The Disappearance of Deposit Banks: An Explanation

Abstract

This paper asks why deposit banks thrived in the late Middle Ages, but had virtually disappeared by 1600 and studies banking in Venice in order to answer the question. A model is developed that shows that a partial reserve banking system is an efficient means of allocating investment funds only if the returns from long-term investment are sufficient both to compensate the banker for the costs of running a bank and to offer depositors a return over what they can receive through market allocation. Thus the collapse of deposit banking in Venice can be explained by the fact that in the 16th c. the costs of operating deposit banks remained high, while the returns from long term investment declined.