d63edbdf_brary_of_Economics_and_Liberty__ast_Highlights_HIDE_HIGHLIGHTS
[Time] 15:40
Banks vs. other businesses. Car manufacturer cheats on quality of the car --some get stuck with mediocre car, but most of the losses are borne by the stockholders who lose future benefits. With banking, you are going to wipe out people's savings. In such a world, would not people be uneasy putting any significant sum of money in any one bank, instead spreading them across many banks? Or would there be insurance of some kind? That's what bank capital is for. Front line of defense of the banks is their capital. Put your money in a bank that's got a lot of capital. Any losses it suffers as a result of bad loans come out of that capital. If it overissues, it will suffer reserve losses and a liquidity problem that should constrain it very quickly. If it makes bad loans, lack of solvency, comes out of capital; only after capital exhausted do depositors and note holders suffer. In whole Scottish free banking history until 1845, total losses of those who held Scottish bank notes were minuscule compared to losses borne by taxpayers as a result of bank failures in modern times. Capital suppliers like Adam Smith bore the losses. Feedback loops: if car doesn't run well or falls apart quickly, word of mouth spreads information. Hard to see how that would work with free banking. Would get signals much faster than with car maker. Notes are assets, traded in secondary market; the minute there is any doubt about the value of a bank's balance sheet, solvency, its notes are going to trade at a discount. Generally notes stay at par. Which of all these banks do I consider worthy of having my money? Individuals have an incentive to do some research, into its capital; will want to put as much effort into choosing a bank as into buying a car--which today nobody does for banks because of deposit insurance. Next, will want to ask: What notes and checks of other banks is my bank willing to take? If your bank accepts them, you can safely accept them. Usually same as group within clearinghouse. Banks not in good standing get weeded out or couldn't get started in the first place.
Selgin on Free Banking | EconTalk | Library of Economics and Liberty