Minsky and Narrow Banking

Michael Stephens | August 24, 2012

The idea of breaking up the big banks, while seemingly growing in popularity, leaves a lot of unanswered questions.  And one of the biggest questions is probably this:  what will be the structure of the smaller institutions that remain after such a break up?  If these smaller institutions are allowed to entangle themselves in the same complex activities as before, then we will still be a long way from stabilizing the financial system.

In this context (and with a recent IMF paper reconsidering the Depression-era “Chicago Plan”), Jan Kregel looks at one potential proposal for simplifying the financial structure; an alternative to Dodd-Frank’s partiality and complexity.  In his latest policy brief (“Minsky and the Narrow Banking Proposal: No Solution for Financial Reform“), Kregel looks at Hyman Minsky’s consideration of a narrow banking proposal in the mid-1990s (at the time, Minsky was looking at potential reforms for a post-Glass-Steagall financial system).  In this narrow banking proposal, commercial and investment banking functions would be separated into distinct subsidiaries of a bank holding company, with 100 percent reserves required for the deposit-taking subsidiary and a 100 percent ratio of capital to assets for the investment subsidiary.

Minsky eventually turned against the proposal, and Kregel likewise concludes that narrow banking is not the answer.  Among other reasons, Kregel notes that in such a narrow bank holding company system there would be no leverage, no liquidity creation, and no deposit-credit multiplier.  Banks would not be able to act as the “handmaiden to innovation and creative destruction,” as he puts it.  And for all that, the system would still be vulnerable to destabilization.  “[T]he real problem that must be solved,” Kregel writes, “lies in the way that regulation governs the provision of liquidity in the financial system.”

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