Banking and Finance Law
The dominant view of banks and other financial institutions is that they function primarily as intermediaries, managing flows of scarce funds from those who have accumulated them to those who have need of them and can pay for their use. This understanding pervades textbooks, scholarly writings, and policy discussions – yet it is fundamentally false as a description of how a modern financial system works. Finance today is no more primarily “intermediated” than it is pre-accumulated or scarce.
This Article challenges the outdated narrative of finance as intermediated scarce private capital and maps the basic structure and dynamics of the financial system as it actually operates. We begin by developing a three-part taxonomy of ways to model financial flows – what we call the “credit-intermediation,” “credit-multiplication,” and “credit-generation” models of finance. We show that only the last model captures the core dynamic of a complex modern financial system, and that the ultimate source of credit-generation in any such system is the sovereign public, acting primarily through its central bank and treasury. We then trace the operation of this dynamic throughout the financial system, from the banking sector, through the capital and “shadow banking” markets, all the way out to the “disruptive” frontier of peer-to-peer digital finance.
What emerges from this retracing of the financial system’s operative logic is a comprehensive view of modern finance as a public-private franchise arrangement. On this view, the sovereign public acts effectively as franchisor, licensing private financial institutions to earn rents as franchisees in dispensing a vital public resource: the public’s monetized full faith and credit. We conclude the Article by drawing out some of the potentially transformative analytic and normative implications of a paradigmatic shift from the orthodox theory of financial intermediation to the franchise view of finance.
Hockett, Robert C. and Omarova, Saule T., "The Finance Franchise," 102 Cornell Law Review 1143 (2017)