Switzerland is going to hold a referendum on whether the country should ban commercial banks from creating money via the routine process that almost all banks use to extend credit to customers – fractional reserve banking.
In other words, protestors want to limit the amount of financial speculation private banks can do by forcing them to only lend cash that can be taken from existing reserves.
For instance, if Bank X has £100 million in its reserves, it will only be allowed to lend up to £100 million.
Campaigners want Switzerland’s central bank to be the only institution that has the power to create money in the financial system.
The referendum was triggered by the Swiss Sovereign Money movement (known as the Vollgeld initiative), which gathered 110,000 signatures for a petition. Under Swiss law, a referendum can be held within 18 months of a successful motion. A successful motion needs 100,000 signatures.
This all sounds a bit crazy right? After all, if the campaigners’ vote is successful, it’ll mean Swiss banks won’t be able to make, or lend, as much money.
But when you take a look at the Swiss financial system at the moment, you can see why the country’s banking system is in a bit of a pickle.
Most of Switzerland’s cash doesn’t really exist — it’s kind of an illusion
Every bank in the world creates money electronically every time it loans out cash. But in Switzerland’s case, 90% of money in circulation is “electronic” meaning there’s no real physical cash floating around.
So, banks don’t actually lend the same amount that is on its balance sheet from physical deposits from customers. In other words, only a fraction of bank deposits are backed by available cash on hand that are able to be withdrawn.
This is what campaigners in Switzerland want to stop.
Actual cash is valuable because it’s fungible — exchangeable for an identical unit — and liquid.
Electronic cash is composed of numbers whose value can change at the push of a button. Effectively, it means that if electronic cash is sitting on balance sheet somewhere, it can depreciate and become worth less, depending on what the central banks tell the private banks.
For example, Miles Kimball, a professor of economics at the University of Michigan, pointed out this year that two $ 10 notes are only worth $ 20 because the US Federal Reserve says so, and is willing to swap the $ 10 notes for a $ 20 when a commercial bank asks it to.
But Switzerland currently has a negative interest rate, because the central bank there is attempting to flush cash out of banks and into circulation, to boost the economy. (Denmark, Sweden, and the European Central Bank have all done this too). Negative interest can kill off some the value of the money. For example, if there was a -4% rate (which Kimball uses as an example), a bank trying to hand over $ 100 would get $ 96 back in e-money after a year, or $ 92.16 the year after that.
Negative interest rates are an issue for Switzerland
Abhay Kumar, Youtube
has negative central policy rates. The policy cost its banks $ 1 billion a year.
The intent of negative interest rates is to discourage people from storing money inside bank accounts, and to spur them to pump money into the economy by buying things or investing elsewhere.
In other words, it’s not in a person’s interest to deposit the cash because they will come out with less, even if they didn’t do anything with the money other than let it sit there.
The widely understood problem with a negative interest rate policy is that if you forced negative interest rates on consumer deposits, depositors wouldn’t just be losing out in real terms (from inflation), they’d actually see the numerical amount of money they hold falling.
There’s a well-known concept called the money illusion in economics, which among other things, explains that people are extremely resistant to losing out in nominal terms.
Currently, the costs associated with negative central policy rates haven’t yet been passed down to consumers in Switzerland. But how much longer will banks eat those costs before adding fees and charges to Swiss accounts to defray the cost?
One consumer bank, Alternative Bank Schweiz, has already told people it will apply negative interest to customer accounts in 2016. The fear around negative rates is that they might have the opposite effect of that which is intended — that banks are afraid of charging consumers negative interest, so they will impose those costs in other formats.
Will banning banks from creating money help or hinder the situation?
Those who are in favour of banning banks from creating money argue that forcing banks to just lend from customer deposits will prevent financial systems from collapsing again. Campaigners argue that electronic cash lets banks create asset bubbles by doling out credit without having a physical cash to back it up against market shake-ups.
However, since Switzerland has a negative interest rate environment, it looks like the only people that would lose out if fractional reserve banking was banned would be the consumer. With less money available, banks will take fewer risks, and there will be less lending to customers.
NOW WATCH: How ISIS makes over $ 1 billion a year