Reflections on the ‘Purpose of Finance’ from Positive Money

Positive Money is delighted to see a Parliamentary think tank addressing long-standing problems with our monetary and financial system. David Pitt-Watson and Hari Mann’s effort to kick-start a debate on the purpose of finance is an important contribution to the struggle to improve the sector and its impact on society.

However, the authors’ functional interpretation of purpose downplays the consequences of relying so heavily on privatised interests to manage the public good that is a monetary and financial system. Their definition of ‘intermediation’ – ‘matching the users and suppliers of money’ – is too agnostic about actual patterns of investment and the shape of the economy. Not all uses of money are equal from the perspective of social purpose.

As Amelia Watts wrote on the APPG blog recently, ‘inclusive growth requires long-term investment in people, places and industries.’ To create and sustain a healthy society and guard against an upwards trend in inequality, investment needs to go to the right things. The present financial system is unfit for purpose precisely because it fails to achieve this.

The UK’s banking sector, typical of the fractional reserve system in place worldwide, sees private money creation (in the form of new loans extended by commercial banks) flow towards socially undesirable or harmful activities:

• A bias towards mortgages – which, on average, represent some 40% of growth in M4 lending by UK financial institutions (monthly, 2016-17) – is crucial, as it contributes to rising house prices.
• Positive Money’s recent analysis finds that productive lending in the UK has fallen from just under 20% of total bank lending in 1997, to 10.4% at the end of 2017. Lending on financial intermediation, by contrast, represents 18.7% of all lending.
• These flows of newly created money enable the soaring inequality (especially when measured as the gap between the very richest and the rest) generated by high salaries and bonuses in banks and the rest of the financial sector.
• Relying on money creation by private banks for growth leads to high levels of private debt (households and firms). Data from the OECD shows the UK has seen the largest proportionate rise in its house prices to income ratio since 1997 among all OECD countries other than Sweden. This has a social and economic cost, not only through financial instability but also the unequal burden of debt as it falls across the population.
• Finally, the UK’s banking sector is immensely concentrated and very reliant on commercial banks in comparison with other countries. These large organisations are worse at serving the real economy, provide worse customer service, and are less financially stable than alternative, more locally-oriented ‘stakeholder’ banks.

It is not clear how the authors’ view of the purpose of banking – ‘keeping our money safe, helping us transact and intermediating between providers and users of capital’ – helps in analysing these issues. Furthermore, other financial institutions (equity markets, funds and asset managers) are operating in a world where the structure of the modern monetary system generates perverse incentives.

Pitt-Watson and Mann provide a useful heuristic for thinking about the financial sector and its place in society, and a promising cause around which to build a broad coalition for reform. However, huge imbalances in intermediation (in terms of the ‘users and suppliers of money’) also demand attention. For instance, the merit of a policy like the creation of a National Investment Bank, as presented by Justin Protts on the APPG blog, is that it promotes a better distribution of investment (in this case, increasing lending to otherwise underserved SMEs). Outcomes in lending and investment still need a place in a new framework.