A bad thing happens in financial system; the policymaker/regulator responds with ‘remedies’. Those remedies create other ‘bad things’, to which policymakers respond with further, possibly confusing ‘remedies’. A recent example and a suggestion.
In an interview with the Financial Times yesterday, Paul Tucker, deputy governor of the Bank of England until 2013, said central banks should “act decisively to prevent bank runs by requiring lenders to keep enough collateral with central banks so they could honour demands for 100 per cent of their short-term deposits in a single day.” This collateral could take the form of “high-quality government bonds, portfolios of loans or other assets accepted by central banks”. Central banks would assess the value of the collateral daily, and ask for more if the assets’ value had fallen too far.
Hold on! Has Mr Tucker not heard of ‘Lender of Last Resort’. You know, that historic role of a central bank where they offer liquidity to a bank suffering liquidity problems in return for high quality collateral and high interest rates? Bagehot and Thornton laid out the basics in mid-nineteenth century.
Perhaps we’re now too modern for Bagehot and Tucker is suggesting an update. Perhaps he is suggesting that Lender of Last Resort become a permanent operation for all banks and all deposits? To be fair, the article is not very clear. It did lead me to a number of strange thoughts. Most of which are probably due to my misunderstanding. It also prompted a suggestion - at the end.

He may be suggesting that banks permanently lodge collateral at the central bank – a bit like the ONRRP at the Fed. But the article implies the central bank would only lend against this collateral in the event that the bank needed the liquidity. Would the collateral just sit idly at the central bank?
If the central bank uses permanent collateral to engage in repo lending with banks, this resembles the procedure known as Open Market Operations - a staple of all central bank policy, past and present.
Or is he proposing a massive hike in reserves requirement, though it would differ from normal reserves requirement in that he’s willing to allow ‘high quality collateral such as government bonds’ instead of just reserves. As we have recently seen, the value of these ‘high quality’ government bonds may fall in value, unlike reserves. By the way, the Fed abandoned reserve requirements in March 2020 because the ‘ample reserves’ system made requirements redundant.
Banks everywhere (in UK and US and Eurozone) still hold ‘ample reserves’ as assets. I believe, and some in the Fed also believe, that the commercial banking system in aggregate (tho’ not all banks) operates a quasi-reserve requirement regime without any Fed oversight. If this is what Mr Tucker aims for, his suggestions seems a poorly implemented version of what the banking system in the US has already achieved on its own, without regulatory instruction.
Unfortunately, I’m driven to the tentative conclusion that his true aim is revealed in the quote ‘if enacted, the proposal would end banks’ ability to use assets tied to their banking businesses as collateral to finance other activities, including trading’.
The quote implies Mr Tucker would like banks to divert repo operations away from bank customers towards the central bank in the name of safety. If that is really what he is suggesting its deeply alarming that a (ex)central banker isn’t aware of how finance works.
As Manmohan Singh has persuasively argued, repo is an important part of money supply (and thus credit). ‘Other activities’ include repo transactions with other banks, pension funds, insurance companies, hedge funds, mutual funds, margin lending. I note the egregious inclusion of ‘including trading’ in the quote. Somehow this (ex)central banker seems frightened of banks trading. As if all of banking is not a form of trading, which in reality is another name for ‘capital allocation’.
From the available article, I admit it is hard to decipher exactly what Mr Tucker is advocating. So, if I’ve been unfair, let me know. But here is a suggestion for what central bankers, past and present, could say: “SVB and others failed because we, the central bankers, maintained policy settings that were far too loose for far too long and now we are tightening – these bank failures are a consequence of and a demonstration of, our monetary tightening. It is unfortunate, but we need to be aggressive to counter the inflationary damage we also unleashed. So, the weaker banks will just have to bear the pain - it’s part of our policy. If bank failures look like they are getting out of hand, we’ll change policy. In the meantime, did we tell you about ‘lenders of last resort’? It is quite an well-known concept.”