The Moorad Choudhry Anthology, + Website

Foreword

Paul Fisher

What is a bank? Few people seem to know. As explained in this book, banks can provide many financial services, but they are defined by regulators in relation to an official authorisation to take deposits: you cannot call yourself a bank unless you are a licensed deposit taker. The meaning of banking is equally vague in the popular consciousness. Among the most notable popular canards are the following: you put your money in a bank and they look after it for you; they take savings and lend them to borrowers; they invest in the real economy. None of these statements is true. In fact, retail bank deposits are effectively loans by customers to the bank, so it becomes the bank's money. Banks actually create most of their deposits in the process of lending, enabling them to generate much higher leverage (assets relative to capital) than any other type of financial firm. And banks provide credit services to borrowers for a fixed or floating rate of interest rather than sharing in the risk and actual returns on an investment.¹

Why do we regulate banks? In short, regulation could be said to reflect concerns matching those three observations. The first concern is that retail depositors are at risk of not being repaid, yet not in a position to judge that risk or get paid for it. Hence deposit insurance schemes. The second is banks' very high leverage, which increases the risk of insolvency when any sizeable loan goes bad. Hence capital requirements. And banks traditionally ...