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Tuesday, December 19, 2023

Should Everybody Have An Account At The Central Bank?

This will be my last posting before Christmas, and depending on what I get up to, possibly the last of 2023. This article is somewhat of a placeholder for my manuscript chapter. It is a group of related topics that I think belongs in there, but not ones that I spent much time looking at. I will revisit this text when I put the manuscript together.

Happy Holidays (and probably) Happy New Year!

In this article, I will breezily run through a few topics that are related to the idea of “everybody getting accounts at the central bank.” Many (but not all) of these proposals are being put forward as a means to fixing the problems with the private banking system that were exposed during recent financial crises, and/or proposals to del with the somewhat backward retail banking infrastructure of the United States of America (and perhaps a few other countries).

One possible variant of these ideas is that the central bank (or the central government via a “postal bank” system) operates in direct competition to private banks — they offer loans and accounts. Alternatively, the central bank could just move into offering retail payment and deposit services, without offering loans itself.

Postal Banking

I am going to use “central bank” herein as a shorthand for the central government offering banking services more widely. In practice, this might not be done by the existing central bank, under the argument that central bank generally has zero expertise in offering such services. (I believe that the Bank of England used to offer accounts to a limited number of people, but dropped those facilities. I need to get a reference for this alleged history.) In order to match private banking services, one would need widespread retail outlets. Post offices already provide that retail footprint.

Rather than duplicate the post office infrastructure build out, it makes sense to offer banking/payments services at post offices — postal banking. This a system that exists to a certain extent in various countries. A reinvigoration or expansion of postal banking might result in greater availability of banking services to all citizens, but how this would be done would depend upon the conditions in the legal jurisdiction. Although it might improve conditions for some people, such a move is not going to have a major macroeconomic impact since firms and most individuals will not use postal banking services.

From a Canadian perspective, it is not clear that postal banking would amount to much. At present, many “post offices” are franchises run out of retail businesses (often pharmacies). (Go to to check out franchising opportunities.) As such, the central government has only limited control over the branches, and although they are going to have access to payments systems, they cannot take financial risks. Beyond adding some payments options, it seems much easier to slap a mandate on the handful of private Canadian banks that they serve all Canadians (within reasonable limits). This might not work in fragmented banking system (like the American one), but it is much more efficient to browbeat a few private senior bankers than try to replicate their branch system.


Another set of proposals involves the central bank getting involved in direct lending decisions to non-banks. As discussed earlier, I am opposed to this. Central governments are involved in lending programmes — for example, student loans — but they quite often offload credit analysis and servicing to the private sector. The government just takes on the credit risk, although they can charge a fee for that. (For example, the Canada Mortgage and Housing Corporation (CMHC) — a Crown Corporation — insures most mortgages that are originated with a loan-to-value ratio above 80% (the rest are insured privately).

Although one can readily argue that such programmes should be expanded, doing so is a political decision. There is no economic magic created by having the central government directly “create the money” for loans versus taking on the credit risk of a private bank loan. In either case, somebody in the private sector is transferred cash under programme specifications — with the hope that the money is paid back — and this transfer is matched by the issuance of liabilities that are either direct liabilities of the central government, or private sector liabilities wrapped with a central government guarantee. Although those two types of liabilities might appear different, they are economically equivalent.

The key point to note is that if the government wants to go hog wild underwriting private sector credit risk, it does not need to involve the economics doctorates at the central bank who have zero expertise in credit analysis.

Central Bank Offering Safe Bank Accounts

We can now move to what some view as a major concern — people should have bank accounts with the central bank so that they do not have to worry about the credit risk behind their “money.”

The idea is that if the central bank allowed everybody to bank with them, everybody would rejoice and financial crises would allegedly be impossible. This theory runs into two serious problems.

  1. Choice of bank for holding deposits generally depends upon the other services offered by the bank. For example, we ended up banking with the bank that offered the best mortgage rate on our first house — which I assume is a fairly typical situation. The credit risk to deposits is pretty much at the bottom of the list of criteria I would use, courtesy of the existence of deposit insurance (a topic that is discussed further below).

