In this article, we reveal and correct a common misconception, namely, that current account holders own the money they have deposited with a credit institution (e.g., a commercial bank, credit union, savings bank, etc.). The legal facts are unambiguous on this.
A common misconception
According to a survey of 2,000 Austrians conducted in 2020, 68% believe that cash and bank deposits are backed by gold (Kraemer et al., 2020). Another survey carried out in 2009 among 2,000 Britons revealed that 74% believe they are the legal owners of the money in their current account (The Cobden Centre, 2010). These responses are not only provably wrong; they are also indicative of what most people have in mind when they think of ‘money in the bank’ and their role and their bank’s role in their relationship, namely, something akin to an act of safekeeping, or to be legally more precise, of custody, bailment or trust.
Under this conception, the bank with which the account holder deposited his/her funds keeps the funds in a secure place, free from any claims by others, segregated and separate from the bank’s own assets, and it is part of the understanding of the account contract that the bank is obliged to return those funds — or, alternatively, to transfer them to a third party (a payee) — when instructed to do so by the account holder. The account holder has both control over and ownership of the funds, the account being merely a formal — and nowadays digital — acknowledgement of that agreement.
Although this picture of the world is intuitive enough and, it would seem, fair, the reality is quite different — shockingly so, for many. Bank accounts have none of these properties.
The reality: what is a current account from a legal standpoint?
Let’s start by unpacking what are the possible legal relationships when it comes to ‘money’, and try to map what ordinary people think their relationship with their bank is, and contrast it with what it actually is.
When you give money to someone, there are at least 4 different legal arrangements as to the rights and obligations binding the parties to that transaction and under which that money has been delivered:
a) Bailment: Bailment is a contract whereby one person (the bailor) leaves property in the custody of another, the bailee, on the terms that he is to have it back when he wants it, and in the meantime, the bailee is responsible for its safekeeping (Perry, 1987, p. 20). The receiver of the property is obliged to return the identical property to the bailor (Palmer, 1979, p. 1). The bailor retains ownership of the bailed assets, which are not available to the creditors of the bailee in its insolvency (Yates and Montagu, 2009, p. 27). The bailee has physical ownership of the property, while the bailee remains the legal owner. In other words, bailment transfers possession but not ownership (Practical Law).
b) Trust: similar to bailment, with the difference that, while bailee has only a special property in or special ownership of the goods bailed — the general property or general ownership remaining in the bailor — the trustee is the full owner. Consequently, the bailee cannot, as a rule, pass a title to the goods that will be valid as against the bailor, but a trustee can pass a good title to someone who acquires legal ownership bona fide for value without notice of the trust. While bailment is typically applicable to tangible property, trust is more appropriate for intangible property (Yates and Montagu, 2009, p. 5, 27, 35; Zaccaria, 2015, p. 17)
c) Agency: A relationship under which the law recognises a person as having the power to create or alter legal rights, duties or relationships of another person, the principal. The agent facilitates contracts between the principal and a third party (the customer) by introducing the third party, soliciting orders from the third party or by concluding contracts with the third party on behalf of the principal. An agent usually benefits from the relationship by receiving a commission from the supplier. An agent does not contract with customers in his own right and he therefore generally has no liability to them (Practical Law)
d) Debt: under a debt relationship, the person receiving funds from another is obliged to return the monetary equivalent of those funds and not the identical funds. The debtor is both the legal and beneficial owner of the money received from the creditor, while the creditor holds a debt claim on the debtor for the return of an equivalent amount of funds (Ellinger, Lomnicka and Hare, 2009, p. 120)
Let’s compare (a) and (b) with (c).
Suppose a person (the client) were to deposit money with a securities broker (the custodian) acting as trustee. The broker would receive the funds, and place them with a credit institution by way of trust. Both the funds received (‘client trust account’) and the offsetting liability (‘funds in trust’) would be recorded off the balance sheet of the trustee in ‘memorandum accounts’. From the point of view of the client, he/she would not be incurring credit risk against the broker/trustee, for these funds do not form part of the trustee’s estate and would not be available for distribution to creditors on the trustee’s insolvency. The funds are segregated (i.e., keep separate) from the trustee’s own monies, and earmarked in the name of the client and held in a separate account with a credit institution. As Goode (2011, p. 212) puts it:
“Where a company holds an asset on trust for a third party, this does not form part of its estate so as to be available for creditors. Trust property is excluded whether the trust is express, implied, constructive or resulting or is imposed by statute (as is the case under, e.g., Ch. 7 of the Client Asset Sourcebook (CASS7)”.
