Vollgeld or Fool’s Gold…?

On June 10th the good burghers of Switzerland will vote in a federal popular initiative (referendum) that is causing some consternation amongst the country’s banking institutions, including the Swiss National Bank (SNB), the central bank. The proponents of the referendum seek to end the system of fractional reserve banking within Switzerland, through which local banks (as in all other major global banking systems) in effect create so-called “private money” when they create new assets through lending, and hold only a fraction of their reserves in “central bank money” as created by, e.g., the SNB (or the Federal Reserve, ECB, or Bank of England) and backed by the full faith and credit of the sovereign.

This may all seem rather arcane, but the reality of the modern world is that most “money” in an advanced economy (often over 90%) does not consist of notes and coins, but rather exists because of the activities of its banking system as it makes loans and takes deposits. “Runs” on banks occur (with the film It’s a Wonderful Life being the paradigm in popular culture) when a bank’s customers all want “their money” back (in the form of true cash) at once- something which no modern bank can do because of its inherent leverage. The entire system is based upon confidence.

The idea of having at least some sectors of the banking system (usually those which deal with individuals or small businesses) operate more as utilities with a “full reserve” model is not new (President Roosevelt rejected the Chicago Plan in 1933, creating the FDIC instead), but the Vollgeld referendum proposal represents an extreme version in that it would require the SNB to become the sole provider of Swiss Francs to the financial system, as all Swiss Franc sight deposits (some CHF 555BN at end-March 2018) would be required to be held at the SNB. This has caused the usually apolitical institution to characterize the referendum as a “dangerous experiment”.

In effect, if the referendum were to pass (which still appears unlikely, although certainly a “fat tail” risk in an era of populism), the SNB would determine the amount of money provided to the Swiss economy, effectively controlling directly one of its key levers. Of course, historically, central banks have used various mechanisms to control money supply and lending (who can forget the Bank of England’s “corsets”?), but have stopped short of being the sole source of money, allowing regulated banks to create the above-mentioned “private money”.

While implementation of the Vollgeld Initiative would be unlikely to cause the Swiss banking system or the economy to seize up, it would increase friction with unforeseeable consequences, as the “experiment” has not been tried before in a developed economy. As such, in a world in which economic stability is often hard won, and easily disrupted, the Initiative represents another factor potentially adding volatility and uncertainty.

At Awbury, the existence of the Vollgeld Initiative counts as a “known unknown”- an observable potential event, but one with as yet uncertain parameters in terms of outcomes. As such, we shall continue our monitoring of it as another factor in the ever-changing risk matrix that makes life as underwriters of credit, economic and financial risks so “interesting”!

The Awbury Team

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