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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.
Acknowledgements
I wish to thank Roberto Ciccone for valuable advice and suggestions, and Antonio Di Majo, Riccardo Pariboni, Marco Veronese Passarella and Sergio Cesaratto, for very helpful discussions, as well as two anonymous referees. A previous version of this paper was presented at the 19th STOREP Annual Conference 28/05/2022; I wish to thank all the participants of the conference, and in particular Louis-Philippe Rochon and the discussant Paolo Paesani. Any errors or omissions are obviously the sole responsibility of the author.
Disclosure Statement
No potential conflict of interest was reported by the author(s).
Notes
1 Ricardo (Citation1816), p. 108.
2 We can therefore say that banks pay each other with ‘reserves’ or ‘reserves of CB money’ or, more simply, ‘CB money’. They are the same thing. It is generally more common to talk about reserve movements between banks, however in this paper it would be more useful to talk about CB money.
3 For example, in contrast to Hilferding (Citation1910).
4 On this subject, see among others: Lavoie (Citation1984), Moore (Citation1988a, Citation1988b), Rousseas (Citation1989), Wray (Citation1992); Palley (Citation1987, Citation1991, Citation2002), Rochon (Citation1999, Citation2001), Rochon and Vernengo (Citation2003), Deleidi and Levrero (Citation2019), Deleidi (Citation2020).
5 As this webpage reports, many central bankers have confirmed the validity of this approach: https://rwer.wordpress.com/2012/01/26/central-bankers-were-all-post-keynesians-now/. See also ECB (Citation2011), McLeay, Radia, and Thomas (Citation2014a, Citation2014b), Jakab and Kumhof (Citation2015), Ihrig, Weinbach, and Wolla (Citation2021).
6 Note that inserting banknotes and coins does not change the picture. It simply has to be taken into account that each bank has cash reserves in order to supply, for example, ATM services. Certainly, payments between banks do not take place via cash, nor do large payments in the real sector.
7 Graziani (Citation2003), pp. 90–91, adds that a bank with only one customer would have a need for reserves equal to the amount of deposits (Note that in this example Graziani Citation2003, excludes central bank financing later than the initial financing): ‘At the other extreme, an equally imaginary bank having one customer only would be forced to hold an amount of reserves equal to the amount of deposits collected: in fact any loan granted to its only customer implies by definition an equal loss of reserves as soon as the beneficiary of the loan makes use of it by making a payment. Its credit potential would be identical to the amount of reserves in its possession’. In fact, receiving no other deposit, the credit would be limited by the reserves, the bank being able to transfer reserves to cover claims up to the amount of that deposit.
8 Nersisyan and Dantas (Citation2017, Citation2018) place the nonbank financial institutions (NBFIs) at an intermediate level between the real sector and the banking sector. However, the two authors specify that they refer to the shadow banking system. Moreover, the MMT authors point out that at the top of the pyramid can only be occupied by the central bank of a country that has monetary sovereignty (or, more precisely, a high level of it, which varies from country to country).
9 To intuitively understand the concept, consider that until relatively recently, the State issued only metallic money and that banknotes were nothing more than ‘bank notes’, records of what the bank owed to the bearer of that note, practically standardised cheques issued by the banks. Only later the State took control of the issue of banknotes, which ended up having the same nature as coins (usually with a higher nominal value). So, bank liabilities have been used as methods of payment for centuries.
10 On the limitations of this approach see Rochon and Vernengo (Citation2003).
11 See Rochon and Vernengo (Citation2003) on the role of international markets and institutions as banks and the State (that ‘provide bridges between the present and the future’, p. 65).
12 Although we are familiar with this issue, in this paper it will be omitted for the sake of simplicity. Indeed, this issue does not seem to alter the analysis developed in these pages.
13 On the contrary, if there were several banks, each with a single customer, each one would have to hold liabilities of the upper level equal to every liability of its own, because in this case essentially the banks would occupy the same level of the pyramid as the real sector, and banking would not take place. If a bank had no deposits and borrowed all its money from the CB, it would not be much different from a company that finances its investments by taking on more and more debt with the CB. It is also very unlikely that the CB would finance the liquidity needs of this ‘bank’, as it would not meet the requirements of financial security and stability. The possibility of a multiplicity of deposits makes banking possible and secures its place in the pyramid.
14 C may have obtained, for example, the money deposited in his deposit by the Government as wage as a civil servant. Once the State has granted the central bank seigniorage power, it must take the money from the central bank to make its payments. This complicates the analysis, but as mentioned above, the relationship between the State and the central bank is not discussed here.
15 To make the example more realistic, one would have to include capital, salary-related expenses, etc. Finally, the colours and divisions of the boxes are instrumental in understanding the concepts expressed (e.g., by marking deposits with different origins separately and in different colours).
