BANK SHARES
There is not space in this chapter to deal exhaustively with the risks
of shareholders, but it may be mentioned that, with the exception of
the old chartered banks, the members or partners of every joint-stock
bank in the United Kingdom were, prior to 1858, liable jointly and
severally for the debts of the company. This Act, Statute 1858, c.
91, was not, however, compulsory; and although no bank of unlimited
liability has since been formed, it was not until the passing in
1879, after the failure of the City of Glasgow Bank, of the Act 42 &
43 Victoria, c. 76, that all the unlimited banks eventually limited
the liabilities of their members. Naturally, a person of considerable
wealth would hesitate to risk his fortune by buying shares in an
unlimited bank which perhaps returned him only 5 per cent. on his
purchase-money; but this objection is not now applicable, though it
must not be forgotten that the shareholder is liable for a certain
known sum, part of which may be callable and the remainder reserved
liability, or all of which may be reserved liability and callable only
in the event of the company being wound up. Where notes are issued the
members may also be liable for the circulation.
Now that the liability on bank shares is a certain sum that cannot
be exceeded the investor is inclined to regard them favourably; and
though a rich man, who can afford to take a certain amount of risk, may
decide to hold a few bank shares among his other securities on account
of their higher yield, this liability, be the risk of a bank coming
to grief never so small, makes them a most undesirable investment
for those persons the interest upon whose capital is just sufficient
to supply their wants. Bank shares, in short, are rich men’s shares;
but this fact was brought home to the public so forcibly during the
Australian banking crisis of 1893 that it seems unnecessary to dwell
upon a point which must be apparent to everybody. Besides, we all know
that a man of small means cannot afford to incur a liability on bank
shares any more than he can sign an accommodation bill, and it would
be as foolish of him to accept the one responsibility as the other.
Nor is he the class of shareholder to whom the depositor can look with
confidence.
While allowing that the great majority of our banks are prudently
managed, it must be granted that banking history is a remarkably
stormy one, though it is equally true that the surface of the waters
has been but little ruffled during recent years; still, the Baring
crisis of 1890 is not yet ancient history; and seeing that the banks
are intimately connected with the Stock Exchange, the bill-brokers and
the commercial community, a person who predicts that a British bank
will never again be in difficulties must be blessed by the Almighty
with a most sanguine temperament, for such a prediction is altogether
opposed to the weight of evidence adduced by the past, and though
its fulfilment is eminently desirable, so peaceful a solution of the
banking question seems highly improbable.
In Chapter II, on the choice of a banker, an attempt was made to
show why a customer should select a strong institution whose working
resources are plentiful, and whose reserve of liquid assets is large
enough to enable it to meet a drain of deposits during a run or a
panic. The shareholder who guarantees the customers of a bank against
loss to a limited extent will naturally take care that he is a partner
in a company which maintains an adequate reserve of cash and securities
as an insurance fund against those accidents which are quite beyond
the control of the most able board of directors. A shareholder, say,
holds twenty-five shares in a bank. These shares are for £80 each, and
the amount paid up upon each is £20. He, then, receives a dividend
upon £500, and incurs a liability of £1,500. But he bought these £20
paid shares at such a price that they only yield him 4½ per cent., and
he certainly cannot afford to run any great risk for such a return;
so he therefore, before purchasing, took care that the bank held a
large accumulation of cash and gilt-edged securities as a reserve fund
against those banking risks for which he pledged £1,500 of his fortune.
Every prudent man should take the same precaution.
The following illustrations, which are taken from the balance-sheets of
two English joint-stock companies that need not be named, will clearly
demonstrate that there are banks--and banks.
An English Provincial Bank.
Liabilities to the public upon current, deposit and other accounts are
given in the balance-sheet as £4,200,000. The bank’s liquid assets are
thus described:--
Ratio per cent.
of liquid assets
to public liabilities
of £4,200,000.
£ £
Cash in hand, at call and at
short notice 582,750 13·8
Consols and other securities 172,170 4·1
-------- -----
£754,920 £17·9
======== =====
This bank’s position might be described in one very short word. In
the first place, it has neglected to state the amount of its cash in
hand and with bankers at call separately, but has mixed it up with
its loans at short notice. The only deduction to be made is that the
bank possesses so little legal tender that it deems it prudent not to
give the figures in its balance-sheet, but to inform the public that
it holds £13·8 of cash in hand, at call and at short notice to each
£100 of its public indebtedness. The second entry is equally vague. We
are quaintly informed that this unique institution, which owes some
millions on demand, is in possession of a certain amount of Consols,
but the exact sum, and the price at which they are taken, have been
left to our imagination, so the bank may be the proud possessor of
either £100 or £1,000 of Consols; and goodness only knows what is meant
by “other securities.” The second column of our form, however, shows us
that this company held £4·1 of “Consols and other securities” to each
£100 it owed to its customers. Then, with a touch of true comedy, the
auditors tell us that the balance-sheet, in their opinion, exhibits a
true and correct view of the state of the bank’s affairs. One’s very
soul goes out to those auditors, and a longing seizes hold of one to
pat them on the back and shout bravo! No doubt the statement is true
and correct, but how strangely incomplete.
