Bernard Lunn

Swiss Vollgeld initiative could end Fractional Reserve Banking

Safety comfort

It was an odd Xmas present to the global banking industry. On 29 December headlines were announcing that:

“Switzerland to vote on banning banks from creating money”

The Swiss referendum would strip commercial banks of the ability to create money using Fractional Reserve Banking. Banks would have to back loans 100% with reserves. As an article in Stratfor pointed out, this has implications globally and

“could shred core business assumptions that have underpinned the banking model over the past three centuries.”

Vollgeld

The idea of what the Swiss call Vollgeld (translation is “full money”) was first outlined in a 2012 paper from the International Monetary Fund. Iceland is also considering this, but Iceland is tiny compared to Switzerland. This research note look at Iceland as one of the alternative Fintech Capitals, which is # 84 on the Global Financial Centers (GFC) index and tiny in GDP terms. So any move they make can be dismissed as irrelevant by the banking industry. However if Switzerland makes the move it cannot be dismissed as a blip. Zurich alone ranks # 7 in GFC and Geneva ranks # 13. Switzerland is a global leader in Wealth Management.

Vollgeld would be a totally radical move that would hurt traditional banking in Switzerland in the short term, but it could vault Switzerland into a leadership position longer term. If Switzerland does it, other centers will have to follow. This is a case of disrupt before you are disrupted. Together with the move by Xapo from Silicon Valley to Switzerland and the growing crypto expertise in Zug, this could put Switzerland on the Fintech map.
How the people will vote is obviously unknown. Most bankers will warn of bad results, but one can see a populist case forming that citizens are fed up with bailing out banks and that Vollgeld eliminates systemic risk.

Some forward-thinking bankers and Fintech entrepreneurs may also make a case within the Banking industry along these lines:

  • The transition from creators of capital to conduits of capital is already happening in the lending and equity crowdfunding marketplaces. So why fight the inevitable? Get ahead of the trend aka disrupt before you get disrupted.
  • The  line of business least impacted by Vollgeld will be Wealth Management, where Switzerland excels. Investors will pay directly for having assets protected. This maybe called negative interest rates today. It might simply be called direct fee for service – pay to have your assets secure and protected.
  • If banks are paid to store assets, banks can also offer to lend money based on these assets as collateral. This is different from fractional reserve banking because the risk is the individual customer’s risk. There is no systemic risk.

This seems like an odd move for Switzerland given how important Financial Services is to the Swiss economy (over 10% of GDP and 5% of workforce).

Maybe they are seeing the Fintech writing on the wall that banking will return to a utility model, a subject I covered in an earlier post.

The implications globally – both for incumbents and startups – will be profound.

Will a referendum pass and when?

In Switzerland’s direct democracy, a referendum can be held if a motion gains 100,000 signatures within 18 months of launching.

What will be the implications if it passes?

This will move Banking to a utility direct revenue model. Banks will charge directly to store (custody) your assets whether they be cash or securities or gold or bitcoin or anything else. There will be zero systemic risk and no need for taxpayer bailouts or government insurance schemes.

Bankers everywhere – not just in Switzerland – will have to track Vollgeld and plan for that as one possible future scenario.

Daily Fintech Advisers provide strategic consulting to organizations with business and investment interests in Fintech.

6 comments

  1. “The idea of what the Swiss call Vollgeld (translation is “full money”) was first outlined in a 2012 paper from the International Monetary Fund.”

    This is only true if you look at what happened since the last financial crisis. In fact, the idea to “strip commercial banks of the ability to create money” dates back to the early 20th century (http://www.fullreservebanking.com/Irving%20Fisher%20and%20the%20100%20Percent%20Reserve%20Proposal.pdf).

    And this is exactly the problem with the idea. We are in the middle of the digital revolution. The financial system has fundamentally changed over the past decades – the rise of Fintech is just one example. This is why the Vollgeld-idea is outdated: It is the wrong answer to fix today’s problems.

    As we have seen during the latest financial crisis, not banks but other financial institutions ultimately triggered a banking panic (all those ABS, MBS, CDO, ABCP, etc. often summarized under the term shadow banking). All those institutions are virtually unaffected by rules imposed on traditional banks only, which is the approach of Vollgeld. As Jonathan McMillan neatly put together a year ago in a blog post, today’s monetary reformists ask for too little:

    http://www.endofbanking.org/why-todays-monetary-reformists-ask-for-too-little/

    Reply

    • I disagree that “The “culprit” for the mess we are in today is the digital revolution.” (from Jonathan McMillan’s post http://www.endofbanking.org/why-todays-monetary-reformists-ask-for-too-little/ ).
      Yes, shadow banking emerged in the 70s and gained traction that led to the 2008 blowup. The avalanche hit because there were are other important contributing factors: ZIRP, ignored confilicts of interest between rating agencies and FNMAs/Freddie mcs etc, real estate market structural problems etc. We can argue to death about the order but IMHO, shadow banking was not a baby born from the then digital revolution. It was and is, creative financial engineering that “takes advantage” of the legal loopholes. Lack of transparency and a huge, untraceable Over the Counter market, is at the heart of it.

      Reply

      • I agree with you that the digital revolution is not the culprit. But isn’t it true that all shadow banking is inconceivable without modern ICT? How would you have repackaged thousands of loans over and over again in a time when your only tools were paper, pencil and an abacus? The conclusion is obviously not to ban technology, but to adapt the legal framework to the new situation. And this is what I liked in McMillan’s proposal, it is just an elegant solution. Though yes, calling the digital revolution the culprit is wrong.

  2. Thanks for that historical perspective Ryan. By not enough, I assume you mean we need something like this also for the shadow banking sector?

    Reply

  3. I am a supporter of the proposals put forward in “The End of Banking”. If you have a subscription to Wilmott, the ideas have been summarized quite nicely in a cover story there: http://onlinelibrary.wiley.com/doi/10.1002/wilm.2015.2015.issue-76/issuetoc

    Basically, the argument goes as follows: In the digital age, money creation is no longer limited to traditional banks; all limited liability companies can turn credit into money. This is why the problem has to be tackled at a more abstract level. Regulating banks or even financial institutions will always fall short because of the boundary problem (see Goodhart: http://ner.sagepub.com/content/206/1/48.abstract).

    In case you have no access to Wilmott, I recommend this long read: http://www.endofbanking.org/todays-concept-of-limited-liabitity-wrecks-our-modern-economy-1-18641278/

    Best,
    Ryan

    PS: For you who is moving in the Fintech space, this blog post by McMillan might be interesting, too: http://www.endofbanking.org/fintech-must-lead-the-way-to-free-finance-1-18651291/

    Reply

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