Monday, January 19, 2009

RC on Banking

Doug Reich has an interesting post on banking over at the Rational Capitalist (be sure to check out the comments too, as the discussion continues there).

My simple take on the issue is that in a free market you'd distinguish between pure warehousing of money, versus using banks as investment vehicles. That is, a pure demand deposit would be akin to a warehousing or storage transaction, most likely resulting in the depositor paying fees, not receiving interest. OTOH, if someone has capital that they want to invest, banks could act as one type of investment vehicle, competing with mutual funds, hedge funds, etc. And just as the other types of investors have strategies with different risk levels, banks could too, ranging from relatively safe to relatively risky.

Of course, in a free market every transaction has some risk, but assuming the warehouse acted as a warehouse, and insured itself against theft and disaster, then that type of storage would be among the lowest risk transactions. I.e. you could consider your money safely stored.

For investment transactions, including allowing the bank to use its judgment in lending your funds out, there would be considerably more risk, and the payment you got for lending your money to them would have to compensate you for this risk. (If everyone understood the nature of these transactions, there would be no call for the government to step in when things went wrong, it would already be seen as a possible consequence of the activity.)

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