UK Banking Reform

Douglas Carswell recently introduced a Banking Reform Bill into the UK Parliament. His bill establishes the distinction between lending intermediary services account and custodial deposit account. His speech introducing the bill is worth a listen, because he hits the nail on the head. He explains that the problem with banking is that when I put my money in the bank, I think that I still own it, but banking law says that the bank owns it. That legal twist means the money has two owners, which leads to problems with runs on banks.

I was excited when I read his bill because his diagnosis of the problem and his proposal solution is very similar to the one that I outline in Bank Deposits and Loans. The only difference is that I refer to a safe-keeping service whereas he refers to custodial deposits, but they are exactly the same.

I hope that Douglas’s Bill succeeds, but I presume the financial powers will fight against it. They will not let such an essential change take place

The only thing that this bill lacks is my second proposal for sound banking, which matching of loans. His prescription for the lending intermediary service should specify that banks can only lend out money for the same term as that for which it is deposted. This would prevent Banks from borrowing short and lending long, which is the other problem with modern banking.

More at Money System

Bailments not Bailouts

The previous post described the situation under law, but there is no reason why the relationship between a bank and a depositor should be decided by judges. Banks are providing a service to their customers. The customers are entitled to demand whatever service they want. If enough customers demand a particular service, an astute bank will provide that service. If enough people demanded a different service, several banks might start to provide it.

Many people will be happy to accept the service provided by banks under the current legal arrangements. They are happy for the bank to take control of their money and use it as they please, provided they can get good interest and no fees on their cheque account. If that is what they want, that is fine.

However, many other customers will want a different type of account. They will prefer a bailment-type cheque account in which their money does not get transferred to the balance sheet of the bank, but remains the property of the depositor. Many customers do not want to become creditors of the bank. They want to be the owner of their money.

Modern banking law does not prevent banks from contracting with depositors to provide a bailment-type account. The money in this account would not become an asset of the bank. It would not be available for the bank to use. It would be stored in the same way as a storage warehouse stores my furniture.

When my salary goes into my cheque account, I want it to be available when I demand it. I do not want to the bank to treat my money as its own property. I do not want the bank to loan my money out to someone else. If the bank provides this service well, I am happy to pay a small fee for that service.

I do not want the bank to decide when I am not going to use my money. I am capable of doing that myself. If I do not need some of my money for a time, I will move it into a term deposit, so the bank can lend it out for a time, but I do not want the bank just deciding it can lend the money in my cheque account whenever it chooses. I do not want the bank treating my money in the way described by Lord Cottenham in my previous post. I want a cheque account that is a bailment. If enough customers were to demand this service, some innovative bank should provide that service.

We should stop talking about bailout of banks and start demanding bailment from banks.

Bailment (2)

If a deposit in a cheque account is a bailment, then the bank could not record the cash as an asset on its balance sheet. It could not use the cash for its own purposes.

During the 19th century, the British Law Lords ruled that a demand deposit is not a bailment. This decision has since between adopted by courts all over the world.

In a case in 1811, Sir William Grant ruled that money paid into a bank is not a bailment, but a loan. The banker is not a bailee, but a debtor (Carr v Carr). In a subsequent case, he said, “The money paid into a banker immediately becomes a part of his general assets and he is merely a creditor for the amount" (Devayne v Noble).

Lord Cottenham summed up the early decisions in Foley v. Hill and Others.

Money, when paid into a bank, ceases altogether to be the money of the principal; it is then the money of the banker, who is bound to an equivalent by paying a similar sum to that deposited with him when he is asked for it . . . . The money placed in the custody of a banker is, to all intents and purposes, the money of the banker, to do with it as he pleases; he is guilty of no breach of trust in employing it; he is not answerable to the principal if he puts it into jeopardy, if he engages in a hazardous speculation; he is not bound to keep it or deal with it as the property of his principal....

According to modern law, a bank deposit is not a bailment, so the bank is entitled to record the deposit as an asset on its balance sheet.

I doubt that this is understood by most bank depositors.

Bailment (1)

Bailment is an important legal concept.

Bailment is the process of placing personal property or goods in the temporary custody or control of another. The custodian or holder of the property, who is responsible for the safe keeping and return of the property, is know as the bailee. The person who delivers or transfers the property to the bailee is known as the bailor. For a bailment to be valid, the bailee must have actual physical control of the property. The bailee is generally not entitled to the use of the property while it is in his possession, and a bailor can demand to have the property returned to him at any time (Lawyers.com).

A bailment is not the same as a sale, which is an intentional transfer of ownership of personal property in exchange for something of value. A bailment involves only a transfer of possession or custody, not of ownership. A bailment is created when a parking garage attendant, the bailee, is given the keys to a motor vehicle by its owner, the bailor. The owner, in addition to renting the space, has transferred possession and control of the vehicle by relinquishing its keys to the attendant (Free Dictionary).

The main distinguishing feature of a bailment is that possession of the property is transferred to the bailee, but ownership remains with the bailor. Trusting my furniture to a warehousing company for storage is an example of a bailment. The warehouse has possession my furniture, but I am still its owner.

The second feature of a bailment is that the bailee is not entitled to use the property for their own purpose. The warehouse company is not entitled to use my furniture.