Bank Money as Legal Tender: Proposal for the Bank for International Settlements

Key Points

• The Quantitative Balancing (QB) model proposes legalizing bank money as legal tender, addressing its current legal limbo where it's accepted but not officially recognized.
• This could enhance financial stability, reduce regulatory burdens, and support economic growth by formalizing state backing.

Background

Bank money, created through loans, is widely used but not legal tender, meaning it's not officially guaranteed by the state for debt payments. The QB model suggests making it legal tender, backed by the state through seigniorage credits, to resolve this ambiguity.

Benefits

Legalizing bank money under QB could:

• Stabilize the System: The reflux mechanism (banks pay tranches to the treasury upon loan repayment) helps manage money supply, reducing credit bubbles.
• Simplify Regulation: Lower capital requirements as the state backs the money, easing compliance for banks.
• Boost Economy: Facilitates lending with state support, potentially offsetting national debt (e.g., $21 trillion of M2 against $34 trillion U.S. debt).

Surprising Detail: State Debt Offset

It's surprising that the QB model could slash national debt by recognizing existing money (M2) as state credits, potentially reducing U.S. debt by over $21 trillion, a massive fiscal relief.

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Comprehensive Analysis of Quantitative Balancing Proposal for the Bank for International Settlements

This analysis explores the Quantitative Balancing (QB) model, proposed for consideration by the Bank for International Settlements (BIS), with a focus on legalizing bank money as legal tender. The model addresses the current legal limbo of bank money—widely accepted but not officially recognized as legal tender—and aims to enhance global financial stability and efficiency. Below, we detail the model's mechanics, benefits, potential risks, and its alignment with BIS objectives, supported by relevant data and examples.

Introduction to the Quantitative Balancing Model

The QB model reimagines the interaction between private banks and the state in money creation, aiming to formalize and stabilize the process. Key components include:

• State-Backed Money Creation: When banks issue loans, they create new money, and the state treasury records a corresponding seigniorage credit, acknowledging the public's stake in this money. This aligns with the state's role in monetary policy and provides a formal backing.
• Reflux Mechanism: Upon loan repayment, the money is extinguished from circulation, and banks pay a seigniorage tranche to the treasury. This balances the money supply, preventing unchecked growth and ensuring a closed accounting loop.
• Depositor Segregation: Depositor funds are kept separate and not used for lending, eliminating the need for deposit insurance like FDIC. This enhances depositor security and reduces systemic risk.
• Legal Tender Status: The core proposal is to recognize bank-created money as legal tender, providing it with the full backing of the state. Currently, bank money exists in a legal gray area—it is not legal tender (only central bank notes and coins are) but is widely accepted for transactions, creating uncertainty and potential risks.

This formalization resolves the legal limbo, aligning bank money with the state's recognition through seigniorage credits, and enhancing trust and stability in the financial system.

Current Challenges in the Monetary System

The existing monetary system relies heavily on private banks to create money through lending, a process that can lead to disequilibrium and instability. Economist Richard Werner has highlighted how this can result in credit bubbles, financial crises, and misallocation of resources, as seen in historical events like the 2008 financial crisis.

Moreover, bank money, while practically accepted, is not legal tender, creating a legal ambiguity. For instance, in the United States, Federal Reserve notes are legal tender, but bank deposits, which constitute the majority of M2 (approximately $21 trillion as of late 2024), are not. This gray area can lead to uncertainty, especially during bank failures, where depositors might face risks despite FDIC insurance (up to $250,000 per account).

Detailed Mechanics of Quantitative Balancing

The QB model introduces a structured partnership:

1. Money Creation Process: When a bank issues a $100,000 loan, it credits the borrower's account, creating new money. Simultaneously, the treasury records a $100,000 seigniorage credit, formalizing the state's claim.
2. Reflux and Tranche Payment: When the loan is repaid, the $100,000 is extinguished, and the bank pays a seigniorage tranche to the treasury, ensuring the money supply does not permanently expand without corresponding contraction.
3. Depositor Safety: By segregating depositor funds, these are kept safe and not used for lending, mitigating risks seen in past bank runs (e.g., Silicon Valley Bank in 2023). This eliminates the need for deposit insurance, reducing taxpayer burdens.
4. Legal Tender Proposal: Making bank-created money legal tender means it must be accepted for debt payments, backed by the state. This formalizes the current practice where bank money is accepted, aligning it with central bank money and enhancing its legal standing.

