Imagine a world with no banks. This is probably quite a frightening prospect. The global economy is after all entirely dependent on banks, as we all realised in 2008 when huge government bailouts took place to make sure there were still banks. Well actually this has happened before, in Ireland, in the 1970s where a fabulous (if you are an economist) natural experiment took place. Strikes meant the closure of all clearing banks in the country on three occasions in the 1960’s and 70’s. The longest in 1970 lasted six months, but a slowdown in bank processing leading up to and after the strike effectively meant the country didn’t have a functioning banking system for a whole year.
Expectations of the consequences of the strike were essentially some kind of economic armageddon. Businesses were expected to fail, unemployment and poverty to rise dramatically and the population was predicted to resort to bartering. The interesting thing is that none of this happened. Whilst there were certainly significant consequences to the strike, people adapted and got on with their lives and businesses. GDP not only remained positive; it didn’t reduce in any meaningful way in comparison to periods without the strikes.
First people kept using cash in a time and country where, previous to the strikes, 50% of people received their wages in cash. Then people continued to use cheques as payment. This meant accepting more credit risk than before. Normally when someone handed you a cheque by means of payment you only had to wait a few days before receiving the cash – now you had to wait until the banks opened again. As you weren’t receiving as much cash as before and just had a pile of cheques sitting in your house, you had to write other people cheques yourself when you needed to pay for things. When cheques in cheque books ran out people started making their own, sticking postage stamps in them to ensure the legally required duty on the cheque was paid.
If you really needed to cash a cheque, or perhaps access other financial services such as getting a loan, pubs and some local shops stepped in to fulfil this role. Pubs essentially became banks. Whilst a publican and a banker are not generally two occupations you would put close together, in 1970’s Ireland publicans were perfect to perform this role. They knew their communities well and were some of the best judges of whether someone would pay you back.
The strike was not without negative consequences however. In particular the property market basically stopped functioning, as without banks the large transactions and loans involved in house sales could not take place. Large business investment also fell dramatically: a small business could have gone to the local pub for a loan, but this is not a feasible business model on a larger scale. The stock market took a hit and there are clearly obstacles to international trade when your country has no banks of its own.
Predictably fraud also increased, by ten times, but may have not been as high as you might think. In a country of 3 million people 750 cases of fraud were investigated: a rate of 0.03%. Most people aren’t looking to steal, particularly if they know the person they are transacting with and have a future livelihood to look out for.
Does this mean the panic of 2008 was somewhat unfounded and we don’t actually need banks after all? Well, yes and no, but mainly no. There are some important differences. In Ireland in the 1970’s the banks weren’t insolvent they were just closed temporarily. People worked on the premise that the banks would be opening again soon, not that they would stop existing forever. Nobody knew at the start of the strike that it would go on for such an extended period. Irish society and the Irish economy at the time was predominantly formed of small, close-knit communities where everyone knew each other. This made trusting people’s credit easier and would be less of the case today. Clearly the financial system today is also far more complex than when everyone used just cash or cheque to pay for everything.
That said people predicted in 1970’s Ireland that society wouldn’t function without banks and this turned out not to be the case. In the event that some unmitigated disaster did befall our modern banks this is a lesson that people can be resourceful, innovative and cope when they need to. Households need to trade goods and services so they can do things like eat, be warm, have shelter and enjoy themselves – all things which people tend to prioritise and find ways to do! Modern products such as peer to peer lending and cryptocurrencies are all newer ways of circumnavigating the conventional banking system. This is also a lesson that markets work on trust: Ireland kept functioning because it had trust even if it didn’t have banks. If you have banks but no trust you will perhaps be less successful.