Did the Swiss National Bank unpeg its currency, and thereby unleash mayhem in currency markets, because its private shareholders were concerned about incurring losses from the recent depreciation of the euro?
That's the argument Cullen Roche, author of the Pragmatic Capitalism blog, made last week in a post titled: "The SNB is 48% Privately Owned ... No Wonder They De-Pegged":
It's one thing to socialize or politicize potential losses (as would be done when a publicly owned [central bank] incurs losses), but when it's a private bank that is effectively controlled by private citizens then that changes the political dynamic completely. It becomes a bit more difficult to rationalize a persistent balance sheet expansion that could expose private shareholders to substantial losses at some point.
This is an elegant theory but it's also both entirely conjecture and inconsistent with past precedent -- namely, the historical behavior of the once-private Bank of England, which, it's worth pointing out, is recognized as a model for central banks around the world.
Walter Bagehot wrote at length on this in Lombard Street: A Description of the Money Market, the "bible of central banking" published in 1873. At the time, the Bank of England wasn't only privately owned; its directors would "scarcely acknowledge" that they had an elevated duty to be particularly prudent when it came to managing the United Kingdom's bank reserves -- that is, all of them.
Not to overstate the point, but had the Bank of England failed at doing so, not only would the economies of England, Scotland, and Ireland have been ruined, but also virtually every banker and merchant on the European continent would have been threatened with failure as well. As Bagehot noted:
All banks depend on the Bank of England, and all merchants depend on some banker. If a merchant has 10,000 pounds at his bankers, and wants to pay it to someone in Germany, he will not be able to pay it unless his banker can pay him, and the banker will not be able to pay if the Bank of England should be in difficulties and cannot produce his "reserve."
Keep in mind that the Bank of England also held the reserves for most continental European banks, as deposit-taking (which necessitates the holding of reserves) had yet to take hold outside of England.
The question, in turn, is this: How did the directors of the Bank of England behave? Did they act according to the profit-maximizing dictates of a private bank? Or did they, despite refusing to acknowledge their public duty, operate in the more responsible manner that one would expect from an institution entrusted to uphold the public's trust?
The answer is that the bank acted as one would expect a central bank to act -- that is, by subordinating its duty to private shareholders in favor of maintaining a fortress-like balance of liquid reserves. "As anyone can see by the published figures," Bagehot wrote, "the Bank of England keeps as a great reserve in bank notes and coin between 30% and 50% of its liabilities, and the other banks only keep in bank notes and coin the bare minimum they need to open shop with."
This may not seem notable to a person unversed in the profit levers of banking, but to a banker, keeping such a considerable reserve is nothing short of blasphemy. A bank is nothing more than a highly leveraged fund. It borrows money from depositors and other types of institutional lenders and then reinvests the proceeds into interest-earning assets. The difference between a bank's cost of funds and its earnings on assets is where much of its profit derives from.
It's axiomatic, in other words, that the strategy of a privately owned bank is to safely maximize the yield on its asset portfolio. This can only be done by investing in illiquid assets -- namely, loans. By contrast, this can't be done by leaving money in a highly liquid form, such as cash or government securities. "The more money lying idle, the less, cæteris paribus, is the dividend; the less money lying idle, the greater is the dividend," explained Bagehot. Thus, by keeping between a third and a half of its funds essentially in cash, the Bank of England was in no way behaving like a private bank.
To further drive this point home, Bagehot compared the Bank of England's philosophy toward reserves to that of another widely respected private bank, the London and Westminster Bank (emphasis added):
If we compare the London and Westminster Bank -- which is the first of the joint-stock banks in the public estimation and known to be very cautiously and carefully managed -- with the Bank of England, we shall see the difference at once. The London and Westminster has only 13% of its liabilities lying idle. The Banking Department of the Bank of England has over 40%. So great a difference in the management must cause, and does cause, a great difference in the profits.
My point is that people can argue all day long about the theoretical incentives of a quasi-privately owned central bank like the Swiss National Bank. But history speaks clearly on the point that this alone doesn't mean that such a structure will subordinate the bank's public duties to its private desires to earn a substantial profit. And this is particularly the case in a country like Switzerland, which profits greatly from its long and storied reputation of prudent financial management.
Thus, Roche might be right. Or he might be wrong. But either way, the evidence cited by him neither supports nor refutes his underlying point. Indeed, far more likely, albeit less conspiratorial, is the simple fact that the Bank of Switzerland abandoned the franc-to-euro peg because it became imprudent from a public perspective to maintain the exchange rate in the face of a rapidly depreciating euro.
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