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The Democratization of Banking

What steps should policy makers take to ensure that bank services are available to the broadest number of people?

July 20, 2012

What steps should policy makers take to ensure that bank services are available to the broadest number of people?

The business model that bankers have evolved over the centuries is a great idea, and people who know this well have sought to encourage a broader and broader application of this model. That is, they have been trying to democratize banking, moving it beyond its original role in serving primarily the wealthy and the financially sophisticated. This initiative stands as an excellent example of finance performing its role in the stewardship of society’s assets.

But what about the severe financial crisis that began in 2007? Doesn’t that point to a perversion of the laudable role of finance in recent years? It is important to recognize that this crisis, severe as it was and still is, was not due to any failures in the traditional banking business model.

Instead, it was due to certain new kinds of business models, in which loans made to homeowners were not retained on the books of banks and other mortgage originators. When they were bundled together into securities and sold off to other investors, including other banks, that reintroduced the very problem of moral hazard that banks were supposed to solve.

Regulators, notably in the United States, have been increasingly permissive of alternative forms of banking. Over the past generation, they have allowed an unregulated “shadow banking” system to develop, which is not subject to the same regulatory oversight as the commercial banking system.

Shadow banks are merely financial institutions that manage to escape banking regulation by designing themselves so that they do not fit the definition of commercial banks. They do not literally accept deposits, but instead get the money they lend in slightly different ways.

Examples of shadow banks include the now-failed Bear Stearns and Lehman Brothers, which were called investment banks but were not regulated as commercial banks, since they did not accept deposits. They became shadow banks when they began to “act” like commercial banks.

New regulations, notably the Dodd-Frank Act in the United States, are designed to put many of these shadow banking activities under stronger regulation, to help prevent a repeat of the crisis. But that process has been slow and cumbersome.

And it will be difficult to develop regulation to keep pace with, and prevent problems with, new kinds of shadow banks as they are invented. Critics of the financial system are right to be wary of this situation.

Peoples’ banks

Current circumstances aside, there have been a number of historical movements to democratize banking. In the early 19th century, there was the savings bank movement in Great Britain, followed by similar ones in the United States, Germany, Switzerland and elsewhere.

Many of these banks were set up as mutual institutions so that everyone would know that all profits reverted to depositors. Philanthropists created them to give those with low incomes the means and incentive to save. Hence, their non-profit character.

That same century saw the beginnings of the building society movement in Great Britain, followed by the savings and loan association movement in the United States, both of which were aimed at providing people the wherewithal to buy homes. Postal savings banks arose in that century and the early 20th century to provide savings vehicles to every town that had a post office.

The late 20th century saw the rise of the microfinance movement, exemplified by Muhammad Yunus’s Grameen Bank in Bangladesh. Microfinance institutions specialize in making very small loans to people who traditionally have been ignored by banks. Evidence shows that lending programs like Grameen’s “increase ability to cope with risk, strengthen community ties, and increase access to informal credit.”

Today, microfinance loans are further promoted by a web site,, that allows individual lenders all over the world to loan small sums to individual entrepreneurs in poorer regions and, through the power of the Internet, to deal one-on-one with the very people who benefit from their loans.

The democratization of banking is a slow process, occurring over centuries, benefiting from technological progress of various sorts, and still far from complete, even in advanced countries. A Federal Reserve study based on 2007 data showed that 25.1% of U.S. families in the bottom fifth of income have no transactions accounts at all.

Because of the absence of elementary banking services, these families find it difficult to save, thus undermining their ability to acquire important skills, send their children to college and plan for their future.

A number of government policies to encourage the democratization of banking have been proposed, including explicit incentives to banks to provide services to low-income people and the automatic opening of bank accounts for tax refunds and welfare payments.

We should also consider another drive to encourage more people to avail themselves of financial services. That would foreshadow a repeat of the 19th-century savings bank movement for the 21st century.

For the better part of two centuries, there has been an effort to deliver the full range of banking services to the broadest cross section of society, but the job is not yet complete. The democratization of finance is a route to the good society, and the democratization of banking is a trend — admittedly slow and long-term — that should play an important role in that process.

Further democratization of banking is also the best means of dealing with the hostility currently felt toward bankers, which means it should be very much in the interests of the industry itself.

Editor’s note: This article is excerpted from Finance and the Good Society by Robert J. Shiller. Published by arrangement with Princeton University Press. Copyright © 2012 by Princeton University Press.


Bankers have long been trying to democratize banking, moving it beyond its original role in serving the wealthy.

The 2007 financial crisis, severe as it was, was not due to failures in the traditional banking model.

The 2007 crisis was due to new business models and financial instruments that reintroduced moral hazard.

There have been past efforts to democratize banking. In the early 1800s, a UK savings bank movement spread to the US.

The late 20th century saw the rise of microfinance, specializing in tiny loans to people often ignored by banks.