Commercial Bank Money
Commercial bank money is the money that exists as deposits at commercial banks. It is a private bank's promise to pay, created when banks lend, and makes up the large majority of the money that households and businesses actually use.
Also called: commercial-bank money · bank money · deposit money · inside money
When a bank makes a loan it credits the borrower's account, and a new deposit comes into existence. That deposit is a liability of the bank, not of the state. It is accepted as money because it can be converted into cash or transferred to another bank at face value, and because deposit insurance and supervision make that promise believable.
The promise depends on the bank. If depositors doubt it, they ask for central bank money instead, by withdrawing cash or moving funds elsewhere, and a bank run is under way. Payments between customers of different banks therefore need a final leg in which the banks themselves settle in central bank money.
The same layering explains newer instruments. E-money, balances at payment institutions and fiat-backed stablecoins are claims on private issuers one step further out, backed by commercial bank deposits or securities rather than by direct access to the central bank.
In practice
Deposit insurance covers balances only up to a statutory limit per depositor and bank. Above it, a business holds unsecured credit exposure to its bank.
Commonly confused with
| Term | How it differs |
|---|---|
| E-money | E-money is issued by a licensed non-bank against funds received and must be safeguarded; it is not a deposit and is not created by lending. |
See also
- Central Bank MoneyCentral bank money is money that is a direct liability of the central bank: banknotes and coins, and the balances that commercial banks hold in their accounts at the central bank. It carries no credit risk and is the safest settlement asset.
- Bank RunA bank run is a rush by depositors or other short-term creditors to withdraw their money from an institution because they fear it will fail. Because no bank holds enough liquid assets to repay everyone at once, the rush itself can cause the failure.
- Maturity TransformationMaturity transformation is the practice of funding long-term, illiquid assets with short-term liabilities that can be withdrawn or must be renewed quickly. It is the core economic function of banking and the source of its fragility.
- Central BankA central bank is the public institution that issues a country's currency, sets monetary policy, holds its foreign exchange reserves and acts as banker to commercial banks and the government. Most also run the core payment system and lend in emergencies.
- SafeguardingSafeguarding is the statutory requirement that an authorized payment or e-money firm keep customer funds apart from its own money, by a method the rules prescribe, so the funds are identifiable and returnable to customers if the firm fails. It is a licensing condition, not best practice.
- StablecoinA stablecoin is a crypto-asset designed to hold a steady value against a reference, almost always a fiat currency such as the US dollar. How that steadiness is supported differs sharply from one issuer to the next, and so does what a holder can actually redeem.