THE PROBLEMS OF COMMERCIAL BANKING
The conduct of commercial banking presents problems both to the
bankers and to the public, the methods of solution of which will be
given attention at this point. The problems concerning the bankers
primarily may be grouped under the heads, supply of cash, selection of
loans and discounts, and rates; and those which primarily concern the
public may be grouped under the heads, protection against unsound
practices, and adequacy and economy of service.
_1. The Supply of Cash_
The credit balances on checking accounts and the notes of commercial
banks are payable on demand in the legal-tender money of the nation to
which they belong, and such banks must at all times be prepared to
meet these obligations.
The term employed to designate the funds provided for this purpose is
_reserves_, and in this country they consist of money kept on hand
and of credit balances in other banks. In other countries there is
also included under this head commercial bills of the kind which can
always be discounted. The term _secondary reserve_ is sometimes
employed in this country to designate certain securities, such as
high-class bonds listed on the stock exchanges, which can be sold
readily for cash in case of need.
The amount of reserve required can be determined only by experience.
In ordinary times it depends chiefly upon the habits of the community
in which the bank is located regarding the use of hand-to-hand money
as distinguished from checks and upon the character of its customers.
These habits differ widely in different nations, and considerably in
the different sections and classes of the same nation. In most
European and Oriental countries, for example, checks are little used
by the masses of the people, while in the United States and England
they are widely used. In these latter countries, however, they are
less widely used by people in the country than in the cities, and by
the laboring than the other classes in the cities. Within the same
city one bank may need to keep larger reserves than another on account
of the peculiarities of the lines of business carried on by its
customers and the classes of people with whom it deals.
In times of crisis and other periods of extraordinary demand, bank
reserves must be much larger than in ordinary times. Hoarding,
unusually large shipments of money to foreign countries and between
different sections of the same country, and payments of unusual
magnitude, increase the demands for cash made upon banks at such
times.
The manner in which clearing and other balances between banks are met
also has an influence on the amount of reserves required. If such
balances are paid daily and always in cash, the amount needed for this
purpose is much larger than if they are paid in checks on some one or
a few institutions and at longer intervals.
The note issue privileges of a bank also affect its reserve
requirements. Since, if not prohibited by law, notes may be issued in
all denominations needed for hand-to-hand circulation within a nation,
and since for all purposes except small change such notes are as
convenient as any other form of currency, a bank with unrestricted
issue privileges can supply all the demands of its customers for
currency for domestic use, except those for small change, without
resort to outside sources of supply. In this case, however, it needs
to keep a reserve in order to meet demands for the redemption of
notes. Such demands arise on account of the need of coin for small
change or for shipment abroad or of means for meeting domestic
clearing and other bank balances. The aggregate needed for the supply
of such demands, however, is much less than would be required if the
privilege of issuing notes did not exist.
In the maintenance of reserves the chief reliance of commercial banks
is the circulation of standard coin within a nation and the
importation of such coin. The coin within the borders of a nation
passes regularly into the vaults of banks by the process of deposit,
and on account of the credit balances they carry with foreign
institutions, the loans they are able to secure from them, the
commercial paper they hold which is discountable in foreign markets,
and the bonds and stocks sometimes in their possession which are
salable there, they are able to import large quantities in case of
need. Since the standard coin in existence in the world adjusts itself
to the need for it in substantially the same manner that the supply of
any other instrument or commodity adjusts itself to the demand, banks
ordinarily have no difficulty in supplying their needs, and under
extraordinary circumstances, though difficulties along this line
sometimes arise, means of overcoming them are available which will be
discussed in the proper place.
If, as is the case in the United States, certain forms of government
notes are available as bank reserves, these find their way into the
banks' vaults by the process of deposit in the same manner as coin.
The possession of such notes by a bank enables it, to the extent of
their amount, to throw the responsibility for the supply of standard
coin upon the government, and in the circulation of the country such
notes take the place of an equivalent amount of standard coin. Whether
or not a government ought to assume such a responsibility is a
question which will be discussed in a subsequent chapter.
