Richard Murphy, Seigniorage and Banks: Explained

I was wondering where Ritchie was getting his information on the way that the banks make billions out of seigniorage from. So I asked, and was told to go and read Galbraith and Keynes.

Hmmm. I know they wrote a lot about money, about money creation, about the monetary system, but given that Sunday afternoons are of sadly limited length I wasn\’t going to read all of their output to see if they had indeed talked about the seigniorage that banks earn from the credit creation inherent in fractional reserve banking.

I very much doubt they did in fact say anything of the sort for it would be a fairly silly thing to say: while I may disagree with their views at times I don\’t make the mistake of thinking that they were silly.

Then some idle googling landed this paper. It\’s from the blokes who started up the new economics foundation, a group which Ritchie is vaguely associated with. I don\’t know that this is where his views on this matter come from but they are close enough to make it seem likely to me. This is how they calculate what they call* the seigniorage earned by the banks from the creation of credit.

Amounts are estimated as follows: a) The special margin rate which earns the special banking profit from creation of sight deposits is in principle equal to the national base rate of x% (e.g. repo rate, discount rate, or similar). So the special profit on all non-interest bearing sight deposits SD in M1 = SD ● x%. b) A certain proportion of SD is interest-bearing to the customer. That interest of y% payable by the banks has to be subtracted from the base rate which is receivable by the banks. c) Another proportion of SD is created by current overdrafts. On these, customers pay an additional extra interest rate of z% which has to be added to the base rate. d) Composition of deposits and interest rates differ according to country. For simplicity’s sake we assume that in all countries 3/4 of chequebable deposits would be non-interest bearing, and 1/4 interest-bearing (except in the UK, where the approx. proportion rather is 1/4 to 3/4), furthermore, 1/4 of SD is currently created by overdraft. Interest rates could be accounted as follows: Base rate USA 5% – UK 5.5% – Euro area 3% – Japan 0.5%. Interest paid on sight deposits USA and UK 1.5%, Euro area 1%, Japan 0.3%. Additional overdraft rate USA and UK 5%, Euro area 4%, Japan 3%. e) All in all, the special profits can be estimated at: ((2SD ● x%) + (SD ● x+z%) + (SD ● x-y%))/4. In the UK: ((SD ● x%) + (SD ● x-y+z%) + (2SD ● x-y%)) / 4.

Ahhh, now I see what they are doing and I hope you can too.

What they are really saying is that some bank deposits (current accounts for example) do not pay interest,. But there\’s pretty no such lending out that a bank does which does not pay interest to the bank (well, OK, assuming no defaults which we might not want to assume right now). Getting money at no interest and lending it out at good interest rates is indeed a profitable activity. Mebbe.

This isn\’t seigniorage at all. I usually refer to it as the banking float but I\’m not sure that\’s quite the right name either.

The way that they get to this being seigniorage is that banks do the credit creating, greater credit will mean that there are more accounts not paying interest and thus the banks clean up. But the cleaning up is because there are accounts that don\’t pay interest, not because credit is created. In a sense it doesn\’t matter who is doing that credit creating, the profits for the banks will still be there because some of those accounts are not accruing interest. And if the profits don\’t come from the credit creation itself, rather, from the fact that there are zero interest accounts, then we can\’t call these profits seigniorage, can we?

They also go on to tell us how much profit is created for the banks in this manner.

This costs the public large sums of money in seigniorage revenue foregone, in the UK, for example, of the order of £47bn a year (Appendix, Table 4G). It gives the commercial banks a hidden subsidy in the shape of special, supernormal profits of the order of £21bn a year in the UK (Appendix, Table 4B).

OK, so I\’ve shown, at least to my own satisfaction, even if not to anyone else\’s, that what they\’re talking about is not seigniorage. Given that there\’s no public value to be captured by reform of credit creation….at least, not in this sense…. then nationalising the banks to capture this seigniorage for the common good just ain\’t gonna work.

However, we also know something else about "supernormal profits". They don\’t last in a competitive marketplace. I\’m entirely willing to agree that there is some, quite possibly large although not perhaps as large as the authors seem to think, amount of money made out of the point that the banks charge interest on the money they lend out from accounts that they\’re not paying interest upon. But this is better referred to as gross revenue from the activity, not profit (and Richard should get this as he is indeed an accountant). For there may well be costs associated with the provision of these bank accounts that do not pay interest. There\’s the usual overheads of course, there\’s the cost of a branch network….you don\’t get many chequing and current accounts of the type that don\’t pay interest without one of those. As an entirely trivial point you do not in the UK pay for your chequebook unlike the system in general in the US. The UK banks print that for free for you and then post it to you.

