A bank deposit is a sum of money placed by the depositor with the bank, in cash or by check or any other transfer document representing cash. A deposit creates a debtor creditor relationship between the bank and the depositor. While the depositor is a creditor, the bank is a debtor that owes money to depositor concerned. The bank pays the depositor interest for the use of the deposit funds.
The bank will not hold back or retain the entire sum of money from the deposit with itself as reserve. Instead in compliance with the minimum reserve ratio prescribed, the banker lends out permissible amount of the funds at interest to the borrowers. This process is known as ‘fractional reserve banking’.
While the banker pays interest at lower rate on the deposits, it charges higher interest rate on advances made out of such deposited funds. This margin or spread is the income of the bank.
The ownership of the deposits is capable of being transferred from hand to hand usually by endorsement and delivery of the deposit receipts. Thus they can supplement physical cash as a mode of payment. In this manner, banks create economic money although the same is not legal tender. In fact, deposits comprise most of the money supply in circulation today.
Banks can accept deposits only in conformity with the prudential regulation or norm. Prudential regulation puts ceiling on the quantum of deposits of the bank commensurate with its capital base. The purpose is to reduce the risk of bank failure or minimize the extent of depositor loss in the event of banker’s bankruptcy .
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