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What role do demand deposits serve in the financial system? The answer to this simple question has great implications in keeping the legal terms of the contract consistent with the demands of the financial system. Demand deposits are a perfect monetary substitute. Since money is only held to hedge against perceived uncertainty in both the timing and magnitude of future expenditures, demand deposits are demanded for the same reason. From this we derive three main conclusions. First, a financial contract similar to a demand deposit (e.g., very short-term bonds, money market mutual funds, etc.) cannot substitute for money. Second, full agreement to a financial contract does not create a perfect substitute for money unless it provides money's two key characteristics: on demand and par value redemption. Finally, the demand for fractionalreserve demand deposits is fostered by an exogenous source (deposit insurance) and that demand for a good or service is not a sufficient condition to justify its legality or ethicality.

We use unique depositor-level data for a bank that faced a run to understand the factors that affect depositor behavior. We find uninsured depositors are most likely to run. Deposit insurance helps, but is only partially effective. Bank-depositor relationships mitigate runs, suggesting that relationship with depositors help banks reduce fragility. In addition, we also find that social networks matter. Finally, we find long-term effects of a solvent bank run in that depositors who run do not return back to the bank. Our results help understand the underlying dynamics of bank runs and hold important policy implications.

A large literature has shown money demand functions constructed from simple-sum aggregates are unstable. We revisit the controversy surrounding the instability of money demand by examining cointegrating income-money relationships with the Divisia monetary aggregates for the U.S., and compare them with their simple-sum counterparts. We innovate by conducting a more granular analysis of various monetary assets and their associated user costs. We find characterizing money demand with simple-sum measures only works well in a period preceding 1980. Divisia aggregates, their components, and their user costs provide a more reliable interpretation of money demand. Subsample analysis across 1980 and 2008 suggests the instability of money demand is a matter of measurement rather than a consequence of a structural change in agents’ preference for monetary assets.

Retail banks usually apply simple linear regression models for describing the dynamics of the deposit rates of non-maturing accounts (NMA) like savings deposits. Thus, typical patterns like asymmetry or rigidity that banks follow when adjusting their deposit rates are ignored. This is insofar surprising, as the asymmetric deposit rate adjustment affects the pricing of embedded options for NMA. In this work we contribute to the elimination of these inconsistencies. Based on data for deposit rates from a representative sample of Swiss banks we provide a strong evidence for both asymmetric adjustment and rigidity pattern. Our proposed modeling approaches reveal that the strategies of Swiss banks to adjust deposit rates are regime dependent. In times of market stress, Swiss banks are tight to market rates; however, in normal regimes this is not observed. [PUBLICATION ABSTRACT]

The COVID-19 crisis underscored the urgency of digitizing sovereign money and ensuring universal access to banking services. It pushed two related ideas--the issuance of central bank digital currency and the provision of retail deposit accounts by central banks--to the forefront of the public policy debate. To date, however, the debate has not produced a coherent vision of how democratizing access to central bank money would--and should--transform and democratize the entire financial system. This lack of a systemic perspective obscures the enormity of the challenge and dilutes our ability to tackle it.

Diamond and Dybvig (1983) show that while demand-deposit contracts let banks provide liquidity, they expose them to panic-based bank runs. However, their model does not provide tools to derive the probability of the bank-run equilibrium, and thus cannot determine whether banks increase welfare overall. We study a modified model in which the fundamentals determine which equilibrium occurs. This lets us compute the ex ante probability of panic-based bank runs and relate it to the contract. We find conditions under which banks increase welfare overall and construct a demand-deposit contract that trades off the benefits from liquidity against the costs of runs.

Deposits held at Federal Reserve Banks are an essential input to the business activity of most depository institutions in the United States. Managing these deposits is an important and complex inventory problem for two reasons. First, Federal Reserve regulations require that depository institutions hold certain amounts of such deposits at the Federal Reserve Banks to satisfy statutory reserve requirements against customers' transaction accounts (demand deposits and other checkable deposits). Second, some inventory of such deposits is essential for banks to operate one of their core lines of business: furnishing payment services to households and firms. Because the Federal Reserve does not pay interest on such deposits used to satisfy statutory reserve requirements, banks seek to minimize their inventory of such deposits. In 1994, the banking industry introduced a new inventory management tool for such deposits, the retail deposit sweep program, which avoids the statutory requirement by reclassifying transaction deposits as savings deposits. This is an interesting inventory problem for fungible items, where the conversion process is reversible. We examine two methods for operating such sweeps programs within the limits of Federal Reserve regulations, and we develop a stochastic dynamic programming model to implement one such method, the threshold method.

This manuscript examines the contemporary practices in Islamic finance and the associated systematic risks. It critiques the current instruments of Islamic finance and the conventional financial framework within which Islamic banks function, highlighting their suboptimal nature. The discussion extends to the challenges of tenor and currency mismatches and their influence on systematic risk, as observed in the deposit banking model concerning asset-liability management. The study advocates for a direct connection between resource mobilization and lending activities, aiming to counteract the trend of Islamic finance converging with conventional finance and to prevent the recurrent financial crises attributed to the disparities between resource mobilization and bank lending. The arguments rest on the premise that the profit-loss sharing principle in Islamic finance is designed not to absolve borrowers of their obligations. Rather, it ensures that investors, as opposed to the general public, share in both the profits and the risks. Furthermore, the manuscript suggests the potential development of Shari’ah compliant capital market alternatives within an appropriate financial framework, which is currently absent. Additionally, it addresses the Shari’ah compliance concerns associated with sukuk, specifically the issues surrounding the sale and lease-back-based (bai’ al-’inah) and commodity murabaha (organized tavarruq) transactions. This paper anticipates several outcomes from the proposed measures. These include establishing a fair risk-sharing system aligned with Islamic finance principles, enhancing resistance to speculative bubbles by mitigating systemic risks in the current structure, and contributing economically to society through genuine financing models.

The current norms governing deposit banking activities are the result of a centuries-old evolution of the construct of bank account, the legal nature of bank account, the subject of deposit, and banking institutions themselves. Different civilizations and cultures have contributed to the shaping of deposit activities. The aim of the article is to present and discuss, from a historical-legal point of view, the origin and unfolding of deposit banking activities over time: from antiquity, through the Middle Ages, the early modern period, to modern times. The deliberations are set against a broader financial and legal backdrop to include the transformation of economic power that accompanies deposit activities, expressed in the form of: commodity money, bullion, paper money, and funds. The picture of evolution is completed by the emerging institutions of supervision, capital requirements or deposit guarantee schemes, constituting a series of normative solutions adopted due to the need to provide a framework for deposit activities that would prioritize the security of the depositor. The study, due to its historical-legal character within the scope of detailed sciences, does not aim at applying the conclusions in legal practice or in the theoretical-legal dimension. It serves to collect and show the already acquired historical-legal knowledge about the foundations of contemporary normative solutions of bank deposit activities. In order to achieve the research goal, the study uses the research method of critical literature review. Thus, a reference was made to scientific historical-legal and historical studies, from the point of view of a selected research problem, which has not been elaborated in a cross-sectional manner so far.