A Banking model with digital payments

This paper examines the impact of digital payments on the banking sector through a partial equilibrium model. In this model, banks make loans using deposits and wholesale funding, which is subject to financial frictions. We find that digital payments increase the demand for deposits, thereby increasing banks' market power and their loan supply. Furthermore, this financial innovation strengthens the transmission of monetary policy to the firm’s financing costs. However, the benefits of digital payments in terms of increased lending and lower financing costs for firms are limited when the higher liquidity of deposits raises the transaction costs of using cash.