In 1919, the state of North Dakota established its own bank as a public institution. It is the only one of its kind in the country, having operated successfully for a century during the Great Depression and a dozen recessions. Nine other states tried to follow suit over the following decades, but failed and closed their banks. Founded to provide capital in an agriculture-centric economy that was underserved by large regional financial institutions that charged double-digit interest rates on agricultural loans, the Bank of North Dakota served as inspiration and a touchstone to political populists, anti-bank politicians and easy money advocates.
Over the past decade, lawmakers in more than half of the states have revived legislation in favor of public banks, according to the Public Banking Institute, an advocacy organization. The arguments in favor of these bills are similar: the private banking sector does not serve low-income communities, minorities and women; banks only lend to people who don’t need money; the profits of the banks are excessive, the States must therefore equip themselves with a competitive benchmark; public banks can promote economic development opportunities that the private sector ignores; and state banks could earn money on their investments and deposits – a win-win situation for taxpayers. It doesn’t matter that money is cheap today and the banking system is inundated with excess reserves.
Perhaps the best discussion of the pros and cons of state-owned banks was written in August for the Public finance review. This article described various legislative efforts that failed or stalled, as well as the objections that were raised and why, while also considering the possibility that one day a multi-state consortium could overcome economic risks and political pitfalls. .
Even beyond what we call the “global glut of capital”, however, what advocates and the professional literature overlook is the spectacular disruptive growth of the “fintech” – financial technology – which brings in capital. to previously underserved communities and businesses. It turns out that capital markets, big data, artificial intelligence, and witchcraft occupy many niches that allegedly clamor for public banks. But first, there are two other strategic public policy alternatives: âtied depositsâ and the use of pension fund capital for non-bank loans, or âshadow bankingâ as its critics call it.
As a young municipal finance officer, while moonlighting in undergraduate classes in the late 1970s, I fell in love with the concept of tied deposits. The idea was for municipalities to invest in term deposits with banks that undertake to provide local loans for economic development. I will never forget speaking at a panel at the State Finance Officers’ Conference and watching the state’s most prominent public funds banker scowl and shake his head. head of disgust at what struck him as a far-fetched concept. At the time, this idea was going nowhere.
But the concept never died, and in fact it continues today. In the 1980s, Ohio State Treasurer Mary Ellen Withrow embarked on a program to tie state deposits to a loan program and touted the concept among her peers at the National Association of State Treasurers. (She went on to become the 40th Treasurer of the United States.) Ohio continues to operate several linked deposit programs, and there are similar programs in a few other states, with New York and Washington being often cited as examples. .
While such linked deposits may be more apparent than substantial, their advocates would argue that they underscore the need and desirability for the banking sector to work cooperatively with the public sector to fill gaps in the country’s lending system, so why reinvent the wheel and socialize the bank?
An opportunity for public pensions
Meanwhile, with interest rates at record highs, public pension funds have been looking everywhere for ways to get a better return on their fixed income capital allocations. One of the vehicles that has emerged over the past decade has been direct lending through professionally managed portfolios that offer business loans at attractive interest rates.
After the Great Recession, banking regulations were tightened considerably, which opened the door for such private lenders who are exempt from a host of restrictive rules. Pension funds are ideal sources of this capital, which can be loaned on a secured or unsecured basis, depending on risk appetite and investment policies. Although direct lending has been tainted with the term âshadow bank,â it is an unfair nickname when attached to institutional capital dedicated to fueling growing businesses, not underwriting leveraged buyouts.
At the start-up level, where startups are the engines of economic development, the money usually comes from âangelâ investors who take a stake in the business and from âmezzanine loansâ from banks and corporations. capital risk. But we are also now seeing a growing number of well-managed, privately funded, early-stage ‘income-based lenders’ who, by viewing repayment as a percentage of a company’s gross income, are filling the gaps in Unsecured loans that public banks are once again touted to provide. Even the smallest municipal pension funds could play in the field of income-based lending if they spread.
Before embarking on the controversial rise of the creation of a state-owned bank that uses short-term unused treasury cash as a foundation, lawmakers may be wiser to promote long-term investments of their public pension funds. in these loan agreements. Pension trustees, who are required to act as trustees, will play an important oversight role by removing the policy. In the case of early stage income-based loans, the target rates of return are double digits, so there is money to be made when underwriting is done professionally and borrowers are properly screened. May pension funds, and not public treasuries, be the investors and sponsors of sustainable economic development.
The FinTech revolution
This brings us to the most recent challenge facing public banking advocates now: the recent revolutionary disruption of technology in the financial services industry. Billions of dollars are now being invested in companies backed by venture capitalists and recent IPOs that don’t need the brick and mortar of traditional banks – or the backing of states. The new technology compiles the information used to secure loans much more quickly, accurately, completely, and efficiently than traditional bank lending practices, allowing for quick (and seemingly impartial) credit approval decisions. Americans will hear more and more of “buy now, pay later” as a mainstream dimension of fintech, but the lending applications comparable to small businesses are equally spectacular.
Clearly, regulators will need to watch for redlining and statistical bias. But the fintech revolution is likely to eclipse the historic need for capital to serve many potential commercial borrowers who would otherwise seek a state bank, and thus eliminate the most creditworthy, regardless of race, ethnicity, country. gender or location.
This does not leave much of a foundation for advocates of public banks. For now, at least, I suggest promoters take a break and let the financial innovations outlined here take their course. Some of the new fintech companies will undoubtedly fail in the next downturn, but many will thrive and reach underbanked communities. Look for loan market failures after the low tide and we can see who swam naked before diving head first into turning states into bankers.
GoverningOpinion columns reflect the opinions of their authors and not necessarily those of Governingthe editors or the management of.