To solve this crisis, let’s think out of the box

Posted by Biagio Bossone on 8 March 2009

Nobody has said it yet, but at this stage of the crisis the world would need some sort of “helicopter” money. Let’s face it: all else seems to be ineffective or unfeasible. Banks do not lend, and would not do so even if recapitalized, since borrowers find it hard to repay them. Government fiscal stimuli, on the other hand, may not do the trick either – remember Japan? They imply growing public indebtedness: not many governments can afford it. Moreover, larger debts are a drag on future output; they may thus induce higher savings and lose impact as a result.

A mechanism should be found to give out some fresh money for people to spend. It should be market driven and work under strict monetary policy control. Years ago, we performed a mental experiment trying to think of unorthodox ways to overcome the formidable obstacles that hinder conventional lending in poor economies (Bossone, B. and A. Sarr 2005). Today, we think the solution we then proposed could prove helpful for advanced economies that are liquidity trapped.

Our economies are based on credit money, that is, claims that banks are allowed to issue on themselves under loan contract terms and that people accept and use as means of exchange. To the extent that banks are permitted to operate under a fractional reserve regime, they create the bulk of the economy’s money.

We propose a noncredit money system, where money creation is separated from lending through specialized entities, which – like banks – only need to keep a fraction of their deposit liabilities at the central bank to settle net deposit outflows. Unlike banks, these institutions may not lend, but may distribute new money to depositors the same way banks create money via lending. We call these institutions Deposit Creating Institutions (DCIs). DCI money is distributed under no restitution obligation; it takes the form of deposits issued on the accounts of depositors, and is additional to the deposits outstanding at the time of distribution – just like loans. Like bank deposits, DCI deposits can be state guaranteed. They are convertible into cash and foreign exchange on demand by their holders, and may be used for all types of real and financial transactions.

The DCIs provide deposit safekeeping and payment services, for a fee, and may offer other services such as cash management for enterprises. Fee income is their raison d’être. DCIs start with some initial capital, and hold part of their assets as reserves with the central bank and liquid securities. The remainder of their assets consist mainly of physical assets. The deposits distributed – equivalent to conventional loans – are reported on the asset side of the DCI balance sheet for record keeping purposes only, and represent liabilities – as deposits created via bank lending do.

The proportion of deposit balances a DCI distributes is a market strategy variable determined by the DCI itself. Different DCIs can apply different rates to different types of depositors. For instance, DCIs aiming to achieve large market shares may prefer to attract many small depositors rather than few large ones. On the other hand, intermediaries wishing to offer DCI payment services within broader financial service packages may aim at fewer but larger customers. The deposit distribution rate is one of the instruments available to the DCIs to compete in the market for deposits. DCIs negotiate with their customers their liquidity distribution policy.

 In a noncredit money system, liquidity – not solvency – is the essential criterion for DCI viability. The capital of a DCI equals its fixed assets plus its own liquid funds. Call primary liquidity the funds DCIs are required to hold as cash, central bank reserves, liquid securities, or as excess reserves. DCIs may purchase government securities on their own behalf, but only with their own capital and not with the public’s deposits. DCIs need primary liquidity to comply with regulatory requirements, settle payments to other DCIs, and meet customer demands for cash.

Primary liquidity is a key factor of competition in the DCI market. DCIs that are more capitalized can take more liquidity risk and distribute more money, thereby attracting depositors from other DCIs. In turn, by expanding its capacity to attract deposits, a DCI economizes on the use of (costly) primary liquidity since its share of “on us” payments increases relative to its competitors. A larger deposit capacity also enables the DCI to distribute new deposits with a higher probability to attract them back to its own books.

In sum, DCIs compete in the market for primary liquidity with a view to increasing their capacity to provide their main output: payment services. To this end, they seek to enhance their deposit-creation capacity and attract more depositors. Winning over a larger share of the deposit market increases their profitability by increasing their fee revenues and by reducing their optimal level of primary liquidity relative to liabilities.

Monetary and fiancial policy

DCIs are required to hold a minimum reserve-to-deposit ratio with the central bank. Prudentially, they may also be required to hold a minimum ratio of liquidable securities.Like in conventional banking, the reserve requirement determines the maximum deposit creation by the DCIs. Through it, the central bank sets a ceiling on liquidity distribution by individual DCIs and, hence, on aggregate money supply.

The central bank issues reserves periodically, and determines the reserve stock consistently with expected output growth and inflation targets. Injections and withdrawals of reserves take place through open market operations. To facilitate payment settlements, the central bank may sell reserves to DCIs in exchange for securities they hold against capital, or it may make reserves available to them on a collateralized basis and at penalizing rates. DCIs may raise liquidity in the money market using their own assets and the room provided by reserve requirement averaging.

