How did commercial banks obtain the privilege to create money?
The short answer to this is financial innovation.
Here is the longer answer. Commercial banks used to have the power to create paper money at will but this was banned in the UK by the 1844 Bank Charter Act after several periods of financial turmoil and banking collapse. The intention of this act was to confine the power of money creation in England* to the Bank of England. However, innovation by commercial banks, and a failure of legislation and regulation to respond to this innovation, allowed them to create money in other ways. For example, instead of creating bank notes they created demand deposits, which were just ledger entries, and allowed customers to write checks against these deposits in order to spend. Late they developed credit cards and internet payments as other means of payment from demand deposit accounts. Now paper money is used only for a tiny fraction of transactions by volume. Thus an inability to print money is now no restraint on money creation by commercial banks.
It is hardly surprising that legislators in 1844 failed to anticipate credit cards and electronic payment systems when writing this Act!
But surely it is time to update the 1844 Bank Charter Act so that it functions as intended: preventing commercial banks from creating money of any type?
*Interestingly this did not apply to Scotland and Wales where certain commercial banks are still allowed to create banknotes.
The short answer to this is financial innovation.
Here is the longer answer. Commercial banks used to have the power to create paper money at will but this was banned in the UK by the 1844 Bank Charter Act after several periods of financial turmoil and banking collapse. The intention of this act was to confine the power of money creation in England* to the Bank of England. However, innovation by commercial banks, and a failure of legislation and regulation to respond to this innovation, allowed them to create money in other ways. For example, instead of creating bank notes they created demand deposits, which were just ledger entries, and allowed customers to write checks against these deposits in order to spend. Late they developed credit cards and internet payments as other means of payment from demand deposit accounts. Now paper money is used only for a tiny fraction of transactions by volume. Thus an inability to print money is now no restraint on money creation by commercial banks.
It is hardly surprising that legislators in 1844 failed to anticipate credit cards and electronic payment systems when writing this Act!
But surely it is time to update the 1844 Bank Charter Act so that it functions as intended: preventing commercial banks from creating money of any type?
*Interestingly this did not apply to Scotland and Wales where certain commercial banks are still allowed to create banknotes.
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