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 (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.

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.

Bill John and Pete

Before assuming that Bank No 2 described in my previous post, read this example.

If John returns from overseas and puts $10,000 in his check account, the balance sheet of the bank shows an increase of $10,000 under cash. If John were the first client of the bank, its balance sheet would look like this.

Liabilities
Deposits 10,000
Total 10,000

Assets Cash 10,000
Total 10,000

It is true that the bank also records a liability to John. However, because the bank has control of the cash, it has a stronger position. John has become a creditor of the bank, so he is now very dependent on the bank honouring its obligations.

If the bank thinks that John is unlikely to withdraw its money, it may make a loan to Pete. Its balance sheet would then look like this.

Liabilities
Deposits 10,000
Total 10,000

Assets
Loans 10,000
Cash 0
Total 10,000

Pete buys a truck from Bill, who deposits the cash he received in the bank. The bank’s balance sheet now looks like this.

Liabilities
Deposits 20,000
Total 20,000

Assets
Loans 10,000
Cash 10,000
Total 20,000

The banks cash to asset ratio is fifty percent, so the bank now complies with the Basel Accords. It easily meets the standards set by governments all over the world.

Despite this compliance, we now have a strange situation where the bank only has $10,000 cash, yet both John and Bill think they have $10,000 in the bank. If they both try to withdraw their cash out at the same time, they will not be able to get it. The bank cannot call in the loan from Pete, because he no longer has the cash. He has brought a truck.

Bill and John’s cash is not lost, but they cannot get hold of it when they demand it. The best the bank could do is to give $5,000 to both Bill and John and make them wait for the rest of their money. The bank could force Pete to repay his loan, but if he has to sell the truck quickly, he might only get $5,000 for it. John and Bill would then be in trouble, as one of them would have lost $5,000.

Two Banks

Imagine two banks.

Bank No 1 says,

We will store your money and keep it safe. We will not use your money as if it belonged to us. We will deliver it to any person, as you instruct us. To cover the cost of providing this service, we will charge a small monthly fee, but you can be sure that your money will be here when you want it.

Bank No 2 says,

We will look after your money for you and we will deliver it to anyone according to your instructions. However, if we see that you are not using your money, we will lend it to someone who can make use of it. The interest will compensate you for the risk.

The risk you run is that when you want your money, the person who borrowed it may not have returned the money back to us. We will have to borrow the money from some else to repay you, so you may have to wait to get your money. If for some reason a whole lot of people all decide to withdraw their money at the same time and there is a run on the bank, many of you could lose your money. This risk is unlikely and the benefit is that you will have no fees.

Which bank would people choose?

I do not care which bank people would choose. They can work out the risks and the benefits and do what is best for them. If they prefer the cheaper option, they are free to choose it, provide that they do not expect me to rescue them, if things go wrong.

The problem today is that we do not have a choice. Most people think that they are dealing with Bank No 1, whereas there bankers believe they are Bank No 2. There is a dangerous disconnect between the understanding of risks and expectations.

Demand Deposits (13) - Bank Fees

Banks that accept these biblical principles will not be able to make money from accepting money on deposit for safekeeping. Therefore, it will be quite appropriate for them to charge a fee for the services that they provide. Depositors will look for banks that provide the best service for the most reasonable fee. They will be able to choose the level of service. Banks that provide better security and a wider range of transactions will be able to charge more.

Christians should not expect banks to pay interest on demand deposits.

The full series can be found at Bank Deposits and Loans.

Demand Deposits (12) - Torn Donkeys

There are limits on the duty of care that is required when caring for something. The person providing safekeeping is not accountable for things that are beyond their control.

If a man gives a donkey, an ox, a sheep or any other animal to his neighbor for safekeeping and it dies or is injured or is taken away while no one is looking, the issue between them will be settled by the taking of an oath before the LORD that the neighbor did not lay hands on the other person's property. The owner is to accept this, and no restitution is required. But if the animal was stolen from the neighbor, he must make restitution to the owner. If it was torn to pieces by a wild animal, he shall bring in the remains as evidence and he will not be required to pay for the torn animal (Ex 22:10-13).