For the nation as a whole, the balances in other banks and the
discountable commercial paper and bonds which a bank may count as a
part of its reserves are not reserves except to the extent that they
may be employed as a means of importing gold. They are only means
through which real reserves of standard coin are distributed. The
payment in cash of a balance with another bank or the discount of
commercial paper with another domestic bank or the sale of bonds on
domestic stock exchanges do not add to the sum total of the cash
resources of the banks of a nation. Their only effect is to increase
the cash resources of one bank at the expense of another.
Adequate facilities for the distribution of the reserve funds of a
country, however, are second in importance only to the existence of
adequate supplies of standard coin. If such facilities are lacking,
existing reserves can be only partially and uneconomically used, with
the result that much larger aggregate reserves are required than would
otherwise be necessary and that the entire credit system is much less
stable than it otherwise would be.
_2. The Selection of Loans and Discounts_
The problem of the reserves is vitally connected with that of the
selection of loans and discounts. As was shown in the preceding
chapter, the chief business of a commercial bank is to conduct
exchanges by a process of bookkeeping between individuals, banks,
communities, and nations. This process consists primarily in the
converting of commercial bills and notes into credit balances and
bank notes, in the transfer of such balances and notes between
individuals and banks, and in the final extinguishment of such
balances and the return of such notes at the maturity of the
commercial bills and notes in which the process originated.
In this process there is little need for cash, provided the
arrangements between banks for clearing checks and for the interchange
of notes are complete and efficiently administered. But when a bank
accepts investment in lieu of commercial paper, its need for cash at
once increases, because the demand obligations created by the credit
balances or the bank notes into which this paper was converted are not
extinguished by payments for goods purchased, but must be met by cash.
To distinguish between commercial and investment paper is, therefore,
one of the chief problems confronting commercial bankers. For its
solution an accurate knowledge of the business operations of customers
is necessary. An inspection of the paper presented and a general
knowledge of their wealth and business capacity are important, but not
sufficient. The forms of the paper employed in both commercial and
investment operations may be the same, and the possession of wealth
does not ensure the payment of the paper at maturity.
The chief means available for the acquisition of this knowledge are
the requirement from customers of frequent statements of their
operations, on properly prepared forms; the use, wherever possible, of
the documented commercial bill of exchange; and the maintenance of
credit departments equipped with the means of accurately studying
commercial, industrial, and agricultural operations, and of diagnosing
economic conditions. The study of carefully prepared statements of
customers made at frequent intervals reveals to the banker not only
the nature of the operations represented by the paper presented for
discount, but the trend of the business of his customers and, through
them, of the entire country. With such knowledge, he is not only able
to protect his institution against improper loans and discounts, but
to give valuable advice to his customers, advice which no one else is
in a position to give so accurately.
By a documented bill of exchange is meant a bill drawn by a seller
upon the purchaser of goods, accompanied by documents evidencing the
transaction; such, for example, as bills of lading, warehouse
receipts, and insurance policies. The names on such bills guide the
banker in his efforts to trace the transaction in which it originated
and the documents enable him absolutely to identify it, and constitute
security for the loan.
Instead of such bills, promissory notes made payable to banks are
commonly used in this country, greatly to the disadvantage of the
banking business. Such a note reveals nothing to the banker concerning
the purpose for which the loan is made, while a commercial bill, even
without documents, reveals the names of the principals of the
transaction in which the banker is asked to participate. Acquaintance
with these men and knowledge of the business in which they are engaged
at once suggests the probable origin of the bill and furnishes the
clue needed for subsequent investigation.
A properly equipped credit department will keep on file and at all
times available for use the data requisite for the information of the
officers upon whom the responsibility of selecting the loans and
discounts rests. Such data will not only concern the character and
business of each customer and the bank's previous dealings with him,
but general economic conditions, the operations and experiences of
other banks, other business institutions, governments, etc.
_3. Rates_
Besides rates of exchange considered in the preceding chapter,
commercial banks are concerned with loan and discount rates.
Rates on deposits, though sometimes employed, have no place in
commercial banking, since commercial deposits are only the credit
balances resulting from loans and discounts or from funds intrusted to
the bank for temporary safekeeping or disbursement in the interest of
the depositor. In every case they represent a service rendered the
depositor for which the bank must be paid, and, when interest is
allowed, the depositor must repay it in some form with an increment
sufficient to remunerate said service.