  2. Unless all lending activity is nationalised, credit risk has to go somewhere. Removing it from the banking system will just push it to non-bank finance — where most of the real financial crises have arisen in recent decades. (The Silicon Valley debacle appears to be an exception, however that crisis just tells us that nobody in San Francisco should be allowed to work for a private or central bank.)

There is nothing stopping the private sector to have credit risk free payments/”deposit” system — just tie Treasury bill funds into the payments system. The problem is that it is not in anyone’s economic interest to offer that service for free — the need to be paid for running the payments system. The reality that deposits are loans to banks gives them an incentive to provide the payments services at a “reasonable” price — as well as the reality that deposit services are a “loss leader” that allows the sale of more profitable services (e.g., mortgages). Even if the government mandated the provision of 100% safe deposit facilities, it is unclear that anyone other than the most risk-averse would use them.

Unlimited Deposit Insurance

If the objective is to provide deposits with no credit risk whatsoever, we can just remove the limit on deposit insurance. (At the time of writing in Canada, the limit is $100,000, in the United States, $250,000.) This creates the economic equivalent of a deposit with the central government without requiring the central government to put a bank branch in every small town in the country. In a financial crisis, it is clear that the limit is somewhat of a fiction — the central government is probably going to cover all deposits to prevent a panic.

One could easily argue that we should not have ambiguities that allows a crisis to happen — if the government is going to bail out all deposits, then it should say that up front. Although I am not a huge fan of fictions, I think the legal ambiguity is useful. Unlimited deposit insurance takes away the discretion of regulators to allow a fraudulent bank to get wiped out. Although one might attempt to shed a tear for the poor widows and orphans caught up in the calamity (who are somehow able to muster deposits above the insurance limit), it is entirely possible that the major “depositors” who would get bailed out are in on the scam in some fashion.

In a country with a few large banks, such fraud concerns are perhaps not an issue. But in a country like the United States where the barriers to setting up a bank are low, we cannot expect regulators to pre-emptively catch all problem banks. Unlimited deposit insurance implies a need to regulate on the basis that no bank is expected to fail — which is not the American situation.

“Backup” Risk-Free Deposits Would Make Crises Worse

Creating risk-free deposit options that are not used in normal times (because they are uneconomic) would just make financial crises worse. The premise of conventional banking is that they have sticky deposit bases, and the core banks of the system are presumed to be the safest, so they do not face a flight-to-quality risk. Creating risk free accounts at the central bank that are only used in crises just creates an incentive for a run on the core of the banking system — which is exactly the nightmare financial crisis scenario you want to avoid.

Wholesale Payments System — Nationalise It

One of the campfire horror stories that experts love to discuss is the potential failure of the wholesale payments system in a country. The response to that is straightforward: nationalise it if things look ugly. Until then, you let the private banks worry about containing credit risk so that you do not have to.

Central Bank Digital Currencies

The final angle is the possibility of central banks hopping on to the crypto-currency hype train and creating their own “digital currency” that is not the national currency. (“Digital currency” is a bit of a silly name in that electronic transactions on digital computers represent the vast majority of daily transaction volume.)

From what I have seen of the discussions of these currency proposals, they seem aimed more at micro issues (privacy, accessibility) and not macro.

Concluding Remarks

The willingness of politicians to have the central government stick its nose into lending decisions is going to rise and fall with political trends. Having the government outsource the implementation of lending to private lenders and instead just providing lending guidelines uses much less resources than setting up a parallel lending infrastructure that might be redundant one election later.

Having the government get involved in retail payments is a question that might have different answers in different countries. That said, postal banking has been in decline, and it is not clear that it is the most efficient way to deal with actual problems.

Finally, we are left with question of financial system instability. The expected final instalment of this series will look at financial instability — would 100% credit risk free deposits make a difference?

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(c) Brian Romanchuk 2023

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