Drawing on monetary circuit theory, this study develops an approach to analyze the integrated functions of banking and finance in a monetary production economy. The study proposes a micro-founded, circuit-sequenced model of a decentralized-decisions economy, where production, exchange, and investment from households and firms are integrated through money creation and funds allocation operated, respectively, by banks and non-bank financial intermediaries. The model is used to draw implications on: the special nature of banks and the role of non-bank financial intermediaries; the relationship between saving and investment; and the channels through which finance may cause the circuit process to break down. The study also discusses how the circuit approach can be used for an integrated analysis of economic and financial structural change.

Are banks special intermediaries? Do they play any unique role in the economy? And if so, will they retain their specialness in the ever-faster changing world of finance? The rapid evolution of finance over the last two decades and the breathtaking “e-age” revolution have persuaded many that, eventually, banks will be indistinguishable from other financial intermediaries since all their functions can, at least as efficiently, be carried out by nonbanks. This study re-explores the issue of the specialness of banks in light of the large existing literature on the subject, and presents an approach which identifies the banks' specialness with their unique capacity to lend out claims on their own debt which the public accepts and uses as money. The study discusses various structural and policy implications deriving from the approach, and draws on it to point to the continuing relevance of banking in a world where nonbanks are taking business away from banks, lending to production has become relatively less important, and the use of e-money may soon be dominating financial transactions.