Saturday, May 3, 2014

Gurley and Shaw on Banking

Gurley and Shaw (1956), "Financial Intermediaries in the Saving-Investment Process":
As intermediaries, banks buy primary securities and issue, in payment for them, deposits and currency. As the payments mechanism, banks transfer title to means of payment on demand by customers. It has been pointed out before, especially by Henry Simons, that these two banking functions are at least incompatible. As managers of the payments mechanism, the banks cannot afford a shadow of insolvency. As intermediaries in a growing economy, the banks may rightly be tempted to wildcat. They must be solvent or the community will suffer; they must dare insolvency or the community will fail to realize its potentialities for growth. 
All too often in American history energetic intermediation by banks has culminated in collapse of the payments mechanism. During some periods, especially cautious regard for solvency has resulted in collapse of bank intermediation.  Each occasion that has demonstrated the incompatibility of the two principal banking functions has touched off a flood of financial reform. These reforms on balance have tended to emphasize bank solvency and the viability of the payments mechanism at the expense of bank participation in financial growth. They have by no means gone to the extreme that Simons proposed, of divorcing the two functions altogether, but they have tended in that direction rather than toward endorsement of wildcat banking. This bias in financial reform has improved the opportunities for non-monetary intermediaries. The relative retrogression in American banking seems to have resulted in part from regulatory suppression of the intermediary function. 
Turning to another matter, it has seemed to be a distinctive, even magic, characteristic of the monetary system that it can create money, erecting a "multiple expansion"of debt in the form of deposits and currency on a limited base of reserves. Other financial institutions, conventional doctrine tells us, are denied this creative or multiplicative faculty. They are merely middlemen or brokers, not manufacturers of credit. Our own view is different. There is no denying, of course, that the monetary system creates debt in the special form of money: the monetary system can borrow by issue of instruments that are means of payment. There is no denying, either, that non-monetary intermediaries cannot create this same form of debt. ... 
However, each kind of non-monetary intermediary can borrow, go into debt, issue its own characteristic obligations - in short, it can create credit, though not in monetary form. Moreover, the non-monetaryintermediaries are less inhibited in their own style of credit creation than are the banks in creating money. Credit creation by non-monetary intermediaries is restricted by various qualitative rules. Aside from these, the main factor that limits credit creation is the profit calculus. Credit creation by banks also is subject to the profit condition. But the monetary system is subject not only to this restraint and to a complex of qualitative rules. It is committed to a policy restraint, of avoiding excessive expansion or contraction of credit for the community's welfare, that is not imposed explicitly on non-monetary intermediaries. It is also held in check by a system of reserve requirements. ... The [money multiplier] is a remarkable phenomenon not because of its inflationary implications but because it means that bank expansion is anchored, as other financial expansion is not, to a regulated base. If credit creation by banks is miraculous, creation of credit by other financial institutions is still more a cause for exclamation. 
The first paragraph of this long footnote is a succinct statement of a basic tension in bank regulation that remains unresolved. (Recall that Simons' proposal to eliminate the intermediation function of banks was recently revived by Michel Kumhof at the IMF.) The other two paragraphs are a good clear statement of the argument I've been trying to develop on this blog, that there is no fundamental difference between money and other forms of financial claims, and a macroeconomically meaningful "quantity of money" was an artifact of mid-20th century regulatory arrangements.


  1. It is fascinating that the same things seem to be re-said decade after decade and yet still seem to be viewed as surprising!

    Have you also seen the latest post Nick Edmonds has done on his monetary reflections blog?

    Personally I think the lending system needs to be entirely separated off from the payments system (in totally different companies) so that the payment system isn't held hostage whenever the lending system wants bailing out. A separated off payments system could be much like MPesa or PayPal and also 100% backed by reserves (or short term government debt)- we now have ample amounts of both to enable that.

    If the lending system was not permitted to conduct maturity transformation and could only issue debt with a time to maturity matched to the loans made, then bank runs would no longer be a source of financial fragility and debt would be priced at a level that no longer gave it a distorting advantage over (more robust) equity financing.

  2. Hi JW. I'm trying to understand part of that long footnote:

    "However, each kind of non-monetary intermediary can borrow, go into debt, issue its own characteristic obligations - in short, it can create credit, though not in monetary form."

    An example of an NM-Intermediary and its obligation would help me understand.

    If the NMI borrows from a... from a monetary intermediary, then it is the power of the latter that created the money. No, the quote says the NMI creates non-monetary credit. I don't know what that is, I guess. Help!

