Bank Deposits are IOUs
Understanding that your bank balance is a promise, not physical money
What is an IOU?
Simple Definition
An IOU (I Owe You) is a written acknowledgment of debt - a promise to pay back what is owed. It's not the actual money itself, but a claim or promise to money.
Real-World Example
If you lend a friend $20 and they write "IOU $20" on a piece of paper, that paper isn't money - it's a promise to give you money later. The paper itself has no value; only the promise does.
⚠️ Your Bank Balance is an IOU
When you deposit money at a bank, you exchange physical cash for the bank's IOU. Your account balance is the bank's promise to give you your money back when you ask for it.The bank doesn't store your money - they use it for loans and investments.
What Happens When You Deposit Money
You Deposit Physical Cash
You bring $1,000 in physical cash to the bank and deposit it into your account.
Bank Takes Your Money
The bank takes your physical $1,000 cash. You no longer have the physical money - the bank does.
Bank Gives You an IOU
The bank updates your account balance to show $1,000. This is the bank's IOU - their promise to give you $1,000 back when you ask for it.
Bank Uses Your Money
The bank doesn't store your $1,000. They keep a small reserve (maybe $100) and lend out the rest ($900) to make profits through interest.
When You Withdraw
When you withdraw, the bank gives you someone else's money (from their reserves or new deposits) to honor their IOU. Your original $1,000 is long gone - lent out to others.
The Key Insight
💡 You Don't Own the Money in Your Account
When you deposit money, you become a creditor to the bank. The bank owes you money. Your account balance is a record of that debt - an IOU from the bank.
The physical money you deposited is gone - lent out to others or invested. What you have is a digital claim on the bank's assets, not the actual cash itself.
🏦 Banks Don't Store Your Money
Banks use fractional reserve banking. They only keep a small fraction of deposits as reserves (often 10% or less). The rest is lent out to make profits.
This means if everyone tried to withdraw at once (a bank run), the bank couldn't pay everyone because most of the money has been lent out and isn't available.
Physical Money vs Bank Deposit IOU
Physical cash - actual dollars you can touch
Digital IOU - a promise from the bank to pay you
You directly own and control the money
The bank owes you money (you're a creditor)
In your possession (wallet, safe, etc.)
Lent out to others or invested by the bank
Theft, loss, fire (physical risks)
Bank failure, freezing, seizure (counterparty risk)
Immediate - you have it right now
Depends on bank hours, ATMs, or electronic systems
No insurance - if lost, it's gone
FDIC insured up to $250,000 per account
Limited - need to carry it, count it, store it
High - digital payments, cards, transfers
The ATM Receipt
📄 What an ATM Receipt Shows
When you check your balance at an ATM, the receipt shows your account balance. This number represents:
- The bank's IOU to you (how much they owe you)
- A digital record of the bank's debt
- NOT the physical cash sitting in a vault with your name on it
💭 The Common Misconception
Many people think their bank balance represents physical money stored in a vault, like a safety deposit box. In reality:
- Your money has been lent out to others
- The bank only keeps a small reserve
- Your balance is a digital IOU, not stored cash
- If the bank fails, you could lose your money (unless insured)
Why Bank Runs Happen
What is a Bank Run?
A bank run occurs when many depositors try to withdraw their money at the same time, usually due to fear that the bank will fail.
Why Banks Can't Pay Everyone
Because banks use fractional reserve banking and lend out most deposits, they don't have enough physical cash on hand to pay all depositors at once. If everyone demands their IOUs simultaneously, the bank can't honor them all.
FDIC Insurance
The FDIC (Federal Deposit Insurance Corporation) insures deposits up to $250,000 per account. This protects depositors if the bank fails, but it's still an IOU system - just with government backing instead of only bank backing.
Key Concepts
What is an IOU?
An IOU (I Owe You) is a written acknowledgment of debt - a promise to pay back what is owed.
Your Bank Deposit is an IOU
When you deposit money at a bank, you're not storing physical cash - you're exchanging it for the bank's IOU.
Banks Don't Store Your Money
Contrary to popular belief, banks don't keep your physical money in a vault waiting for you.
Your Balance is a Digital Claim
The number you see in your bank account is a digital record of the bank's debt to you, not physical cash.
Fractional Reserve Banking
Banks only keep a fraction of deposits as reserves, lending out the rest to make profits.
The Bank Run Problem
If too many people demand their IOUs at once, banks can't honor them all because the money has been lent out.
IOU vs Physical Cash
Physical cash is actual money you hold. A bank deposit is an IOU - a promise that may or may not be honored.
Implications of Understanding IOUs
💼 For Banking
Understanding that deposits are IOUs helps explain why banks can fail, why FDIC insurance exists, and why fractional reserve banking works the way it does.
💰 For Your Money
Knowing your bank balance is an IOU means understanding counterparty risk. Your money depends on the bank's ability to honor their promise. This is why diversification and FDIC insurance matter.
🌐 For Cryptocurrency
This is why some people prefer cryptocurrency - with self-custody, you actually own the private keys and the assets directly, not an IOU from a third party. However, crypto exchanges often operate similarly to banks (holding your crypto as IOUs).
📊 For the Economy
The IOU system allows banks to create money through lending (money multiplier effect), which expands the money supply and enables economic growth, but also creates systemic risks if confidence is lost.
Key Takeaways
📝 Your Bank Balance is an IOU
When you deposit money, you exchange physical cash for the bank's IOU - a promise to pay you back.
🏦 Banks Don't Store Your Money
Banks use fractional reserve banking - they only keep a small fraction as reserves and lend out the rest.
💳 You're a Creditor
When you deposit money, you become a creditor to the bank. The bank owes you money, not the other way around.
⚠️ Counterparty Risk
Your deposit depends on the bank's ability to honor their IOU. If the bank fails, you could lose money (unless FDIC insured).
🏃 Bank Runs Explained
Bank runs happen because banks can't pay everyone at once - most deposits are lent out and not available as physical cash.
🛡️ FDIC Insurance
FDIC insurance protects deposits up to $250,000, but it's still an IOU system - just with government backing.