When do institutions exchange physical currency from electronic payments?

Question

This question always been on my mind and I never truly understood the concept. I’ve done some digging and haven’t found the answer that is comprehensive.

I want to understand at what point does a bank issue the physical currency from a cardholders digital payment to a merchant.

For example, if I deposit 25$ into a Chase checking account and then I order something for 25$ from a store far away, I understand the banker will transfer funds digitally but they still have the physical 25$.

So what happens to the 25$ in this card holder's account? Does the banker keep it or do they physically transport it to the merchant later?

Answer 1

You're missing something very important. Banks do not have a 1 to 1 accounting of deposits with cash. Hence why bank runs are a problem, in a panic situation where everyone wants to withdraw their money, they literally do not have it. So physical cash you deposit just sits around until someone else wants to make a withdrawal. As long as your accounts are up to date and the bank isn't perceived as insolvent (by making too many bad loans), then we are all willing accept this situation.

Answer 2

"I want to understand at what point does a bank issue the physical currency from a cardholders digital payment to a merchant."

Almost certainly never :-) If you deposit $25 in bills at your Chase branch, those bills are probably paid out to the next person who asks for cash.

Meanwhile, the now-electronic $25 in your account gets transferred to the merchant's account, which we'll say is with Bank of America. If the merchant wants some cash, he takes it out of his account, but they're not the same bills as you deposited.

In fact, Chase and BoA rarely if ever transfer actual cash between each other. Each branch office of both banks probably has about the same amount of physical bills coming in and going out. If there's an excess or deficiency, they send or get some from a central office, which in turn occasionally gets new bills from the Fed, and sends worn bills to them for destruction. But the amounts of such transfers are balanced electronically: physical cash is only for convenience.

Answer 3

As I understand it (probablly oversimplified and details will vary by country).

The government or central bank creates money. Some of this money exists in the form of cash, but most of it only exists in the form of numbers in the central bank's computers. Economists call this "central bank money".

When you deposit cash in the bank your bank will add the cash to it's cash reserves and update your balance. Similarly when you withdraw cash the bank will remove the cash from it's reserves and update your balance. The bank will keep a certain proportion of total deposits in reserve. Some of those reserves will be deposits with the central bank, some will be cash in the bank's vaults. The rest of the deposits will be invested by the bank in some way.

Of course your bank balance still looks and feels like money to you, so the effective amount of money in circulation is much greater than the amount of central bank money in circulation. Economists call this extra effective money "commercial bank money".

When you transfer money to an account at another bank there needs to be a corresponding transfer of central bank money from one bank to the other. For some high-value or high-speed transfers there may be a specific transfer from one bank's reserve account to another specifically for your transaction. However for most normal transfers your transfer will be grouped with many many other transactions and only the net amount after considering all the transactions will actually be transferred between the banks.