FT Alphaville had the pleasure of moderating the "Future of Banking" panel at OuishareFest, a collaborative economy gathering, earlier this month. During this discussion, an interesting point was made by Francois Carbone, CEO of an equity-based crowdfunding venture Anaxago. Namely, when you think about it, every peer-to-peer initiative (P2P) on offer today is really representative of a move towards a private sector version of full-reserve banking. That's whether the P2P ventures are equity-based (as in Anaxago's case), reward-focused, donations-based or even if they focus on traditional interest-based lending. And that, of course, is because most peer-to-peer lenders operate almost exclusively in the world of existing money. They do not, unlike conventional lenders, get involved in the business of money creation, parallel currencies or seigniorage. They simply redirect what's already available. To explain this a little bit, it's worth revisiting John Maynard Kenyes" famous graphical representation of the money universe from his Treatise on Money: In any economy there is, according to Keynes, a shared root to all money, which revolves around a social consensus of what the "Money-of-Account" in that economy is - namely, the unit in which all debts can be settled. In primitive human economies, this can be shells or feathers (even though they range in size and quality). In early societies, it was standardised coin or commodity weights. In today's more complex economy, it's more abstract and standardised concepts like the dollar. The money of account in that sense is the description or title of the money which any society collectively agrees has the power to cancel social liabilities. It forms, you might say, the Emperor's New Clothes "money consensus." If we all believe the unit matters, it does. Money itself, meanwhile, is the thing that answers to that description. In Keynes" view, this real form of money can then be further subdivided into two forms: "Money-Proper" and, separately, money which is representative of an "Acknowledgement of Debt" within the system, which itself is a type of money that has a tendency to bleed into "Bank-Money." Further down the trunk we encounter yet more types of money. Among them is finally "Commodity Money," which very importantly evolves out of state (or social) money and whose value is determined entirely by its relative position and placement in the representative money sphere of a particular economy. "Representative Money" itself is made up of a mixture of "Managed Money," "Fiat Money" and "Bank-Money." Its defining characteristic is simply that the State (a.k.a. the collective) believes these forms of money are acceptable when it comes to discharging a liability in the system. The interesting thing about bank money specifically, however, is that it resides in a domain largely independent of the State. If the State has any control over bank money, it is either by influencing the supply of "State-Money" on a relative basis or through its authority to dictate what counts as representative money and what does not. It can, for example, declare at any point that money issued by Bank X no longer counts as real money. This is the equivalent of a bank losing its banking license, or - during a crisis perhaps - failing to match its liabilities with assets that actually count as state money, falling short of the minimum reserve requirement and not being able to convince the State to create fresh volumes of state money to plug the shortfall on its behalf. As Keynes himself noted: Bank Money is simply an acknowledgment of a private debt, expressed in the money-of-account, which is used by passing from one hand to another, alternatively with Money-Proper, to settle a transaction. We thus have side by side State-Money or Money-Proper and Bank-Money or Acknowledgements-of-debt. As a consequence of this parallel currency feature of bank money, the money universe actually evolves like this: As can be seen from the graph, bank money is fully fungible with state money only because of its interaction with the central bank reserve system. So, even though banks can create as much money out of thin air as they want (over there on the right-hand side), they are in theory restricted from over doing it due to their ultimate need to satisfy the minimum reserve requirement. When the minimum reserve requirement is zero, the bank is ultimately constrained by the need to pay out state money to depositors on demand. That means managing the risk of asset and liability mismatch in such a way that the bank can always provide state money to satisfy such claims. Not being able to match those demands creates a crisis of confidence in the banks" own parallel currency units, which are really a subclass of equity of the bank, because to all extents and purpose they now appear to have been grossly over-issued. The State can either bail the bank out, by printing the state money the bank lacks, or decide to point out that this particular bank is - in emperor's new clothes parlance - naked. See here for an explanation of why a bank's share price must always be above 1-dollar, euro, pound, franc (or whatever) if it is to remain solvent. In any case it is for this reason that a bank is held back from over-issuing its own money, unless all other banks are also over-issuing money - meaning there are more alternative forms of bank money around that a distressed bank can borrow (and which qualify as a reserve money, or the sort of cash a depositor would accept) to avoid being caught naked. Or as Keynes noted: ... it must keep step with the other banks and cannot raise its own deposits relatively to the total deposits out of proportion to its quota of the banking business of the country. In a world of full-reserve banking, however, there is no chance for the banks to move forward (or over-issue) unless the State creates (by means of managed money) additional money for the system first. The control of the money supply is therefore given back to the State (or the collective authority). The problem now, of course, is slightly different. Banks have already been caught "naked." They have been given the state money needed to plug the hole, but are not creating enough money to satisfy the needs of the system because they are concerned that if they continue to create money at their previous rate they may run into a liability mismatch all over again. Consequently the money creation responsibility is falling back to the State. Except in the current context the reserve system is preventing the money from flowing further into the real economy. This is because the money is being created as reserves held by member banks, rather than reserves held by the public. In our opinion this is one reason why the State should seriously consider issuing official e-money. Given the above, the velocity of money is dying on the banking side. Not only are banks reluctant to take credit risk, but, as Anat Admati argues, they have no interest in funding themselves directly because they can now rely on excess reserves of state money to underwrite their weak capital position. Reserves should not, as she always notes, be confused with capital. Just because the bank system has excess reserves does not mean the banks are fully capitalised. Rather, the capital (or state money) the system owns has been diluted (by the State) to satisfy the banking system's existing claims. This has, however, been done disproportionally to capital held by the public. So a bit like owing Peter five apples, but since you're a bank, being allowed to settle the claim with five apple slices while everyone else still has to provide Peter with the original number of apples. In that sense, QE has changed the nature of the game for the banks, but not for everyone else. And since the banks, having satisfied their liabilities, are now dealing in apple slices rather than apples - on fungible terms with apples - they now understandably wish to swap those slices into safe apples (especially those which have already been transformed into "income money" in old apple terms) as quickly as they can. All of which is actually contracting the number of apples (state money) in the investment sphere, and causing an inordinate amount of apple slices to crowd out the last remaining safe apple opportunities. The reason the slices are not being passed down to the real economy is mainly because the chances of creating similar income streams with apple slices, compared to those already existing in old apple terms, are low. Which is where the boom in P2P lending - fully funded from the onset - comes in: P2P happens to be the surest way for the private sector to increase the velocity of money in the "Held by Public" section of the chart - velocity which is needed to compensate for all the state money being sucked out of private hands and into member bank or financial hands instead. Of course, if and when, the social consensus decides that totally disintermediated money - that is, not bank money, nor state money - can be used to settle claims, then we would have a shift in the system that looks like this: The demand for virtual/disintermediated money would be understandable given the lack of state money in public hands relative to needs. The only problem with such a shift, however, is that there really would be no restriction to issuance. There would also be no obvious convergence with the reserve system or the legal unit-of-account; no social authority to clarify when the issuer is naked or not; no lender of last resort; no stability due to insufficient money supply management (especially relative to a price target) and last, but not least: no guarantee that the social consensus around the virtual unit would prevail. In short there could be monetary chaos. A greater adoption of P2P, however, has the advantage of increasing the velocity of money in private hands within the construct of the existing system. And also with ongoing accountability to the State. Related links: Guest post: The case for digital legal tender - FT Alphaville A digital solution for the repo squeeze? - FT Alphaville More on M-pesa and e-money - FT Alphaville M-euro, a lesson in money supply from Kenya - FT Alphaville Why central banks should take charge of their digital currencies - FT Alphaville