Central bank money vs commercial bank money
Most of the money people and companies use is not issued by a central bank. Bank deposits are claims on a commercial bank, and only cash and the reserves banks hold at the central bank are central bank money. The difference decides who carries the risk and how payments settle. Dated events on payments are in the calendar below.
Two kinds of money
The BIS defines central bank money as the monetary liabilities of the central bank. In the euro area that means banknotes, which anyone can hold, and the reserves that banks keep on accounts at the Eurosystem. Commercial bank money is the balance on a current account. Banks create it when they lend, as Thomas Jordan of the Swiss National Bank explained in a speech on money creation, and it is a claim on the bank, payable in central bank money.
A deposit carries the credit risk of the bank that holds it. Deposit guarantee schemes cover up to 100,000 euros per depositor and bank under the EU deposit guarantee directive, and supervision and capital rules make failures rare. Central bank money carries no credit risk, because the central bank cannot run out of its own currency.
How payments between banks settle
When a customer of one bank pays a customer of another, the banks settle the difference in central bank money. Large payments between banks run through T2, the Eurosystem's real-time gross settlement system, and instant payments through TIPS, both covered on TARGET2 and TIPS. Final settlement in central bank money is why a bank transfer is safe even though the payer only ever moved a deposit.
Both kinds of money trade one for one. A euro in a Sparkasse account, a euro at a private bank and a euro banknote are worth the same, and that rule, the singleness of money, holds because deposits can always be turned into central bank money at par.
Tokenization and the digital euro
New forms of money test that structure. Tokenized deposits are commercial bank money on a ledger. Stablecoins are claims on a non-bank issuer backed by reserves. The digital euro would give the public a second form of central bank money next to cash, with a holding limit so that deposits do not drain from banks, which digital euro holding limits covers.
For wholesale markets the Eurosystem plans settlement of tokenized transactions in central bank money, described on wholesale CBDC. The BIS Annual Economic Report 2023 proposes a unified ledger in which tokenized reserves and tokenized deposits sit side by side.
Upcoming payments events in Germany
What is central bank money?
Central bank money is money issued by the central bank: cash and the reserves commercial banks hold at the central bank. It carries no credit risk.
What is commercial bank money?
Commercial bank money is the balance on a bank account. It is a claim on the bank that keeps the account and is created mostly when banks lend.
Why is a bank deposit worth the same as cash?
Because a bank must pay out deposits in central bank money at par, and supervision and deposit guarantees support that promise. Payments between banks settle in central bank money.
Central bank money and Finance Loop
Finance Loop covers the forms of money in its Payments & Digital Money track, from cash and deposits to stablecoins and the digital euro. Finance Loop is a strategic partner of the Digital Euro Association in Frankfurt, the home of the ECB and the Deutsche Bundesbank.
Finance Loop is a professional network and has the goal of driving the adoption of emerging technologies in finance, such as AI, digital payments, cloud and blockchain solutions. Finance Loop helps its members build skills and personal networks in these fields: Investment & Digital Assets, Payments & Digital Money, Digital Infrastructure & Sovereignty, and Risk & Compliance.