Public Banking Key Terms
AB 857 : the Public Banking Act
Signed into law in October 2019, this sets out the guidelines under which California counties, cities, and regions can form public banks.
Capital
Public bank capital, also known as equity capital, is the money that the bank’s owners (counties, cities, and government agencies in the case of public banks) invest to start the bank. Equity capital cannot be withdrawn; it can be lent. It does not have to be collateralized.
Charter City
Many of the larger cities and counties in California have their own charters. Becoming a charter city allows voters to determine how their city government is organized and, with respect to municipal affairs, enact legislation different than that adopted by the state. Under AB 857, California charter cities which wish to form local public banks do not require a referendum.
Collateral
The assets on which a lender can draw to make up a defaulted loan (such as the house a bank can seize if the homeowner doesn’t pay the mortgage). In the case of collateralized deposits in California banks, there are very specific rules, some of the most important of which can be summarized as follows:
On the same date that the local agency’s funds are placed pursuant to subdivision (b) by the private sector entity, the selected depository institution shall receive an amount of insured deposits from other financial institutions that, in total, are equal to, or greater than, the full amount of the principal that the local agency initially deposited through the selected depository institution for investment pursuant to subdivision (b).
(a) Eligible securities, except (most) promissory notes secured by first mortgages and first trust deeds, and letters of credit issued by the Federal Home Loan Bank of San Francisco, shall have a market value of at least 10 percent in excess of the total amount of all deposits of a depository secured by the eligible securities.
(b) Promissory notes secured by first mortgages and first trust deeds shall have a market value at least 50 percent in excess of the total amount of all deposits of a depository secured by those eligible securities.
(c) Letters of credit issued by the Federal Home Loan Bank of San Francisco shall have a market value of at least 5 percent in excess of the total amount of all deposits of a depository secured by those eligible securities.
Community Bank
An informal designation that usually refers to smaller, more locally focused and/or owned banks. Banks under around $1B in assets are sometimes called ‘community banks’ due to their size, but this does not always reflect local ownership or investment. For our purposes, we use the term to refer to locally or regionally owned and operated financial institutions. Community banks are for-profit entities.
Credit Union
A financial institution owned by its members. Credit unions are nonprofit entities that are controlled by a board elected by their members, who are their customers, rather than by shareholders in the case of a bank. Credit unions seek to earn profit but uses it to grow its activities and services for members’ benefit, although they do sometimes pay dividends.
Deposits
The money held in checking and short-term savings accounts by a bank on behalf of its customers. Public banks under California AB 857 may only provide banking services like checking accounts to retail and business customers in partnership with community banks and credit unions. As a result, AB 857 banks will likely only accept deposits from public entities (cities, counties, and public agencies such as school boards, water districts and transit districts).
Under California law, all public money must be held by financial institutions which prove to hold sufficient collateral, usually 110% of the deposited amount. Because these deposits are public money, they must be collateralized by cash or treasuries of equal or greater value, allowing public agencies to withdraw any funds with 24 hour notice. This restricts how these deposits can be leveraged in the bank’s lending activity.
Discount Window
A credit facility provided by the Federal Reserve to banks, sort of like a line of credit. By using the discount window, banks can borrow money for very short terms (often overnight) at extremely favorable rates. The discount window is intended to maintain the stability of the payments system and banking services by ensuring that banks can never be so over extended that they can’t meet their short term obligations. The rate of interest charged to banks for borrowing from this credit facility is widely regarded as the benchmark interest rate that sets the floor for lending across global finance, including interest paid on treasury bills, prime and sub-prime mortgages, and credit cards.
Fractional Reserve Lending
The technical term for how banks can lend up to ten times their deposits. This ‘power’ that banks have to multiply money derives from their ability to issue currency in the form of new deposits tied to loans, and federal and international regulation which permits them to hold a fraction of their total obligations to depositors in the form of actual currency, with the remainder invested in loans and other securities.
Loan Screens
The criteria a bank uses in making loan decisions. While many of these are purely financial, we anticipate that public banks will have both negative screens (“the Public Bank of the East Bay does not invest in private prisons”) and positive screens (“Our mission is to get affordable money into underserved neighborhoods, and small businesses owned by people of color.”)
Mutual Benefit Corporation
A corporation formed for common gain purposes. This is one of the two forms of corporation allowed under AB857, and perhaps the most likely one for a local California public bank to adopt. These corporations are managed by members of the corporation (in our case, cities, counties, and other public agencies).
Partnership Loans
Often loans have more than one lender. Multiple lenders combine their funds. Sometimes these lenders have different expectations of the same loan, such as differing rates of interest to be earned from payments. These partnership loans (also called correspondent or warehouse loans) allow different types of lenders to work together to meet a borrower’s needs while taking different risks. If a bank, particularly a community bank, or a credit union, thinks that a loan application is good and deserves to be funded, but is outside the bank’s guidelines for amount of loan, specifics of applicant credit, or some other factor, it may ask other banks to “partner” with it in making the loan. As public banks under AB 857 will not make many direct loans, we anticipate deep, rich partnership loan arrangements with many local community banks and credit unions.
Public Bank
Under AB 857, a local California bank which takes deposits from public entities, makes loans in cooperation with community banks and credit unions, and returns profits to the depositor entities.
Quantitative Easing
A monetary policy whereby a central bank (the Federal Reserve in the United States) purchases at scale government bonds or other financial assets in order to inject money into the economy to expand economic activity. The Federal Reserve has relied heavily on this practice in 2020, purchasing trillions in mortgage-backed securities and corporate debt. This activity raised the price of those assets, crowding private capital into investments that policy makers hoped would stimulate the economy.