In Parliament this Wednesday, there is a Ten Minute Rule Bill being introduced into Parliament by the inspirational and principled MP for Clacton, Douglas Carswell, with support from my co-Director at TCC, Steve Baker, the Member for Wycombe. Carswell described the proposal in a post on Friday entitled ‘How should we reform the banks?‘, and Steve promoted it earlier today on CentreRight.
This web site has had many articles on this matter and a survey, conducted on our behalf by ICM, showed great confusion on the part of the British public concerning the legal relationship between banker and customer.
The Current State of the Law
The key case is Carr v Carr 1811 (reported in Merivale (541 n) 1815 – 17). A testator in making his bequest said “whatever debts might be due to him…at the time of his death”, the key question in this case being whether “a cash balance due to him on his banker’s account” passed by this bequest. The Master of the Rolls, Sir William Grant held that it did. He reasoned that it was not a depositum; a sealed bag of money could be, but this generally deposited money could not possibly have an ‘earmark’. Grant concluded on this point, “when money is paid into a banker’s, he always opens a debtor and creditor account with the payor. The banker employs the money himself, and is liable merely to answer the drafts of his customers to that amount.” For the legal scholars among you, Vaisey v Reynolds 1828 and Parker v Merchant 1843 both affirmed this position.
In Davaynes v Noble 1816 it was argued in front of Grant that a banker is a bailee rather than a debtor. Rejecting that argument, Grant said “money paid into a banker’s becomes immediately a part of his general assets; and he is merely a debtor for the amount.”
In Sims v Bond 1833 the Chief Justice of the Queens Bench Division affirmed in judgement “sums which are paid to the credit of a customer with a banker, though usually called deposits, are, in truth, loans by the customer to the banker.”
The House of Lords, then the highest court in the land, had its say on the matter in Foley v Hill and Others 1848, duly reported in the Clerk’s Reports, House of Lords 1847-66 (pages 28 and 36-7). In summary, the appellant in 1829 opened a bank account with the respondent bankers. Two further deposits we added in 1830 and in 1831 interest was still added. In 1838 the appellant brought proceedings against the respondent bankers seeking recovery of both the principle and interest. The counsel cleverly tried to argue that it was the duty of the respondent bankers to keep all the accounts up to date at all times and thus there was more to this relationship than that of debtor and creditor.
The Lord Chancellor Cottenham said the following in judgement
Money, when paid into a bank, ceases altogether to be the money of the principal; it is by then the money of the banker, who is bound to return an equivalent by paying a similar sum to that deposited with him when he is asked for it. The money paid into a banker’s is money known by the principal to be placed there for the purpose of being under the control of the banker; it is then the banker’s money; he is known to deal with it as his own; he makes what profit of it he can, which profit he retains to himself, paying back only the principal, according to the custom of bankers in some places, or the principal and a small rate of interest, according to the custom of bankers in other places. The money placed in 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; but he is, of course, answerable for the amount, because he has contracted, having received that money, to repay to the principal, when demanded, a sum equivalent to that paid into his hands.
That has been the subject of discussion in various cases, and that has been established to be the relative situation of banker and customer. That being established to be the relative situations of banker and customer, the banker is not an agent or factor, but he is a debtor.
Thus the settled position of the law is that when you deposit, the bank becomes the owner of the money deposited and you become a creditor to the bank.
The Carswell Bill
This seems to seeks to align the law to mirror what people actually think happens: that they deposit money and it is theirs. It also seeks to allow savers to save in a term deposit, by which they knowingly and indeed willingly allow the bank to lend their money to borrowers. This relationship will then be that of a depositor lending to the bank and the bank being the debtor to the lender.
The honesty of this approach is refreshing indeed. The economic consequences are that credit granted to borrowers is from real savings and the leveraging of loans (multiple on-lending of the same deposit) that has caused such financial destruction ceases to happen. Real savings lent to borrowers will produce goods and services, and once the loans are repaid, the lenders will be in a position to buy the goods and services. This will have the very positive effect of smoothing out the credit-induced boom and bust cycle, providing us with greater sustainable financing. Credit created out of nothing only supports activities that could not get funding out of real saved resources. Think of all those nutty Dot.com projects, and more recently the nutty finance projects embarked upon.
I hope this Bill gets a second reading so that Honest Money can become a major taking point in the banking reform debate.
The survey points to the extremely low solvency ratios of high street banks. It also explains how as money is put into bank accounts, it becomes the property of the bank and is then owed to the individual putting it in. What i feel the survey fails to explore is whether this practise is the cause of the extremely low solvency ratios. If it was not the case that banks owed their customers the money they had put in, their total liabilities would then fall, which then presumably would raise their solvency ratios.
The very low solvency ratio is caused by central banking and deposit insurance. Normal depositors don’t have to concern themselves about the possibility of bank failure because of deposit insurance. Large financial institutions know that other large banks would be bailed out if they got into trouble.
> If it was not the case that banks owed their customers the
> money they had put in, their total liabilities would then fall,
> which then presumably would raise their solvency ratios.
No, because the bank’s assets are loans which are created by lending deposits. Deposits become something that can’t be loaned out.
So, is there any case in English common law where the banker, conducting a current account for his customer, was held to be something other than a debtor concerning the balance of the account?
In the case of Foley v Hill that the banker was a debtor of the customer was not in dispute (that case was about legal procedure).
I’m not a lawyer, but I would venture that the answer to David Hilary’s question is that the rule as stated in Foley, that the banker was a debtor of the customer is founded on the fact that, if he were not, he could not conduct the business of banking.
This fact can be challenged by what is called the circuit theory of money. Its key names are Keynes, Kaldor and Graziani, and it holds that loans are created endogenously within the banking system. Deposits come only afterwards, as the money lent is redeposited by the borrower, or else spent by him and deposited as cash by his supplier.
Another legal question arises. If money is created out of nothing by the very act of lending, then it cannot have pre-existed the contract. Ergo, no valid contract?
The circuit theory of money has good points and bad points.
The Keynes and the post-Keynesians who created it seem to have believed Knapp’s stories about what the mainstream think about money. But, these aren’t really true, Knapp’s “metallism” has very little to do with what the mainstream, or the Austrian Economists, thought in 1900 or today.
Certainly loans are created endogenously by the banking system, nobody denies that. Also, every school of economics except Rothbardian 100% reservers think that assets are required before money-substitutes can be issued, the rest of the modern Austrian school don’t agree with Rothbard.
Since the 17th century at least and probably long before money has been a form of debt. We may argue about how base money originally arose. But, it’s clear that at some point the private sector produced close substitutes in the forms of banknotes and current accounts. So, money has been endogenous to some degree since then.
The arguments the mainstream and Austrians have made about the quantity theory occur in different contexts. Hume’s context was before banking existed, he was wrong to apply his thoughts on that to a world where banking did exist. Later the Classical economists and the British Banking School were dealing with a situation where a monopolistic central bank controlled the quantity of money. Friedman was also arguing in that context.