Forms of money: central vs commercial bank money

IN ONE LINE

Start with a plain question: whose promise is the money you hold? When Maya Chen has EUR 2,000 in her account at Bank Alfa, she does not hold cash in a vault with her name on it.

She holds a claim on Bank Alfa — the bank owes her that amount.

This is commercial bank money: a promise from a private bank.

It is money because you can spend it, but it is only as good as the bank behind it.

There is another kind.

When Bank Alfa itself needs to pay Northstar Bank, it does not use a claim on some other private bank.

It uses the account it holds at the Central Bank.

Money on that account is central-bank money — a claim on the central bank, the one institution that cannot run short of the currency it issues.

So there are two layers: customers hold claims on their banks; banks hold claims on the central bank.

A payment between two customers usually is not finished until the banks square up in the lower, safer layer.

WHAT IT ACTUALLY IS

The distinction matters because the two forms of money carry different risk.

Commercial bank money is a claim on a private bank and carries that bank's credit risk: if the bank fails, the claim is impaired.

Central-bank money carries no such credit risk — it is the safest settlement asset in the currency, which is why interbank obligations are settled across accounts at the central bank rather than by passing claims on private banks around.

Physical cash is central-bank money you can hold in your hand; a bank balance is commercial bank money you can only move by instruction.

What lets ordinary people ignore the difference is the singleness of money: one euro in one bank is treated as worth exactly one euro in any other, and one euro of cash, at par, all day, every day.

That equivalence is not automatic.

It is held together by supervision, deposit protection, and — underneath it all — the ability of banks to settle with each other in central-bank money.

HOW IT WORKS

This two-layer picture is the reason so many payment designs look the way they do.

A retail credit transfer moves commercial bank money between customers, but the banks close the loop by settling in central-bank money in a real-time gross settlement system — the safe asset does the final job.

Card schemes, cheque clearing, and instant-payment rails all end the same way: obligations expressed in commercial bank money, extinguished in central-bank money.

The digital-money designs in the rest of this domain are, at heart, arguments about which layer a new instrument sits in and what backs it.

A central bank digital currency would be central-bank money in digital form.

A stablecoin or a tokenized deposit is a claim on a private issuer — closer to the commercial layer — and so its safety depends on what stands behind it.

*These digital-money characterisations are forward-looking and design-dependent; concrete designs vary by jurisdiction and are illustrated here, not verified against a primary central-bank source this pass.* Keep asking the layer question and each new instrument becomes far easier to place.

THE WORDS

Central bank money

Money that is a claim on the central bank — banknotes and the balances banks hold in accounts at the central bank. No commercial credit risk.

Commercial bank money

Money that is a claim on a commercial bank — the balances in ordinary bank accounts. Most everyday payments move this kind of money.

Settlement asset

The asset actually transferred to discharge an obligation between parties in a payment or securities system — typically central or commercial bank money.

Singleness of money

The property that one unit of money is worth the same wherever it is held — a euro at one bank equals a euro at another, and equals cash.

READ FIRST

• Money, accounts, and ledgers

CONNECTED TO

• CHECKPOINT Digital money & trade finance checkpoint

SOURCES

• A glossary of terms used in payments and settlement systems — CPSS (now CPMI), Bank for International Settlements
• Payments Signal editorial teaching models — Payments Signal