Why so? Is taking deposits just a service the bank provides us, or do banks actually need deposits?

Well, the short answer is yes, banks really need deposits. The basic business model of a commercial bank is to take money from depositors and lend it to someone else. The bank makes money by paying less interest to the depositors than it receives from the borrowers. Without deposits there would be no bank.

Suppose I want to set up a bank. First, I need capital. I still have HK$10 left over after losing most of my money in stocks and I use this money to open Alanson Bank. I will not be able to do much business with just HK$10, so I try to find customers by offering to take deposits at 1 per cent. This might not sound like much, but it is 100 times more than most of my competitors are offering.

Let us say Bob deposits his life's savings of HK$70 with Alanson Bank. But I still need more. So Alanson Bank issues 20 five-year bonds for HK$1 each with a 2 per cent interest rate. That gets me 20 investors. Now the bank has my HK$10, Bob's HK$70, and HK$20 from the bonds, giving it HK$100 to play with.

To start making money, Alanson Bank lends out HK$90 of this money to Donald, who wants to buy an apartment. Alanson Bank charges Donald 3 per cent for this loan and takes a mortgage over the apartment.

The asset side of the bank's balance sheet now consists of HK$10 in cash and HK$90 in loan to Donald. On the liabilities side would be HK$70 in deposits, HK$20 as bonds and HK$10 as shareholder's equity.

This is the slightly odd thing about bank balance sheets: deposits are called liabilities, while loans are assets. This is because the bank has a liability to Bob and to its bondholders as it will have to pay this money back. But the loan made to Donald is its asset as Donald owes the money to the bank, and this asset produces income in the form of interest.

The other thing to note is that the value of the assets must equal the value of liabilities and shareholder's equity. This is important when we get to the part on what can go wrong.

Alanson Bank is very simple, but its balance sheet follows the same rules as every other commercial bank balance sheet. Some banks will have a greater or smaller proportion of customer deposits to commercial borrowing, but virtually all commercial banks rely heavily on deposits.

And just like in the real world, our cheapest source of funds is depositors. Local banks might be able to offer 0.01 per cent or 0.001 per cent to us, but their bondholders and big investors, who have a choice on where their money goes, will expect more.

Alanson Bank is paying its depositors 1 per cent and bondholders 2 per cent, but our largest asset, the loan to Donald, is paying us 3 per cent. The difference is our profit. The more interest we can get Donald to pay us and the less interest we need to pay our depositors, the more we make.

So though we really need our depositors, it is really not in Alanson Bank's interest to pay them any interest. In fact, once we work out that no other local bank is offering much more than 0.01 per cent, we will write a letter to Bob and tell him we have adjusted our rates on deposits to 0.01 per cent, increasing our profit.

Now, we cannot actually afford our depositor withdrawing his deposit since we only have HK$10 in cash. The problem is compounded for us as we have just one depositor, but like most commercial banks, we do not have enough cash on hand to pay back all our depositors at once.

So not only do we rely on our depositors to give us money for us to make loans with, we also rely on them not asking for their money back. Not all at once, anyway. If all our depositors asked for their money back at the same time, we would need to ask the government for help.

So how do we explain to our depositors that we are not really going to pay them any interest? Most bankers will talk about liquidity in the system, or the movements in official lending rates. The justification banks often rely on is that if loan rates fall, they need to make a corresponding reduction in their deposit rates to protect their margins.

If Alanson Bank has to reduce its loan rate to Donald from 3 per cent to 2.75 per cent, we need to make up for this somehow. We cannot reduce the interest we pay our bondholders, that is fixed. But we can reduce the interest we pay our depositor. It is a question of supply and demand. If the bank really needs your deposit, it will pay you for it. But if you have got nowhere else to put your money and no one else is offering you decent rates, what are you going to do?

In fact, the only competition local banks really face right now is the shoe box under the bed. And although it is not quite so secure, and offers slightly lower deposit rates, it does have the advantage that it will not send you pointless letters or go bankrupt.

While on bankruptcies, let us see what can go wrong. Or rather, what has gone wrong with so many banks.

Suppose Donald loses his job and is unable to meet payments on his HK$90 mortgage. Alanson Bank will take possession of Donald's HK$90 apartment. If we can sell it for HK$90, there is no problem, but if there has been a downturn in the property market and that apartment is only worth HK$85 now, the bank's balance sheet looks like this: on the assets side are cash (HK$10) and apartment (HK$85); on the liabilities side are deposits (HK$70), bonds (HK$20) and shareholder's equity (HK$5).

What happened? Total liabilities and shareholder's equity have to balance with total assets, so something has to change when assets shrink by HK$5. The deposit amount cannot change because the bank owes that money to Bob and the money we owe to bondholders cannot change either. The only thing that can change is shareholder's equity.

So Alanson Bank lost half of its shareholder's equity - or, it is worth half as much as it used to be. This is a big deal, but things can get worse. If we sell that apartment for only HK$80, shareholder's equity will be wiped out. Any less and the bank does not have enough money to pay back its liabilities and it is insolvent.

Substitute our mortgage to Donald with a big bag of Alt-A mortgage-backed securities, subprime loans and dodgy consumer credit and you have the subprime crisis. Shareholder's equity starts approaching zero and governments have to step in.

You will remember that one of the first things governments did to rescue the banking system was guarantee deposits. Why? Because as shareholder's equity approaches zero, depositors will start to think they should take their money out before it is too late. When everyone does this at the same time, it is curtains for the bank.

Without depositors there are no banks. Now do you think they would mind paying us a little bit of interest?