DCI activities and balance sheets must be kept separate from the activities and the balance sheets of other financial intermediaries. DCIs can thus be either dedicated entities or specialized subsidiaries of financial holding companies or, else, specialized fire-walled departments within financial companies offering a range of different products. All nonDCIs hold deposit accounts at DCIs.

A DCI fails when it runs out of primary liquidity and cannot settle payment obligations. Since DCIs are subject to a reserve requirement, settlement failure happens when a DCI has lost primary liquidity to the point where it cannot comply with its requirement persistently.

This situation can result from competitive pressure or depositor runs. In a run situation, however, DCIs are not subject to solvency problems and, therefore, are much less exposed than banks to risk of runs. Although seemingly paradoxical, this is a major result of a system that creates and distributes claims on real resources through acts of giving, rather than lending.

The risk of runs is reduced due to the way DCI failures can be handled. Once a DCI has run out of primary liquidity, and has exploited all options to raise reserves, it is allowed to fail and exit the system.Upon failure, its deposit liabilities are allocated to the surviving DCIs with net open credit positions vis-à-vis the failed institution. The allocation can be effected on a pro-rata basis relative to the capital of each surviving DCI. Obviously, depositors are free to transfer the reallocated deposits to other DCIs and to use them as they wish.

Since DCI liabilities are not matched by real claims on DCI books, their allocation to other DCIs does not require full collateralization with performing assets (restructuring bonds). The only necessary and sufficient condition for the allocation not to undermine public confidence in the receiving DCIs is that the latter have enough primary liquidity to maintain the required ratios even after the allocation.

In the event of insufficient reserves, a portion of the allocated liabilities would remain uncovered, and any such reserve shortage would have to be supplemented through recapitalization. The needed injection of funds, however, would likely cost less than under a comparable case of bank failure, where all the bank’s uncovered liabilities would have to be written off, matched with restructuring bonds, or refunded with deposit insurance funds.

Moreover, the exit of a failed DCI, however large, would not trigger systemic reactions, since depositors would have their deposits transferred immediately to surviving DCIs, which either would be able to honor their liabilities or would be recapitalized to that effect. In the event of a simultaneous run on all DCIs, the government could in principle let all DCIs fail, order the transfer of all deposits to a central institution, and keep the payment system alive allowing deposit transfers to be executed with only a fractional reserve base. This outcome, however, is unlikely since depositors have no incentive to run on the system if deposits are state guaranteed. This guarantee does not create moral hazard, as it does in conventional banking, since DCIs do not lend funds and their distribution is constrained by the reserve base. The system would not be sustainable in the case of a run on the currency, but the consequences would not be different than under conventional banking.

The proposed system would have two major advantages relative to conventional banking. First, DCI depositors select – through their consumption decisions – the enterprises that will capture the liquidity created by the DCIs. In other words, the money created by the DCIs is allocated across the economy by market preferences. Second, and very important, DCIs may come to the economy’s rescue in those situations where structural constraints to the provision of credit prevent monetary policy from managing effective demand – like when protracted bank restructurings and weak balance sheets make inoperable the banking channel of liquidity provision. These situations typically lead the central bank to inject liquidity in the market with no effect on the real economy.

In our proposed system, the DCIs would fuel demand since the money distributed would translate directly into household disposable income. Neither new private nor public debt would be incurred. The quantity of liquidity made available would increase demand permanently since DCI money carries no restitution obligation. In conventional banking, on the other hand, the money created via lending is destroyed as loans are repaid. This requires banks to create more money on a gross basis than is destroyed if the money stock is to grow in line with nominal GDP growth, otherwise deflation sets in (For a review of money creation and destruction in a monetary circuit process, see Bossone 2001).


To the extent that a new consumption cycle is set in motion, the real business sector may want to re-access bank credit to fund production and investment, and the banks may regain better prospects to resume lending. Confidence would build in, and bank shares may recover value, thus making extreme measures (such as heavy recapitalization or nationalization) less necessary.  


Biaggio Bossone and Abdourahmane Sarr


Bossone, B., 2001, Circuit theory of banking and finance, Journal of Banking and Finance, 25, 5.

Bossone, B. and A. Sarr (2002), A New Financial System for Poverty Reduction and Growth," IMF Working Papers 02/178, International Monetary Fund.

Bossone, B. and A. Sarr (2005), Noncredit money to fight poverty, in Fontana, G. and Realfonzo, R. (editors), “The Monetary Theory of Production, Tradition and Perspectives;”