Greater liquidity and insurance will help prevent banks from causing another financial downturn
Lord Mervyn King believes the global financial system will always be prone to collapse in times of crisis unless banks are forced to take out insurance on their deposits.
The former Governor of the Bank of England told attendees at a student-run London Business School (LBS) event that insuring deposits would relieve the pressure on central banks to bail out struggling banks during an economic downturn.
“You don’t let someone loose on the road to drive a car unless they’re compelled upfront to take third-party insurance,” he said at Navigating a low return world, an Asset Management Conference organised by the LBS Investment Management Club.
He added that banks would need enough collateral to maintain a “guaranteed credit line” with the central banks to cover their deposits.
“We’d have a banking system where no one would have the incentive to run. Before the crisis, banks used to hold less than 1% of assets in liquid and government securities, but now they have 20% because they have deposits in the central bank. I’d like it to stay there.
“When you have a crisis, central banks won’t need a penalty rate or to panic about the collateral. Everyone will know that any commercial bank has a credit line with the central bank with more than enough to pay their deposits. If other people start to run, you can relax and stay at home.”
On the short-term outlook for the global economy, Lord King said he was “not optimistic”. He expects to see further crises driven by factors other than banking, such as China’s slowdown or emerging market and eurozone debt.
But Lord King – who questions whether money and banking are the Achilles heel of a modern capitalist economy in his book The End of Alchemy: Money, Banking and the Future of the Global Economy – believes that in the long-term, scientific breakthroughs will spark a global recovery.
“I am optimistic because I don’t share the view that our long-run productivity growth has fallen and, therefore, we should be reconciled to a period of slow growth in living standards indefinitely, which in turn leads to weaker demand today.
“If you talk to anyone in scientific research, IT, material science or links between physics and biology, they all feel we’re in a golden age of scientific discovery. Over the years, their ideas and innovations will feed through to practical applications and products, which may take decades, but in my view the long-run rate of productivity growth will be at least as high as growth in the past.”
Photo credit: Alexa Sharples, LBS Photography Club