A Functional Analysis of the Role of Deposits in the Traditional Banking Industry

ABSTRACT This paper proposes a functional analysis of the input of the traditional banking sector in an endogenous money framework. Although banks create bank money, central bank money (or reserves) cannot be produced by banks, which require it as an input. Deposits are the cheapest source of central bank money already in the system, so it can be argued that deposits serve as inputs for the banking industry. Nevertheless, for individual banks it is necessary to draw some distinctions between deposits corresponding to liquidity injection and pure accounting entries that are generated by the creation of loans. Furthermore, the role of bank bonds is discussed, in the context of whether they function more as equity or as deposits. Unlike other industries, it is hypothesised that the functional role of bank bonds is very different from that of equity, and it is rather a different form of bank funding of liquidity, with some advantages and disadvantages compared to deposits. Finally, a brief comparison is pursed between this analysis of the traditional banking sector and the simpler study of other financial intermediaries.