Wednesday, September 05, 2007

Term Deposits (3) - Control not Ownership

Money loaned to the bank is also fungible. When a person lends money to be bank, it will mix the money up with money lent by other people, to make it more productive. This does not shift ownership of the money to the bank. It just means that the lender has shifted from ownership of a specific amount of money, to ownership of a share of a larger pool of money. The share of the money jointly owned will be equivalent to amount of money deposited in the bank.

The important point is that ownership of the money does not transfer to the bank. However it does have the right to use the money however it chooses, provided it complies with the conditions of the loan agreement. Ownership is not transferred, but the right to control the use of the money is transferred for a specific time.

The lender owns the money, but the bank controls its use. It can lend the money to anyone that it considers to be creditworthy. The loan agreement may also specify they types of uses for which the money can be loaned by the bank. Provided these conditions are met, the bank can control how the money is used. If the bank can get a higher interest rate than it pays to the lender, it can keep the difference to cover its expenses and provide a profit to the bank owners.

The bank cannot loan the money for a longer term, than the term agreed with the owners of the money, because it does not have control over the money beyond that time. It only has control for a specified time. When that period, the bank loses this control and must return the money to the owners.

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