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Banking: Contract And Accounting Laws

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Free Banking, the Balance Sheet and Contract Law Approach

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Intention to Create Legal Relations

Meritt v Meritt [1970] – In determining the intention of the parties an objective test is used by asking if reasonable people would regard the agreement as legally binding.

With two parties so at odds, I cannot see how we have any intention to create legal relations in the vast majority of deposit contracts.

I would even go as far to say that the vast majority of deposit contracts are unlawful under the Law of Contract.

A sensible policy prescription should be to align the banks to the account holders’ wishes and make the deposit contract one where the bank holds the depositors’ money as custodian / safe keeper and not as borrower. Make this contract explicit. Charge a fee for custodianship / safe keeping.

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As far as I am aware, in the UK Under International Financial Reporting Standards and UK Generally Accepted Accounting Principles, you have to report your creditors as current, under one year and over one year. This shows the outside world what your ability is to pay your debts, as and when they fall due. Most companies will always aim to match their current creditors with their current debtors, their less than one year creditors, but over current creditors, with the equivalent matching on the debtors’ side and with the long term debt being matched with long term creditors.

Most companies in this sense in the commercial world, other than banks, would indeed be 100% reserve companies and not companies that only keep a small fraction of money aside to pay their creditors. A very good research project for a graduate would be to map out all the FTSE 100 companies and see what percentage were 100% reserved and what were not. With those that were not, what were above 95% , 90%, 85% etc. In reality, if they are not very highly reserved their auditors will not sign off their accounts and they run the risk of insolvency. There is a grey area between a 99%, 95% reserved company as to if it is solvent and at the extreme end, the banks, where they are 3% reserved to current creditors!

Banks need another set of laws that only apply to themselves to operate. Thus they have a privilege accorded only to them. This allows them, like Barclays, to have creditors and debtors only. So all the current money on demand is lumped in with a catch-all lump of all creditors. This implies to the outside world that they perfectly balance their short term creditor needs, i.e. withdrawals with their long term debtors’ repayment profiles such that they never prejudice the current creditor losing his/her shirt. I do not know what specific accounting laws that the banks are allowed to audit to, but they sure are not GAAP that applies to all other commercial organizations. I do intend to find out when I have time, and again, this could be a rich source of research work for a graduate. Notwithstanding, it is clear there is one law for all commercial companies and one law for banks.

It should be clear that a lending and custodian bank where a deposit contract of either type conforms to the Law of Contract, at all points in time will conform to the normal commercial law.

It is clear that a Fractional Reserve Free Bank violates the law of contract and the normal commercial law for every company, thus they have accounting and legal privilege. A custodian / lending bank, conforming to the law of contract and normal commercial accounting law, could not compete with a fractional reserve free bank as the latter would be able to fully use all of its clients’ deposited money to do whatever it pleases, including the creation, on average, of 33 times more deposits. If we take the example of Barclays with some £300 billion of current creditors, the ability to fully use this would place it at a distinct unfair advantage with all other commercial enterprises. Indeed, under the current law, if would be very difficult indeed for a custody / safe keeping bank to get off the ground, the odds are so stacked in favour of the current arrangement.

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Interesting article, which goes into lots of details, legal cases etc.

While I'm generally more interested in the mechanics of a system and whether it works well or not, viewing things from a legal/contractual standpoint paints in interesting picture too.

There seem to be special accounting rules, vague contracts and other oddities. In the words of Injin: is banking fraudulent? ;)

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Free Banking, the Balance Sheet and Contract Law Approach

Interesting article, which goes into lots of details, legal cases etc.

While I'm generally more interested in the mechanics of a system and whether it works well or not, viewing things from a legal/contractual standpoint paints in interesting picture too.

There seem to be special accounting rules, vague contracts and other oddities. In the words of Injin: is banking fraudulent? ;)

It can be fraud even if it's all otherwise legal - all that need happen is that one party is mislead by the other to increase thei rprofits. This is true for liar loans, whereby the borrower is lying to increase their gain and it happens with FRB banking, when the banker is ommiting material facts (such as not having any sodding money) to increase theirs.

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  • 152 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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