Savings Bank

In a comment piece earlier this week in the Telegraph, Andrew Lilico bemoaned the fact that the new TSB Bank being launched by Lloyds Banking Group was not going to be a Savings Bank in the manner of it’s namesake predecessor.

Andrew LilicoThe TSB brand had never quite disappeared – remember, Lloyds used to be called “Lloyds TSB” – and the use of the brand appeals to memories of the old “Trustee Savings Bank” that Lloyds took over in the mid-1990s. But in the past a “trustee savings bank” was something quite specific and different from a modern bank. Perhaps we are missing an opportunity to reconstitute the TSB as truly a “savings bank”

When modern banking first developed in Britain in the early 19th century it developed in two, quite distinct, forms. One form was like all the main retail banks we have in Britain today. In that form, depositors lend money to the bank, which the bank then uses to support lending to businesses (say, for investment) or to consumers (say, for a loan for a holiday). Because the bank uses the money deposited in it to make these sort of loans, only a fraction of all the deposits made into it are kept in reserve so as to be available to be withdrawn at any moment in time. Hence such banks are known as “fractional reserve” banks.

But not everyone saving money wants to be investing it at risk. Some people just want to store up money, as they save it, and be able to be certain of taking it out again when they need to. So as banking developed, in the early 19th century, a second, entirely distinct form of bank arose. This was called a “savings bank”. Deposits in savings banks were not permitted to be used to support loans to businesses or consumers and savings banks were not permitted to keep in reserve only a fraction of what could, in principle, be withdrawn. Instead, savings banks were allowed either to keep deposits only at the Bank of England or to use them to buy UK government bonds that could be redeemed or sold in time to pay out on any permitted withdrawal. There was a specific law, the Savings Bank Act 1817, that set out the definition of a savings bank, and no bank was allowed to call itself a “savings bank” that did not meet that definition.

Over the next 160 years, savings banks evolved, particularly through the “trustee savings bank” movement, probably reaching their peak in the period of deflation in the 1920s and 1930s, when collectively the many small savings banks there were are thought to have been as big as any one of the UK’s main fractional reserve banks. They tended to do better in periods of deflation, and worse in periods of inflation, for two reasons.

First, when there is inflation government bonds lose value and the real returns on them are very low, so deposits in savings banks tend to decline in real terms. Deposits in fractional reserve banks do less badly, because fractional reserve banks make loans to businesses that are raising their prices in line with the inflation so offer better protection of real value.

Second, in periods of deflation fractional reserve banks often go bust as business and consumers can’t service their loans if their incomes are falling, but (absent fraud or negligence) savings banks cannot go bust and lose depositors’ money unless the Government goes bust.

The resurrection of the TSB would be an opportunity to resurrect it as a true savings bank. Lloyds depositors who prefer to have their investments at risk of loss, and be paid higher interest, could stay with Lloyds, while those that simply want a safe place to store their money (and are willing, in consequence, to receive little or no interest, or perhaps even to pay a storage fee) could switch to the TSB.

Banking will never be healthy as long as governments feel unable to allow those intrinsically risky loans made to fractional reserve banks that we call “deposits” to be genuinely at risk. The cancers at the heart of the banking system are explicit and implicit deposit insurance, destabilising the system, creating financial crises and creating huge implicit government subsidies to bankers’ salaries, which causes damage to public confidence in the system and encourages harmful regulation and taxes.

There’s some excellent stuff in there, but whilst Andrew’s idea of a new Savings Bank is a good one, there is of course the obvious fact that a fractional reserve bank tends to make more profit than a savings bank and given that the market likes profit, why wouldn’t you sell off a fractional reserve bank for an IPO?

However all is not lost. The idea of a savings bank is not a bad one at all, and given that at the moment high street bank’s interest rates are so low and Gilt Redemption Yields are around 2.5% over 10 years and 3.5% over 30 years, is there scope for a non-profit savings bank to bring prudence and forward planning to those parts of society which aren’t at the moment terribly keen on investing for the future?

As Andrew points out, the way that Savings Banks made money was to take their depositors’ cash and with it buy bonds, essentially passing the money onto the government in return for a guaranteed return on the money higher than the interest rates they were paying to their depositors. Of course, if such a bank runs as a non-profit it has greater scope for delivering the best returns for it investors. It would be pretty easy for the Savings Bank legislation to be adapted to allow such a bank to buy foreign gilts that were ranked as safe by the leading credit agencies and so diversify their returns. A savings bank holding sovereign bonds from the UK, Germany, Scandinavia and the USA would be a pretty acceptable risk methinks.

But how to do it? What you would need to make it work is an established network of local outlets that reached into every community allowing quick and easy deposits. This could combine with an internet and post offering that allowed depositors to access their money easily, either by BACS transfer or cheque (remember those – they’re going nowhere (in both senses)). The whole thing could be run with a minimum of staff from a central office and would be a brilliant way of both fostering a healthy genuine savings culture (as opposed to a “lending to the banks even though we don’t realise that we’re doing it” culture) amongst the public AND provide a commercial challenge to the high street banks who often appear to take their customers for granted (and some of whom pay miserable interest rates to their credit balances).

And I know someone who could do it as well and might even love to do it. Justin, where did I put your number?

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