Why trust a bank with deposits of money into a bank account?

[PseuTonym]

Is a contract enough to protect a depositor? That seems unlikely because the contract is not made with people known to the depositor.

The following seem to play a role in practice:

1. Federal deposit insurance
2. The existence of bank branches. This seems a bit silly because the depositor does not know that the bank actually owns the branches. At the end of some month, all branches could simultaneously stop being rented by the bank. Furthermore, even if all branches are owned by the bank, the amount of money that would be made available by selling the branches would be very small compared to the total obligations of the bank.
3. A contract with the bank
4. The fact that the bank has not only depositors, but also investors, and that the investors get information that often includes photographs of the faces of senior executives.

What else plays a role? What should play a role?

 

[JimG]

I don’t understand the question. Are you asking about the risk of bank failure? About the risk that you won’t be able to withdraw all your money?

Neither do I understand the point about branches. There are banks with no branches and no public brick and mortar access; they do on-line banking only.

Unless you keep all your money in demand deposits–i.e., checking accounts, the bank can have limits on withdrawals. Certainly no bank would have enough cash on hand to honor every depositor if they all demanded their money simultaneously. Of course you can withdraw funds on-line as well. (There can in fact, be on-line runs on a bank that would be far more damaging than the bank runs of the 1930’s).

Or, you could keep all your cash under the mattress, which would pay about the same interest rate as currently obtainable at a bank–near zero.

 

[PseuTonym]

I don’t understand the question. Are you asking about the risk of bank failure? About the risk that you won’t be able to withdraw all your money?

I am not denying that banks can be trusted. I am wondering why banks are trusted, and why they should be trusted.

In the 1980s, there were a lot of S and Ls that should not have been trusted, and it was expensive for the government to cover their losses of depositor money. Perhaps regulations not known in detail to the general public played a role in making S and Ls trustworthy, and deregulation kicked away supports that had kept the system worthy of trust.

People who propose deregulation do not need to start from scratch. They have the luxury of experimenting with a system that they did not create. It might be actually impossible for a functioning banking system to come into existence under the framework of law and government that they propose.

Neither do I understand the point about branches. There are banks with no branches and no public brick and mortar access; they do on-line banking only.

I agree with you. However, my impression is that people tend to be more trusting of banks that have public brick and mortar access, and less trusting of banks that do not have public brick and mortar access.

 

[stinkcat_14]

In my opinion, the reason why people trust banks is because historically since we have had FDIC insurance, people with balances below the maximum insurance amount have not lost anything. I had money in a CD of a bank that went belly up and if I wasn’t paying attention I would have never known that it went belly up because I never lost a penny. If the FDIC goes bankrupt however, there could be a real issue of trusting banks.

 

[StGerardMajella]

I am not denying that banks can be trusted. I am wondering why banks are trusted, and why they should be trusted.

It depends on the country. For many foreigners, they distrust banks because they have seen their wealth confiscated by the government and their bank savings destroyed during times of turmoil. At the same time, if turmoil reaches the point where the government is confiscating your money, then your money would be practically worthless anyways.

In the U.S. at least, you are safer placing your funds in a bank than storing them at home under a mattress where you might be robbed or a fire might destroy your savings. FDIC insurance plays a role in the public’s trust of the banks as well. Large corporations, such as Exxon, Ford Motor, etc. place tens of billions of dollars in our U.S. banks, so they obviously have some level of confidence and trust in our banking system.

 

[jinglebelle]

Ha ha ha in England their grandchildren will be paying off the bankers behaviour

 

[JimG]

I am not denying that banks can be trusted. I am wondering why banks are trusted, and why they should be trusted.

In the 1980s, there were a lot of S and Ls that should not have been trusted, and it was expensive for the government to cover their losses of depositor money. Perhaps regulations not known in detail to the general public played a role in making S and Ls trustworthy, and deregulation kicked away supports that had kept the system worthy of trust.

