A public bank is risky business

A public bank is risky business
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At a time when populist policy approaches are attractive to many voters on both the right and left, the idea of “public banks” has begun to get a bit more airtime.

The latest battleground over whether banks owned and operated by states or cities is good or bad public policy is in Los Angeles, where voters on Nov. 6 will consider Charter Amendment B, which would authorize the city to create its own government-run bank. But proposals to establish or study state-run banks have been introduced in 11 state legislatures and at least six municipalities.

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As lawmakers — and, in Los Angeles, voters — consider these proposals, I would encourage them to weigh whether any prospective benefits of a public bank will outweigh the risks attached to the broader concept—specifically the very real risks that it might pose to the taxpayers and the detrimental effect it could have on consumer choice.

The risks of public banks are many, but a scattered business focus, undue political influence and lack of oversight top the list. Distant U.S. history records the experience of several state banks — and they were not happy ones. Nearly all failed, usually because of political interference that resulted in making risky loans or operating with too little capital (or both), then collapsing when boom times ended. In fact, Abraham Lincoln’s earliest recorded speech as an Illinois legislator in 1837 criticized just this kind of political interference. International examples of political interference in banking also offer instructive lessons to bear in mind.

The only remaining municipal or state bank today is in North Dakota. Formed nearly a century ago as an expression of prairie populism, today it scrupulously avoids competing with the state’s commercial banks, thrifts and credit unions, and it focuses principally on economic development.

Most of today’s public banking advocates, however, are looking for institutions that will compete directly with commercial banks and savings institutions, offering small-dollar consumer loans and checking accounts while meeting the banking needs of cities and states. Which brings us to the risk of a scattered business focus. It would be difficult enough to start a brand-new institution, much less one that can cost-effectively serve the underbanked while simultaneously handling state or municipal banking needs.

Take Los Angeles for example. The city spends nearly $9.3 billion per year. That’s $25 million every single day, spent on public safety, services, infrastructure and education — plus payroll for 33,375 employees. A commercial enterprise of this size typically relies on relationships with multiple banks to meet its financial needs, not just one. Indeed, commercial banks provide valuable financial services today for Los Angeles and localities across the country after competing for that business.

And who would oversee this new bank? The proposed public bank would not have the FDIC insurance that consumers expect, meaning that their deposits would be protected not by the trusted FDIC but by state or local politicians. Without professional regulators overseeing the bank, would it be swayed by the politically connected to make excessively risky loans? Or would its capital reserves become a convenient pot of money to raid for other political priorities?

To that point, where would the money to capitalize the bank come from? Law professor Mehrsa Baradaran has perceptively noted that certain public-sector deposits — for example, those of federal agencies — may require higher levels of capital to protect taxpayers. The effect of those enhanced capital requirements would result in reduced lending to the very borrowers the public bank would be intended to serve. Ultimately, taxpayers will be on the hook to provide the billions of dollars in startup capital the bank would require — and they would be required to pay should the bank fail to manage its risks properly.

America has more than 5,500 banks operating more than 80,000 branches securing secure $13.5 trillion in deposits. The regulated commercial banking sector has a long track record of meeting the needs of small-dollar borrowers, consumer depositors and large-scale enterprises alike. From homelessness to education to drug abuse, cities like Los Angeles have huge problems to tackle. Why should voters add to those problems by replacing a system that works with a risky alternative that could leave them holding the bag?

Rob Nichols is president and CEO of the American Bankers Association.