More Than One Bank (Q&E)

How to pay someone who uses a different bank

We’ve already seen how you can use a cheque or debit card to pay someone who uses the same bank as you. You do it indirectly. When buying a cake, Alice transferred £5 of raw net worth to the bank (by writing off £5 in her account) and the bank transferred £5 of RNW to the baker (by creating a new £5 in its account).

Alice pays £5 to the baker indirectly, via the bank they both use

But what if Alice uses Bank X and the baker uses Bank Y? We want Alice to end up with £5 less in her account with Bank X, and the baker with £5 more in its account with Bank Y, like this:

Alice and the baker are happy, but what about the banks?

But something’s not right. Look at the changes in everyone’s RNW:

Alice and the baker have what they want. But Bank X has gained £5, and Bank Y has lost £5. That’s obviously not right. Fortunately there’s a simple solution: Bank X has to transfer £5 to Bank Y.

Historically, there have been various ways to transfer RNW between banks, but the standard way today is for banks to have accounts with a central bank, and they do the equivalent of making debit card payments from one bank to another.

Complete transaction, where Bank X transfers £5 to Bank Y via central bank

Now everyone ends up where they should be.

Alice and the baker have swapped £5 for a cake. The baker transferred the cake directly to Alice, but Alice’s transfer of £5 to the baker followed a long, indirect route: via Bank X, the Bank of England, and Bank Y.