The North Dakota Model for Capitalizing Community Banks

Ellen Brown.Author, "Web of Debt"

http://www.huffingtonpost.com/ellen-brown/escape-from-pottersville_b_409813.html

Posted: January 4, 2010 02:30 PM BIO Become a Fan Get Email Alerts Bloggers' Index .Escape from Pottersville: The North Dakota Model for Capitalizing Community Banks
0 The recent proposal to vote with our feet by shifting our deposits from Wall Street to community banks is a great start. However, community banks are not suffering from a lack of deposits so much as from a lack of the capital they need to make new loans, and investment capital today is scarce. There is a way out of this dilemma, demonstrated for over 90 years by the innovative state of North Dakota -- a partnership in which community banks are backed by the deep pockets of a state-owned bank.
Our fearless editor and leader Arianna Huffington just posted an article that has sparked a remarkable wave of interest, evoking nearly 5,000 comments in less than a week. Called "Move Your Money," the article maintains that we can get credit flowing again on Main Street by moving our money out of the Wall Street behemoths and into our local community banks. This solution has been suggested before, but Arianna added the very appealing draw of a video clip featuring Jimmy Stewart in It's a Wonderful Life. In the holiday season, we are all hungry for a glimpse of that wonderful movie that used to be a mainstay of Christmas, showing daily throughout the holidays. The copyright holders have suddenly gotten very Scrooge-like and are allowing it to be shown only once a year on NBC. Whatever their motives, Wall Street no doubt approves of this restriction, since the movie continually reminded viewers of the potentially villainous nature of Big Banking.

Pulling our money out of Wall Street and putting it into our local community banks is an idea with definite popular appeal. Unfortunately, however, this move alone won't be sufficient to strengthen the small banks. Community banks lack capital -- money that belongs to the bank -- and the deposits of customers don't count as capital. Rather, they represent liabilities of the bank, since the money has to be available for the depositors on demand. Bank "capital" is the money paid in by investors plus accumulated retained earnings. It is the net worth of the bank, or assets minus liabilities. Lending ability is limited by a bank's assets, not its deposits; and today, investors willing to build up the asset base of small community banks are scarce, due to the banks' increasing propensity to go bankrupt.

It's a Wonderful Life actually illustrated the weakness of local community banking without major capital backup. George Bailey's bank was a savings and loan, which lent out the deposits of its customers. It "borrowed short and lent long," meaning it took in short-term deposits and made long-term mortgage loans with them. When the customers panicked and all came for their deposits at once, the money was not to be had. George's neighbors and family saved the day by raiding their cookie jars, but that miracle cannot be counted on outside Hollywood.

The savings and loan model collapsed completely in the 1980s. Since then, all banks have been allowed to create credit as needed just by writing it as loans on their books, a system called "fractional reserve" lending. Banks can do this up to a certain limit, which used to be capped by a "reserve requirement" of 10%. That meant the bank had to have on hand a sum equal to 10% of its deposits, either in its vault as cash or in the bank's reserve account at its local Federal Reserve bank. But many exceptions were carved out of the rule, and the banks devised ways to get around it.

That was when the Bank for International Settlements stepped in and imposed "capital requirements." The BIS is the "central bankers' central bank" in Basel, Switzerland. In 1988, its Basel Committee on Banking Supervision published a set of minimal requirements for banks, called Basel I. No longer would "reserves" in the form of other people's deposits be sufficient to cover loan losses. The Committee said that loans had to be classified according to risk, and that the banks had to maintain real capital - their own money - generally equal to 8% of these "risk-weighted" assets. Half of this had to be "Tier 1" capital, completely liquid assets in the form of equity owned by shareholders -- funds paid in by investors plus retained earnings. The other half could include such things as unencumbered real estate and loans, but they still had to be the bank's own assets, not the depositors'.