    (I was going to suggest the idea that NMIs rely on MIs for "reserves" the way MIs rely on the Fed for reserves.)

    An interesting post. I spent a good couple hours surfing your site yesterday.

    RE your conclusion here -- regarding "the argument I've been trying to develop on this blog, that there is no fundamental difference between money and other forms of financial claims" -- another footnote comes to mind:

    1. Without disturbance to this definition, we can draw the line between “money” and “debts” at whatever point is most convenient for handling a particular problem. For example, we can treat as money any command over general purchasing power which the owner has not parted with for a period in excess of three months, and as debt what cannot be recovered for a longer period than this; or we can substitute for “three months” one month or three days or three hours or any other period; or we can exclude from money whatever is not legal tender on the spot.

    Whether or not there is "no fundamental difference between money and other forms" it seems would depend on the "particular problem" being handled. Now, if the problem is excessive reliance on credit...

    1. @The Arthurian, I thought that "non-monetary credit" meant things such as bonds and repo-agreements. Shadow banks create lots of credit expansion in that way when they conduct financial intermediation (in the USA apparently as much as banks do).

      Nick Edmonds gave this explanation when I asked about shadow banking in the comments of his blog: "Typical shadow bank maturity transformation works something like this. Long dated loans are repackaged into long-dated marketable securities. These are then held and funded by short dated repo, subject to daily mark-to-market and over-collateralisation. If the repo counterparty doesn't want to roll, the bonds are just sold."

    2. Stone, it's all greek to me. If I buy a bond, the seller has the use of my money. So he's the one using credit, and I have the asset. I don't see how the bond I'm holding is credit. Yeah, I don't see how both sides of that transaction can be credit. You're probably right. I just can't see it.

      I visited your post & followed a link to Nick Edmonds' "Banks, Non-Banks and the Medium of Exchange". Interesting stuff.

    3. The Arthurian, I suppose it is a sort of "I owe you an IOU" type expansion. My feeling was that if you can trace along what actually happens, then it is simply a case of accepting that that is what the finance system does. That is what is happening behind the scenes to ensure we get our mortgages and credit card credit and such like.

  3. I think we can use the parking garage analogy to improve understanding of the role of banks in money supply expansion.

    Imagine a parking garage where cars were loaned to people. The car is in the garage because it is unneeded at the moment so why not lend it to others? It works if all of the cars are identical.

    Now the loan of a few cars goes unnoticed but if we count all the obligations for cars, the number of obligations has increased while the number of cars has remained unchanged.

    A problem arises if all the people with claims on cars want their car at the same time. There is not enough cars.

    Banks have the identical problem. Banks do not truly create money, they only create the PERCEPTION that they create money. Perceptions matter. When depositors perceive that the bank can not give all depositors their car (money) upon demand, bank runs happen and there are not enough cars (money) for all.

    1. Roger Sparks, sorry if this seems pedantic but I personally use a bank account and I'm reassured in the financial prudence of doing so by the assurance that the government will do what it takes to ensure that deposits up to the guaranteed limit (£100k for a couple in the UK) are honored.
      It is all a matter of definitions but to my mind the fact that bank deposits are trusted and used as "money" is enough to magically transform them into being "money" not withstanding that they couldn't all be simultaneously withdrawn without the need for a bank bailout.
      After all, no form of money really amounts to more than a trusted form of tally. Paper folding legal tender money depends on trust in the system just as much as bank deposits do. Gold coins only have value because we trust that in future other people will value them for no better reason than we do today.

  4. The issue as I see it as that the two concepts in this paragraph -- while both true in their own way -- are working at cross purposes. If it is possible, given the right circumstances, for anyone to issue liabilities that are trusted as money, then it is possible for anyone can effectively become part of the payments system, or pose at least some of the same kinds of threats to financial stability as the payments system people. If your intermediaries are involved in a credit bubble and are issuing liabilities that people trust, with no backstop except the value of the bubbly assets being used as collateral, then what happens when the bubble deflates?

  5. One of the lessons from Kindleberger's "Manias, Panics, and Crashes" is that there is a huge variety of ways in which it is possible to create credit and indeed broad money, and this is relatively independent of whether the currency is fiat, metallic, or something else. It is open to anyone who sells to offer credit and also to make their bills assignable, and once this is done, you have the basis of endogenous money. In fact, this may even predate money itself.

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