How Adopting a Public Banking System Could Change the Loan Interest-Rate

You probably have a checking account opened in a bank. According to the Federal Deposit Insurance Corporation (FDIC), 95% of Americans own at least one bank account. Whether your deposit is held at JP Morgan Chase, Bank of America, or Wells Fargo, you are using the services provided by the private banking sector. But what does it even mean, and what are the implications to you, as a client, and to the general public, as the main stakeholder? It is essential to answer this question, as today financial services of the banks are used by almost everyone, and their actions are of great significance.

The term "private banks" describes privately owned banks whose actions cannot be directly influenced by the government. Private banks (also referred to as commercial banks) deposit your money, give out loans, provide financial assistance and analysis, to name their most common actions. Like most companies established in a free market, commercial banks are profit maximizing institutions, which means they pursue their actions according to the profit maximizing opportunities. One of the most popular policies acquired by private banks to increase their earnings is the differentiation of interest rates on loans. When a bank decides whether to give you a loan, they evaluate your credit score, which is "a number that represents a rating of how likely you are to repay a loan and make the payments on time." If your credit score is high, the bank will offer you a relatively low interest rate because they are assured that you will pay back. However, if your credit score is low, the bank might either not give you a loan or charge you a high interest rate to back up from possible losses. For instance, if an already profitable company asks for a loan to expand its business, it is more likely to receive a lower interest rate than a single person who wants to start his own business, be it a bakery or shoe store.

This practice is undesirable in reference to the general public: it makes it more difficult for people to develop and start their businesses, which lowers society's development and entrepreneurship. Moreover, as assumed by the new growth theory, technological change is determined by the efficiency of the working market, which implies that the increased number of businesses in the economy would be favorable for technological change. Nonetheless, the practice of loan-interest rate differentiation is desirable for the profit-maximizing private banks as it ensures that giving out loans will turn profitable for them. In effect, private banks have no reason to distribute their loans more equally among the customers.

This issue could be resolved by a public bank that would provide loans without unfavorably increasing the interest rate for many start-ups and newly created businesses. This practice could improve the fairness of the banking system and ensure that the societal benefits are greater than in the private banking system. Because the public bank, as the name implies, would be controlled by the public (for instance, by designated officials or government), its main goal would not be profit-maximization. Rather, the bank would operate to ensure fairness in providing the opportunities to start a business and support existing businesses that altogether develop society and entrepreneurship and incentivize technological change. Furthermore, public banks do not have shareholders (whose objective is usually to increase profit); ergo, the bank could use its earnings to invest in the local community instead of paying dividends.

Nonetheless, as a financial institution not concentrated on profit-maximization, the public bank could not offer as many opportunities to increase customers' savings as private banks. One such action could be a lower interest rate on the saving accounts, which would decrease the profitability of using the saving deposits and limit society's ways to increase their money supply. When deciding whether to adopt the public banking system, economists should analyze if the upsides outweigh the losses and accordingly adjust the bank's role to make it profitable to the general public.

As of now, there is only one public bank operating in the U.S. - the Bank of North Dakota (BND). Although the primary reason for establishing the institution was to increase and promote agriculture, its function expanded to provide various loans to the local public, including a student loan. Moreover, more states seem to consider following North Dakota's path: in New Jersey, Governor Phil Murphy signed in 2019 a directive to establish a board that would develop and analyze a plan for establishing the public bank in New Jersey. The turnover to the public banks in the U.S. could ensure fairness in the entrepreneurial opportunities, but it would require accurate management and policies aimed at maximizing the development of the state, which are yet to come.