The deposits of some type of bank, e.g. the post office savings bank, cannot be used in the settlement of debts until they are withdrawn, but a deposit in a commercial bank van be used to settle debts by the use of cheques or transfers. When the manager of a branch of one of the joint stock banks opens an overdraft account for a customer, the loan creates a deposit; that is to say, a book debt has been incurred to the customer in return for a promise to repay it. Whether or not the overdraft is secured by collateral, such as an insurance policy, or some other asset, the bank has added to the total money supply. In balance sheet terms, the deposit is a claim on the bank 'that is a liability' while the customer's promise to repay it or the collateral security is an asset to the bank.

The limitation on the bank's ability to create deposits is their obligation, if they are to remain in business, to pay out current account deposits in cash on demand. Since the bank's customers meet most of their needs for money by writing cheques on their deposits, the cash holdings the banks need are only a small fraction of their total deposits. This ratio between their deposit liabilities and cash holdings is called the cash ratio. Banks also hold liquid assets (bills of exchange, loans at call and other loans to the money market) of a further, say 20 per cent of their total deposits, the cash and liquid asset ratios together being called the liquidity ratio. In many countries the minimum banking reserve ratios are fixed by law. This gives advantages in flexibility in that the banking system does not set in a violent squeeze on liquidity when, for example, public requirements of cash rise sharply and temporarily at weekends.

The object of the banker is, of course to keep his reserves as near as possible to the minimum, since no return at all is earned on holdings of cash and a very low return in the money market. The banking system is based on confidence in the system's ability to meet its obligations. In the short run, no bank is able to meet all its obligations in cash, and if demands upon it exhausted its cash reserves, the bank would be obliged to close its doors. Runs on banks have not occurred in a developed country since the U.S. bank failures in the l930s, but in 1967 the intra-bank in the Lebanon was closed as the result of a 'run'.

Banking systems in the advanced countries, and especially in Britain have now developed and concentrated to the point where bank failure, or the necessity to control new entrants to the banking system, no longer present any problems. Indeed, many people argue that the banks are insufficiently competitive. Banking in these countries has also developed by acquisition or internal growth to include many other services like credit cards, hire purchase, merchant banking, which were previously the sole province of more specialized institutions.The supply of money is a basic tool of economic policy, and a government exerts control over the creation of credit by the banking system through its finance ministry. In many countries, this function is performed by the treasury, and the central bank.

Deposits at the central bank are regarded by the commercial banks as cash, and in most of the countries about half of the 8 per cent cash ratio is, in fact, held in this form. By buying and selling securities in the open market (open-market operations), the central bank can directly affect the level of the commercial banks' deposits with it, and hence, through the mechanism of the cash ratio, the money supply; An important element in public confidence in the banking system is that the central bank invariably acts as a lender of last resort. By its willingness to lend, the central bank ensures that, in times of temporary tightness in the availability of cash, the commercial banks are not forced to call in loans from the money market on a large scale, and thus perhaps to create a crisis.

In many countries the central bank does not, by convention, lend to a commercial bank but to the discount houses, so that the bank rate is, in practice, the rate or interest at which the central bank will discount first-class securities. In varying the bank or discount rate, the central has another important weapon with which to influence the money supply. An increase in this rate forces the discount houses to raise the rates at which they are willing to do business, since, if they did not do so and were forced to go to the bank to discount bills, they would incur heavy losses should a large differential occur between their rates and the bank rate. For similar reasons, the commercial will also raise their lending their lending and deposit rates.

Thus, an increase in bank rate applies upward pressure to the whole structure of interest rates, and in doing so tends to check an increase in the money supply although the extent to which it would do so with without the back-up of other measures, such as open-market operations, is a matter of controversy among economists. The effect of changes the money supply on the price level and on output is also a matter of controversy.