Typical banking system which was established through collecting deposits from the people and lending money to grain farmers has gone through many revolutionary changes. Since inception, deposit has been the key feature of banking business and mobilising deposit is the main functionality of banking operations. Although banking has reached its present state through many changes, its core functionality remains deposit mobilisation. Bank mobilises deposits from the segment of the people which is known as surplus unit of the society because they save money in the hope of securing better social safety in future. Similarly, bank lends part of deposit collected to other segment of the people which is known as deficit unit of the society. There is a linier relationship between deposit and loan because the bank which mobilises more deposit can lend more maintaining certain liquidity. As bank's deposit rises, the volume of loan also goes up or vice versa. So, the maxim 'deposit creates loan' gained universal currency over ages. Part of each deposit can be lent, so more deposit means more loans. There is a theoretical concept that loan creates further loan because the entire loan amount is not disbursed as certain margin is always retained which acts as bank's deposit and bank can again lend part of it.
CONCEPT OF MODERN BANKING: The aforementioned conventional banking practice has started eroding since the end of last century when the concept of modern banking emerged and this has been widely deviating from the maxim 'deposit creates loan'. Banks no longer rely on deposit for lending. There are innumerable sources from where bank can manage fund to lend to the borrowers. From functionality perspective, deposit mobilisation and lending activity has lost priority in banking business as many new avenues of business have opened-up and banks are now focusing on those areas. Banks are no more known as mere banks, they have turned into a financial institution by extensively diversifying the business activities. These activities are so wide and diverse that core banking functionality is now a small portion of bank's overall operations. This trend has been continuing for more than three decades in the developed world's banking business and now many developing countries have started following it too. In the developed world, banking and bond market are two effective components of money market, so corporate houses are no more dependent on borrowing from banks because they can mobilise fund from bond market. Moreover, all corporate houses now have multiple choices and they enjoy competitive advantages, especially with respect to reducing their cost of borrowing. When lending rate on bank borrowing is higher than the interest rate in bond market, corporate houses borrow from bond market and pays off bank loan or vice versa. People may think that following this new development, bank's revenue will shrink as business opportunity is losing. But this is not quite the case. This new development has created new opportunities for banks because they also make money from this deal as bond issue and other related activities are undertaken by banks in exchange of fees and commissions which constitute banks' revenue.
BANKS' MULTIPLE SOURCE OF FUND: In modern banking, banks do not rely on deposit for long term lending like project financing and real-estate financing or mortgage lending, rather they mobilise funds from bond market. If bank, in an exceptional circumstance, is required to fund from its deposit for the time being, that fund is subsequently supplemented by the fund procured through securitisation process, which is technically issuing ABS (Asset Backed Securities) in the country's bond market. Banks or financial institutions consolidate all collateral securities retained against their lending to form assets against which bond is issued matching with the terms of lending. So, in the present financing environment borrowers are not required to depend on bank loans for their financing and at the same time, banks are not required to depend on deposit mobilisation for their loanable funds. Moreover, now-a-days, the role of interest rate on both deposits and loans has lessened and in many situations, deposit rate is found higher than lending rate. Since the global financial crisis erupted in 2008, benchmark rate remained zero and near zero in the developed world and some European countries and Japan maintained negative interest rate policy. As a result, interest rate on loans including personal loans, such as-- mortgage loans, car loan etc., remained historically low during the last one decade, whereas deposit rate is comparatively better in many financial institutions, especially private firms and / or schedule B or C financial institutions. Even many large banks or financial institutions also offer higher rate on deposits from time to time. It may be mentioned here that traditional interest rate policy which basically determines lending rate adding certain spread with deposit rate, is no more effective in today's banking. In the developed world and even in many developing countries, lending rate and deposit rate are considered exclusively two separate aspects and determinant of these two rates are quite different. This modern monetary concept is being effectively manipulated by the corporate and business world and even by many individual customers as well because they borrow money from one unit and deposit it to another unit.
MODERN MONETARY THEORY: This modern monetary concept has changed conventional definition of bank as channeling fund from surplus unit to deficit unit because no surplus unit posses surplus fund any more while no deficit unit is short of fund all the time. People maintain deposit with one bank while obtain mortgage loan, car loan, credit card loan and other personal borrowings from another bank or financial institution, so surplus unit is no more absolutely surplus. Similarly, many corporate establishments and business houses maintain adequate cash reserve, but still borrow fund from banks and financial institution to meet needs of one or the other project. So, deficit unit is no more absolutely deficit. A business house or corporate body may be in fund deficit for a particular project or business activity but not in overall deficit. In the present world economy, most IT based companies are highly cash-rich, yet they borrow from banks and financial institutions to finance their specific projects. Many cash rich business houses do not finance their business needs from their own source, but borrow from banks. Market scenario shows that many business houses borrow fund from banks and deposit part of it with non-bank financial institutions. Even many individuals are found to maintain both personal borrowing which mostly include real-estate loan, car loan, credit card loan etc and good amount of deposit as well.
Modern monetary theorists strongly advocate this banking practice. Not only this, the proponents of modern monetary theory are coming up with many new money policies and techniques that are completely different from those developed by the conventional monetary theorists. The way modern banking is heading, conventional relationship between deposit and lending is being almost dismantled and new structural changes are taking place. It is now evident that in modern banking, deposit does not always create loan, rather loan also creates deposit.
Nironjan Roy is a banker based in Toronto, Canada.
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