I was recently involved in an interesting discussion regarding
the sense in which shadow bank liabilities might be considered money. Along with many people, I feel that there is
a qualitative difference between claims on banks and claims on non-banks, but I
find it hard to put my finger on exactly what that difference is.
One possible approach is simply to say that claims on
non-banks are not generally transferred to others as a means of payment for
goods, services or other assets.
However, this answer overlooks the fact that bank deposits are not
transferred as payment either. Instead, what happens if I make a payment to you is that the
balance of my account is reduced as consideration for my bank procuring that the
balance of your account (potentially with another bank) is increased. This may look very much like I have
transferred a deposit to you, but the distinctuion is important.
Shadow bank liabilities are generally held by large
institutional investors, so it's useful to look at how investors like this manage
their funds. Such investors will typically
hold their liquid funds in a range of short term investments. The most liquid of these, between one day and
the next, will be overnight instruments.
These may be simple overnight bank deposits, but they may also be
overnight repo (reverse repo from the cash investor's viewpoint) or other
instruments, which may be with a bank or a non-bank.
To make and receive payments during the day, investors will
have transaction accounts with banks.
These will typically pay little or no interest overnight. They may also have provision to be overdrawn,
either during the day - if payments are to be made from the account before
receipts are confirmed - or overnight. It is inefficient for institutions with large liquid asset
pools to carry a significant positive or negative balance in their transaction
account overnight. Such institutions
will therefore seek to place as much of their net cash inflow into overnight
instruments during the course of the day.
At the start of each new business day, all of the overnight
money placed the previous day has to be reinvested. Likewise, all of the institutions that had
borrowed through these overnight instruments need to refinance. The money markets are therefore most liquid
at the beginning of the day when there are lots of buyers and sellers. As the day goes on and more and more positions
are filled, the market becomes thinner and it can become harder for someone
trying to match a position to get a good price.
Money managers will therefore try and estimate their daily cashflow and
place it as early as possible, rather than wait till the end of the day.
When money is placed into an overnight instrument, the value
is agreed at which it will be redeemed the next day. However, there is no guarantee of the current
day's value. If an investor places $100
early in the day and then changes his mind later in the day, he cannot expect
to get $100 back. It will depend on what
has happened in the money market during the day and may be less or more than the
$100 placed. The only certain value is
the redemption value the next day.
In contrast, balances in transaction accounts retain their value during
the day. So $100 paid in early in the
day may be paid out as $100 later in the day. When we compare this with overnight instruments, it seems that that this is much more money-like, whereas overnight instruments, including deposits, are more like what we think of as bonds, albeit with a very short maturity.
I'm not sure that this enables us to answer the question of
whether shadow bank liabilities are money.
However, I think there are some useful observations that can be made.
1. Transaction
accounts are qualitatively different to overnight instruments, and shadow banks
are not on the whole in the business of operating such accounts. We could think of transaction accounts alone
as being money, as these are the only means with which general payments can be
made, and everything else as bonds. However, this approach makes it
difficult to say anything meaningful about the quantity of money. The balance of transaction accounts is
managed down to minimal levels by the end of the day, which is the only point
in time at which the balances can be meaningfully measured. The picture given by the end of day balances
bears little relationship to all the activity that takes place during the day.
2. From point of view
of the holder, the liquidity of an overnight instrument does not depend on whether
it is issued by a bank or a non-bank. When
we come to think about implications for the financial markets generally and the
real economy, we should not therefore expect investors to behave differently when
they hold bank claims as opposed to non-bank claims. In this sense, there is nothing special about
banks.
3. When a payment is made
between transaction accounts, one account is credited and one is debited. If both accounts start at zero, this means
one balance becomes positive and one becomes negative. Negative balances can be avoided if the
account from which the payment is made is positive in the first place. Either way, each payment has balance sheet
implications for the bank (or system of banks) providing the accounts.
We have looked at a situation where holders of liquid assets
attempt to manage their transaction account balances to close to zero by the
end of each day. However, this process
involves a mass of individual transactions with little coordination.
If a bank processes a payment from one account, it cannot be sure that this will be covered by subsequent receipts, so it faces a potential
credit exposure. In order for a bank to be able to do this, it
therefore needs a balance sheet of some size.
Part of this will be constituted by the issue of overnight instruments.
So, whilst bank issued overnight instruments may be no more
money-like that those issued by non-banks, in the hands of investors, they are
important in creating the balance sheet depth necessary for banks to be able to
process payments through transaction accounts. It's not so much that overnight bank deposits are money, but rather that they facilitate monetary exchange.
