Public Bank Lending

In my previous article, I discussed (traditional) postal banking, in which the central government manages a deposit-taking bank (which historically used post offices as “bank branches”). Postal banks offered basic payments and savings services for poorer people who were ill-served by private banks.

In my view, the usefulness of such banks depends upon conditions in the country. It may be just as easy to mandate private banks to offer minimal standards of service without the challenges of attempting to replicate the information technology investments required. In countries where private banking has spotty coverage, such banks may be useful.

Nevertheless, I have run into a variety of arguments by progressives that the government should get deeper into the banking business. The usual focus of arguments is the power of “money creation” — which I argue below is somewhat of a red herring. Money creation by banks is a power that solely exists because of the standard definitions of “money” that include bank deposits in the M1 or wider monetary aggregates (the narrowest monetary aggregate M0 consists solely of governmental liabilities). Once we accept that there are a great many “cash” instruments that are used in liquidity management that are not bank deposits, we realise that all lending transactions create mirrored financial assets and liabilities out of thin air (ex nihilo).

If the government wants to intervene in lending, they can do so without needing to own a private bank analogue — and they do.

This article only discusses the topic from the perspective of a central government; the situation for a sub-national government is different. I hope to cover sub-nationals in a later article.

Lending to Businesses

Governments quite merrily lend to businesses. They are happy to do so since nobody in the business press complains — although the editorial stance is against governmental interference in markets, an exception is made for corporate welfare. “Consistency is the hobgoblin of small minds, &c.”

Examples include:

• The Export-Import Bank of the United States (EXIM). URL:

  https://www.exim.gov/. As suggested by the name, the focus of EXIM is on providing financial support for international trade.

• Business Development Bank of Canada (BDC). URL: https://www.bdc.ca/en. BDC is a Federal Crown Corporation (a government-owned business), but is run on a “financial sustainable” basis. It has a wide mandate.

• The United Kingdom has an export finance arm (URL: https://www.ukexportfinance.gov.uk/) and at the time of writing has a scheme for start-up financing for small businesses (URL: https://www.gov.uk/apply-start-up-loan).

Since governments like to improve their country’s export competitiveness, they tend to set up agencies to support finance for international trade. Trade finance is trickier than financing domestic sales. There are longer travel times, and firms are much less happy to have accounts receivables due from foreign companies.

Meanwhile, governments will often make ad hoc loans and loan programmes based on current needs.

Lending to Consumers

Outright lending to consumers by governments is less common, but there are cases of massive intervention in consumer lending markets. The two main areas are student loans for post-secondary education, and in the mortgage market. Furthermore, there can be interventions via the income tax system, such as making mortgage interest tax deductible (which acts as a de facto interest rate subsidy).

Student loan frameworks depend upon the jurisdiction. One strategy is for the government to manage the application process and guarantee the loan, while a private bank (or other lending entity) manages the debt repayment. In this case, the government is not directly creating the loan, rather acts as a guarantor to allow the private sector to make a loan that would otherwise not have been funded.

Mortgages are the largest form of household debt, and governments can end up with large interventions.

In the United States, there are few Federal programmes, but the dominant form was via the “government-sponsored enterprises” (GSE’s) such as Fannie Mae and Freddie Mac. They existed in an in-between world where they were theoretically private yet people believed that they had an “implicit guarantee” from the Federal Government. (In fact, I used to own fixed income textbooks that referred to this “implicit guarantee.) Another GSE — Ginnie Mae — was always purely governmental. However, the “implicit government guarantee” ran into reality during the Financial Crisis of 2008, and Fannie and Freddie ended up in conservatorships. These enterprises are not directly lending — they purchase mortgages from banks and then bundle them into securitisations. That is, they do not “create money” by direct lending, but they allow banks to do so because the banks can get the mortgages off their balance sheets.

The Canadian system is cleaner (although I have been critical of some past decisions). The Canada Mortgage and Housing Corporation (CMHC) acts as a guarantor for mortgages. Under Canadian law, any household taking a mortgages with an initial down payment below 20% must also pay for mortgage insurance. The CHMC dominates the mortgage insurance market, although the private sector has the theoretical right to compete. The CHMC receives the mortgage insurance payment, and in return guarantees the mortgages. These insured mortgages are then often sold into National Housing Association (NHA) mortgage-backed securities (MBS), with the CHMC managing that process. Since the CMHC is a full faith and credit obligation of the Federal Government of Canada, those NHA MBS are effectively Federal Government securities, albeit less liquid than Canadian Government Bonds (CGBs), and thus show up in the Federal component of Canadian bond indices.

An important advantage of government mortgage insurance is that it acts as a macroeconomic stabiliser. Modern developed economies are rich, and the household sector can sustain mortgage debt/income ratios that are high when compared to pre-World War II norms. This means that mortgages end up as a large weighting in private debt portfolios. This is fine until there are concerns about mass defaults. To the extent that mortgages are stuck in the hands of leveraged investors (including banks), they pose systemic risk to the financial system. Having the lowest credit quality mortgages backstopped with a guarantee of a floating currency sovereign dampens this risk. Although Canadian mortgage lending evolved to alarmingly weak standards, a crisis has been avoided (so far) by the CMHC guarantee. (The Canadian system also dodged the bullet of the 2008 Financial Crisis courtesy of the fact that the real collapse in lending standards only dated to the late 1990s, which is not-coincidentally house prices adopted the “hockey stick” price trajectory. The lateness of Canadians to the lax mortgage lending standard game meant that exposures were too bad in 2008.)

