Why do banks offer current and savings accounts to the general public if they don’t act as intermediaries between savers (depositors) and borrowers?

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When a bank makes a loan, it is extending to the borrower a promise that it will settle payments on the borrower’s behalf up to the value of the loan. It can make this promise whatever the state of its own finances, but it can only keep the promise if either:

  • the borrower wants to make payments only to others who are in turn prepared to accept the bank’s promise in lieu of immediate payment, i.e., people who already have accounts or who are prepared to open accounts with the bank, or
  • the bank is in possession of sufficient cash or other assets, i.e., central bank reserves, with which it can induce other banks to credit the accounts of those whom the borrower wishes to pay or enable the borrower to make payments directly to those without bank accounts.

If the bank is the only bank, then it will want everyone to open accounts with it so that they can all make their payments to each other through the bank’s books, and the bank will never have to pay cash to anyone. It can also make any promises it pleases to borrowers (regulatory constraints aside) since these can all be kept simply by changing the account balances of those making and receiving payments.

If there are other banks, however, then eventually its own customers are going to want to make payments to customers of those other banks and the bank is going to have to pay over reserves to those banks to keep its promises to settle these payments. At the same time, however, payments and reserves will be flowing in from those other banks and their customers, so the net flow of reserves will be considerably less than the total amounts of the payments, the amounts that would have had to be paid out in cash if people didn’t have bank accounts.

In principle, if everyone had accounts at one or other of the banks, the net payments between banks should all average out to zero, but in practice each bank will experience day-to-day fluctuations ranging from net payments to net receipts, and these fluctuations could vary wildly. The worst case scenario for a bank would be if all its customers decided one day to pay all of their account balances to customers of other banks and at the same time received no payments in return. The more customers a bank has, and the more cautious the bank is in extending new loans, the less probable are such extreme events, but the probability can be reduced even more by encouraging customers to set aside part of their account balances as savings, and make payments only from the residue.

So banks offer current and savings account to the public because current accounts allow payments to be settled by book entries rather than with cash and savings accounts greatly reduce the day-to-day volatility of payments settlement net balances.

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