may already have mentioned this somewhere in your much appreciated and incredibly well thought out notes on these subjects. I have two thoughts around Martin Wolf's thoughts (both may be bogus, but would be keen to get an expert opinion on them)

Firstly, the concept of full reserve banking on purely deposits may create holes. The issues of potential self-fulfililng liquidity "runs" that unfunded liabilities can create are not just deposits of a regulated bank but a much broader set of envisaged securities within regulated and un-regulated shadow-banking institutions (would full reserve banking have prevented a run on AIG from the structured protections it sold against subprime and subsequent repo liquidity issues at banks). If we want the financial sector to create some form of insurance type instruments, liquidity events are always a potential concern (but is the reason why we need substantial equity buffers, which banks compared to other types of financial intermederies simply don't have).

Secondly, especially with regard to pure deposits, we seem to be in the mist of a technological wave that may question whether consumers actually need to utilise commercial bank deposits. Technologies in e-wallets, mobile money and the blockchain technology behind bitcoin seem to be getting people excited about the potential lack of need for a centralised hub to provide a safe vault for our money pots. In which case are some of commercial banking's activities potentially doomed to become defunct even without considering a change in regulation? In this regard are we potentially barking up the wrong tree and should be paying more attention to what the benefits and potential costs are of a payments evolution that seems to be occuring are?

Frances Coppola

sorry, I don't mean "at par" - I mean at a discount, of course, since bonds are interest bearing.

Frances Coppola


A few points.

The central bank does not "fix the price of money" as far as bank-produced money is concerned. It sets the price of base money only, and this acts as a price floor for bank-produced money.

Regarding the rest of your comment, the problem is that ending bank creation of money is not that simple. Even under a gold standard, banks still created money. It is a consequence of double entry accounting. I suggest you read my critique of the IMF paper (link in the post) - I explain this in some detail there.

By Treasury notes I presume you mean the quasi-bank notes produced by the US government, which are really a form of non-interest bearing debt? To my knowledge, the US government is the only government in the world that produces non-interest bearing debt. But US Treasury notes are already fully convertible at par to interest-bearing bonds - it's just that you have to do it via central bank notes.

Your suggestion of using government bonds to drain excess money is similar to my suggestion here:

Ms. Coppola, money is not demand-driven today. We have a central bank which fixes the price of money. There are solutions to your problem. Under Wolf's proposed system, as well as the Chicago plan, people can still go to a private bank and loan money, and the rate of interest would be market-driven. Also, non-interest bearing circulating Treasury notes could be fully convertible to interest-bearing government bonds, so when there is too much money relative to economic activity, people can buy bonds and the government can retire the notes.
The Chicago Plan is simply a way to keep private sector and public sector in their proper spheres, can restore accountability and, most importantly, JUSTICE, to money creation. Private banks should not be allowed to create government-guaranteed money or credit. Plain and simple.

Thankyou for the kind reply Frances, and I read your previous article - awesome. As it says, there's not much sign right about now of our private banks being great at distributing money - that thing that being private supposedly makes you so good at. (No surprise really, as there are more profitable things to do instead, so by law - currently - the directors must do that.)

If public banking and private banking are roughly equal at the job of distributing money, have roughly equal amounts of corruption, are roughly equal in efficiency (as research shows re- public vs private) - that leaves me still with my original difference: "run for the benefit of the people, with all profits reinvested, versus run for the benefit of a few super-rich people, with every penny possible stripped out for them."

Though the problem might go away if we changed company law so that "maximise shareholder return" was only the second rule for directors, and the first rule was "do what's right for the country" (or some such).

Thanks again, great articles.

Frances Coppola


It really isn't as simple as replacing interest rate targeting with money supply targeting. The two are closely related. Prior to 2008, central banks raised or lowered interest rates by changing the quantity of base money in the system. That's what "open market operations" do. They can't operate that way now because we have too much base money in the system - so they adjust the amount that banks can earn on their holdings of base money instead.

I regard it as folly to ignore the role of central banks in the behaviour of the financial system as a whole. They are not "wholly" culpable for the crisis, but they do bear some responsibility.


