Why the mCD now?

The 2008 financial crisis led to a new and intense scrutiny of the liquidity of banks.  It prompted the introduction of strict quantitative standards for liquidity and stable funding for banks in most jurisdictions. 

Recent announcements by the Federal Reserve Bank show this pressure has not abated for US banks.  The rating agencies also remain concerned about the liquidity of banks as do global markets as evidenced by the premium for term debt, which remains higher than pre-crisis levels. 

Liquidity has always been very important to both banks and depositors. For banks, besides liquid assets, it includes stable funding sources as these reduce any potential reduction in their liquidity from redemption demands on their cash. For depositors, they have always valued and often demanded liquidity.

Historically, either the bank or the depositor could have the benefit of a liquid position (by varying the term of deposits), not both. This was because any increase in the depositor’s liquidity necessitated a reduction in the bank’s liquidity, through shorter term funding, and vice versa, any increase of the bank’s liquidity, through longer term funding, necessitated a reduction in the depositor’s liquidity, from longer termed investment. The party (bank or depositor) with the more liquid position compensated the other by providing them with more attractive pricing. This trade-off is no longer inescapable since for each bank there are numerous depositors. If very efficient inter-depositor trading can be enabled, depositors can have a liquid position while the bank can also retains its liquidity and stable funding by lengthening the term of the traded deposits.

Until recently such a trading system was not practical. Web-based trading technology, enabling the rapid trading of debt and equity securities, is now well established and such a trading system can be readily built.

Banks have always been reliant on inter-depositor liquidity in the following sense:

When a depositor makes a withdrawal (redeems), the loan is unlikely to be repaid then, so the bank needs new funding e.g. from similar deposits from other depositor(s).

While there is no certainty that such a new deposit can be obtained, the reality is there are numerous deposits being made (except in a run) and being withdrawn all the time.

This makes the availability of funding for any particular withdrawal much more likely, as the payments system circulates money through the economy.  This greatly stabilizes the bank’s aggregate deposit base, but if many depositors want to withdraw at the same time usually because of some disruption or scare a run will ensue.

If one depositor’s withdrawal is usually being funded by another’s deposit, why not connect them directly and make this certain rather than just probable thereby eliminating the possibility of a run?

Until recently such a trading system was not practical. Web-based trading technology, enabling the rapid trading of debt and equity securities, is now well established and such a trading system can be readily built although, the form of the financial instruments traded to date on web-based systems remains as designed for traditional paper-based systems, whereas the mCD is a new form, modified to maximize the capabilities of web based trading.

The formalization of direct inter-depositor liquidity, where redemptions are funded by new depositors, simply switches the role of the bank from that of principal trader of deposits to being an issuer of term deposits which can be traded between depositors by the mCD Exchange.  Once this inter-depositor liquidity is well established, the term of the traded deposit becomes much less important to the depositor allowing longer term, ideally evergreen (often called Notice Period), deposits to be issued and at lower rates.

It is also important that this inter-depositor trading be at the original deposit amount (at par) so that the mCD is closely aligned with the regular bank payments system as for conventional demand deposits.  The capabilities of web-based trading does make it practicable for the mCD to remain at par value in all but extreme conditions.