Munich Personal RePEc Archive

On the Necessary and Sufficient Conditions for Legitimate Banking Contracts

Bagus, Philipp and Gabriel, Amadeus and Howden, David (2018): On the Necessary and Sufficient Conditions for Legitimate Banking Contracts. Published in: Journal of Business Ethics , Vol. 3, No. 147 (1 January 2018): pp. 669-678.

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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, that a financial contract similar to a demand deposit (e.g., very short-term bonds, money market mutual funds, etc.) cannot substitute for money. Second, that 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, that the demand for fractional-reserve demand deposits is fostered by an exogenous source (deposit insurance) and that demand for an action is not a sufficient condition to justify its legality or ethicality.

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