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On the Special Role of Deposits for Long-Term Lending

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  • Perazzi, Elena

Abstract

I build a general equilibrium model to show that deposits are a special form of financing, that makes banks more suitable to extend long-term loans when confronted with the risks of monetary policy. In the model, banks borrow short-term and lend long-term, are subject to a minimum equity requirement consistent with Basel III, and face a financial friction: they cannot raise equity on the market. Consistent with the "bank-capital channel" of monetary policy, when the risk-free rate increases, the value of the banks' assets and equity are eroded, and banks deleverage by cutting their lending. I show that, thanks to a combination of banks' market power in the deposit market and of the money-like properties of deposits, the profits on deposits are strongly countercyclical, and reduce the contraction of lending at high interest rates due to the bank capital channel. Amid current proposals for narrow banking, this effect provides a rationale for the coexistence of lending and deposit-taking activities in current commercial banks.

Suggested Citation

  • Perazzi, Elena, 2019. "On the Special Role of Deposits for Long-Term Lending," MPRA Paper 96716, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:96716
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    References listed on IDEAS

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    More about this item

    Keywords

    Deposits; Banks; Long-Term Lending; Narrow Banking;

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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