People who propose deregulation do not need to start from scratch. They have the luxury of experimenting with a system that they did not create. It might be actually impossible for a functioning banking system to come into existence under the framework of law and government that they propose.

I agree with you. However, my impression is that people tend to be more trusting of banks that have public brick and mortar access, and less trusting of banks that do not have public brick and mortar access.

Now I understand what you mean. Actually, I think that the main reason banks are trusted is because of deposit insurance. During the S&L crisis many S&L’s were covered by FSLIC deposit insurance, but not all. My brother had deposits in an uninsured S&L, which became insolvent. He got back only about 80% of his money. A receiver was appointed to take over and reorganize the company.

It turned out the receiver was himself a crook who embezzled even more money from the depositors! So my brother lost some more money.

So now, I suspect that there are no banks which do not have deposit insurance under the FDIC. I think one problem might be that rather than paying depositors off, FDIC simply finds another bank to take over the assets of failed banks. That works fine, but it can also leave bad management in place. It’s the bad managers and investors who should lose.

And if there were widespread bank failures, the FDIC fund would be insufficient to bail out all banks. But there is always the Federal Reserve to print money as a last resort.

 

[PseuTonym]

During the S&L crisis many S&L’s were covered by FSLIC deposit insurance, but not all. My brother had deposits in an uninsured S&L, which became insolvent. He got back only about 80% of his money. A receiver was appointed to take over and reorganize the company.

It turned out the receiver was himself a crook who embezzled even more money from the depositors! So my brother lost some more money.

Thank you for an injection of reality into the thread. If we were talking about a Hollywood movie, then the receiver would have worn either a leather jacket (while riding a motorcycle) or an expensive suit (while speaking with an Italian or Sicilian accent and cooking up some stereotypical Italian or Sicilian food).

 

[PseuTonym]

I think that the main reason banks are trusted is because of deposit insurance.

Theoretically, deposit insurance could be provided by a private insurer, rather than by a governmental institution. So, in principle we could agree that deposit insurance is important and necessary while simultaneously committing ourselves to radical deregulation of banking.

In principle, we could imagine a private insurer doing everything that a bank examiner does.

However, what we end up with is then a debate purely about procedure and not about policy. A private insurance company could choose to operate according to the same rules and regulations that happen to be the written policies of a governmental institution that provides deposit insurance.

The question that then arises is: do we have any reason to believe that anybody is or could be developing innovative, efficient, and effective rules and regulations for private insurance of bank deposits? Alternatively, would we have reason to expect innovation that consists of advertising campaigns with catchy melodies, and the kinds of logical fallacies that commonly are used in advertising, plus a cutting of corners that could result in failure of oversight, and the possibility of insurers going bankrupt along with the banks that they insure?

Perhaps we could make an analogy with the law of evidence in criminal trials. That body of law was not created by for-profit business enterprises. Is there any reason to imagine that for-profit business enterprises would be good at creating that kind of law?

 

[exnihilo]

Banks, or at least fractional reserve banks, shouldn’t be trusted. They are intrinsically dishonest. The bank makes the promise to return your deposits on demand and then immediately takes the money and gives it to someone else. They play a statistics game and hope that too many people will not make good on the bank’s promise at any one time.

We wouldn’t accept this business model in any other area. If you put a fur coat in winter storage you wouldn’t accept the idea that the company immediately rented out the coat to someone else. You wouldn’t accept it even if all fur coats were exactly the same and they could give you another person’s coat if you asked for yours to be returned.

 

[JimG]

Theoretically, deposit insurance could be provided by a private insurer, rather than by a governmental institution. So, in principle we could agree that deposit insurance is important and necessary while simultaneously committing ourselves to radical deregulation of banking.

In principle, we could imagine a private insurer doing everything that a bank examiner does.

However, what we end up with is then a debate purely about procedure and not about policy. A private insurance company could choose to operate according to the same rules and regulations that happen to be the written policies of a governmental institution that provides deposit insurance.

