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Narrow banking is a proposed type of bank called a narrow bank also called a safe

bank. Ultimately, if adopted widely, this could lead to an entirely new banking
system. Narrow banks can, by risk reduction measures designed into the narrow bank,
significantly reduce potential bank runs and the need for a deposit insurance provided
by the central bank. It is sometimes suggested as an improvement upon fractional
reserve banking.

Narrow banking would restrict banks to holding liquid and safe government bonds.
Loans would instead be made by other financial intermediaries. That is, the deposit
taking and payment activities have been separated from financial intermediation
activities. Two different types of banks (financial companies) are needed, one for each

Key attributes of narrow banks include -

1. no lending of deposits (reducing a key risk materially but constraining return on

investment for depositors and shareholders alike)
2. extremely high liquidity (typically short-term assets e.g. bonds)
3. extremely high asset security (typically government bonds)
4. lower interest rates paid to depositors (as a function of the no lending and other
5. possibly specific regulatory framework with higher level of scrutiny and
operational/investing restrictions

Additional criteria applied to safe banks include -

1. no derivatives
2. no off balance sheet assets
3. high degree of institutional transparency (e.g. continuous real-time disclosure of
financial records)
4. capped executive salaries
5. low risk jurisdictions

Narrow banking and investment banking: the Glass

Steagall debate
• Source: Speech by Adair Turner, Chairman, FSA to the British Bankers'
Association annual conference 30 June 2009

"The third complex issue is the appropriate relationship between retail and
commercial banking and investment banking activity, and in particular risky
proprietary trading. It is clear that there is a problem which has to be addressed.
In the years running up to the crisis, we had large commercial banks taking the
benefits of retail deposit insurance and perceived too-big-to-fail status and using these
to support risky proprietary trading activities which created large bonuses for
individual bankers but large costs to taxpayers and financial instability which has
produced a recession. That is not acceptable: the question is not whether we need
significant change but how to achieve it.

One way would be to enforce a legal separation between narrow banking activities
and investment banking activities, re-imposing, or in some countries imposing for the
first time, Glass Steagall type distinctions. And some legally enforced distinctions of
economic functions are clearly possible – indeed we already have one in the UK, with
building societies not allowed to participate in the full range of financial activities
which banks can perform – certainly excluded from exotic investment banking
activities and subject to limitations on the percentage of their balance sheet which can
be invested in for instance commercial real estate. Having such a tier of clearly
narrow institutions does make sense; and indeed in my report to the Chancellor on the
Dunfermline Building Society, I raised the issue of whether perhaps the freedoms to
perform functions beyond residential mortgage lending had been set too loose after
the various deregulations of the 1980s and 1990s.

But the real issue is not what the existing very narrow institutions should be allowed
to do, but what should be the freedoms for those large commercial banks which are
involved in the provision of services not only to residential customers and SMEs, but
also to large complex corporates operating in the global economy and therefore
involved in the management of complex foreign exchange, interest and credit risk.
Can we keep these banks out of the trading activities which played a role in the crisis
by writing a law which defines what they can and cannot do?

I suggested in The Turner Review that this was difficult. The key point to recognise is
that the activities which caused the crisis were not ones which had been previously
defined, under for instance Glass Steagall, as clearly outside commercial banking –
activities such as equity underwriting and distribution – but activities which seemed
close to the core functions of commercial banks such as credit intermediation,
liquidity provision and interest rate risk management. Much of what went wrong went
wrong in activities which a commercial bank was free to perform even before Glass
Steagall was dismantled. It is, I think, difficult to imagine applying a law which says
that a commercial bank cannot hold fixed income securities in its Treasury portfolio,
turn loans into securities for distribution but hold them until distribution is achieved,
or use credit derivatives to manage credit risks. And you certainly cannot say that a
commercial bank cannot take any proprietary positions, without making it impossible
to perform necessary market-making functions in, for instance, foreign exchange and
interest rate markets.

But once you have said that a commercial bank can do all of those functions, you
have allowed it to do most of the activities which, pursued on a large scale and in a
risky fashion, caused the crisis.

That is why my tentative conclusion in The Turner Review was that we could not
proceed by a binary legal distinction – banks can do this but not that – but had to
focus on the scale of position-taking and the capital held against position-taking. That
is why the increases in trading book capital to which I referred earlier are so
important. And such increases need to be applied to all trading activity by banks or
non-banks, since even where those trading activities are performed by institutions
which are not insured deposit-takers, large systemic risks can still result. That was the
lesson of Bear Stearns and Lehman Brothers.