Commercial banks may and usually do conduct savings accounts also, for
which an interest payment is not only defensible but in every sense
desirable, but in so doing they are going beyond the sphere of
commercial banking, which alone is under consideration at this point.
Rates charged on loans and discounts are the chief means through which
commercial banks are remunerated for the services they perform. In the
long run these rates are determined by competition, and represent the
current market value of the services performed by bankers. Custom
often affects them temporarily and sometimes for long periods prevents
their response to influences tending to produce change, but in the
long run they yield to economic force and conform to the laws of
value.
Variations in the rate of discount are the most efficient means
employed by commercial banks for the regulation of the volume of their
loans and discounts and for changing the percentage their reserves
bear to deposits and note issues. An increase of these rates tends to
check loans and discounts, to decrease deposits and note issues, to
increase reserves, and consequently to raise the percentage of
reserves to deposits and issues.
It checks loans and discounts by increasing the expense of conducting
business operations on a credit basis, thus diminishing profits and
sometimes causing losses, checking enterprise and decreasing the
volume of commercial transactions. A decrease of loans and discounts
correspondingly diminishes deposits or note issues, or both, since
these are simply the counterpart or representative of such loans and
discounts in the form of credit balances in the checking accounts
conducted by the banks or the equivalent of such balances in a
hand-to-hand money form. An increase in the rate of discount at a
given point tends to attract funds from other points where the rates
are lower and thus to increase reserves. A decrease of rates produces
opposite effects all along the line.
_4. Protection against Unsound Practices_
Commercial banks are an essential part of the machinery by which the
agriculture, industry, and commerce of a country are carried on, and
their proper conduct is, therefore, a matter of public concern. On
this account they have long been subjects of legislation and of public
supervision and control. The methods evolved for safeguarding the
public against abuses and unsound practices differ considerably among
different nations and to some extent among the different states of the
United States, and could only be adequately explained by a history of
banking in each nation. Only the more important and most widely used
of them will be described here.
(_a_) _Capital and Surplus Requirements and Double Liability of
Stockholders._--A very common, indeed, almost universal, legal
requirement is that before beginning business the proprietors of a
commercial bank shall contribute a fund to be known as the _capital
stock_, and that an additional fund, usually called the _surplus_,
shall afterwards be set aside from profits. These funds are required
to be maintained intact, so long as the bank continues in business,
and to be used for the payment of losses in case of failure or
liquidation for any reason. In this country it is also customary to
hold the proprietors legally liable in case of failure for an
assessment equal to the amount of their capital stock. In foreign
countries it is a common practice to have the subscribed considerably
in excess of the paid-in capital, the balance being subject to call by
the directors at any time, and being available for the payment of
losses in case of failure.
These funds serve not only as a protection against loss to the
customers of a bank in case of failure, but also as a restraining
influence on the managers in the everyday conduct of the bank's
affairs. They constitute the proprietors' stake in the business, what
they are likely to lose if the management is imprudent, dishonest, or
inefficient. The absence of such funds would put a premium on rashness
and speculation and tempt into the business the unscrupulous and the
unfit.
In the determination of the size of capital and surplus funds and of
the amount of the liability of stockholders for subscriptions in case
of failure, no well-founded principles have been developed for the
guidance of legislators. They should be great enough to cover
prospective losses and to induce conservatism, honesty, and efficiency
in management, and not so great as to prevent the free flow of an
adequate amount of capital into the business. Unfortunately, the
statistics of losses in cases of failure are not a sufficient guide.
In some cases they bear a large proportion to the volume of business
transacted and in others a very small one, and the number of cases
available are too small to give much value to averages. The amount
necessary to secure the best possible management is also purely
problematical.
In lieu of well-founded principles, the practice has developed in this
country of making the minimum capitalization permitted depend upon the
population of the town in which the bank is located. This seems to be
a very crude and indirect method of proportioning capital to the
volume of business transacted. The fixing of such a proportion, or of
a proportion which no bank should be permitted to exceed, is probably
the best method of solving this problem, but it should be done
directly and not by the roundabout method which has been mentioned
above.
