A deposit account is an account at a banking institution that allows money to be held on
behalf of the account holder. Some banks charge a fee for this service, while others may pay the client interest on the funds deposited.
The account holder retains rights to their deposit, although restrictions placed on access depend upon the terms and
conditions of the account and the provider.
The banking terms "deposit" and "withdrawal" actually tend to obscure the economic substance and legal essence of transactions
in a deposit account. From a legal and financial accounting standpoint -- and as counter-intuitive as it may seem -- the term
deposit is actually used by the banking industry in financial statements to describe the liability owed by the bank to
its depositor, and not the funds (whether cash or checks) themselves, which are shown an asset
of the bank. For example, a depositor opening a checking account at a bank in the United States with $100 in currency surrenders
legal title to the $100 in cash, which becomes an asset of the bank. On the bank's books, the bank debits its "currency and coin
on hand" account for the $100 in cash, and credits a liability account (called a "demand deposit" account, "checking" account,
etc.) for an equal amount. (See Double-entry bookkeeping system.) In the
audited financial statements of the bank, on the balance sheet, the $100 in currency would be shown as an asset of the bank on
the left side of the balance sheet, and the deposit account would be shown as a liability owed by the bank to its
customer, on the right side of the balance sheet. The bank's financial statement reflects the economic substance of the
transaction -- which is that the bank has actually borrowed $100 from its depositor and has contractually obliged itself
to repay the customer according to the terms of the demand deposit account agreement. To offset this deposit liability, the bank
now owns the actual, physical funds deposited, and shows those funds as an asset of the bank.
Typically, an account provider will not hold the entire sum in reserve, but will loan the money out at interest to other
clients, in a process known as fractional-reserve banking. It is this process
which allows providers to pay out interest on deposits.
By transferring the ownership of deposits from one party to another, they can replace physical cash as a method of payment. In
fact, deposits account for most of the "money supply" in use today. For example, if a bank
in the United States makes a loan to a customer by "depositing" the loan proceeds in the customer's checking account, the bank
typically accounts for this event by debiting an asset account on the bank's books (called loans receivable or some
similar name) and credits the deposit liability or checking account of the customer on the bank's books. From an economic
standpoint, the bank has essentially created "economic money" (although obviously not legal
tender). The customer's checking account balance has no "dollar bills" in it, as a demand deposit account is simply a
liability owed by the bank to its customer. In this way, commercial banks are allowed to increase the money supply
(without printing currency, or legal tender).
Regulatory protection
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Depending on governmental restrictions, the funds in the account are insured, in the event the financial institution is forced
to close or goes bankrupt. This type of protection is also offered in the event the
institution or the account holder are defrauded, provided all the necessary measures had been taken to prevent unauthorized
access.
Types of deposit account
See also
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