The following OpEd was written on behalf of Banking on New Mexico in response to arguments in Santa Fe against the creation of a public bank there.
Usually, a household wishing to own a house must borrow the funds from a bank. The household pledges its future earning capability to pay off a mortgage during the home owner’s lifetime. Likewise, the City needs to borrow for public projects like Roadways and Streets, Utilities, and the Airport. And, the City pledges its earnings from taxes to pay off the loans over its lifetime. Of course, a city’s lifetime is indefinite, so it borrows continuously forever.
Interest typically adds at least 40% to the costs the City must repay on its borrowing. Wouldn’t it be marvelous if our City could recover that interest? For a household the interest goes to the bank’s private owners. For a City borrowing from its own Public Bank the interest goes back to the City, which owns The Bank to benefit our community.
Critics of a Public Bank question how a city can benefit by depositing funds in a bank and borrowing those same funds back while paying bank overhead costs to boot. If that were the case, those critics would be rightfully indignant.
Overhead costs of about $1million are trivial compared to the expected cost savings to the City and the bank profits that are returned to benefit the community.
A Five-Year Model for a Public Bank for Santa Fe considered refinancing only $45million of the City’s existing debt of over $300million and another $5million in partnership lending with other financial institutions for things like local affordable housing, small business loans, or renewable energy. The model found that The Bank could make a profit of $10.5million to benefit the public, reduce both the City’s total debt and the amount of its annual debt payments.
Many people think that banks merely pay a low interest rate on deposits and lend those same deposits at a higher rate to make a profit. Surprisingly, this misleading oversimplification is espoused by some bankers. But, the primary focus of bankers is on the creditworthiness of their borrowers and meeting regulatory requirements. Bankers seem to forget that issuing loans creates new money in our economy. A close look at the double-entry accounting of banks tells the story.
A bank deposit is a liability for the bank that must be repaid to the depositor upon demand. Chartered banks do not loan out deposits. When the City deposits our taxes and fees in a bank, the money is not held in that bank. The money is held in the bank’s asset account at the Federal Reserve Bank. So, the deposit is a promise (IOU) that the bank will redeem requests for cash or check withdrawals. Banking regulations allow a bank to issue loans up to several times its core capital. Interest on those loans is the main source of a bank’s income. A Public Bank returns loan interest to the community it serves.
A loan is an exchange of promises. The bank has an asset in the borrower’s promissory note to repay the loan and an equal liability in the new deposit. The borrower has a liability in the promissory note and an asset in the new deposit. The new deposit is new money created when the bank issued the loan.
Chartered bank loans are fundamentally different from non-bank loans. A non-bank is any financial institution or process that does not own a bank charter. Non-banks acquire assets through borrowing or investment and loan those assets to make a profit.
Because a Public Bank’s profit on its loans is returned to the public through the City, we see that a Public Bank provides responsible stewardship of public funds.