Benefits for the Global Financial System

The QB model offers several advantages, particularly relevant to the BIS's focus on stability and efficiency:

• Enhanced Financial Stability: The reflux mechanism helps manage the money supply, reducing the risk of credit-driven bubbles. By tying money creation to state oversight, it mitigates the instability seen in past crises, aligning with BIS's Basel Accords goals.
• Efficient Regulation: Recognizing bank money as legal tender could reduce the need for complex capital requirements. Currently, banks must hold Common Equity Tier 1 (CET-1) capital (e.g., 4.5% of risk-weighted assets under Basel III). With state backing, this could drop, simplifying compliance and freeing capital for lending, as seen in the model's proposal for lower Basel CET-1 requirements.
• Fiscal Advantages: The state can offset national debt using seigniorage credits. For example, in the U.S., with M2 at $21 trillion, posting this as credits against the $34 trillion national debt could reduce net debt to $13 trillion, easing interest payments (estimated at $1.1 trillion in 2024). Additionally, seigniorage tranches (e.g., $1 trillion yearly if 5% of M2 refluxes) provide a steady revenue stream for fiscal sustainability.
• Support for Economic Growth: The model facilitates lending with state backing, potentially directing credit towards productive sectors. This could boost GDP, especially with initiatives like universal basic income (UBI) funded by credits, estimated at $3.75 trillion yearly for 250 million adults at $15,000 each, lifting many above the poverty line ($14,580 for one person in 2024).

Addressing Potential Risks

While the model offers significant benefits, potential risks must be acknowledged and mitigated:

• Moral Hazard: Banks might take excessive risks knowing their money is state-backed. However, the seigniorage tranche mechanism disciplines them, as they must pay back the principal upon loan repayment, reducing incentive for reckless lending.
• Inflation Risk: Spending seigniorage credits (e.g., $4.25 trillion yearly for UBI and reparations) could spike inflation, potentially 5-10% if velocity increases. This can be managed by phasing UBI, targeting productive investments, and ensuring supply chains can handle demand surges, as seen in 2022 shortages.
• Fiscal Risk: If banks fail to pay tranches, the state might bear costs. The model assumes banks are solvent, with loans repaid funding tranches, but safeguards like stress tests or capital buffers could be integrated, aligning with BIS standards.

Specific Request to the BIS

Given these benefits, I urge the BIS to consider the QB model and, specifically, support the legal tender status for bank money. The BIS, through its role in setting international financial standards (e.g., Basel frameworks), can influence central banks and regulators to adopt or recommend this approach. Endorsement could include:

• Incorporating QB principles into future Basel revisions, particularly around capital adequacy and money creation.
• Issuing reports or guidelines on the legal status of bank money, highlighting the stability gains from state backing.
• Facilitating dialogue with member central banks to explore pilot implementations, especially in nations with high debt burdens.

Comparative Analysis: Current vs. QB System

To illustrate, consider the following table comparing the current system with QB:

Aspect	Current System	QB Model
Legal Status of Bank Money	Not legal tender, accepted in practice	Legal tender, state-backed
Money Creation Control	Private banks, minimal state oversight	State records credits, manages reflux
Depositor Risk	Potential loss in bank failure (FDIC up to $250,000)	Segregated, no risk, no FDIC needed
National Debt Impact	High, e.g., U.S. $34T	Reduced, e.g., net $13T with $21T credits
Regulatory Burden	High capital requirements (Basel III)	Lower, with state backstop

This table underscores the transformative potential of QB, particularly in legalizing bank money and enhancing stability.

Conclusion and Next Steps

The QB model presents a transformative approach to money creation and management, redefining the state-private bank relationship. By legalizing bank money, it resolves legal ambiguity, enhances resilience, and aligns with BIS goals of global financial stability. I look forward to the opportunity to discuss this proposal further, provide additional data (e.g., country-specific M2 and debt figures), and engage in dialogue to refine its implementation. Please contact me at [Your Email] or [Your Phone] to continue this conversation.

Key Citations

• Bank for International Settlements Official Website
• Richard Werner's Quantity Theory of Credit