Is the new block chained backed payments system (LIBRA) to be introduced by Facebook a pure and much lower cost payments system? Or a bank, or equivalently a money market fund, upon which transactions can be drawn conveniently for low or no fees.
The operating costs for a bank that provides a payments facility are largely covered by the difference between the interest paid on deposits (perhaps zero) and the interest earned by the bank/payments provider making loans- of varying degrees of default risk. Unlike a Visa that collects fees to cover its costs –and does not make loans.
The banks have cross-subsided the fees that might otherwise have to charge with the revenue earned from their lending activities. The profitability of banks depends in part on managing their cash reserves, keeping them as small as possible to meet demands for cash back. And holding no more than prudent reserves of equity capital to cover non-performing loans. And provide shareholders with enough of a return to keep them in the banking business.
It is this leverage (banks holding fractional reserves of cash) that exposes the bank shareholders (and the broader economy that depends upon sound banks facilitating transactions) to the danger that non-performing loans may exceed the equity of the bank. However it is not only the deposits (liabilities of the banks and assets of depositors) that may be destroyed by the failure of a banking system. Of greater importance is that the payments system, can go down with the banks, with truly catastrophic effect for any modern, highly specialized economy that depends on its payments system.
Perfect safety for a payments system can only come with deposits fully backed by cash issued by the central bank with its power to create as much extra cash as the system might need. Block chain may well offer enormous savings in protecting the transactions they give effect to, against fraud. Savings that mean low enough fees that would cover the full costs and still provide a profitable return on capital. And avoid the dangers of leverage. SA banks lose as much as R800m a year to credit and debit card fraud. They likely spend even more on trying to prevent fraud.
Leaving banks to make the trade-off between risk and return, has worked well enough for most, but not all the time. The Global Financial Crisis of 2008 (GFC) demonstrated why it is very important to be able to deal with a banking crisis – should banks or more specifically- the payments system delivered by banks, be threatened with failure. The solution to any run on the banking system is for the central bank to supply more than enough cash to the banking system to stop any run on the banks- as the GFC also proved.
Perhaps modern information technology will allow a 100 percent, central bank deposit backed (not private bank backed) fee collecting payment providers, to compete effectively with the deposit taking banks for our transaction balances. If so, deposit taking banks, supplying a bundled service of payments with the aid of leverage, may fade away to be replaced by other forms of financial intermediation. That is by other financial institutions that can provide essential credit and take on leverage profitably, but without accepting responsibility for effecting payments.
This new world (of fully backed transaction accounts) may be the next phase in the evolution of the modern financial system. One that would provide for the separation of the payments system from the dangers of leverage. Wisdom would be to let a profit seeking, competitive financial system to evolve in response to the preferences of lenders and borrowers. And for regulators to stay out of the way so that a pure payments system could possibly evolve. However, if Libra is a bank- dressed up as a money market fund, carrying risks on its balance sheet, it should also be required to play by the same rules as its banking competitors. However these rules applied to vulnerable banks could be relaxed if the payments system were secure.