James McAndrews
CEO and Chairman of the Board of Directors, TNB USA
Age: 62
Industry experience: 28 years 

James McAndrews spent nearly three decades of his career as an economist at the Federal Reserve Banks of New York and Philadelphia, where he conducted research on policy issues, money, banking and payment systems. When the Federal Reserve began paying interest on reserves, he saw an unmet demand in the institutional investor marketplace for a safe deposit service that would pay a more competitive interest rate. That need has fueled McAndrews’ latest venture, TNB USA Inc., which stands for The Narrow Bank.  

TNB is a de novo bank based in Norwalk that does not offer FDIC insurance or originate loans, but instead has one purpose: Collecting deposits, mainly from large, nationwide institutional money market investors, and placing those deposits in a master account in the New York Fed.  

The Federal Reserve began paying interest on bank reserves to provide incentive for banks to hold onto reserves in 2008. This interest is referred to as the interest on excess reserves, and is closely linked to the federal funds rate. TNB says it would be able to offer returns much closer to federal funds rate instead of the lower rates that money marketchecking and savings accounts currently offer.  

To do this, TNB, like every other bank, needs to open a master account with the New York Fed to get access to the payments system. However, the Fed did not grant TNB a master account over concerns with its business model, and now TNB has sued the New York Fed. The Commercial Record caught up with McAndrews to discuss TNB and the narrow banking model.  

Q: What is narrow banking, and at what point in your career did you start to believe this model would work?
A: Narrow banking became economically feasible when Congress authorized the Federal Reserve Banks to pay interest on reserves, which they began doing in October 2008. That has led to significant changes in the way the Federal Reserve implements monetary policy. It now seeks to influence interest rates by paying interest to banks on their reserves. Banks compete with one another to attract funds to earn the interest paid by the Fed and narrow banks specialize in that activity. 

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Q: Will there ever come a day when the Fed stops paying interest on reserves? If so, what would TNB do?
A: It is very difficult to know or predict what will happen in the distant future, so I wouldn’t like to speculate, but the Federal Reserve banks pay interest now, and that way of conducting policy has many advantages for everyone – taxpayers, depositors – and leads to greater financial stability. Congress gave the Fed the authority to pay interest on reserves in the Financial Services Regulatory Relief act of 2006.   

Federal Reserve governors testified many times between 1999-2006 in favor of such authority. Paying interest on reserves, they suggested, would remove a tax on banks holding required reserves, and so would improve incentives that banks had to maintain liquidity for their depositors. They also suggested that the interest earned by banks would be passed through to depositors and reduce the advantages that large banks had at that time in offering special services called “sweep account” to their larger depositors.   

Most countries allow their central banks to pay interest on reserves and, in general, implementing monetary policy by adjusting the rate paid on reserves offers many advantages to the previous quantity-adjustment way of doing it.  

Q: In its lawsuit against the Fed, TNB alleges the Fed is protecting larger banks by not opening a master account for TNB. But doesnt the Fed pay interest on reserves to every bank that has a master account with the Fed? Why is the Fed protecting larger institutions?
A: In our complaint we state that “TNB’s business objective is to attract customers who wish to receive a more competitive rate on safe deposits. If successful, TNB will place competitive pressure – primarily on large banks – to raise depository interest rates for all depositors, including small businesses and consumers.” The reason that TNB would pose more competitive pressure on large bank is because institutional investors, TNB’s potential customers, primarily do business primarily with those banks. 

Q: Critics of narrow banking say the practice could destabilize the financial system by drawing away cheap funding from commercial banks and creating an overreliance on the Federal Reserve. Why do you think they are wrong?
A: Narrow banks, if successful, would tend to raise deposit rates of other banks, and not necessarily reduce the quantity of their deposits. In fact, if other banks offer higher deposit rates, they may well attract additional deposits. If narrow banks were to raise deposit rates that would reduce rents banks earn now by paying a rate to their depositors that is less than what they earn on their reserves at the Fed.  

The reduction in rents would not destabilize banks. Institutional investors would likely be attracted to TNB in preference to investing in short-term government securities, the most comparable financial instrument, and not necessarily from their deposits in banks. The Federal Reserve has various policy tools that would constrain any potential “overreliance” on it, but it is not clear what an overreliance might be. Again, narrow banks, if successful, would increase competition for banking deposits, which would improve deposit rates and services. 

McAndrews Five Things to Know about Narrow Banking 

  1. TNB USA Inc. is a narrow bank. It only invests in reserves, which are deposits that banks hold at Federal Reserve Banks. 
  2. A 100 percent reserve Bank is the safest type of narrow bank. 
  3. A narrow bank that holds only reserves takes no risk. 
  4. Since 2008, reserves pay interest, providing income to banks that maintain deposits, i.e., reserves, at Federal Reserve Banks. 
  5. Narrow banks can provide both safety and relatively high deposit rates to institutional depositors.  

The Case for Narrow Banking

by Bram Berkowitz time to read: 4 min