Updates from Chicago Booth

The safest bank the Fed won’t sanction – A ‘narrow bank’ offers security against financial crises
By John H. Cochrane – One might expect that those in charge of banking policy in the United States would celebrate the concept of a “narrow bank.” A narrow bank takes deposits and invests only in interest-paying reserves at the Fed. A narrow bank cannot fail unless the US Treasury or Federal Reserve fails. A narrow bank cannot lose money on its assets. It cannot suffer a run. If people want their money back, they can all have it, instantly. A narrow bank needs essentially no asset risk regulation, stress tests, or anything else.

A narrow bank would fill an important niche. Right now, individuals can have federally insured bank accounts, but large businesses need to handle amounts of cash far above deposit insurance limits. For that reason, large businesses invest in repurchase agreements, short-term commercial paper, and all the other forms of short-term debt that blew up in the 2008 financial crisis. These assets are safer than bank accounts, but, as we saw, not completely safe.

A narrow bank is completely safe without deposit insurance. And with the option of a narrow bank, the only reason for companies to invest in these other arrangements is to try to harvest a little more interest. Regulators can feel a lot more confident shutting down run-prone alternatives if narrow bank deposits are widely available. more>

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