I found this to be a fascinating read (it's a bit long):
https://www.bloomberg.com/view/articles/2018-09-06/fed-rejects-bank-for-being-too-safe... someone came up with a much simpler and amazing solution. It’s this:
- Start a bank;
- Take deposits;
- Invest 100 percent of those deposits in reserves at the Fed; and
- Pass the interest on to your depositors.
It is called TNB USA Inc. (for “The Narrow Bank”), it is run by the former head of research at the New York Fed, and it is simultaneously a dumb simple one-sentence idea and the most interesting bit of financial engineering that I’ve seen this year. ...
... TNB wants to offer its accounts only to “the most financially secure institutions,” meaning apparently money-market funds and foreign central banks, and it does not plan to “provide any retail banking services for individuals.” It is a pure interest-rate arbitrage for money-market funds: Instead of effectively depositing money with the Fed through its reverse repo facility at 1.75 percent, funds could deposit their money with TNB and get the Fed’s higher rate on reserves, 1.95 percent. Presumably TNB would take a cut, but its expenses would be small: It would have only a relatively small number of very large customers, so there’s not a lot of administrative overhead, and it’s not doing any lending or investing work.
It’s fine, you know, it’s a trade, but if it works the really interesting extension is to do it for retail. The overhead would be higher — you’d need at least a website, a customer service department, ATM cards — but the opportunity is intriguing. You could offer retail depositors a checking account at a bank that is immune to financial crises, runs and bad investments, a checking account that is fully backed by the Fed.
Also, weirdly, you might be able to pay them more interest than regular banks offer. “The FDIC recently reported that jumbo deposits — $100,000 or more — on average earned eight basis points (0.08 percent) from savings accounts, and five basis points (0.05 percent) from checking accounts, while the Federal Reserve Banks pay 195 basis points (1.95 percent) as the IOER rate,” notes TNB. If banks are mostly investing in things that are riskier (and so higher-return) than Fed deposits, they should be able to pay interest that is higher than the rate on Fed deposits. But of course if you’re a regular bank doing that, you have to hire a lot of bankers to evaluate those loans and investments, and risk managers to check up on them, and some of the investments will go bad and you’ll lose money, and you probably have branches, and the whole thing is just big and expensive. The TNB model is much leaner, and it is quite possible that it could pay a higher rate.
But so far it doesn’t work. TNB is in the news because it got a provisional banking charter in Connecticut, set itself up as a bank, and went to the Fed asking to open a reserve account, but the Fed said no. So TNB is suing the Fed, arguing that the Fed’s rules require it to open an account for any qualified bank, and that it is a qualified bank. Here is TNB’s complaint; here are an analysis from John Cochrane and an article about it in the Wall Street Journal. From the complaint it seems like TNB is mystified about why the Fed said no, but it apparently goes all the way to the top: The New York Fed declined the account “reportedly at the specific direction of the Board’s Chairman,” Jerome Powell. The Fed has not said what its objection is.
Given that reluctance to completely scrap the banking system and start over, people have proposed more incremental, optional steps: FedAccounts, or now TNB. In these plans, nothing changes in bank regulation; banks can keep doing exactly what they’re doing now. But their competitive landscape changes: Instead of just competing with other banks, or other non-government-backed sources of money-like claims (money-market funds, etc.), the banks would now have to compete with interest-bearing accounts issued directly (or, with TNB, somewhat indirectly) by the Fed. But that is tough competition! If you can get paid 1.95 percent on perfectly safe deposits, getting 0.08 percent on imperfectly safe deposits is not very appealing. Narrow banking by competition might end up in the same place as narrow banking by regulation: If banks can no longer attract deposits — or, with TNB, if they can no longer attract short-term funding from money-market funds who go to TNB instead — then they will effectively be forced to transform into something else. (Cochrane uses the term “equity-financed banks”: They would have the assets of traditional giant banks — loans, securities, etc. — but their liabilities wouldn’t include anything deposit-like; they’d just be funded by equity and long-term debt.) If you think that that would be a bad thing — if you think that pulling deposits from big banks would precipitate a crisis, or at least reduce lending — then you won’t want to do it accidentally. You won’t want to open a Fed account for a tiny weird bank whose business model might bring the whole system down. No matter how interesting it is.