In what way did central banks “cause the crisis”? They are commonly blamed for not spotting irresponsible private bank lending, but that’s like blaming the police for robberies: along the lines of “it’s the police’s fault because they should have kept tabs on all burglars”.

One could argue that central banks kept interest rates too low prior to the crisis. But interest rates adjustments are the accepted way of regulating aggregate demand, and demand was not excessive prior to the crisis, so little blame can be layed at the doors of central banks there.

In fact therein lies a merit in full reserve (at least as set out by Positive Money). That is, the big flaw in using interest rates to regulate demand is that if demand is inadequate, central banks cut interest rates which encourages dangerous borrowing and lending. In contrast, under PM’s system, demand is regulated by varying the amount of base money created and spent into the economy, while interest rates are left to find their own level.

Of course interest rates under PM’s system might drop to the “dangerous” level, but at least there is no artificial cutting of rates when demand is low. Plus I’m pretty sure interest rates would rise a bit on implementing full reserve because lending is more restricted under full reserve than fractional reserve.

Woodford's purpose IMHO was to "'buy time and sell distance" until a few crucial positions (think London Whale for starters) could be unwound and a few more so-called fines could be paid under the Himpton Doctrine. The end game was bookended between Greenspan's "Map & The Territory" (out with the old and in with the new, i.e. "the map is the territory" and "the receipt is the transaction" ala Bitcoin & Triple Entry Accounting) and Yellen's move from Quantitative Easing to Qualitative Easing... with such ease.

The stage is set for Mervyn King's Divorced Currency model as Andy Haldane has effectively announced his own financial version of "George Bush Mission Accomplished" when he added the BlackRocks and BlackStones to the TBTF BlackSwans. Standby for a global sovereign debt for equity swap of biblical proportions. It's baked in the cake... anyone got a toothpick?.... I think it's done.

Frances Coppola


Like many supporters of management-by-committee, you ignore the role of central banks in causing the crisis in the first place. Central banks make mistakes, sometimes very big ones, and when they do the result can be total disaster. I'm not advocating eliminating central banks - I think they serve a useful purpose - but I don't think they should be all-powerful. Market discipline is vital.

Hi Frances,

Sorry: I didn’t notice that your four “problems” were specifically related to the IMF paper rather than full reserve in general. My mistake. I agree the IMF paper is flawed: indeed I criticised it on my own blog a year ago. However, I have other criticisms of your article.

First, in relation to Kotlikoff you say his proposals would mean the “death of commercial banking”, and that that is some sort of problem. I certainly don’t disagree with your phraseology: at least, full reserve certainly does change the whole banking industry out of all recognition. Indeed one of Kotlikoff’s fans (Matthew Klein) is quite open about that. The title of a Bloomberg article of his is “The best way to save banking is to kill it”.

Re your objections to the end of “free while in credit” banking, that’s already ended, at least in the case of my High Street bank. I pay £13 a month in bank charges, and don’t do an inordinate number of transactions per month: roughly fifteen. As to interest, I’ve got about £5 a year in recent years.

Next, you say that “People put money in banks for two reasons” the first being that they “want safety AND a return”. That actually goes to the root of the problem. My response to the above “want” is “sure people want that combination”. People also want the Moon, and politicians constantly promise them the Moon, e.g. by making their bank accounts 100% safe (thanks to taxpayer largesse).

But the REALITY is that if money is earning a return it has to be invested or loaned out, and that involves risk. I.e. the combination “safety” and “return” is a blatant self-contradiction. And that’s a self-contradiction that full reserve disposes of.

Next, you say “But there is another possibility too – and that is a vast increase in the amount of equity that banks hold.” The word “possibility” is inappropriate there: reason is that the advocates of full reserve, certainly Milton Friedman and Lawrence Kotlikoff are quite open about the fact that entities that lend must be 100% funded by shareholders or equity. I.e. the word possibility needs replacing with “certainty” or something like that.

Re your last 3 or so paragraphs, you argue that commercial bank money creation gives us more stablity than a system under which money creation is done by or dominated by central banks. Strikes me you contradict that point when you say, quite correctly, that commercial bank lending is pro-cyclical.