30 In order not to complicate the example with further entries representing the use of money lent, withdrawn and used (and thus deposited with another bank), cash (considered central bank money) is introduced.
16 Of course, it is possible for the bank to settle a debt by taking out another debt, or by taking out another debt with a less immediate maturity. Nevertheless, in the end, an uncollectible credit must correspond to a smaller profit or a loss.
17 Shaikh (Citation2016, pp. 180–182) discusses the functioning of the banking sector and his reasoning has overlaps in several places with what is discussed in these pages. In particular, Shaikh (Citation2016, p. 181) distinguishes between ‘initial’ deposits and ‘new deposits [which] arose from new loans’, obviously both of which are included in the total count of the system's money supply. Moreover (in footnote 5, p. 181), he adds (emphasis added): ‘While loans create deposits, not all deposits are created by loans. For instance, a deposit of cash raises deposits independently of loans. Also, for an individual bank, increased lending will lead to a loss of reserves as some portion of the newly created deposits are transferred to other banks or taken out in the form of cash. Thus, while lending enhances the profitability of individual banks, it also strains their viability, since a higher sum of deposits is backed up by a lower sum of reserves’.
18 An increase in a bank’s liquidity translates into an increase in its liquid reserves at the central bank, unless we assume the accumulation and storage of huge sums of money in banknotes or metallic money. See Cesaratto (Citation2016, pp. 157–167), Lavoie (Citation2006, p. 62); as well as the ECB website https://www.ecb.europa.eu/ecb/educational/explainers/tell-me-more/html/target2_balances.en.html; also see Cesaratto (Citation2016 footnote 6, p. 47): ‘[…] In the Eurosystem, however, although mandatory reserves are remunerated at the rate on the main refinancing operations (MRO), normally excess reserves held in the reserve account at the ECB are not remunerated. In normal times, excess reserves are thus more conveniently held in the “marginal deposit facility” where they get a positive remuneration, albeit lower than the rate on the MRO. Therefore, a stimulus to purchase government bonds would remain even in regimes that normally remunerate excess reserves held in the deposit facility. I said “normally” since at the time of writing, excess reserves held both in the reserve account or in the deposit facility are remunerated at a negative’. We add that since 27/07/2022 the rate on the ECB deposit facility has been raised several times, up to 3.25 per cent (10/05/2023). See: https://www.ecb.europa.eu/stats/policy_and_exchange_rates/key_ecb_interest_rates/html/index.en.html.
19 For the ECB’s reserve requirements see: https://www.ecb.europa.eu/mopo/implement/mr/html/index.en.html.
20 One of the two referees pointed out the risk of misinterpreting the analytical approach adopted in this article: he believed that some elements could be interpreted as favouring the mainstream approach of exogenous money. The purpose of this paragraph is precisely to try to avoid such confusion.
21 See McLeay, Radia, and Thomas (Citation2014b, p. 18): ‘By attracting new deposits, the bank can increase its lending without depleting its reserves […]’. Furthermore, a passage from Graziani (Citation2003, p. 92), seems to confirm these conclusions: ‘As noted above, each bank thus has a double reason for constantly trying to take deposits from other banks: each increase in its deposits not only increases the absolute amount of its reserves, but also decreases the level of the reserve requirement ratio’.
22 With regard to costs, we may think of buying an insurance or an alarm system. Moreover, the impracticality is also evident: it would be difficult to physically place, for example, 1 million dollars ‘under the mattress’, in a drawer or in a cupboard.
23 However, in the EU the recent provisions on bank resolution (Directive 2014/59/EU), providing for the so-called ‘bail-in’, make bank bonds much riskier than in the past, somewhat bringing their level of risk in line with that usually associated with shares, while not giving the bondholder any decision-making power.
24 The time series goes back as far as the Unification of Italy in 1861. A time sample greater than that examined tends to confirm the analysis conducted of the period between 1980 and 2011.
25 We recall that Nersisyan and Dantas (Citation2017, Citation2018) place non-bank financial intermediaries at an intermediate level between the real sector and the banking sector, deeming money and liquidity creation a hierarchical process.
26 It should be noted that in the US, investment banks and commercial banks were divided by law through the Glass-Steagall Act of 1933. The activities of these two types of banks were then carried out by two different financial intermediaries until the Gramm- Leach-Bliley Act of 1999, which abolished the previous regulation. In 2010, the Dodd Frank Wall Street Reform and Consumer Protection Act re-established certain constraints on banks’ investments.
27 It should be noted that there are many other financial intermediaries, such as insurance companies, which carry out various other financial activities.
28 See Mazzucato (Citation2018) on financialisation at the expense of the real sector.
29 Even following the approach of Nersisyan and Dantas (Citation2017, Citation2018) commercial banks occupy a higher step of the payment pyramid, second only to the central bank.