Pennacchi On Narrow Banking

I stumbled across this overnice article, "Narrow Banking" past times George Pennacchi. The commencement part has a informative capsule history of U.S. banking.

George defines a spectrum of "narrow" banks. For trial he includes prime number coin marketplace funds -- borrow money, hope fixed value instant withdrawal, purchase Greek banking firm commercial paper. But that is "narrower" than traditional lending, every bit the assets are brusk term too commonly marketable.

Some interesting tidbits:

Prior to the twentieth century, British too American commercial banks lent nigh alone for brusk maturities. Primarily, loans financed working majuscule too provided merchandise credit for borrowers who were expected to obtain cash for repayment inward the nigh future

Therefore,

... the typical construction of these early on banks contrasts amongst the modern thought of banks, according to which the received wisdom is that “[t]he top dog business office of a banking firm is that of maturity transformation---coming from the fact that lenders prefer deposits to live on 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 U.S. of A. Civil War, many banks ... invested inward commercial paper... With the institution of the Federal Reserve System inward 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 too trust companies held to a greater extent than than 99% of commercial paper....In contrast, banks today concur really piffling commercial paper

so "bank" so = "prime coin marketplace fund" today -- but, after 1913, amongst discount window liquidity support. Some disintermediation makes a lot of sense. In 1830, you lot could non hope to sell commerical newspaper inward 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 only was completely absent from banks inward the nineteenth too early-twentieth centuries was the loan commitment. In recent years, to a greater extent than than 70% of work organisation lending was from loan-commitment drawdowns.

This was an peculiarly interesting trial inward the crisis. Chari,  Christiano, too Kehoe noticed banking firm lending going upward inward autumn 2008. Lending freeze, what lending freeze?  Scharfstein too 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 brusk price to the same borrower....During the fiscal panic menses 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 means to save the alternative non to lend inward a crisis. Perhaps Fed liquidity back upward is what changed rolling over to promising to exercise so.

Narrow deposit creation too the viability of equity-backed banking:

...[the] Louisiana Banking Act of 1842. ...required a banking firm to concur specie (gold) too bills of telephone substitution too promissory notes maturing inward ninety days or less inward amounts at to the lowest degree equal to its deposits too notes issued. Moreover, the ratio of specie to the full of deposits summation notes had to live on at to the lowest degree one-third. The banking firm could brand loans amongst maturities greater than ninety days, such every bit mortgages, too concur existent estate too other fixed assets only they must live on 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 clit too integrity, the police clit governing them was non by too large emulated.” Sumner (1896, pp. 387, 389) is to a greater extent than enthusiastic, calling the human activity “the most remarkable police clit to regulate banks, which was produced inward this period, inward whatever State…"

We seem doomed to constantly reinvent the steam engine, so to forget how it worked.

In summary, prior to the early-twentieth century, many U.S. of A. banks functioned similarly to narrow banks past times belongings primarily short-maturity assets to stand upward for their brusk maturity liabilities. Despite the several episodes of banking panics, it may live on 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 answer to the 1907 panic was the institution inward 1913 of a authorities lender of final resort too key banking firm inward the shape of the Federal Reserve System. Access to the Fed’s Discount Window made it less costly for banks to concur longer-term too to a greater extent than illiquid loans. Indeed, Friedman & Schwartz (1963) fence that the Fed’s beingness changed banks’ behaviour inward ways that led to to a greater extent than banking firm failures during the early on 1930s. Banks shifted to higher credit-risk loans too felt less necessitate to lend to each other during times of stress because that was at in 1 trial 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%), only the refuse accelerated next the founding of the Fed too the FDIC. The majuscule ratio so stabilized inward the attain of 6%–8% starting inward the early on 1940s

too one-half of that at the start of the fiscal crisis inward 2007.

As amongst other proposed banking firm reforms, recommendations for narrow banks look most ofttimes next major fiscal crises. With the exception of the Louisiana Banking Act of 1842, too maybe the U.S. Postal Savings System, proposals involving narrow banks bring non been implemented.

Well, non yet!

The remainder of the newspaper has a overnice summary of narrow banking proposals, too theoretical analysis.