We can wander through all sorts of other things that banks pay out to run these non-interest paying accounts. Tellers, ATMs, well, make your own list. These are, if we\’re not paying for them in service fees, clearly being paid for by someone, somewhere. And a large part of that someone, somewhere, are those of us with money in non-interest bearing accounts, the money from which the banks lend out to other people at interest. The margin thus earned, the gross revenue, goes to offset some or all of the costs of attracting those non-interest bearing accounts in the first place.

I\’m entirely willing to agree that the banks do indeed still make a profit from this, that\’swhat they\’re in business to do after all. If there were no profit in retail banking then no one would do it, would they? But not "supernormal profits", for these are competed away by the fact that we have competition. That\’s why we have certain things for free on accounts that don\’t pay us interest.

In fact, and I would welcome confirmation of this, I think that some banks agree that they will pay you interest on current balances….but that you must then pay a fee for each service. Or a lower rate of interest and a limited number of free services. Or "free banking" and no interest.

To recap. The banks aren\’t making seigniorage out of credit creation. Those who say they are are getting confused with the revenues made from accepting non-interest bearing deposits which are then leant out at interest, what I call the float. And much if not the vast majority of those revenues are offset by the costs of running those non-interest bearing deposits, costs which the customers are not paying in any other manner. Meaning that, umm, sorry Ritchie, "Bring  seigniorage back into state control for the benefit of all – which I believe will be a source of considerable future wealth for the common good;"….there just ain\’t no wealth there for the common good to expropriate. Just the normal return to the capital invested in the banking business.

* Note please that this "they say" is extremely important.

5 thoughts on “Richard Murphy, Seigniorage and Banks: Explained”

  1. The theory also seems to ignore the fact that a significant amount of credit creation in the UK is carried out by mutuals. If banks were making a supernatural profit from lending, mutuals would be passing that same profit on to their investors and borrowers in the form of much better rates. Unless there was massive inefficiency across the mutual sector, they would have driven the shareholder owned banks out of the market.

  2. It is worth noting that banks have substantial costs in managing credit decisions.

    Credit analysts and sanctioners are employed by all banks, plus researchers and such like, who provide information about businesses, big and small, and individual applicatants, as well as economists, city watchers, money markets specialists, accountant s, and compliance officers.

  3. Mind you, even in the esssay I highlighted yesterday in the responses to Richard’s post, Hayek says that “providing the public with good money which it can trust and use can not only be an extremely profitable business” even if he goes on to say that it cannot be done by government because “it imposes on the issuer a discipline to whicih the government has never been and cannot be subject”.

    I used to be a big supporter of the publicly created money of Robertson and Huber – even they acknowledge that the function cannot be trusted to government per se, but would have to be done by an entity independent of the government and its financial policy. If it were only ever spent into circulation on, say, rent creating projects, any excess could be recaptured and cancelled through LVT.

    But in what way is that really different from the Bank of England monopoly created in 1845 – it is still a monopoly without any real incentive to keep that money good and keenly priced like competing private and commercial currencies would.

    Most of all though, whilst it’s easy to say that “banks create money from nothing” when the supply of credit is constantly being inflated as it has been but seeing the scramble for some of the “real stuff” by the banks to cover their positions should blow that theory out of the water. If all that lending was genuine money as opposed to fractional credit it could just be written off at effectively no cost to the creator if their loans went bad.

  4. The non-interest-bearing current accounts are also completely fungible — in that depositors may empty out their entire account at any given time, without warning — so while banks may indeed loan out the money, they have to keep some in reserve against that dread day.

    Mostly, sums thus deposited are relatively small. Try to leave, say, a million in a non-interest-bearing current account, and the banks will absolutely deluge you with offers of CDs (certificates of deposit) which tie up the cash for some period of time, while earning you some small rate of interest. That’s where they make their real money, in short-term / overnight loans, not on the few hundred grand lying fallow in current accounts.

    (Actually, a buddy who does have that amount of scratch lying spare — he collects vintage sports cars, so he needs the float — refuses point blank to keep it in an account, but rather in a safe-deposit box.)

  5. Pingback: The nef’s report on banking.

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