The question that then arises is: do we have any reason to believe that anybody is or could be developing innovative, efficient, and effective rules and regulations for private insurance of bank deposits? Alternatively, would we have reason to expect innovation that consists of advertising campaigns with catchy melodies, and the kinds of logical fallacies that commonly are used in advertising, plus a cutting of corners that could result in failure of oversight, and the possibility of insurers going bankrupt along with the banks that they insure?

Perhaps we could make an analogy with the law of evidence in criminal trials. That body of law was not created by for-profit business enterprises. Is there any reason to imagine that for-profit business enterprises would be good at creating that kind of law?

I could see a certain benefit to a private insurance system, in that the responsibility would in effect be transferred to depositors and exercised by delegation to an insurance company. However, unless depositors paid the insurance company directly there is the possibility that the insurer would become too cozy with the bank management. It has the benefit that market forces might force bad banks out of business. Whereas it is rather hard to force bad government regulators out of business.

 

[stinkcat_14]

Banks, or at least fractional reserve banks, shouldn’t be trusted. They are intrinsically dishonest. The bank makes the promise to return your deposits on demand and then immediately takes the money and gives it to someone else. They play a statistics game and hope that too many people will not make good on the bank’s promise at any one time.

We wouldn’t accept this business model in any other area. If you put a fur coat in winter storage you wouldn’t accept the idea that the company immediately rented out the coat to someone else. You wouldn’t accept it even if all fur coats were exactly the same and they could give you another person’s coat if you asked for yours to be returned.

How much would you be willing to pay a bank to hold your money for you on the promise that it won’t lend out the money?

 

[SyroMalankara]

Theoretically, deposit insurance could be provided by a private insurer, rather than by a governmental institution. So, in principle we could agree that deposit insurance is important and necessary while simultaneously committing ourselves to radical deregulation of banking.

Technically FDIC (and SIPC) is a independent institution with governmental oversight. So while not strictly ‘private’, it is not strictly ‘government’ either.

In principle, we could imagine a private insurer doing everything that a bank examiner does.

However, what we end up with is then a debate purely about procedure and not about policy. A private insurance company could choose to operate according to the same rules and regulations that happen to be the written policies of a governmental institution that provides deposit insurance.

It would be much more difficult to build public confidence of the needed stature for a private insurer. It would also be very difficult to insure compliance - the SEC, statutes, and legislation mandate governmental reguation.

A similar example could be UPS or FedEx vs. the USPS. The latter have legal requirements to fulfill, the first two could potentially refuse service to anybody anywhere. If they decided they will look through every’s packages before delivery and informed their customers, there is really nothing to be done about it. (Other than bad publicity, leading to declining customer base, etc)

The question that then arises is: do we have any reason to believe that anybody is or could be developing innovative, efficient, and effective rules and regulations for private insurance of bank deposits?

Supposedly, there are those that claim to be doing this:
usatoday30.usatoday.com/money/perfi/columnist/krantz/2008-09-11-bank-broker-insurance_N.htm

Alternatively, would we have reason to expect innovation that consists of advertising campaigns with catchy melodies, and the kinds of logical fallacies that commonly are used in advertising, plus a cutting of corners that could result in failure of oversight, and the possibility of insurers going bankrupt along with the banks that they insure?

It would probably have to be for-profit, if private - which raises a host of ethical problems. If non-profit and self-regulating, the first big crisis would make it near impossible to trust.

Perhaps we could make an analogy with the law of evidence in criminal trials. That body of law was not created by for-profit business enterprises. Is there any reason to imagine that for-profit business enterprises would be good at creating that kind of law?

The closest analogy I could come up with are the Railroad Police from the 17-1800s. These started off as private police forces funded by wealth railroad investors. However, these weren’t necessarily trustworthy to uphold the rule of law, as many ‘lawmen’ would listen to whoever was signing the paycheck.

 

[exnihilo]

How much would you be willing to pay a bank to hold your money for you on the promise that it won’t lend out the money?