The principle is clear. The owner is the owner. The neighbour providing care is never the owner. If the animal is stolen, the neighbour must make restitution to the owner. If the animal is killed by wild animals, the neighbour does not have to make restitution, because this event was beyond his control.

The same applies to a bank. If it claims money that has been deposited as its own asset, it has committed theft. However, if the money is destroyed by a fire or war, the bank is not liable for the loss, because it was beyond the bank’s control. A bank must provide the best care possible for money on demand deposit, but it is not accountable for events beyond its control.

Demand Deposits (11) - Biblical Principle

Here is a biblical principle that applies to demand deposits.

If a man gives his neighbor silver or goods for safekeeping and they are stolen from the neighbor's house, the thief, if he is caught, must pay back double. But if the thief is not found, the owner of the house must appear before the judges to determine whether he has laid his hands on the other man's property…. The one whom the judges declare guilty must pay back double to his neighbor. (Ex 22:7-9).

When someone takes the goods of another for safekeeping and it goes missing, he is accountable for the loss. If the thief is found, the thief must make restitution. If not, the person caring for the property is accountable fro the loss. He must make restitution to the owner, because what his neglect is the equivalent of theft.

The other important thing to note is that the Bible refers to the person who presented the valuables for safekeeping as the owner, even when they are in the house of the other person. This confirms the principle that the ownership of property does not transfer to person who takes it for safekeeping. The owner remains the owner, until the goods are actually sold.

Applying this principle to banking, the bank that treats money that has been deposited for safekeeping as its own asset has misappropriated something that does not belong to it. If it was taken before the judges, it would have to pay back double to the owner. Paying back the amount that was deposited is not enough.

Demand Deposits (10) - Fungible Money

What applies to oil and wheat also applies to a demand deposit in a bank. Although the money is fungible, ownership does not transfer to the bank. Rather the depositors own a share of all the money in the bank. This is true regardless of the form of money. If gold is deposited in the bank, the depositor changes ownership of a particular piece of gold, for a defined share of all the gold in the bank. He can always get his gold back, because the amount he has put in has been added to the total amount in the bank. Each depositor’s share of the total amount of gold is equivalent to the amount that they put in.

The same applies if the money is notes and coins or electronic money. All the money on demand deposit at the bank is jointly owned by the depositors. Each one owns a share of the total, which is equivalent to the amount they deposited. If money depreciated in value, the loss is shared by all depositors. The important point is that none of the money in demand deposits is owned by the bank.

Demand Deposit (6) - Two Owners

Having an asset with two owners might be fine for a while, if the real owner does not want to use the asset immediately. However, eventually problems will arise. If the owners of money in the bank want to withdraw it and the bank has done something else with the money, the conflict is obvious. If too many people want to withdraw money at the same time, the problem compounds. A bank run can occur, and the bank might end up defaulting on its obligations. This has happened to Countrywide recently, when depositors queued to withdraw their deposits, fearing that their money might not be there.

This problem does not arise with a warehouse. If all the people with stuff stored in a warehouse decided to take it out on the same, this would not matter. The warehouse owner would be very busy handing out stuff and he might be worried about his future income, but every person would get back what they owned. There is no reason why a bank should be any different. The solution to this is quite clear. If the warehouse owner claimed ownership of the stuff stored in his warehouse, he would be accused of misappropriation or theft. If a bank claims ownership of money entrusted to its care, the same applies. It has appropriated something that does not belong to it. It has stolen money from the owners.

The bible is clear that a thing cannot have two owners. If two people claim the same thing, the case should be resolved by judges.

In all cases of illegal possession of an ox, a donkey, a sheep, a garment, or any other lost property about which somebody says, 'This is mine,' both parties are to bring their cases before the judges. The one whom the judges declare guilty must pay back double to his neighbor (Ex 22:9).

If I say of my demand deposit ,'This is mine' and the bank is also saying, 'This is mine,' something is wrong. This is an issue that should be resolved by judges. If they find that the bank has claimed something that does not belong to them, they should be made to pay back double to the depositor.