Practical analysis for investment professionals
18 December 2014

Book Review: The End of Banking

The End of Banking: Money, Credit, and the Digital Revolution. 2014. Jonathan McMillan.

Announcing the demise of the financial system as we know it has become popular in the aftermath of the Great Recession. In fact, the Financial Times has dedicated an entire series to the topic, aptly named Death of Banks, wherein author Izabella Kaminska chronicles the downfall of traditional banking.

A recent book called The End of Banking goes one step further: In addition to carefully explaining how the financial sector maneuvered itself into the financial crisis of 2007–08, it presents several unconventional ideas to do away with regulatory capital arbitrage that sticks taxpayers with the bill for bankers’ risk taking. The book proposes a fairly straightforward policy framework that promises to reduce shadow banking, decentralize financial services from too-big-to-fail banks, improve regulation, and realign the private and the public sector with transparent monetary policy.

Banking in the Industrial Age: Banks as a Sensible Approach

Written by two authors — one an investment banker, the other an academic with a PhD in economics — under the collective pseudonym Jonathan McMillan, the book begins with an explanation of banking in the industrial age. The authors define banking as “the creation of money out of credit,” where the function of traditional banks consists of addressing information asymmetries and mitigating credit risk, matching differing maturity needs of lenders and borrowers, and facilitating transactions with payment systems. Since borrowers prefer loans with large notional amounts and long maturities but lenders prefer loans with small notional amounts and short maturities, matching the differing needs of lenders and borrowers is the essence of banking. As a welcome side effect, banks also multiply deposits several times on their balance sheets and thus create inside money. Fractional reserve banking works well until a bank run occurs, which is the Achilles’ heel of banking. When it takes place, a bank run can lead to a banking panic, which results in a credit crunch. Financial regulators are aware of this. To avoid runs on banks, they introduced deposit insurance and lender of last resort facilities, which resulted in people today feeling little difference between holding cash at home and maintaining a balance in their bank account. Depositors thus care less about a bank’s risk profile than they should, and that entices bankers to take on undue risk with other people’s money. Limited liability motivates excessive risk taking.

Banking in the Digital Age: Banks Out of Control

The authors note that while the balance sheets of banks were relatively easy to oversee and understand in the industrial age, the digital age brought about new complications. Ready availability of inexpensive computing power mobilized credit, enabled financial innovation, and made securitization possible. Without much effort, banks could now link several balance sheets easily via special purpose vehicles (SPVs). This allowed them to remove risk from their own balance sheets, all the while evading regulation in regulatory capital arbitrage. Further structuring their assets into newfangled instruments, such as asset-backed securities (ABSs), collateralized debt obligations (CDOs), CDO2s, and CDO3s, an alphabet soup of complex financial instruments emerged that quickly overwhelmed regulators and rating agencies. As a result, a massive unregulated shadow banking sector came into existence, where every company could now create inside money out of credit with next to no oversight. In the aftermath of the financial crisis of 2007–08, regulators quickly hit a wall in their efforts to stimulate the economy with a zero lower bound (ZLB) of interest rates. This prompted them to undertake the experiment of unprecedented quantitative easing (QE) to prop up asset prices and avoid a deflationary spiral. At the same time, ever-increasing complexity of regulation has consolidated the largest banks even more, and smaller banks simply lack the scale that would enable them to comply with Basel II and now Basel III. Today’s banks and non-banks are encouraged more than ever to assume enormous tail risks, as these are essentially risk-free strategies in light of government bailouts. This has given rise to the notion that today’s banking is out of control — a fact that the authors seek to change.

