Pennacchi On Narrow Banking

I stumbled across this dainty article, "Narrow Banking" past times George Pennacchi. The get-go component subdivision has a informative capsule history of U.S. banking.

George defines a spectrum of "narrow" banks. For instance he includes prime number coin marketplace position funds -- borrow money, hope fixed value instant withdrawal, purchase Greek banking concern commercial paper. But that is "narrower" than traditional lending, equally the assets are curt term in addition to commonly marketable.

Some interesting tidbits:

Prior to the twentieth century, British in addition to American commercial banks lent roughly exactly for curt maturities. Primarily, loans financed working uppercase in addition to provided merchandise credit for borrowers who were expected to obtain cash for repayment inwards the nigh future

Therefore,

... the typical construction of these early on banks contrasts amongst the modern persuasion of banks, according to which the received wisdom is that “[t]he main component subdivision of a banking concern is that of maturity transformation---coming from the fact that lenders prefer deposits to endure of a shorter maturity than borrowers, who typically require loans for longer periods” (Noeth & Sengupta 2011, p.8)....maturity transformation was often considered a violation of prudent banking.

On the nature of assets:

Following the US of America Civil War, many banks ... invested inwards commercial paper... With the institution of the Federal Reserve System inwards 1913, commercial newspaper became peculiarly desired because it was eligible collateral for borrowing from the Fed’s Discount Window. According to Foulke (1931), prior to the 1930s, banks in addition to trust companies held to a greater extent than than 99% of commercial paper....In contrast, banks today concur real niggling commercial paper

so "bank" in addition to then = "prime coin marketplace position fund" today -- but, after 1913, amongst discount window liquidity support. Some disintermediation makes a lot of sense. In 1830, yous could non hope to sell commerical newspaper inwards 10 milliseconds on an electronic exchange, so the "liquidity creation" past times banks was to a greater extent than necessary.  The struggles the SEC is having amongst prime number funds today has deep roots.

Credit lines:

One credit service of banks that is ubiquitous today but was completely absent from banks inwards the nineteenth in addition to early-twentieth centuries was the loan commitment. In recent years, to a greater extent than than 70% of line of piece of occupation organisation lending was from loan-commitment drawdowns.

This was an peculiarly interesting resultant inwards the crisis. Chari,  Christiano, in addition to Kehoe noticed banking concern lending going upward inwards autumn 2008. Lending freeze, what lending freeze?  Scharfstein in addition to Ivashina argued increased lending was mostly companies grabbing cash promised nether existing lines of credit.

Prior to the 1930s, banks often had long-term relationships amongst item borrowers: Banks would lend repeatedly for curt price to the same borrower....During the fiscal panic menstruation of 1857--1858, the [Black River] Bank’s number of borrowers declined past times nearly 75%,..early banks made virtually no formal loan commitments.

so rolling over loans without commitment is a agency to save the selection non to lend inwards a crisis. Perhaps Fed liquidity back upward is what changed rolling over to promising to exercise so.

Narrow deposit creation in addition to the viability of equity-backed banking:

...[the] Louisiana Banking Act of 1842. ...required a banking concern to concur specie (gold) in addition to bills of central in addition to promissory notes maturing inwards ninety days or less inwards amounts at to the lowest degree equal to its deposits in addition to notes issued. Moreover, the ratio of specie to the full of deposits addition notes had to endure at to the lowest degree one-third. The banking concern could brand loans amongst maturities greater than ninety days, such equally mortgages, in addition to concur existent estate in addition to other fixed assets but they must endure funded amongst equity capital, non deposits or notes.

Hammond (1957, p.683) states, “The available bear witness is that the organisation operated amongst distinguished success…Although the banks of New Orleans were good known throughout the province for their forcefulness in addition to integrity, the constabulary governing them was non to a greater extent than often than non emulated.” Sumner (1896, pp. 387, 389) is to a greater extent than enthusiastic, calling the deed “the most remarkable constabulary to regulate banks, which was produced inwards this period, inwards whatever State…"

We seem doomed to constantly reinvent the steam engine, in addition to then to forget how it worked.

In summary, prior to the early-twentieth century, many US of America banks functioned similarly to narrow banks past times asset primarily short-maturity assets to tally their curt maturity liabilities. Despite the several episodes of banking panics, it may endure argued that panics occurred primarily at banks that deviated from the narrow-banking ideal. 

Influenza A virus subtype H5N1 novel variety of moral hazard:

Influenza A virus subtype H5N1 to a greater extent than of import reply to the 1907 panic was the institution inwards 1913 of a authorities lender of final resort in addition to cardinal banking concern inwards the shape of the Federal Reserve System. Access to the Fed’s Discount Window made it less costly for banks to concur longer-term in addition to to a greater extent than illiquid loans. Indeed, Friedman & Schwartz (1963) debate that the Fed’s beingness changed banks’ behaviour inwards ways that led to to a greater extent than banking concern failures during the early on 1930s. Banks shifted to higher credit-risk loans in addition to felt less involve to lend to each other during times of stress because that was directly considered the Fed’s responsibleness (which the Fed failed to perform adequately).

...bank capital-asset ratios were trending downward since the 1840s (when they were over 50%), but the refuse accelerated next the founding of the Fed in addition to the FDIC. The uppercase ratio in addition to then stabilized inwards the hit of 6%–8% starting inwards the early on 1940s

in addition to one-half of that at the start of the fiscal crisis inwards 2007.

As amongst other proposed banking concern reforms, recommendations for narrow banks seem most oftentimes next major fiscal crises. With the exception of the Louisiana Banking Act of 1842, in addition to maybe the U.S. Postal Savings System, proposals involving narrow banks convey non been implemented.

Well, non yet!

The residuum of the newspaper has a dainty summary of narrow banking proposals, in addition to theoretical analysis.