A proportion of ten to one between capital and aggregate demand
obligations would probably be justified by American experience. The
present practice of fixing the surplus fund at twenty per cent of the
capital would be justifiable if the capital fund were properly
regulated in amount.
(_b_) _Inflation and Means of Protecting the Public against It._--The
greatest abuse to which the business of commercial banking is subject,
and against which the public most needs protection, is inflation. This
is a condition difficult to diagnose, and not well understood by the
general public and even by bankers. The most easily recognized symptom
of its existence is the forced liquidation of credits; that is, forced
sales of property in order to meet maturing obligations to banks.
When, for example, the people whose notes or bills have been
discounted by banks default in large numbers, and the collateral
deposited as security has to be sold, or, in the absence of
collateral, the courts must order the sale of their property, the
presence of inflation may be suspected.
The chief cause of inflation is the issue by commercial banks of
demand obligations against investment securities. The means of
liquidating such securities are the profits of the enterprises in
which the investments were made and in the nature of the case several
years are required for the accomplishment of this end. Meantime the
demand obligations of the banks issued against them in the form of
balances on checking accounts or notes must be met and, the funds
regularly deposited with them as a result of the operation of such
enterprises being inadequate, other means must be found. The only one
available is the sacrifice, at forced sales, of the property in which
the investment was made or of some other property in the possession of
the persons responsible to the bank.
The banks usually protect themselves against such forced liquidation
by the requirement that the paper they discount shall mature at short
intervals, usually not to exceed four to six months, and accept the
long-time securities, such as bonds, stocks, and mortgages, only as
collateral. By this means they are able to force the liquidation on
their customers. Otherwise they would be obliged themselves to endure
it, with the result that their capital and surplus funds would be
impaired and perhaps exhausted; and, if they should prove inadequate,
failure would be inevitable.
The evil involved in the forced sales of property caused by inflation
is the readjustment of prices through which it is accomplished, and
the depression and, sometimes, panic which follow. When the prices of
many kinds of property must be greatly depressed in order to induce
their transfer to other hands, the machinery of commerce and industry
is thrown out of adjustment and is sometimes rendered temporarily
useless. This result is due to the fact that the relations between
costs of production and the returns from the sale of finished products
are so changed that profits are reduced or annihilated, and many
persons are financially ruined. Readjustments of the prices of raw
products, labor, and finished goods, and the transfer of plants to new
hands, are, therefore, necessary before industry, commerce, and
agriculture can again operate in a normal way, and during the period
of readjustment some enterprises must entirely stop operations, and
all must slow down. At such times many laborers are thrown out of
employment, many more work part time only, the wages of nearly all
are lowered, and most other classes of income are cut down. Depression
and, in extreme cases, panic are the result, and these have serious
consequences other than financial.
The means employed for the protection of the public against inflation
are crude and inadequate. They may be grouped under the heads:
regulations regarding investments, reserves, and note issues. Under
the first head belong in the banking legislation of this country
limitations on real estate investments and on the amount that may be
loaned to a single firm or individual. Our national banking act and
most of our state banking acts prohibit banks from holding real estate
except for their own accommodation, and as a means of reimbursing
themselves for defaulted loans, and our national banking act prohibits
the taking of real estate security for loans, and many of our state
banking acts limit the amount of such security that may be held. Our
national banking act limits the amount that may be loaned to a single
firm or individual to one-tenth of the bank's capital and surplus, and
similar regulations are common in state banking legislation.
The purpose of these regulations is to confine the investments of
banks to what are called liquid securities, but they fail to evince a
proper conception on the part of their authors of what really makes a
security liquid. Apparently legislators and their advisers have felt
that if the securities held by the banks mature in short periods, or
are listed on a stock exchange, they are liquid; but such is not
necessarily the case.
Commercial paper only is really liquid, since it represents a current
commercial process which will soon be completed and the completion of
which automatically provides the means for its payment. Such paper
usually matures in short periods, but the characteristic of liquidity
results not from the date at which it is made to mature, but from the
commercial process which called it into existence and will ultimately
retire it. In this country very often paper of short maturity is so in
form only, its makers expecting to renew it, instead of pay it, at
maturity.