To enlarge on that, I don’t disagree with your claim that “Central banks’ record on producing accurate forecasts of the economy is dismal..”. But at least central banks and governments act in an anti-cyclical manner, whereas commercial banks act in pro-cyclical manner. Strikes me that’s game set and match to central banks and governments (for all their faults).

Indeed we have just been through a credit crunch lasting five years and caused by irresponsible commercial bank activities which central banks and governments have been trying desperately to counteract.

Frances Coppola


Most economists' experience of state banking systems would be something like the Soviet Union, which was rigid, corrupt and in the end unstable. Corruption is as big a problem in state-run banks as it is in private ones - just look at the Spanish Cajas. But even when there isn't corruption as such, political agendas and lack of accurate information can mean that state-run banks simply don't respond well enough to the economy's need for finance.

Having said that, I actually recommended nationalisation of banking here:

because as far as I can see, our present banking system is unable to operate without sovereign guarantees. If it can't run without state backing, it might as well be state-owned.

Frances Coppola


The "four principal problems" relate SPECIFICALLY to the IMF's paper, not to the other two proposals. Perhaps you would like to reconsider your comment in the light of your evident failure to read either this article or my detailed critique of the IMF's paper properly.

Frances’s “four principal problems” are nonsense.

First, the claim that “banks would have to clear all lending decisions with the central bank in advance in order to obtain funding”. Where on Earth does that idea come from?

As Positive Money, Milton Friedman, Lawrence Kotlikoff and other advocates of full reserve clearly explain, lending under full reserve is done by entities that are 100% funded by shareholders. Who those lenders lend to is ENTIRELY THEIR BUSINESS. It has nothing to do with the central bank.

For Milton Friedman’s explanation, for example, see Ch3 of his book “A Program for Monetary Stability”, under the heading “Banking Reform”.

Second, “banks would have to clear all lending decisions with the central bank”. Same answer as above. I.e. the above “funded by shareholders” entities are in much the same position as unit trusts currently are: who they lend to or invest in has sweet nothing to do with the central bank.

Third, “banks would have to pay fees to the central bank for the reserves required to back deposits”. Where does that idea come from? Different advocates of full reserve have slightly different views there. Some claim there should be no “fees” or payments either way. Friedman argued that government / central bank should pay a small amount of interest to holders of base money (i.e. that payment should flow in the opposite direction to that suggested by Frances).

Fourth, “margins on what little lending remained after the debt jubilee…”. The whole debt jubilee idea is an idea peculiar to the IMF version of full reserve: with the emphasis on “peculiar”. That is, while there may be arguments for a debt jubilee, that is a separate subject to the pros and cons of full reserve. Other advocates of full reserve do not get the two muddled up, and don’t advocate any sort of jubilee far as I know.

Lovely article. Just one thing:

You write off the first two proposals because you conclude they would lead to the death of commerical banking, and require the full nationalisation of the banking system.

You suggest that this "would not be taken seriously by most economists and politicians" and leave it at that.

Now I can understand politicians backing away from it, since the financial elite fund their parties, and have way more power than the politicians themselves.

But why would economists?

In what way is a nationalised banking system, run for the benefit of society, worse than a privately owned banking system, run (by law) for the primary purpose of 'maximising shareholder return', i.e. its rich owners extracting the maximum money possible from it?

In all seriousness, perhaps one of you economists could write an article on this? All profit reinvested in the country, versus rich owners extracting every penny in every way they possibly can?

As references, you might usefully compare British Rail to the UK's current privatised disaster of a train service. And the cost of NHS services compared to the privatised US equivalent. If that helps.

The thing is, the money supply does not respond to demand at present. During the crisis, bank investment committees decided to create less money because it turned out rates of return were not as high as they had thought, the population did not suddenly demand fewer loans. The last 5 years and the ongoing monetary crisis in the Eurozone surely provide ample evidence that letting a small and privileged community of firms decide how much money the economy needs is not a workable solution either.

I totally agree with you that in a world where money supply responded to demand, that would be the way to do it, but how to create such a world?

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