Can Public Banking Finance the New Economy?

The Bank of North Dakota offers a model for public banking that could stabilize the economy.

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The Bank of North Dakota's headquarters sits in west Bismarck, N.D. The bank recently received an improved rating from the Standard & Poor's ratings agency, which its president says will make it better able to assist private banks with loans and government agencies with financing public works projects.

David Brodwin is a cofounder and board member of American Sustainable Business Council. Follow him on Twitter at @davidbrodwin.

North Dakota shines like a bright star in the dark night of America's Great Recession. It stands out for two reasons: First, it led the United States in sustaining a strong economy and high employment through the last four years. Second, it is the only state in the union with a publicly-owned bank. Many believe the Bank of North Dakota played an important role in stabilizing the state's economy, and they would like to replicate public banks nation-wide. It will be a tough fight, and an important one.

What Is a Public Bank?

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A public bank is a bank that is controlled and initially funded by a government entity rather than by private investors. The Bank of North Dakota is, in essence, an extension of state government. The state deposits all its revenue in the bank and sometimes borrows from the bank. The CEO of the bank does not report to a board of directors, as he would in a private bank. Instead he reports to a commission composed of the governor and other officials. (A professionally-produced documentary of the impact and 90-year history of the bank can be viewed below or on YouTube. It's a fascinating and colorful story.)

Public banking is common around the world, particularly in developing and newly-developed countries. "Globally, 40 percent of banks are publicly owned," says Ellen Brown, chair of the Public Banking Institute and author of Web of Debt. She adds: "The countries with public banks mostly beat the credit crisis." Public banking played an important role in America's past, too. The U.S. Post Office ran the Postal Savings System until 1966. This brought affordable banking services within reach of all Americans for the first time.

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Why the Renewed Interest in Public Banking?

Public banking has gained new respect in the wake of widespread, ongoing problems with America's largest banks. Advocates of public banking believe that the banking industry has deep structural flaws that have not been fixed and probably cannot be fixed, given the industry's clout in Washington. They want to build new and better banking institutions that can operate reliably for benefit of American consumers and small businesses.

Advocates for public banks claim several important benefits: 

  • Local Lending: Public banks can be chartered and managed so they lend locally, within the jurisdiction that set them up. (Ironically, the U.S. banking system was substantially a state-level system until deregulation in 1994 allowed national banks to dominate.)
  • Lower Risk: Public banks can be prohibited from speculating in risky derivatives that can't be adequately regulated. This would prevent bailouts that ultimately burden the taxpayer.
  • Greater Impact: Public banks magnify the money the state can deploy for economic development and infrastructure investment. Because of the way our system of "fractional reserve banking" works, each dollar the state sends to a public bank can support at least two dollars of investment in loans for local business, and potentially more.
  • Money to Cash-Strapped States: The public bank charges interest to borrowers and generates earnings. Since it doesn't have to pay dividends or show earnings to outside investors, it can give its earnings to the state (after retaining some earnings to support growth.) Or, it can offer the state below-market borrowing costs and forgo earnings. But it can't do both; there is no free lunch here.
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    Some of these benefits could be achieved without public banks if it were politically feasible to make major changes such as reinstating Glass-Steagall or establishing rules that support local banking.

    Should a Public Bank Compete with Existing Private Banks?

    While public banking has kindled strong interest, many people are skeptical. "People are just suspicious of the whole idea," says Brown. The biggest fear is that a government entity cannot evaluate loan applications competently and objectively. Memories of Solyndra remain fresh and painful. 

    To counter this objection, today's proposals for public banks call for structural safeguards to keep politicians out of lending decisions. At Bank of North Dakota, executive roles are staffed by seasoned bankers, not politicians. By all accounts the lending process at Bank of North Dakota has been clean. Whether the same protections would suffice in states with long traditions of undue influence remains to be seen.

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    The public banks now proposed would be prohibited from direct lending to consumers and businesses. "A public bank simply does not speculate," says Brown. "They make very few loans directly. They partner with the local bank.  The local bank knows the customer." Public banks should co-lend with community banks. Or they can buy completed loans from community banks, freeing up the local banks' balance sheets so they can lend again.

    Challenge from the Banking Giants

    Critics are not satisfied with the proposal that public banks would stay out of direct lending. Major banks don't want their market power diluted by a new competitor. They don't want states to have a new source for borrowing and a new place to invest extra cash. The Federal Reserve Bank of Boston took the side of the major banks in their report on the North Dakota model. The Fed argued that the income states can gain having a public bank is "relatively minor", that the risk of losses is "real", that the transfer of the state's capital from private banks to a public bank "could disrupt the state's economy", and that alternative solutions are available that need less capital. But perhaps the biggest issue from their perspective is this: "Smaller banks might view a new public bank as a partner, but larger financial institutions would see it as a competitor." This last consideration should not necessarily dissuade us, given the recent track record of these larger institutions.

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    Limited Support from Community Bankers

    Public banks are intended to help community banks increase lending to local businesses. However, not all local bankers see the need, particularly in big cities with many banking options. Vince Siciliano runs New Resource Bank in San Francisco, a community bank that offers "planet-smart banking" for sustainable business. Siciliano says banks like his are "awash in liquidity. There's no shortage of money to lend." His bank has no need for a public bank to participate in its loans, unless the public bank brings a loan guarantee that reduces capital requirements. 

    Instead of liquidity, the problem is credit-worthiness: Lending standards have tightened greatly since 2007. Fewer small business loan applications meet current underwriting criteria. Smaller companies often need more technical assistance than banks can afford to provide. Siciliano would welcome a public bank that absorbs credit risk and helps pay for technical assistance. "If a state bank wanted to multiply the efforts of community development banks, it would be great."

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    Promoting the Growth of Public Banking

    It won't be easy to expand public banking into other states. The banking lobby is strong in statehouses and it can fight the legislation needed to open new public banks. Recognizing this, advocates of public banking have adjusted their strategies and are cultivating new allies.

    Marc Armstrong, executive director of the Public Banking Institute, is forming the Public Banking Coalition to promote public banking across the United States. "We don't try to take on the big banks directly," he says. "We think frankly a diverse banking system is a much stronger banking system."  

    The benefit of public banking may be greater in spread-out counties and smaller states than in a well-banked city like San Francisco. Says Armstrong: "The central issue is how to get capital to Main Street businesses, which don't benefit from the nearly $40 trillion dollars in mutual funds and IRAs that flow to the Fortune 1000 companies." Efforts to start public banks should focus on locations with a diverse economy, a relatively spread-out population, manageable size, and a political climate that is more pragmatic than partisan. Sonoma County in California is an example. It's an agricultural and winemaking region with some high-tech businesses, with a population about three fourths the size of North Dakota. 

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    It's essential to cultivate support among those with a financial interest in the success of public banking. Armstrong sees two kinds of allies: Community banks that need a partner so they can take on more and larger deals—and individual investors who want a safe and easy way to invest in local business. To cement these alliances, a crucial question needs to be resolved: Will public banks act like development banks, as Siciliano proposes, earning lower risk-adjusted returns but spurring economic development? Or will they be managed to take less risk and deliver a market rate of return, diminishing their value to the local community banks? Different strategies may be needed in different markets.

    "Public banking is a keystone," concludes Armstrong. "Tens of billions of dollars from individual investors and pension funds could flow into local economies" if we get this right.

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