Narrow banking

Narrow banking is a proposed type of bank called a narrow bank also called a safe bank. Ultimately, if adopted widely, this could lead to an entirely new banking system. Narrow banks can, by risk reduction measures designed into the narrow bank, significantly reduce potential bank runs and the need for a deposit insurance provided by the central bank. It is sometimes suggested as an improvement upon fractional reserve banking.

Narrow banking would restrict banks to holding liquid and safe government bonds. Loans would instead be made by other financial intermediaries. That is, the deposit taking and payment activities have been separated from financial intermediation activities. Two different types of banks (financial companies) are needed, one for each activity.

Attributes

Key attributes of narrow banks include -

1. no lending of deposits (reducing a key risk materially but constraining return on investment for depositors and shareholders alike)
2. extremely high liquidity (typically short-term assets e.g. bonds)
3. extremely high asset security (typically government bonds)
4. lower interest rates paid to depositors (as a function of the no lending and other constraints)
5. possibly specific regulatory framework with higher level of scrutiny and operational/investing restrictions

Additional criteria applied to safe banks include -

1. no derivatives
2. no off balance sheet assets
3. high degree of institutional transparency (e.g. continuous real-time disclosure of financial records)
4. capped executive salaries
5. low risk jurisdictions

Background

Some early thought leaders in narrow/safe banking include -

1. Satyajit Das from the University of Illinois who published an early paper on the topic of narrow banking.
2. Mike Denoma who advocated the case for it early in his career (circa 2000)
3. Kevin James from the Bank of England who presented very early on in this debate

More recent references include the consideration of safe banks or narrows banks in the next round of Bretton Woods and the Feb 2009 World Economic Forum agenda titled The Future Of The Global Financial System.

Classifications

Each writer tends to apply their own classification system for defining types of narrow banks. Here is one classification system, though there are others defined by the leaders listed above.

Lenders have to become investors (cases PS, PL). The table below shows four different cases of narrow banking.

Classification of the Narrow Banking Proposals^[1]p109

	Permitted to possess short-term safe assets (S)	Permitted to possess long-term safe assets (L) as well as short-term assets
Prohibited from conducting lending activity (P)	PS   Full-reserve banking	PL
Permitted to conduct lending activity (L)	LS This case advocaded by Kobayakawa and Nakamura[1] has a synergy effect between deposit taking and lending	LL This case shows some similarities with fractional-reserve banking but is still more restricted

References

1. ^ ^{a b} Kobayakawa; Nakamura (May 2000). "A Theoretical Analysis of Narrow Banking Proposals" (^{[dead link]}). Monetary and economic studies. http://ideas.repec.org/a/ime/imemes/v18y2000i1p105-18.html.