What I would highlight about these programmes is that these support loans for particular categories of expenditures. Furthermore, these expenditures are supposed to support public objectives — the borrowers enhance their education or purchase their own home. I have not done an exhaustive examination of government lending programmes worldwide, but within the English-speaking world, there may be less political support for the government offering lending for arbitrary purposes. For example, I think it would be a hard sell to push for government to lend people $1000 on Friday night so that they can take a taxi to a casino and test their new system for beating roulette — which could be financed via a private credit card or line of credit.

There is one large expenditure-specific form of household lending that governments tend to stay clear of — auto lending. It is unlikely that doing so makes much sense. The automakers offer financing incentives as a way to sell their product. You do not want to be competing with lenders that have an incentive to offer lending terms that are below market rates.

Aside: Are These Lending Programmes a Good Idea?

Although I am not too much of a fan of invoking supply and demand curves, the reality remains that if the government allows for massive borrowing against certain expenditures, the associated prices will eventually move.

If we look at the two favoured forms of lending — student lending and mortgages — we see two categories of prices that heavily outstripped the other components of the CPI since 1990 in the United States. (Other countries have more government intervention into university tuition, although rising house prices is a generic developed country problem). The loosening of CMHC mortgage insurance standards in the late 1990s were drastic, and the associated price rises were similarly drastic (although house price trends are slower-moving).

If you offer one household a loosened lending standard, you are (perhaps) doing them a favour — they have greater capacity for bidding for one house. If you loosen the lending standards for everybody, everybody can bid more, and that is exactly what ends up happening (and thus prices go up). The end result is that all the house buyers are worse off, while existing homeowners get a windfall gain.

I am in the camp that the infiltration of politics by real estate people has been disastrous — they view high house prices as being good for the country. (Older homeowners — like myself — are also part of the problem.) The dismal state of thinking on the topic is that almost every solution offered by politicians has been to make it easier to marshal spending power to allow households to pay more. (At the time of writing, there has been some movement towards pushing for greater rates of construction of new housing. Unfortunately, local politics often stymies such efforts.)

No Money Creation — So What?

Over the years, I have seen many versions of the argument that governments should “take advantage of the power of money creation” and replace banks as a source of lending. However, the people arguing this never pay any attention to the lending programmes that exist, and which are massive. For example, the CMHC had $440 billion of insurance-in-force in 2024 (which corresponds to 14% of Canadian GDP).

Central governments already create a significant amount of “money”: the monetary base. In the absence of forcing banks to hold government money via “quantitative easing,” government money holdings are driven by liquidity and portfolio management concerns (as well as the size of the underground economy). Otherwise, the government drains government money from the system via issuing bonds and bills. The existing government lending programmes skip the need to build liquidity management functions and instead piggy back off the Treasury/Ministry of Finance liquidity management. Since that is already how the central government operates, why should its lending activities behave differently?

The only way the lending operations would expand “government money” holdings is for a public bank to meaningfully expand its market share at the expense of private banks. However, offering banking services to the unbanked (the usual audience for postal banks) is not going to meaningfully grow demand deposit share. Almost by definition, unbanked people do not have a great deal of money. In order to grow market share, the public bank is going to have to offer a full range of financial services. Growing expertise and reputation is going to take time, while risking that entire operation is one election away from being privatised.

Postal banks can draw in a reasonable amount of long-term savings (as seen in the case of the Japanese postal bank). However, these savings are not interest-free demand deposits, the are instead interest-paying investment vehicles for risk averse individuals, or people with insufficient means to invest with private investment funds (which no longer appears to be a major concern). Countries like Canada and the United States issue “savings bonds” to serve such individuals. These savings vehicles are economically equivalent to substandard government bond investments, and so offering them does not really give the government any new financial flexibility.

In summary, the only reason to expand public banking to include lending activities is the desire to create a public sector bank that is competing head-to-head with private banks. Arguments about “public money” are by themselves meaningless, since governments already issue money in an efficient fashion.

The Problem with Lending Is Getting Paid Back

From the perspective of a professional politician, the problem with expanding lending to individuals outside of “approved” activities is that the government is stuck with the politically awkward problem of enforcing the debt contracts. One of the reasons that banks are unpopular is that they foreclose on people who miss payments, and politicians generally want to avoid situations that force them to make unpopular actions.

The political challenge is straightforward: the same people who might support an expansion of public banking are also the most likely to be squeamish about forcing repayment. One of the divisive issues of the doomed Biden presidency of 2021-2024 was an amnesty for student debt payments. The issue generated far more attention than it deserved. Nevertheless, the political reality is that handouts to households are an easy target for the financial and right-wing commentators, and lending money without enforcing repayment is in fact a gift.

Concluding Remarks

At the central government level, there are already schemes that support lending. These schemes do not attract attention — which partly explains why they still exist. They do not directly create “government money” (or “public money”), but that has no real economic impact. Central governments already create money, so they instead can just worry about providing support for borrowing for targeted purposes in an efficient way. Although some might wish that governments compete head-to-head with private banks, there is no need to do if the only objective is to expand opportunities to borrow.

References and Further Reading

• CHMC 2024 Annual Report. https://assets.cmhc-schl.gc.ca/sites/cmhc/about-cmhc/corporate-reporting/annual-report/2024/cmhc-annual-report-2024-en.pdf

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(c) Brian Romanchuk 2026