Deposit account

• 1. Introduction

  ›

  A deposit account sits at the center of modern money. Every time someone hands $100 in cash to a bank teller, something legally strange happens: that person no longer owns the money. The bank does. What the depositor gets in return is a liability, a promise the bank is contractually obliged to keep.

  That sleight of hand underlies the entire money supply in use today. Commercial bank deposits, not printed currency, make up most of the money circulating in economies around the world. Yet most people who use a deposit account every week have no idea they have technically become creditors of their bank.

  This is the story of how deposit accounts work, why they are legally the opposite of what they feel like, and how banks use the money you park with them to create still more money out of thin air.

• 2. The Legal Inversion

  ›

  When a customer deposits $100 in cash into a checking account at a bank in the United States, the bank debits its cash account for that amount and credits a deposits liability account for an equal amount. Those two entries mirror each other, following the double-entry bookkeeping system.

  On the bank's balance sheet, the $100 appears as an asset of the bank, not of the depositor. The deposit account itself appears on the other side of the ledger as a liability, money the bank owes. From a legal and financial accounting standpoint, the noun "deposit" describes that liability, not the physical funds the bank now holds.

  This means the banker-customer relationship is not one of safekeeping. It is one of debtor and creditor. The bank has borrowed from its customer. The customer retains the right to have that money repaid on demand, subject to whatever terms and conditions govern the account. The bank's financial statement reflects this economic substance directly.

• 3. Eight Kinds of Accounts

  ›

  Transactional accounts, also called current accounts in Commonwealth countries and checking accounts in the United States, are built for frequent access to funds on demand. Because money can be pulled out at any moment, they are also known as demand accounts or demand deposit accounts. A rare variant, the negotiable order of withdrawal account, requires a seven-day notice before withdrawals.

  Money market accounts pay interest at money market rates and in the United States offer check-writing privileges and instant access, though they are subject to savings account regulations including monthly transaction limits. Savings accounts pay interest but cannot be used directly as money at a point of sale; cash can be withdrawn from them at an automated teller machine, and they are usually linked to a transactional account.

  Time deposits, known in the United States as certificates of deposit, lock money away for a preset term and charge penalties for early withdrawal. The longer the term, the higher the interest rate the bank typically offers. Call deposits allow withdrawal without penalty but require a higher minimum balance to earn interest. Sweep accounts automatically move amounts above a set balance into another account under a pre-arranged set of rules. Automatic transfer service accounts shift funds from savings to checking to cover a written check or maintain a minimum balance. Short-term deposit accounts hold funds for no longer than a year.

• 4. Fractional Reserve and Money Creation

  ›

  Banks do not hold every dollar a customer deposits. Most of that money gets lent to other customers, in a process known as fractional-reserve banking. Those physical reserve funds that the bank does keep may be held as deposits at the relevant central bank, where they earn interest according to monetary policy.

  When a bank in the United States makes a loan by depositing the loan proceeds directly into a customer's checking account, it records the event by debiting an asset account called loans receivable and crediting the customer's checking account. No banknotes change hands. The checking account balance is simply a new liability the bank has created on its books. From an economic standpoint, the bank has created economic money, though not legal tender.

  By transferring ownership of deposits from one party to another rather than moving physical cash, banks can conduct payments entirely within their own ledgers. This mechanism allows commercial banks to expand the money supply without printing a single additional note. Reserve requirements, developed over many centuries of banking custom and later codified in statutory regulations, exist to restrain how far that expansion can run and to reduce the risk of a bank failing under the weight of its own created obligations.

• 5. When Banks Fail

  ›

  Statutory regulations on deposit accounts serve two related purposes: reducing the chance a bank will fail, and reducing depositor losses when one does. Reserve requirements are the primary brake on runaway lending, setting a floor on how much of each deposit a bank must keep on hand.

  Beyond reserve rules, some bank deposits are protected by a deposit insurance scheme or a government guarantee. These backstops exist precisely because the depositor's legal position is that of an unsecured creditor, owed money by an institution that may not always be able to pay. Without insurance or a guarantee, a bank failure would mean depositors line up with other creditors and recover only whatever assets remain.

  Some banks charge customers fees for transactions on their accounts; others pay interest on balances. Those two levers, fees and interest, represent the visible surface of a relationship whose deeper mechanics are built from centuries of banking convention and the fine print of terms and conditions that specify exactly how, and through which channels, a customer may move money in or out.