Bonds and stocks, even though they may be listed on a stock exchange
and daily bought and sold, are not liquid securities in the proper
sense of that term. An individual bank may be able to sell them in
case of need, but such sale is simply the transfer of the investment
to another bank or person, and not its liquidation. The security
still exists and must be paid, while its liquidation would take it out
of existence.
Foreign legislators have approximated more closely than ours what is
needed in the regulation of bank investments. In the case of their
central banks, many of them, notably those of France and Germany, have
recognized the fundamental distinction between commercial and
investment paper, and have required them to hold the former against
their demand obligations, especially their notes.
The regulation of reserves has become a subject of legislation in this
country only. Our national banking act classifies national banks into
three groups, called country, reserve city, and central reserve city
banks, and requires those in the first mentioned group to keep cash in
their vaults to the amount of at least six per cent of their deposits,
and balances in approved reserve city banks sufficient to bring the
total amount up to fifteen per cent of their deposits.
Banks in reserve cities are required to keep in their vaults cash to
the amount of at least twelve and one-half per cent of their deposits,
and balances in central reserve cities sufficient to bring the total
up to twenty-five per cent of their deposits. Banks in central reserve
cities are required to keep at least twenty-five per cent of their
deposits in cash in their vaults. When the reserves of a bank fall to
the prescribed minimum, all discounting must cease. Regulations
essentially similar are found in the banking laws of most of our
states.
The purpose of these regulations is to set a limit to the extent to
which banks may expand the volume of their loans and discounts, in the
belief, apparently, that, if at least the prescribed proportion of
cash is all the time kept on hand, the banks will be able to meet
their obligations. As in the case of the regulations concerning
investments, the authors of these failed to recognize the
significance, from the point of view of the cash demands likely to be
made upon banks, of the kind of paper admitted to discount. If
discounts be confined to commercial paper, the demand obligations they
create will be met for the most part by transfers of credits on the
banks' books or by the return of the notes issued, and, as foreign
experience has demonstrated, the adjustment of cash resources to needs
can safely be left to the judgment of the bankers themselves, who,
through variations in the discount rate, rediscounts, and other means,
can regulate it with ease. If investment paper is admitted to
discount, reserves less than one hundred per cent of the demand
obligations thereby created are unsafe, since a less amount is likely
to force liquidation on the banks' customers, with the results above
indicated.
The most elaborate regulations for the prevention of inflation have
been developed in connection with legislation concerning note issues.
The reason for this is the fact that commercial banking was at its
origin and for a long time thereafter carried on almost exclusively
through note issues, the conduct of checking accounts being a
comparatively recent development. The phenomenon of inflation was,
therefore, first observed in connection with note issues and
associated with them. Even now the essential similarity of note issues
and checking accounts as banking instrumentalities is not universally
recognized.
The means of safeguarding note issues which have been incorporated
into legislative enactments are the prior lien on assets, the safety
fund, the requirement and sometimes the mortgaging of special assets,
and the limitation of the total issues. By the prior lien is meant the
provision that in case of failure the note holders shall be paid in
full before any of the assets are distributed among other creditors.
By the safety fund is meant a required contribution from each bank,
usually a percentage of the amount of notes issued, placed in the
hands of some public official and kept for the redemption, in case of
failure, of such of the notes of failed banks as cannot be redeemed
out of the assets of the banks themselves. Additional contributions
from the solvent banks are required for the replenishment of the fund
when it has been depleted.
The practice of different countries regarding the requirement of
special assets to be held against note issues, as well as regarding
the mortgaging of such assets, is not the same. Germany and France,
for example, require their banks to cover their note issues by
designated proportions of commercial paper and coin, while the United
States requires its banks of issue to cover their notes by government
bonds and to contribute a five per cent redemption fund in addition,
and England requires the Bank of England to cover a designated amount
of its issues by government and other securities and the remainder by
coin. Unlike the others, the United States mortgages to the note
holders the securities, that is, the government bonds, required to be
held against the notes, by providing that in case of failure these
securities shall be sold and the proceeds used for the settlement of
their claims.
