Good question.

Let us begin with traditional banking practice and follow the progress of a loan application to buy a house. The bank (maybe) satisfies itself that the asking price is realistic, then gives you a loan to buy it. The bank makes the loan simply by what used to be a stroke of the pen and is now a few keystrokes on the computer keyboard. Yes, the bank has created the money out of nothing. But there are qualifications.

1. First, the overall quantity of loans created by all banks is regulated indirectly by interest rates. Higher interest rates discourage borrowers, and vice versa.

2. Second, the bank takes the title deeds of the property as (what it hopes will be) security.

3. Third, the bank can only make loans up to a certain multiple of its reserves.

It all sounds pretty secure, but in fact the system has been abused to the extent that caused the 2008+ recession and almost derailed the financial system.

1. Despite growing evidence of a property bubble from 2006 onwards, continuing low interest rates encouraged borrowing, and loans, especially mortgages, were made to people who really couldn't afford them. Increasing demand pushed up property prices, encouraging more people to take out mortgage loans on second and third homes on the assumption that values could only go up.

2. Banks meanwhile, were not keeping the house title deeds in their own vaults, but were selling them off to third parties who packaged quantities of mortgages together then sold shares in the package so that no one really knew who owned what. The idea was to spread risk. But this only encouraged irresponsible mortgage loans which spread like a virus through the entire financial system.

3. Traditional banking practice is founded on “reserves”, with loans based on and secured by those reserves. The idea is, that you lend a multiple of your reserves on the assumption that not all of your loans and investments are going to fail at the same time. Reserves are in effect insurance, insurance against bad loans or investments. But as any insurance assessor knows, insurance must be weighed against risk, and bankers' now highly elaborate gambles and their investment “devices” have become so complex that risk is almost impossible to estimate. And experiences in 2008 proved conclusively that banks' reserves have been woefully inadequate as security for their high-stakes gambling.

In the autumn 2008 global financial storm, UBS, Switzerland's biggest bank, was gambling wildly, and grossly underestimated the risks it was taking. Before the beginning of the crisis, UBS calculated its credit risk at SFr 800 million. In the event it had to write down SFr 40 billion – that's 50 times more. The government had to step in and save the bank by putting in $5.3 billion and taking a 9.3 percent ownership. So much for “reserves”. The “reserve of last resort”, it turns out, is the unfortunate taxpayer.

The traditional banking system, it would seem, is not quite as sound as it might have appeared, and as its customers might innocently have believed.

Development Banking: jobs now, without increasing the deficit Is “Development Banking” any different, or more to the point, is it safer, more secure?

Development Banking must remain subject to overall quantity regulation in the sense that investment loans must keep pace with the productive capacity of the economy. Why? Let's take a quick look at that.

When an investment loan is made to a business it creates instant demand in the form of wages which are paid out as of Day One. But the business or production facility may not come on stream bringing goods to the marketplace for some time, weeks, maybe months depending on the depth of the investment. Starting up a whole new factory, for example, would take longer than expansion of an existing unit. So there is an expanded demand, but not a parallel expansion of goods for sale.

In the old Soviet Union with its central planning, the planners concentrated fully on major infrastructure investment, railways, steel mills etc which produced instant demand through wages, but no consumer goods. So people had wages, but a scarcity of food and consumer goods. In the 1970s and 80s you could walk into a Russian supermarket and be confronted with a huge pyramid of jars of Bulgarian tomatoes which happened to be in season. Penetrate further and you were confronted by rows of – literally – empty shelves. Prices were set by the State so there was no inflation. In free-market economies, scarcity simply encourages higher prices. And in economic boom times, inflation mounts, so Central Banks push interest rates up to damp the economy down – in other words, add a touch of recession.

So yes, overall quantity of investment loans must be subject to the prevailing economic conditions. But otherwise, individual banks are expected to be responsible for the security of their own loans – something which as we now all know, they haven't been very good at.

Development Banking: jobs now, without increasing the deficit Back, then, to the critical question, is “Development Banking” any different, or more to the point, is it safer, more secure?

Development Banking, when properly and responsibly applied, can jump-start a stalled economy, bringing it back to life quickly, securely, and without increasing the national debt (as would happen with grants and free handouts), and contributing, moreover, to a firmly-based industrial future.

