Are banks still special?

Publication Date
Financial Markets Group Special Papers SP 248
Publication Authors

Banks have long played a special role in the financial system. Individuals and institutions use banks to access the payment system, and central banks rely on banks to transmit monetary policy to the real economy. Hence, financial and economic stability has rested on the stability of the banking system, in particular on the safety and soundness of systemically important banks. This is the primary reason why banks have access to central banking lending facilities as well as why banks are regulated and supervised. It has also served as the overriding rationale for the reform of regulation and resolution that the G-20 initiated and implemented in the wake of the financial crisis of 2007/8.

But banks are not inherently special. Banks are only as special as central banks make them. Via quantitative easing (QE) as well as eligibility easing (EE), central banks have broadened the transmission mechanism beyond banks. As a result, banks have become less special. This in turn has significant implications for central banks’ responsibilities for liquidity provision and for the regulation and supervision of financial institutions.

Banks’ special role could erode further if central banks introduce central bank digital currencies. Such an innovation would not only replace cash but could also displace deposits. Central banks could not only impose significantly negative rates of interest; they could potentially determine the volume, distribution and pricing of credit, so that the transmission mechanism becomes direct. That in turn would have significant and not necessarily positive implications for banks, for financial markets and for the economy at large.