A Financial System without Banking

The authors propose several innovative solutions to address the problems of today’s financial sector. Without outlining a path of transition, their desired destination is “a financial system without banking,” which they understand as a financial system without the creation of money out of credit, without inside money, and without risk insurance. Essentially, they propose to separate credit and money. This is a paradigm shift for the inner workings of banking. Regardless, the interface for banking clients would change little, and handling money and transactions would remain as convenient as ever. To arrive at such a framework, the authors propose a decentralized, re-intermediated financial sector where banks no longer pool deposits and create inside money but act as custodians for their clients. Instead of matching deposits and loans on their own balance sheets, they would distribute deposits entrusted to them via peer-to-peer lending platforms. If a depositor used her debit card to buy goods and services, trading algorithms would provide market liquidity by scanning financial markets to sell loans or other financial assets she owned. Conversely, if she put money in her account, algorithms would quickly find suitable investment opportunities and execute trades instantly. As a result, changing the “wiring” of the financial system would barely affect the interface.

To discourage financial structuring of assets, the authors count on regulation for financial institutions. They propose two straightforward accounting rules that are easy to enforce and would break the link between money and credit.

  • An updated technical solvency rule: “The total value of the real assets of a company has to be greater than or equal to the value of the company’s liabilities.” This rule would prevent banking from being undertaken with financial techniques other than insurance.
  • A systemic solvency rule: “The value of the real assets of a company has to be greater than or equal to the value of the company’s liabilities in the worst financial state.” This rule would prevent abuse of the solvency rule by using insurance.

To ensure the monetary authority achieves price stability, the authors suggest the use of two additional instruments: a liquidity fee and unconditional income. Compared with positive inflation, a liquidity fee on money holdings would have similar economic effects, but at a lower cost. Such a fee removes money from circulation. It discourages hoarding money and would cut the second link between money and credit. Conversely, unconditional income injects money into circulation. Instead of carrying out open market operations to influence the price level, the monetary authority would issue money by transferring it directly to citizens. Unconditional income would be too low to fund basic living expenses. The authors see it only as an instrument to achieve price stability. This would put monetary policy immediately into effect. It would mitigate political government interference on monetary policy and render monetizing government debt impossible.


In light of fintech start-ups popping up left and right that promise to do away with the antiquated business model of traditional banks, it has become clear that the financial sector is hardly safe from disruption. At the same time, banks have embraced technology since the 1970s to innovate their business models. This has had the result that financial innovation has brought forth a massive shadow banking sector that is unregulated and prone to create instability in the financial sector in the future. It is obvious that the current state of the financial system is unsustainable, and several new models, such as narrow banking or limited purpose banking, have been proposed. The End of Banking goes further than these models by creating a framework that would effectively remove the distinction between shadow banking and the formal financial sector and would curtail balance sheet acrobatics to avoid regulation. Separating credit and money through trading algorithms and peer-to-peer technology is elegant, and re-intermediating banking services with a newly emerging set of custodians that would replace the existing system of credit provision and market liquidity is credible. However, cutting the link between credit and money seems a long stretch — an industry with $691 trillion of outstanding derivatives will hardly disappear without a fight. The framework and the rules the authors propose are mostly policy driven. Governments and policymakers would be hard pressed to replace a mushrooming body of regulation that creates many jobs with simple rules, even though they may be easier to enforce than what is currently in place.

While reading this book, I didn’t find a market-driven incentive for established banks to upgrade their business models. The authors recognize that they only put forward a vision without outlining the path. Still, their approach raises the question of why the existing financial sector and monetary authorities should feel the need to restrict themselves. It is obvious that some ideas of fintech start-ups have the potential to yield high profits for their operators in the future. Financial lending institutions are already — albeit slowly — integrating peer-to-peer lending platforms and digital currency into their operations. The financial sector will adopt best practices if it is to its advantage, but when changes are legislated, it will quickly find a way to escape them. Adopting fintech into the business model of banks is a far cry from the end of banking that the authors propose, but it may be a move in the right direction — toward a financial system better suited for the digital age.

The book is well researched and is a stimulating, thought-provoking read. If you would like to know more, visit The End of Banking.

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Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

About the Author(s)

3 thoughts on “Book Review: The End of Banking”

  1. Here’s one half of Jonathan McMillan give a CE presentation about how P2P lending might become the next subprime to CFA Switzerland:

  2. Bhavna Singh says:

    This is really informative I think you should write a blog on digital banking pros and cons because as people are shifting from offline to online digital banking is more easy and familiar for consumers rather than cash handling problems.

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