23rd August 2012
In a speech given at the Westminster Business Forum in May Andrew Bailey, the executive director of the Bank of England, claimed that the "free" banking model has become dangerous both for the stability of the banking system and for the customers themselves.
"It is a myth," he says, "because nothing in life is free; rather, it means that we pay for our banking services in ways that are hard to link to the costs of the products we receive. This can distort the supply of banking services."
Bailey's claim feeds into the criticism levelled at other free services, such as social media sites and online media: If you're not paying for a product, you are the product. In the case of traditional banking, however, this is surely a reflection of poor or misleading communication rather than a Machiavellian scheme to lure unwitting customers into not paying for services.
In effect charging for an account under the pretext of servicing a customer means that the bank makes money on both sides – from creditors and debtors. They take in money from customers and then lend it back out, barring a small reserve they are legally required to keep in cash. Unless the financial crisis has fundamentally broken the fractional reserve banking system (and if so we as customers should presumably have been told) then charging for accounts is a profound breach of trust.
The principle behind Bailey's myth is not that free banking was fundamentally wrong, but that the risks were not properly explained to end consumers. That is, the problem is one of education not simply of structure.
To achieve any clarity on the issue we have to separate mis-selling scandals such as the furore surrounding payment protection insurance. There, customers were deliberately mis-sold insurance without being provided with sufficient information about what they were being signed up to. People have not been mis-sold bank accounts, but they may not have understood that their deposits were liabilities on a bank balance sheet and not assets.
Indeed replacing the model with a paid-for system does not liberate them from risk altogether. By charging for a current account banks are in effect eroding the interest the customer receives on their savings – a problem that will be exacerbated for those who only have a small amount in their account.
So what is the solution?
Ultimately it is for customers, not banks or regulators, to decide what they want from a current account. If they are to make an informed decision, however, the system must be open to scrutiny and the literature should be accessible.
Bringing in additional charges without a period of consultation is unlikely to engender a greater degree of trust in the system. Indeed for many it will be seen as a confiscation of part of the wealth that they have entrusted to these financial institutions.
If the problem was that these firms ploughed customer deposits into overly risky investments, then regulating the level of appropriate risk is surely the answer. If, however, it is the more fundamental issue of the legitimacy of turning short-term borrowings into long-term loans then we urgently need to begin a discussion.
Before we embark on a reform on this scale the following questions will need to be answered: Do we want retail banks to operate simply as safety deposit boxes? Can we overcome the problems with the free model if customers are told how the banks plan to use their money?
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