What is a Demand Deposit?
A demand deposit is money deposited into a bank account with funds that can be withdrawn on-demand at any time. The depositor will typically use demand deposit funds to pay for everyday expenses. For funds in the account, the bank or financial institution may pay either a low or zero interest rate on the deposit.
The maximum a person may withdraw can be up to a certain daily limit or up to the limit of their account balance. Common examples of demand deposits would be amounts in a checking account or savings account. Note that demand deposits are different from term deposits. Term deposits require depositors to wait a predetermined period before making a withdrawal.
- Demand deposits are accounts that allow people to withdraw money as and when required.
- They are important in consumer spending, as the funds typically hold the money used in day-to-day transactions.
- Common examples of demand deposits would be amounts in a checking or savings account.
Types of Demand Deposits
1. Checking account
A checking account is one of the most common types of demand deposits. It offers the greatest liquidity, allowing cash to be withdrawn at any time. The checking account may earn only zero or minimal interest since demand deposit accounts involve minimal risk. Interest paid may vary based on the financial provider.
2. Savings account
A savings account is for demand deposits held at a slightly longer duration compared to the short-term use of the checking account. Funds in the savings account offer less liquidity; though, for an extra fee, money may be transferred to the checking account.
Savings accounts often come with a minimum required balance. As larger balances are held for extended periods in a savings account, it pays a slightly higher interest rate than a checking account.
3. Money market account
A money market account is for demand deposits that follow market interest rates. Market interest rates are impacted by the central bank’s responses to economic activity. The money market account will, therefore, pay interest either more or less than a savings account, depending on how the market interest rate fluctuates. Traditionally, money market accounts offer a competitive rate to savings accounts.
Importance of the Demand Deposit
1. Consumer spending
Demand deposits are important in consumer spending, as they hold the funds used to pay for everyday expenses. The expenses may include groceries, transportation costs, personal care items, and more. Demand deposits are, therefore, advantageous due to their liquidity and ease of access.
With the on-demand feature of demand deposits, people can withdraw money at any time without the need to give the bank prior notice. Additional funds may be withdrawn from an ATM, debit cards, the bank’s teller, or through written checks.
2. Bank reserves
Demand deposits are important for institutions, as the total amount held in deposit accounts determines the bank reserves that must be kept on hand. Bank reserves are held in the vault or on-site at the bank and are essential in the case of large unexpected withdrawals.
The more money a bank holds in demand deposits, the more money it must keep in its bank reserves. The money not kept in bank reserves is called excess reserves. Excess reserves are then loaned out by banks, contributing to the money creation process.
3. Money supply
Demand deposits are an important part of the money supply of a country, defined within M1 money. M1 money consists of currency plus demand deposits. Demand deposits make up a significant part of the money supply in many countries.
During a financial crisis, many people together will make large withdrawals from the bank. The withdrawals will lead to a decline in demand deposits and a decrease in the money supply, with banks left with less money to loan out.
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