In all of these provisions, the protection of note holders against
loss in case of failure has been an influential consideration, and in
the cases of the prior lien and the safety fund, the only one. The
prevention of inflation may have entered into consideration in the
other cases, but among the states mentioned the regulations of France
and Germany alone are efficient in this direction, since they alone
prohibit note issues against investment securities. The above
mentioned regulations of England and the United States tend rather to
promote, than to prevent, inflation, since they require the holding of
investment securities against note issues.
The limitation of the aggregate amount of notes that may be issued is
a common legislative regulation. In the United States the limit set is
the amount of the capital stock, and in France it is an arbitrary
figure from time to time changed as the needs of the bank seem to
require. As a safeguard against inflation, the value of such
limitation depends upon the basis of the issues. If it is investment
securities, as in the case of the United States, limitation to a low
figure, not in any case to exceed the capital stock, is desirable,
since such limitation keeps the inflation within such bounds that the
banks themselves may be able to withstand the effects of it by selling
upon foreign markets, without great and perhaps without any loss, the
securities in which their capital and surplus funds are invested. If
the basis of issues be commercial paper, such limitation is
unnecessary, since inflation in such a case is improbable, and
pernicious, unless it be placed above the point which the volume of
issues is likely in ordinary cases to reach.
(_c_) _Other Means of Safeguarding the Interests of the
Public._--Experience has shown that publicity is a valuable safeguard
against bad bank practices, and legislation has, therefore, provided
for it by the requirement that statements of banking operations shall
be published from time to time. The national banking act of the United
States and many of our state banking acts, for example, provide for
the publication five times a year of bank balance sheets, drawn up
according to prescribed forms.
The inspection of banks by public examiners and the requirement of
detailed reports to public officials are also provided for in our
federal and state legislation. Canada requires the reports but not
the inspection by public officials, on the ground that the latter
cannot be thorough and efficient, and is, therefore, likely to mislead
the public and cause it to be less vigilant than it otherwise would be
in the use of other means of safeguarding its interests.
Legislation in this country has also concerned itself with the duties
of bank directors and the enforcement of their performance, and with
the relations of bank officers to their banks, particularly those
involved in borrowing for their own uses or for firms or corporations
in which they are interested.
A recent legislative experiment along quite a new line has been
undertaken in this country in the form of laws providing for the
mutual insurance of depositors. Oklahoma started this experiment, and
her example has been followed by other states. The essence of the
experiment consists in the provision of a fund out of which is paid to
the depositors of failed banks that portion of their claims which
cannot be met from the liquidation of the assets of the defunct banks,
such fund to be contributed by the other banks belonging to the
system.
The protection of depositors against loss is a commendable aim of
legislation, but this method of attaining this aim is open to the
serious objection that it removes from depositors all concern
regarding the proper management of the bank with which they do
business, and thus gives the unscrupulous, dishonest, and plunging
banker an advantage. Attraction of depositors is the chief field in
which competition between banks is carried on, and when the power of
good management in this direction is removed, high rates on deposits,
high lines of credit, low or no rates of exchange, extravagance in
equipment, etc., remain the only attractions, and in the offer of
these the unscrupulous and plunging banker will always outdo the
conservative.
It is impossible to overcome this objection by public supervision, and
more frequent and rigid examinations. No public officer can equip
himself to pass judgment on the relations of a bank with each
customer, or to detect secret contracts and unwritten understandings,
or to keep unscrupulous people out of the banking business. There can
be no doubt that a reputation for conservatism, good judgment, strict
integrity, and careful management is, at the present time, the most
valuable asset a banker can have, because customers know that they are
in danger to the extent that these qualities are lacking. To
substitute for the present basis of competition between banks that
established by mutual insurance laws is to undermine the foundations
of our credit system and to invite disaster and ruin.
_5. Adequacy and Economy of Service_
From the point of view of adequacy and economy of service, two types
of banking systems require attention; namely, that characterized by a
large number of relatively small local independent banks, chartered
under general laws, and exemplified in this country; and that
characterized by a relatively small number of large banks endowed with
the privilege of establishing branches, and exemplified in the other
leading nations of the world.
