Recently, however, the introduction of CREST and RTGS, and the European work on TARGET, has expanded on our work considerably. These maps cannot easily convey a sense of the dynamics of change in central banking. Central banks are evolving creatures, which respond to political and economic forces around them. One unusually powerful force, which will change their environment fundamentally, is EMU. But before considering its impact, I would like to consider the state of play in the rest of (non-EU) Europe, where exciting transformations of a different kind have occurred in the last decade. Turning socialist state banks into central banks The central banks of the formerly planned economies of central and eastern Europe have generally developed important responsibilities in each of my five areas (Figure 3). The old state banks have been transformed to fill the vacuum left by the dissolution of the mechanisms and institutions of a planned economy. Most had extensive branch networks and already operated rudimentary payment systems - though transfers often relied on correspondent banking relationships and slow and unreliable postal systems. But under the old regime there was little if any requirement for the other functions - setting interest rates, managing government debt, and supervising banks. Instead the main roles of the state banks had been the provision of banknotes; and making the financial transfers between state enterprises inherent in the central economic plans. The perceived importance of cash, and the bookkeeping culture, still influence to varying degrees their successor institutions.
In financial crises, savers and investors lose money for two reasons: first and foremost, because their pension funds and direct investments such as stocks, bonds and real estate lose value, and also second, because taxpayer money has to be used to rescue banks. Financial crises occur when risks are underestimated and price expectations of investments are exaggerated. This can lead to credit and asset price bubbles which sooner or later burst. When banks do not hold enough equity capital to absorb the losses they incur, they fail. Sovereign money would do nothing to change this situation. Risks can be underestimated and future returns overestimated in a sovereign money system too. Even without recourse to sight deposits, banks can grant loans which are too risky, hold too few provisions for times of crisis and become insolvent if a bubble bursts. Moreover, a key problem in the financial crisis was banks’ heavy reliance on short-term financing from the money market. These interbank loans proved to be a less stable source of financing than private customers’ sight deposits; in fact they dried up at the very start of the financial crisis in 2008. Sovereign money would not help to eliminate this risk of instability either. There are other, far more effective approaches to stave off credit and asset price bubbles than sovereign money. The significant increase in the capital and liquidity requirements for banks in the aftermath of the financial crisis is one such approach.