Let me begin by stating the problem as I see it, drawing on something I wrote a few years ago. I noted the situation where some of the banked, most of the underbanked and all of the unbanked are using alternative providers because they are “underserved” by the banking system. I said at the time that the majority of adults are underserved and therefore present a range of opportunities for non-banks.
My reasoning was quite straightforward. Bank accounts are expensive to operate (as they should be, because institutions that can create money should be heavily regulated). What the underserved need are not banks but new kinds of regulated financial institutions to deliver the modern services needed to support a 24/7 always-on economy. What are these services? Well, as the economist John Kay noted in his paper on “A Robust and Resilient Finance” for the Korean Institute of Finance, while “many aspects of the modern financial system are designed to give an impression of overwhelming urgency… only its most boring part – the payments system – is an essential utility on whose continuous functioning the modern economy depends”.
Indeed. An in a similar vein Gottfriend Leibrandt (who was CEO of SWIFT from 2012 until 2019) and Natasha de Teran wrote in their book “The Pay Off: How Changing the Way we Pay Changes Everything” that “while access to a banking system is seen as a crucial part of a country’s development and necessary for lifting people out of poverty, it is not as basic a need as the ability to pay”.
In other words, the fundamental need in a modern economy is not a bank account but a safe and secure way to get paid and to pay for goods and services. You can see where I am going on this. A great many people, possubly the majority, would be well served by a simple digital wallet that might be provided by any of range of organisations and would be simultaneously a lower cost option for consumers and a profitable business for financial organisation. This would simultaneously mean that banks could stop losing money and the transaction history of the wallet could provide an alternative to traditional “thin file” credit scores when those customers want to obtain financial services beyond simple payments.
To summarise my argument, then, the goal of a forward-looking strategy around financial market infrastructure (FMI) should not be to bank the unbanked but to unbank the banked.
The implications of this are, I would have thought, obvious. While it was true in the industrial era that most efficient economic arrangement was to bring transfers in space (payments), transfers in time (savings and loands) and transfers in scale (investment) into single companies (ie, banks) it is not longer true. In the post-industrial era, it may be far better for society to have these transfer functions separated out into new kinds of institutions that are focused and regulated specifically to bring the maximum benefits to what we might term the “real” economy.
To expand on this line of thinking, I would note that not only is there no fundamental economic reason why banks should be the dominant providers of payment services, there is no fundamental economic reason why they provide them at all — see, for example, Radecki, L., “Banks’ Payments-Driven Revenues” in “Federal Reserve Bank of New York Economic Policy Review”, no.62, p.53-70 (Jul. 1999) — and there are many very good reasons for separating the crucial economic functions of running a payment system to support a modern economy and other banking functions that may involve systemic risk (eg, providing credit). Marilyne Tolle made this point a decadde back, writing in the Bank of England’s “Bank Underground” that “the conflation of broad and base money, and the separation of credit and money, would allow the [central bank] to control the money supply directly and independently of credit creation”.
Talking about the Bank of England, Deputy Governor Sarah Breeden (speaking in 2024) predicted that in the near future she expects to see new technology bringing changes that “broadly preserve the current structure of payment and settlement” but in the longer term, she sees ledgers, digital assets and stablecoins as more disruptive with post-trade processes collapsing and layers of intermediaries being flattened. Her perspective is important because while many central banks were experimenting with digital currency of one form or another, the Old Lady of Threadneedle Street has adopted a particularly innovative approach by creating a new category of central bank account (the “omnibus” account) for institutions.
The US had no similar kind of account, nor any regulatory equivalent of the European “payment institution”. There were some discussions about this approach in the past. The OCC had previously developed the concept of the Special Purpose National Bank (SPNB) charter but this was poorly received by fintechs who made it clear they were not interested unless such a licence would require the Federal Reserve to give them access to the payments system so they would not have to depend on banks to intermediate and route money for them. A digital wallet that is a layer on top of banks is one thing, but a digital wallet that has access to the underying payment infrastruture is a different, and much better, proposition. Crucially, it would not that would allow the wallet providers to provide credit. This would seem far more interesting to not only stablecoin issuers but almost all other fintechs and would separate the systemically risky provision of credit from the less risky provision of payment services, thus accelerating innovation.
All of which is a very long preamble to explain why I think that the news about Kraken is such a big deal. The Federal Reserve Bank of Kansas City has approved a limited-purpose master account for Kraken Financial, granting the cryptocurrency exchange direct access to the central bank’s payment network. This makes Kraken the first digital asset “bank” in to gain direct access to the Federal Reserve’s payment infrastructure.
Why is this such a big deal.
Snippings 