Under our system each community is encouraged to look after its own
banking needs. Local initiative in the establishment of new
institutions is given free play and local capital and local talent is
attracted. Outside promoters and outside capital are not excluded,
but, if they come, they do so as colonists expecting to cast in their
lot with the community and to become identified with it. The managers
of our banks for the most part are local men who are the real heads of
the institutions they manage and whose careers and prosperity depend
on the success of these institutions.
The localism which characterizes this system contributes elements both
of strength and of weakness. It develops local talent, and promotes
mutual understanding and cooperation between the banks and the
business enterprises of the community, and conformity of organization
and methods to local needs. Its weakness consists in the financial
isolation and the narrowness of vision and training which are its
natural accompaniments. Under this system capital does not easily and
quickly move from place to place and readily distribute itself
according to the relative needs of different communities. In
consequence, rates of interest are apt to vary widely, some
communities to be under- and others over-capitalized, and the capital
of the nation as a whole to be inefficiently employed. Under this
system the opportunity of bankers for training is meager, since the
broader and more fundamental aspects of the business are rarely
brought to their attention, and in the smaller towns and country
districts they are apt to be recruited from people of mediocre ability
and often from those not well fitted by nature and education for this
branch of commercial enterprise.
The system of branch banking, almost universally employed elsewhere,
is strong where our system is weak, but it has weaknesses of its own.
It promotes distribution of capital according to relative needs, and
consequently efficiency in the application of a nation's capital as a
whole, and it offers a wide field of training for the people engaged
in the business, and draws its recruits from every quarter. It can
readily supply banking facilities to communities too small or too poor
to provide for an independent bank, and more readily than our system
can adjust itself to rapidly growing communities.
Its chief weakness consists in the lack of independence of the
managers of the branches and the consequent danger that local needs
may not be fully satisfied. The manager of a branch is usually granted
freedom of action only in routine matters. Any business out of the
usual order must be referred to higher authorities connected or
associated with the main office; and, even with the advice of the
manager, who alone is familiar with local conditions, the decision
cannot be made with that intimacy of knowledge of and sympathy with
the business and aspirations of the individual or firm under
consideration that full justice to him and his town may require. In
the matter of adequacy and character of service, therefore, the city
in which the main office is located has an advantage over those in
which the branches are located.
In this connection it should also be noted that, while the branch
banking system is able to adjust itself to the capital requirements of
towns of all sizes more readily than the independent banking system,
and thus to secure a better distribution of the banking capital of the
community, it does not follow that it will do so. On account of
ignorance of conditions, insufficiency of capital or inability readily
to increase it, or inertia on the part of the head office, a town may
have to wait for the establishment of a branch longer than it would
for the establishment of an independent bank.
Whether or not this will be the case, however, depends to a
considerable extent upon the keenness of the competition between the
big banks with branches. The big central banks of Europe, which have
no competition within their field, have been slow to establish
branches. The coercive force of the government has been necessary in
many cases to secure their proper expansion. In the case of the other
big banks, however, both of Europe and of Canada, competition has
resulted in very rapid expansion during the last half century,
probably as rapid as could be desired.
Regarding adequacy of service, the method of granting charters and the
attitude of the government towards private banking is important. If
banks are allowed to spring up spontaneously, like manufacturing and
commercial establishments and farms, they are likely to be plentiful
and to be located wherever needed. Experience, however, has shown that
private banks cannot be adequately regulated in the interest of the
public and that incorporation under public auspices should be
required.
Two methods of incorporation are employed, those of the special
charter and of the general law. Except in the case of special
institutions, like central banks, the former is objectionable, since
it opens the doors to political favoritism and is likely to result in
bad distribution, lack of uniformity in regulation, and lack of
steadiness and regularity in development. Incorporation under general
laws, or the free banking system, as it is sometimes called in this
country, is unquestionably the best from every standpoint. All the
necessary checks and balances can be incorporated in these laws, and
the supervision of public officers, together with the necessary
administrative machinery, provided for. This is the only practicable
method to employ in an independent system like ours.
The special charter method works best in connection with the branch
bank system, in which the question of chartering new institutions only
occasionally arises, and in which delay is not so serious.