The trustee, therefore, cannot use the funds received from the client for its own purposes. Note, nonetheless, that the credit institution does record the funds received on its balance sheet, and although the client is saved from incurring credit risk to the trustee, he/she but may nevertheless lose money in the event of the credit institution’s failure (Morris and Hay, 2012).
A client places funds in custody with a trustee, who places the funds in a trust account on behalf of the client, segregated from its own funds and off-balance sheet. Items in grey are off-balance sheet.
Consider now the case of a credit institution receiving funds from a client. When receiving the funds from the client, a credit institution may book the funds on its balance sheet, as a financial liability, or a claim on itself, i.e., as a current deposit account, holding it “in an account with themselves”, so to speak (CASS 7.10.16). The credit institution would act as “banker and not as trustee” (CASS 7.10.19), treating the client as an ordinary depositor whose funds are in transit of being invested or transferred somewhere else. This is illustrated below.
A depositor places cash (banknotes) with a credit institution, which gets credited to the former’s current deposit account with the latter. Deposits are a debt claim of the depositor on the credit institution. The ‘funds’ deposited become the property of the credit institution, commingled (mixed) with its own funds and available for its use.
The relationship would be one of debt, and the credit institution would be effectively borrowing funds from the client. The funds received from the client are not earmarked or segregated. Rather, the bank is allowed to commingle(mix) the funds with its own, which become its property and to use them in whatever way it thinks best, e.g., “for its own commercial purposes” (Fox and Green, 2019, p. 238), “to fund its investing lending activities” (Grant Thornton, 2018, p. 4), on the condition that it will repay the equivalent amount of funds to the depositor (Law Commission, 2007, p. 28), or “restitute [him or her] in genre, rather than in specie”, as put by Geva (2001, p. 67). As Werner (2014, p. 75) has correctly pointed out,
“Depositors who deposit their money with a bank are no longer the legal owners of this money. Instead, they are just one of the general creditors of the bank whom it owes money to.”
It is this very capacity to record funds on their balance sheet, together with other regulations, that allows credit institutions to create money. This, however, is treated in a separate article.
Note that, when it comes to third-party payments, credit institutions do indeed act as agents of depositors. This is not inconsistent with the fact that the relationship is one of debt when it comes to their bilateral relationship alone. For example, there is no agency involved where the customer pays in cash for his account, for “in this situation, the two principals in the banking contract are dealing directly with each other” (Perry, 1987, p. 14).
Note also that banks can in principle accept funds by way of trust, and therefore be obliged to record them off-balance sheet and forbidden from using the funds for their own purposes. Yates and Montagu (2009, pp. 152–3) describe three possible scenarios for the manner in which cash may be ‘held’ by a custodian which is a bank:
(a) Client cash is held by the custodian bank ‘in an account with itself’. The account record on the books of the custodian shows the debt owed to the client.
(b) Client cash is held in an account with a third party (sub-custodian) bank. Here there are two options:
(b.i)The account is in the name of the custodian, and the custodian will maintain a corresponding cash account in its own books in the name of the client. However, the custodian has agreed with the client that in the event of the insolvency of the third party bank, the custodian’s obligation to pay the client is conditional upon the custodian being paid in turn by the third bank, so that the client bears the credit risk to the third party. The custodian may agree that it holds the benefit of the third party account on trust, which will at least protect the client in the insolvency of the custodian, or may not, in which case the client is exposed to the credit and insolvency risk of both the custodian and the third party bank.
(b.ii) The account is in the name of its client and held by the custodian on his or her behalf. The third party bank owes the debt directly to the client rather than to the custodian. The custodian does not itself hold that cash or owe it to the client, although it will probably have authorisation from the client to operate the account. The client bears the credit risk of the third party bank but not that of the custodian.