Development Banking does not rely on existing assets valued at existing prices (houses which may be valued at the top of a boom), nor does it rely on whiz-kid employees who assure the management that their gambles are based on strategies which are so well-covered they cannot fail but eventually do – spectacularly.

For a start, Development Banks are established on a regional basis, which gives them a basic understanding of local needs and capabilities. The ideal regional definition is a Core City with an active business and industrial background, together with its economically dependent region.

Regional Development Banks (RDBs) rely for their security on thorough prior research of the loan projects in which they are invested, on a close working and constructive partnership with the loan recipient, and a detailed follow-up of results.

Loans are made to encourage and develop new startup enterprises large and small, to secure, expand and improve existing enterprises, and for major regional infrastructure projects, the latter in conjunction with local authorities and national planning. In each and every case, the granting of a loan is preceded by a thorough and complete business plan providing full working detail, proposed use of the loan funds, and precise projections of sales, income and expenditure as appropriate for each project, as well as anticipated repayment schedule.

Once launched, the new enterprise manages itself but the Bank receives a flow of data – production, sales, profits and so on – from which the new or expanded enterprise's progress can be monitored and compared with projections. If anything begins to go wrong, the Bank can give timely help, with advice or further finance if appropriate.

An investment loan is best secured by ensuring the success of the project in which it is invested.

The partnership concept also assumes longterm commitment, resulting in the encouragement of secure long-range planning and productivity investment, research, and development of new-generation products and services.

With a guarantee of adequate long-term finance, the recipient business would be properly set up, equipped and maintained, able to maximize quality and productivity. Indeed the provision of finance for any business or project would be conditional upon the rigorous application of all relevant quality standards pertaining to product design and every aspect of the production process.

In post-WW2 Germany, Regional Banks (Landesbanken) provided secure investment for local industries on a similar basis. This, combined with traditional family holdings, provides continuing security and a culture of longterm development even in economic downturns for the Mittelstand, the medium-sized, highly specialized companies which are the backbone of the German economic and export performance. This kind of industry-secured development investment was largely responsible for the postwar German “economic miracle” and indeed, its continuing success.

Development Banking: jobs now, without increasing the deficit What kind of investments should the RDB consider?

Potential investment projects should be reviewed in terms of creating local employment, either through creation or expansion of local industry. RDBs can also consider regional infrastructural projects where a repayment through an uplift in local taxes can be envisaged, in other words, an investment not a grant. Loans can also be made to small micro industries - equipment for a small tea garden for example, where there is tourist potential. Personal loans for home insulation can also be considered as productive investments where an assessment shows that viable savings in power usage can be made which will finance the repayment of the loan. Two golden rules must apply: First, thorough research and absolute security of loan and payback; second, within that discipline, the RDBs should advertise, and aggressively invite and seek out investment opportunities in order to maximize the creative and productive potential of the region.

Development Banking: jobs now, without increasing the deficit Do the Development Banks need to hold reserves?

Yes, a reserve as insurance may be retained, but the main security of investment loans must be thorough prior research and on-going monitoring.

Development Banking: jobs now, without increasing the deficitWhat abut bank charges?

The RDBs should set their own fixed charges to cover administration costs and insurance. RDBs' charges should not be tied to national interest rates. When the economy begins to overheat and inflation rises, central banks increase interest rates. It makes no sense whatsoever to increase industry costs which will only be passed on to the consumer in the form of higher prices, thus only serving to increase inflation.

Development Banking: jobs now, without increasing the deficit Are the RDBs subject to overall regulation and supervision?

Yes absolutely. All business is subject to accountability and consumer protection, and this must apply with particular rigour to essential infrastructural services, especially the banking sector. RDBs' loans must be checked regularly by an independent agency to ensure that loans are genuine, have been thoroughly researched, and are monitored on a continuing basis. The Disciplines: Registered, accredited, with named responsible officers, twice-yearly inspection by regulatory agency, yearly inspection by a major independent firm of accountants.


That’s the way to create a prosperous nation.
It’s the ONLY way.

And full employment in highly productive industry
requires investment,
targeted, accurately assessed, securely guaranteed, regularly monitored.

Housing: Affordability and Forecolsure

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