Where there may be a role for legal entity definitions, however, is in defining more
clearly the separate legal entities in which core retail banking functions and
investment banking type functions are performed, ensuring that the retail banking
functions are adequately and independently capitalised, and making it clear to the
market that in any future crisis there is at least the possibility that rescue might apply
only to retail banking operations. Such ideas have been floated, for instance, by
Philipp Hildebrand, Vice-Chairman of the Governing Board of the Swiss National
Bank. They would not be straightforward to implement, but they deserve careful

Macro-prudential analysis and tools

In the years running up to the crisis – in, say, 2002 to 2007 – we needed an analytical
approach would put together the dots of the macro-prudential picture. In the UK that
picture was of a growing current- account deficit, rapid credit growth, rapidly rising
house and commercial real estate prices, the rapid growth of securitised mortgages,
rapidly growing banks dependent on wholesale funding, and extensive reliance on
funding from abroad, both via interbank funding and via US purchases of securitised
mortgages, a reliance on funding from abroad which in turn, of course, was the flip
side of the current-account deficit. We needed to do that analysis, identify the
emerging risks, and then take offsetting actions. But we had in place neither the
analytical approach nor the regulatory tools. We need to put them in place for the

If the overall principle is clear, however, much work is still needed to define how
precisely macro-prudential regulation will operate. There are important questions in
respect to objectives, to tools, and to the choice between hardwired and discretionary

On objectives, a crucial issue is how ambitious we should be. Are we simply aiming
to increase the resilience of the financial system, reducing the likelihood of bank
failure? Or do we believe we can reduce the amplitude of economic cycles, more
effectively leaning against the wind of asset price bubbles, using other instruments
than the interest rate to take away the punch bowl before the party gets out of hand?
The more the objective is the latter, the closer the required links to the conduct of
monetary policy.

On tools, one clear priority is a countercyclical approach to capital at the institutional

level. But it is also possible to envisage both the definition and then the through-the-
cycle-variation of margin requirements in secured lending, and of loan to value (LTV)
or loan-to-income (LTI) ratios in, for instance, residential mortgages. Such
approaches are essentially ways of regulating leverage at the product specific rather
than the institution specific level. But establishing and then varying maximum LTV or
LTI ratios in mortgages, raises complex issues relating to consumer access, and
overlaps with conduct of business concerns. The FSA will make a contribution to that
debate in the Discussion Paper on the mortgage market, which we will issue in

Finally, there is the issue of whether macro-prudential tools, and in particular

countercyclical capital adequacy, should be varied in a discretionary fashion or
hardwired, through, for instance, a Spanish dynamic provisioning type approach. The
issue of hardwired countercyclical rules is already being considered by the Basel
Committee, and the conclusions they reach on that issue may in turn have
implications for the balance between hardwired and discretionary elements within the
UK approach.


In India, the concept of narrow banking came into discussion after submission of the
report by the Committee on Capital Account Convertibility (Tarapore Committee). It
was suggested as a solution to the problem of high NPAs and related matters. The
Committee proposed that incremental resources of these narrow banks should be
restricted only to investments in govt. securities.
What is narrow banking ? A ‘Narrow Bank’ in its narrow sense, can be defined as
the system of banking under which a bank places its funds in risk-free assets with
maturity period matching its liability maturity profile, so that there is no problem
relating to asset liability mismatch and the quality of assets remains intact without
leading to emergence of sub-standard assets.
What are advantages : Such an approach can ensure the regular deployment of
funds in low risk liquid assets. With such pattern of deployment of funds, these banks
are expected to remove the problems of bank failures and the consequent systemic
risks and loss to depositors.
What is status of narrow banking in India ? The concept is practically being
implemented by the Indian banking system partly, as a large part of the deposits
mobilised (i.e. more than 46%) by the banks, has been deployed in Govt. securities
(against a prescription of 25% in the form of SLR) as it provides a safe avenue of
investment but at a very low return. This keeps the level of non-performing assets
(rather than advances) low and the requirement of capital adequacy ratio also low, as
the risk weight allotted to such securities is only 2.5% compared to 100% in loan

The narrow banking proposal defining a class of safe and liquid assets (generally
sovereign government securities) for investments by weak banks, backed fully by
demand liabilities (generally non-interest bearing deposits) has been considered as a
means of deposit protection and a possible solution to the banking problems. We seek
to explain the theoretical implications of the proposal and examine its implications for
the Indian public sector banks facing large non-performing loans. The evidence
presented in this paper, based on published and audited annual accounts, shows that
even without a directive, narrow banking on the asset side is already being practised
as part of the asset-liability management by these banks. However, given the structure
of deposit ownership, narrow banking in its strict sense does not afford a solution to
reforming weak banks. Strictly practised narrow banking can neither guarantee
deposit protection nor turn around the weak banks. On the contrary, it can expose
weak banks to immense market and interest rate risks which can make the banking
system vulnerable to idiosyncratic and systemic risks arising from macro-economic
shocks. Considering the fact that the problem of non-performing loans is not as
alarming in India as in some other emerging markets, this paper suggests a cautious
approach to strengthening the banking structure. Pitching excessively restrictive speed
limits in this scenario might turn out to be counter-productive. The paper, however,
recognises that some contraction in the scale of operations of the weak banks

Narrow banking gets a larger audience during big


When the whole financial world has accepted taking risk as a part of life, talking about
narrow banking almost seems like talking about elementary arithmetic. In times of booms,
big financiers always like to believe that adding two and two can fetch you 22 if you know
how to leverage. Where is the fun if at the end of the day you are not able to make money
out of thin air? Narrow banking — also known as full reserve banking — must be for lazy
people, who don’t want to chase high yields and remain satisfied with counting the same
bucks again and again. But in times of big downfalls, we suddenly find much larger
audiences for narrow banking. To understand narrow banking, we need to look at the
financial world through the eyes of a narrow banker.