The reason for choosing a ‘trust’ over cash is that “some clients do not wish to take the credit risk of their custodians [sic] as banker in respect of their cash balances” (ibid., p. 25). According to Goode (2011, p. 89),
“with some exceptions it is only those assets in which the company has a beneficial interest that are available to its creditors. So property held by the company [e.g., a bank] as bailee or trustee does not form part of the common pool.”
In practice, for
“commercial and operational reasons, custodian banks may be reluctant to place client cash with their rival banks. A pragmatic alternative is for the greater part of client cash balances to be regularly invested in ‘near cash’, i.e., highly liquid debt instruments such as CDs, or units in ‘cash funds’, i.e., collective investment schemes investing in near cash. […] Because they comprise securities (and not merely the payment obligation of the custodian to the client) they may be the subject of a trust in the hands of the custodian.”
What scholars say
There is wide agreement that what has been described is correct, and that the bank-customer relationship is one of debtor-creditor, i.e., one of debt. A few quotes will suffice:
Ellinger, Lomnicka and Hare (2009, p. 120) explain that:
“It is now well established that the property in the customer’s money passes to the bank following its deposit and that ‘money paid into a bank account belongs legally and beneficially to the bank and not the account holder’.”
“Money paid by the customer to the credit of his bank account is treated as being lent by him to the bank, and such deposited funds are not earmarked or held in trust for the customer, but become the property of the bank. Essentially, the banker-customer relationship is a debtor-creditor relationship, not one of trust, bailment or agency.” (ibid., p. 215).
“A balance standing to the credit of a customer’s account constitutes a debt owed to him by the bank. […] From the customer’s point of view, such a debt is an asset.” (ibid., p. 884)
Says Yurtçiçek (2013):
“From legal perspective, a bank account is merely a money claim that the depositor has against the bank.”
Bossu and Chew (2015, p. 7):
“deposits of money with a bank are legally not deposits, but actually loans — the bank has contractually the right to use the deposit funds by lending them on.”
Fowler (2014, p. 829) states that:
“When a depositor makes a deposit, the funds become the property of the bank, and, in exchange, the depositor receives a claim against the bank for the amount of the deposit.”
Says Laurinavičius (2006):
“the main legal features of bank deposit are similar to those of a loan. Upon transfer of banknotes or coins to the bank, the latter normally acquires ownership thereof, and the depositor acquires personal rights against the bank.”
Miller (1987, pp. 621–2):
“The relationship between a bank and a depositor is that of debtor and creditor. The depositor, in effect, lends money to the bank in return for the bank’s promise to return the deposit and pay for the use of the deposit, usually in the form of interest. The depositor does not own a right to the exact dollars he deposited; instead, he has a right to demand payment from the bank for the amount deposited. When the deposit is not returned upon the depositor’s demand, the bank has breached the deposit contract and the depositor may then sue for the return of money that the bank owes the depositor.”
Reeday (1976, p. 1):
“the relationship of a banker and a customer is a contractual one, being usually that of debtor and creditor or, less frequently, when the customer has a loan or overdraft facilities, creditor and debtor.”
According to Geva (2001, p. 273), who cites Foley v. Hill (1848):
“It has long been established at common law that the ‘relation between banker and customer, as far as the pecuniary dealings are concerned, [is] that of debtor and creditor … the money placed in the custody of a banker is … the money of the banker’ who is obligated ‘to repay to the [customer] when demanded, a sum equivalent to that paid into his hands’”.
In Geva (2011, p. 43, footnote 171):
“People deposit their money with a banker for safekeeping, but from a legal perspective, they lend him the money.”
In Clarke et al.’s Commercial law (2017, p. 564):
“The relationship between a bank and its customer is that of a debtor and a creditor with regard to the balance in the customer’s bank account […] When the account is in credit, the customer is the creditor and the bank the debtor; when the account is overdrawn, the roles are reversed.”
In the vast majority of cases, when someone deposits cash with a credit institution or transfers funds to its current account, the funds that the credit institution receives are not held in custody, or under bailment, trust or agency capacity. Rather, the current account represents a debt claim of the account holder on the credit institution (a loan of a special kind); the credit institution is a debtor, and is borrowing from the account holder, its creditor. The credit institution is free to use the funds received as it pleases for its own purposes, e.g., to grant loans, invest in bonds, etc. The current account Terms and Conditions only specify that the credit institution is liable to return the equivalent amount of funds on demand to the account holder.