Will Icelands proposed monetary system end banking as we know it?

When the financial crisis of 2008 hit, all three of Iceland’s commercial banks collapsed. The consequences in the wake of this collapse were severe. The national currency fell in value, personal bank accounts were frozen, GDP dropped 5,5% and the market cap of the icelandic stock exchange went down by 90% But from the ashes of the financial collapse prime minister, Sigmundur Davíd Gunnlaugsson promises to bring back the icelandic economy to its former glory without commiting the same mistakes of the past.

In order to walk the talk, the prime minister recently commissioned a report describing a new monetary system where banks are stripped of the power to create money. As explained in the above video, the majority of money in the world today is created by banks in the form of loans.

“Commercial banks create money, in the form of bank deposits, by making new loans. When a bank makes a loan, for example to someone taking out a mortgage to buy a house, it does not typically do so by giving them thousands of pounds worth of banknotes. Instead, it credits their bank account with a bank deposit of the size of the mortgage. At that moment, new money is created.” – Bank of England: Money creation in the modern economy.

The proposed new monetary system propose that the government would essentially run checking and savings accounts and the central bank would be entirely responsible for creating new money. In the current system, the central bank shares that responsibility with banks.

Even though the report points out several flaws in the monetary system of the world today, the proposed solution has received a fair deal of criticism where it is accused of bringing Iceland to a Soviet-style banking system.

As a banker, the most important lesson learned from this proposal is to look at it as a warning shot of how quick the rules of the playing field can change. As of today, banks have a competitive advantage due to the right to create money through the banking license, but regulations sometimes tend to backfire, and there is no shortage of challengers seeking to unbundle and reinvent banking as we know it.