A sound banking system would have two types of bank. Each one would provide a specific type of bank account.
- Transaction Facilitation
- Loan brokerage
1. Transaction Banks
Transactions banks would offer a true warehouse service for people wanting an account to manage their daily financial transactions. These banks would record valid money claims and execute transactions between clients. Some might use paper records while others would use computers. It would not matter how transactions are recorded, as long as all money claims and transactions are recorded accurately.
When a person deposits twenty dollars in a bank, the bank would increase the value of that person's account by twenty dollars. If the person withdraws five dollars, the bank would reduce that person's account by five dollars.
If someone instructs the bank to pay ten dollars to another person, the bank would reduce that person's account by ten dollars, and increase the recipients account by ten dollars.
If the person being paid records his money transactions at another bank, the first bank would instruct that person's bank to increase the recipient's account by ten dollars. The second bank would be willing to do this, provided the first bank confirms that it has already reduced the account of the person making the payment by ten dollars.
The banks do not need to exchange anything, as they are simply recording the fact that one person has ten dollars more than they had before, and the other has ten dollars less than they had before. It does not matter which banks record these changes, provided that every time one person's account is increased, another person's account is decreased by the same amount.
To sustain their business, transaction banks would have to prove to their customers that their records were accurate. They would do this by opening their records up to anyone who wanted to check. Auditors would be able to look at what the bank is doing and confirm that they are not cheating those who trust them. All banks would watch each other carefully. If one could expose cheating by another, it could eliminate a competitor and increase its market share.
The important principle underlining a sound banking system is that the money in a bank does not belong to the bank. A transaction bank is storing the property of someone else, in the same way as warehouse. A warehouse owner keeps an inventory of everything that is stored in his warehouse. He records the identity and contact details of the owner of each item. He can even transfer the ownership of an item to another person, if instructed to do so by the original owner. However, the recording of assets in his care is kept separate from his own asset register. He can treat the warehouse as his asset, but he must not record the furniture given into his care as his property.
Transaction banks would operate in the same way. They would keep an inventory of all the money being stored and the identity of its owners. These records must be separate from the bank's own financial accounts. Money stored must not creep onto the bank's asset register.
The money deposited in a transaction bank is owned by the person who deposited it, not by the bank. This is a biblical principle.
If a man gives his neighbor silver or goods for safekeeping and they are stolen from the neighbor's house, the thief, if he is caught, must pay back double. But if the thief is not found, the owner of the house must appear before the judges to determine whether he has laid his hands on the other man's property. The one whom the judges declare guilty must pay back double to his neighbor (Ex 22:7-9).
When the goods entrusted to person another for safekeeping go missing, that person is accountable for the loss. If the thief is found, the thief must make restitution, but if not, the person caring for the property must make restitution to the owner. In God's eyes, neglect of property given for safekeeping is the same as theft.
The Bible describes the valuables presented for safekeeping as the "property" of the depositor, even when they are in the house of the other person. This confirms the principle that the ownership of property does not transfer to person who takes it for safekeeping. The owners of property retain their ownership, until they sell the goods. This biblical principle applies to banking. When a bank treats money deposited with it for safekeeping as its own asset, it has misappropriated something that belongs to another. It has "laid its hands on the other man's property".
Banks that are operating according to this principle would not be able to lend out money, because they do not own it. This means that they would not be able to pay interest on money deposited with them. To cover the costs of providing their services, transaction banks would need to charge a service fee. Depositors would look for banks that provide the best security and service for the most reasonable fee. Banks that provide better security and a wider range of transactions would be able to charge more. However, bank fees would be quite small. People would be willing to pay the price for a secure and reliable banking system.
Depositing money on call would become less attractive option, because deposits would face bank charges, but no interest. To avoid this problem, people would only deposit money on call, if they expect to use it immediately. If they do not want to use the money immediately, they would be better to deposit it at loan bank for a fixed term (even if only a few days) so it can be lent out and to earn interest.
2. Loan Brokerage Banks
The second type of bank provides a loan brokerage service. These banks would match the savings of depositors who want to lend with people who want to borrow. Each loan would be matched with a deposit or group of deposits for the same term. Every deposit received and every loan made would have a timestamp. The Loan Brokerage Bank would have to match every loan for a particular term with equivalent deposits for the same term.
Interest rates for the various terms would adjust until the supply of deposits matched the demand for loans for each possible term. The bank would charges either a fee or a margin on the interest rate to cover the cost of providing this service. Sometimes the bank will combine a number of deposits together to make up a large loan. This would be part of the brokerage service.
Loan brokerage banks would usually take responsibility for assessing the credit-worthiness of potential borrowers and the viability of the projects for which they are borrowing. If the bank agrees to take responsibility for any bad debts or fraud that may occur, the cost of this service would be built into the bank's charges. Different banks would offer different options with different levels of service.
Brokerage Banks would provide a re-financing service for people who have placed money in a bank for a fixed term. The bank would have been lent the money out to another person for the same term. If the depositor's situation changes and they need the money, they may want to withdraw the deposit early. This would be possible, but there may be a cost. The bank would have to be able to replace the money with a deposit for the same term from a new lender, but it would have to charge a fee to cover the work involved in organising a replacement lender. If the market interest rate had fallen, the first lender may have to cover the interest differential for the rest of the term. This cost should be relatively small, as in a sound financial system interest rates would tend to be very stable.
No Inflation and No Bank Crashes
This banking system can operate without any need for government regulation or political interference. There is no role for governments in a sound banking system.
Inflation would disappear because political powers would no longer control and manipulate the currency in circulation. Banks would not be able to manipulate their reserves, because people would refuse to deposit money with banks that moved depositors' money onto their balance sheets. Once this ability is gone, monetary inflation is not possible, so price inflation would disappear. Instead, prices should decline slowly over time, as technological advances make producers more productive. Falling prices make all consumers in the economy better off.
Banks would not able to expand lending to fund asset bubbles. Once investment bubbles are constrained, the bank crashes that usually follow will cease.