Retail investors have been invited to open gilt accounts with India’s central bank after Prime Minister Narendra Modi launched its Retail Direct scheme on Friday, under which people can invest directly in government bonds. As these are virtually risk-free, many of us would be attracted to use this window for access to our market for gilts. Such disintermediation is not just welcome, the Reserve Bank of India’s outreach could set the stage for other financial relationships with the public, even as digital advancements redefine the limits of possibility, expose the high costs of legacy banking and tempt bank reformers to rethink the core structure of an industry of the brick-and-mortar age. From cryptocurrencies to decentralized finance (‘DeFi’), blockchain innovations have advanced at warp speed, and new online services can operate cheaply by spreading low overheads across vast volumes. Today, legacy banks would be too cost-laden to compete with pure digital plays without the protection of entry barriers to this sector and the privileges assured by state-issued licences. While our banks must be kept shielded by law and regulated by RBI for the sake of systemic stability, we must also mount a swift response to the disruptive potential of technology.
Under consideration right now is a central bank digital currency (CBDC), the launch of which may involve users operating digital wallets or perhaps interest-paying accounts held with RBI. Either way, its public interface will expand to cover the country. Since money kept with the issuer of our legal tender would be fully safe, such a facility will reduce the relative appeal of classic bank deposits, subject as they are to some risk of bank failure. A big question this prospect poses, though, is this: Why should banks soak up depositor funds at all if a central bank could do it just as well in a world of online transfers at the tap of a little screen? Economic efficiency requires all value-adders to do what they do best, after all, and the value-additive function of lenders is to assess credit risk and price it profitably. The central bank could lend them the money it mops up cheaply enough and let them focus on exactly that. Whether an economy’s lender of last resort should take over the depository role of banks has already stirred a debate in America, where the White House candidate for a key bank regulator’s chief, Cornell law professor Saule Omarova has argued for such a radical recast of banking.
Among the advantages, a role-split would turn bank-runs into a worry of the past and deposit insurance obsolete. Safety is a big part of Omarova’s pitch. To the extent that space for reckless credit is made by loan disbursals which convert into client deposits (until withdrawn), letting lenders lend even more, the shift could act as a restraint. Yet, so long as capital cushions as a ratio of risk-weighted assets are sufficient to cover defaults, their loan books need no clamps. What if desirable credit flows suffer? The idea might make better headway as a monetary reform. A central bank with a wide swathe of the cost-of-funds under its control would get a firmer handle on monetary conditions in the economy, with interest-rate settings easier to transmit and risk premiums nudged to form a bigger part of the final rates paid by borrowers. As host-in-chief of people’s savings, the central bank could also execute fiscal transfers—say, a universal basic income—smoothly, not to mention an agenda of state-directed credit. In the US, this bit has raised capitalist hackles. Any centralization deserves scrutiny. But, as the net deepens in India, we need our very own debate.
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