Three ways of obtaining a bank deposit

One may purchase a bank deposit in any of three different ways. In the first place, one may from time to time turn surplus cash over to the bank as many merchants are accustomed to do daily. This may seem like actually depositing money in the bank. But the real transaction is an exchange: the depositor’s cash is paid into the bank, not with any understanding that the cash shall be kept intact and separate, but in exchange for the right to demand the same amount of cash, or any part of it, from the bank at any time. Or, in the second place, a bank deposit may be obtained by turning over to a bank checks signed by depositors in the same bank or in other banks. It is clear that transactions of this type merely result in transfers of deposit credits from one depositor to another and, incidentally, from one bank to another. The total volume of bank deposits within the community is not affected by these transfers.

In the third place, depositors’ credits are created by banks in favor of their borrowers. The business man brings to his bank, let us say, his own promissory note for $10,000, payable at the end of 90 days. Or it may be a note which the business man has taken from one of his customers and to which he has added his own endorsement, or it may be an accepted bill of exchange representing a shipment to the customer. The bank discounts the note or bill of exchange. In other words, it buys it and pays for it, not its face value, but a somewhat smaller sum. The amount of the difference or discount is substantially like interest, except that it is deducted in advance from the face value of the loan instead of being added to the principal of the loan at its maturity. In the imaginary case under discussion, if the rate of discount were 6 per cent per annum, the note or bill of exchange for $10,000, running for three months, would be subjected to a discount of $150 (one-fourth of 6 per cent of $10,000), so that the business man would receive credit for $9850 and would be obligated to repay $10,000. But it must not be supposed that the bank dips down into its vaults and advances cash to every borrower. The common practice is that the borrower is given the right to draw checks upon the bank up to the agreed amount,—in this case $9,850. In other words, he is given a bank deposit. The bank grants him the right to demand money from it at any time in exchange for the right to demand from him or from some third party a somewhat larger sum of money at a definite future date.