Commercial Bank Money

Commercial bank money is money in the form of deposits held at commercial banks, such as the balances in current, checking and savings accounts. Each deposit is a liability of the bank that holds it: a promise by a private institution to pay the depositor on demand or at an agreed time, in cash or by transfer to another account. Most of it comes into being through bank lending, and it forms by far the largest share of the money that people and companies spend and hold.

It contrasts with central bank money, which is a direct liability of the central bank. In everyday life the two are treated as identical, because deposits can be converted into cash at par, but they differ in who stands behind them and therefore in risk. Most payments, from card purchases to currency bought from a dealer in foreign exchange, are settled by moving these deposits between accounts.

When a bank makes a loan, it does not usually hand over existing savings. It credits the borrower's account with a new deposit, creating money and a matching loan asset at the same time. The Bank of England described this process in a widely cited 2014 article on money creation, noting that most money in the modern economy takes the form of bank deposits created in this way. When loans are repaid, the deposits are extinguished.

For example, a bank that lends a customer 10,000 to buy a car credits the customer's demand deposit account with 10,000. When the customer pays the dealer, the deposit moves to the dealer's bank, which then has a claim on the first bank that is settled in central bank money. Banks therefore need reserves to settle payments between themselves, but the quantity of deposits is driven mainly by the demand for credit and by banks' willingness to lend.

Banks cannot create deposits without limit. Lending is constrained by profitability, including the net interest margin a bank can earn, by borrowers' demand and creditworthiness, by regulatory capital and liquidity requirements, and by the central bank's interest rate policy, which sets the cost of funding. In some countries a reserve requirement also applies (the BCEAO, for example, sets one for banks in the West African monetary union), although several major central banks have set it at zero or rely mainly on other tools. The total stock of deposits forms most of the broad money supply.

Because deposits are claims on a private company, they carry the credit risk of that company. Banks invest most deposits in loans and securities with longer maturities, a process known as maturity transformation, so they cannot repay all depositors at once. If confidence fails, depositors rush to withdraw, producing a bank run.

Several safeguards make commercial bank money trustworthy in practice:

• Deposit insurance — schemes such as those of the Federal Deposit Insurance Corporation in the United States guarantee deposits up to a limit, US$250,000 per depositor per insured bank per ownership category as of 2024.
• Prudential supervision — capital, liquidity and conduct rules applied by banking regulators.
• Central bank backstops — access to central bank liquidity and the lender of last resort function.
• Convertibility — the commitment that deposits can be exchanged for cash and settled between banks in central bank money at par.

These features underpin the singleness of money, the expectation that a dollar at one bank is worth exactly a dollar at another. Uninsured deposits, however, remain exposed, as bank failures have shown.

Commercial bank money is one of several kinds of privately issued money. Electronic money issued by non-bank institutions is also a private claim, though e-money issuers may not lend customer funds and must safeguard them instead. Stablecoins are claims on their issuers backed by reserve assets. Tokenized deposits are commercial bank money represented on a distributed ledger, carrying the same legal status and protections as ordinary deposits. Debates over these instruments often turn on whether they can maintain par convertibility with central bank money as reliably as bank deposits do.