A wide difference of opinion exists as to payment of interest on balances as a means of attracting deposits. This problem may best be understood by viewing it in connection with the various classes of deposits and depositors of the commercial bank. The question of paying interest does not relate to sums left with the bank as time accounts or certificates of deposit, for obviously the sole reason for their existence is the fact that they yield interest to the depositors. So the question is confined to whether a bank should pay interest on demand deposits. In normal times governments rarely seek loan accommodations from banks, nor do they make sudden withdrawals of their deposits. Public accounts, therefore, represent deposits of cash which remain relatively inactive, and on such deposits banks are willing to pay interest. The same may be said of fiduciary accounts. There is also little objection to allowing interest on balances of country banks, for these institutions at the same time bring profitable business to their city correspondents.

The problem whether a bank shall pay interest, therefore, refers only to the general individual demand deposits. It is argued that these funds enable banks to operate their business, and therefore depositors are entitled to participate in profits. This contention possessed some force during the period from 1914 to 1920, when banks reaped large earnings and were able to declare high dividends on their stock. However, this prosperity was also shared by other lines of business, and these firms would scarcely be expected to share profits with their customers.

Another argument in favor of paying interest on individual deposits arises by analogy from the fact that such concessions are granted on other kinds of deposits. It must be remembered that there is a special reason for allowing interest on each of these balances as indicated above. Also it is maintained that British and continental banks pay interest on their deposits. However, one must be mindful of the fact that European monetary and banking conditions differ considerably from those which exist in the United States. In most European countries the fundamental medium of exchange is the circulating bank note, while here the leading instrument for making payment is a check drawn against a bank deposit. An account with an American bank is largely the result of credit extended to the customer by the bank itself, while a deposit in a European bank more frequently results from the leaving of actual cash.

Replying to the arguments favoring the payment of interest on deposits, it is held that in general this step would lead banks to adopt unsafe policies. It is an axiom of business that the amount of profit varies directly with the element of risk. If the necessity of granting interest on deposits forces a bank to strive for higher rates on its loans, obviously the possibility of losses will be increased. Also a bank would be compelled to keep all its funds continually on an active earning basis, and would be thus unable to retain any considerable part as a reserve to meet a sudden demand of its depositors for payment.