How a money transfer works 💸

Academy · 24 November 2023Rob Braileanu

Being able to instantly transfer money from your Revolut account to your friend on the other side of the world is great — right? But have you ever wondered what makes it possible?

Behind the scenes, your money moves differently to how you might expect, and in some cases, it doesn’t even move at all. Read on to find out more….

How does a bank store my money? 💰

Many people think that having a bank account is the same as having a small deposit box inside a safe, and that every customer at that bank has their own individual deposit boxes.

In reality, the bank doesn't keep all money separately, but keeps individual records for every customer it has. The bank simply debits and credits accounts by updating these records but never actually touches the money, unless it has to, but more on that below.

How does a money transfer work behind the scenes? 💱

In general, banks offer 2 types of money transfers:

  1. Transfers between two accounts held at the same bank, known as Intra-bank transfers;
  2. Transfers between two accounts held at different banks, called Inter-bank transfers.

Intra-bank Transfers 🏦

When you transfer money within the same bank, it never actually leaves the bank.

The bank simply updates their records, subtracting the amount from your account (i.e., debiting your account) and adding the same amount to your friend’s account (i.e., crediting their account).

Inter-bank Transfers 🏦➡️🏦

Interbank transfers require funds to be moved between two separate banks — this is where things get more complicated.

There are two main ways to do an interbank transfer:

  • Both banks hold accounts with one another
  • Both banks hold accounts at a 'Central Bank'.
  • Let’s look at an example:

    Let’s assume John wants to send Alice £20. John has an account with Barclays, while Alice chooses to bank with Lloyds. To manage the transfer, both banks need to have a relationship established. The easiest way to do this is for Barclays to hold a commercial account with Lloyds, and Lloyds to hold a commercial account with Barclays. Once they have this relationship in place, this is how the transfer would work:

    1. Barclays (John’s bank) will debit John’s personal account by £20. ➖
    2. John’s bank will credit Lloyds’ commercial account held with Barclays by £20. ➕
    3. Lloyds (Alice’s bank) will credit her personal account by £20. ➕
    Notice that in this scenario, the banks have been able to transfer wealth without physically moving any money!

    What happens if John and Alice’s banks don’t hold accounts with each other? In that case, both banks need to find another institution — usually also a bank —where they both hold an account.

    This third bank acts as an intermediary between John and Alice’s banks and allows the transaction to take place. Behind the scenes, this kind of transfer would look like this:

    Let’s call Johns’s bank ‘Bank 1’ and Alice’s bank ‘Bank 2’

    1. Bank 1 will debit John’s personal account by £20. ➖
    2. Bank 1 will ask the intermediary bank to debit their account (Bank 1’s) by £20 ➖, and credit Bank 2’s account by £20. ➕
    3. Bank 2 will credit Alice’s personal account by £20. ➕

    Every country designates a specific intermediary bank that all domestic banks must hold an account with. This entity, often known as the Central Bank (e.g.the Reserve Bank of Australia) serves as a facilitator for interbank transactions, ensuring seamless money between different banks.

    But why does everyone trust the Central Bank? Well, in theory, the Central Bank should never run out of money (as it can print it!) and should therefore always be able to meet their debts.

    International Transfers 🌐

    So far, we’ve explained how money transfers work between two accounts held with either the same bank or with different banks, all based in the same country. But what happens when you transfer money across borders?

    The fundamental idea remains the same. However, there is no single global Central Bank — so we need to explore alternative solutions. As we introduce multiple currencies things get a little more intricate, but we’ll delve into that in our next post. Stay tuned for more insights!

    Disclaimer: Revolut is not a bank in Australia.

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