Who Should Decide

Who should decide if money in a cheque account is not being used and is available for lending to someone else? In the modern system the bank makes this decision. However, the bank cannot read the minds of its depositors, so it does not know what they are planning to do with their money, or when they will want to spend it. Banks can only work on average behaviour and past experience. Neither are good predictors of the future.

The person who is best placed to decide whether money is available for lending is the depositor. They know their plans for the money. They know what they are planning to do. They are best placed to decide how much they need to hold back to deal with unexpected expenses.

If banks only paid interest on term deposits and there was a small fee for the operation of an account where the money is available on demand, then people would respond to these incentives. They would quickly identify money that they do not need immediately and transfer it into a term deposit that paid interest. The bank would then know that it was available for lending to others, without having to make guesses about the depositor’s intentions.

The banking system would function better if banks stopped deciding when money was available for lending and left these decisions to depositors.