That is not a simple question. We don’t have a free market in banking so there aren’t market prices for such a bank. What we have is a socialized market. The cost of bank failures is socialized. Also these are question answered on the margin. The fee I’m willing to pay must be compared to other options such as investments are a safe at home etc.

 

[HelenRose]

I don’t understand the question. Are you asking about the risk of bank failure? About the risk that you won’t be able to withdraw all your money?

Neither do I understand the point about branches. There are banks with no branches and no public brick and mortar access; they do on-line banking only.

Unless you keep all your money in demand deposits–i.e., checking accounts, the bank can have limits on withdrawals. Certainly no bank would have enough cash on hand to honor every depositor if they all demanded their money simultaneously. Of course you can withdraw funds on-line as well. (There can in fact, be on-line runs on a bank that would be far more damaging than the bank runs of the 1930’s).

Or, you could keep all your cash under the mattress, which would pay about the same interest rate as currently obtainable at a bank–near zero.

But if your house burned down - which may or may not be as likely than a bank going broke or closing- you will lose your money anyway.

 

[stinkcat_14]

That is not a simple question. We don’t have a free market in banking so there aren’t market prices for such a bank. What we have is a socialized market. The cost of bank failures is socialized. Also these are question answered on the margin. The fee I’m willing to pay must be compared to other options such as investments are a safe at home etc.

The point of course is that if we want full reserve banking we are going to have to pay for it. Banks are not going to store dollars they can’t lend out for free.

 

[exnihilo]

The point of course is that if we want full reserve banking we are going to have to pay for it. Banks are not going to store dollars they can’t lend out for free.

I agree that storing money costs money. That doesn’t change the fact that modern fractional reserve banks are by their very nature a fraud. They make a fraudulent promise. It is the white shoe version of a shell game. In the context of the question of the thread they shouldn’t be trusted at all.

 

[stinkcat_14]

I agree that storing money costs money. That doesn’t change the fact that modern fractional reserve banks are by their very nature a fraud. They make a fraudulent promise. It is the white shoe version of a shell game. In the context of the question of the thread they shouldn’t be trusted at all.

I would not call fractional reserve banking a fraud, since everyone knows that if you lend money to a bank, it is going to be lent out again. Clearly, the one advantage of full reserve banking is that if there is a run on a full reserve bank it will not run short of funds. On the other hand, in the developed world, full reserve banking does not exist and part of the reason for this is that depositors are not willing to pay banks to hold their money.

 

[exnihilo]

I would not call fractional reserve banking a fraud, since everyone knows that if you lend money to a bank, it is going to be lent out again. Clearly, the one advantage of full reserve banking is that if there is a run on a full reserve bank it will not run short of funds. On the other hand, in the developed world, full reserve banking does not exist and part of the reason for this is that depositors are not willing to pay banks to hold their money.

It is a fraud regardless of wether people accept the fraud. People get involved in pyramid schemes they suspect or know to be pyramid schemes. That doesn’t change the fact they are pyramid schemes.

The problem is the state props up the fractional reserve system. People disliked the system for the very reason that the banks would have runs and they’d go bust. The solution that was forced upon us was to further prop up the fraud through the state. Once you prop up the fraud who is going to want to deposit funds in an honest system where it costs you personally? We accept the fraud because it has been a part of our culture for so long and the people who run it are respected leaders in our communities.

 

[SyroMalankara]

I would not call fractional reserve banking a fraud, since everyone knows that if you lend money to a bank, it is going to be lent out again. Clearly, the one advantage of full reserve banking is that if there is a run on a full reserve bank it will not run short of funds. On the other hand, in the developed world, full reserve banking does not exist and part of the reason for this is that depositors are not willing to pay banks to hold their money.

Germany is selling bonds at the moment that cost the owner some percentage. I don’t see many takers, except some ultra rich to avoid crossing some tax threshold. It wouldn’t be reasonable for more than 99.99999% of people in the world.