Of course there is a serious side to this question. The bank, we can
see from the total in our ratio column, held only £17·9 of cash and
certain securities in reserve against each £100 it owed to the public.
Obviously it is trading on the reputation of its better-prepared
rivals, who, should a determined run be made upon it, might feel
disposed to save it; but during a crisis, when each company has to take
care of itself, such a bank, were its depositors to become nervous,
would be compelled to close its doors in a very few hours. Now, would
any sane person buy the shares of this bank at a price which returns
him about 4½ per cent. on his capital, and incur a liability in excess
of the amount of his holding? One would say emphatically not; but it is
a remarkable fact that people are to be found who will take this risk
with a light heart. Surely they cannot understand the nature of the
security they are buying.
A bank which is caught short of cash during a crisis must apply for
assistance to the Bank of England, and the Bank, which at so critical
a time is the only market for securities in existence, would, before
making it an advance, demand to see its securities. This bank, we know,
possesses a list of “Consols and other securities” which it values at
£172,170; but if the Bank advanced £100,000 against them, which is
highly improbable, how could it pay off even £500,000 of its deposits?
It seems to me that it must go under. The usual fate of these weak
provincial banks is amalgamation with the better managed and more
powerful companies, but the danger is that a storm may sweep them out
of existence before they drift into one or another of these havens of
rest. Fortunately, the state of the bank in question is exceptional
rather than representative, but it is unwise to jump to the conclusion
that the shares of every English bank are a desirable investment.
Our second illustration deals with the balance-sheet of one of the
large joint-stock banks whose liabilities on current, deposit and
other accounts amounts to £26,652,300. The liquid assets held in
reserve against this sum are:--
Ratio per cent.
of liquid assets
to public liabilities
of £26,652,300.
£ £
Cash in hand and at Bank of
England 4,009,622 15·0
Money at call and short notice 6,876,195 25·8
£4,000,000 2½ Consols at 90;
£500,000 Local Loans
Stock at £100 4,100,000 15·4
----------- -----
£14,985,817 £56·2
=========== =====
Ambiguity is not the dominant note in this balance-sheet. We can see at
a glance that the bank is well prepared to pay off a large proportion
of its indebtedness on demand, for it holds £15 in cash against every
£100 it owes. Money at call and notice (short loans to the bill-brokers
and stockbrokers), which is much less liquid than cash, is stated
separately, and its list of investments consists entirely of British
Government securities. Moreover, we are told at what price they have
been taken. The balance-sheet, though not perfect, is clear and
informing; but a company that holds £4,000,000 of Consols at 90 would
not be so foolish as to hide its financial light under a bushel; so
when a bank modestly refers to “Consols and other securities” we may
be quite sure that its holding of Consols is either remarkably small or
else that its directors are exceedingly stupid. It is more probable,
however, that they are astute gentlemen who reason that the luminosity
of a farthing dip might call forth smiles of wonder and amazement were
it allowed to shed its radiance and waste its fragrance outside the
bushel.
The bank we are discussing, then, held £56·2 of cash, call money and
gilt-edged securities in reserve against each £100 of its liabilities
to the public; and such a bank, it need not be said, is splendidly
prepared to protect the balances of its depositors and the interests
of its members. As a matter of fact, the real interests of both are
identical; for if a bank neglects to keep an adequate reserve of
cash and securities it exposes its customers to the risk of loss and
inconvenience through its stoppage during a run or a panic; as, should
the bank suspend payment, the customers must either suspend too, or
find another banker, while its shareholders might lose all their
capital and also be called upon to make good any deficit. Obviously,
then, the bank which holds £56 in liquid assets to each £100 it owes is
the one with which to do business. The shares of this bank return about
4½ per cent. at the present market price; and seeing that the company
has minimized the risks of its members its shares will be chosen in
preference to those of the institution which has accumulated a somewhat
doubtful reserve of liquid assets which works out at a ratio per cent.
to its liabilities of only £17·9.
We next come to a banking company’s profits, which are a source of
great annoyance and wonderment to certain people, who cannot understand
how dividends of from 10 to 20 per cent. can be earned in the worst of
times when everybody else is feeling the depression in trade acutely.
The mystery is not very profound, for a banker’s business, of course,
is only profitable so long as he can trade with the money of his
depositors, and, as his own capital is usually small when compared with
his deposits, it follows that a very small percentage on his working
resources will return a high rate of interest upon his capital. Upon
a certain amount of his deposits he allows a rate which is regulated
by the Bank rate; and he charges a rate upon his loans and advances,
the said rate being also more or less influenced by the Bank rate,
the difference between the two rates representing his margin of gross
profit. He regulates this margin by changing his deposit rate at each
alteration of the Bank rate, but he also obtains money upon which he
does not pay interest, and as that sum earns considerably more when the
Bank rate is at 4 than when it is at 2½, it follows that his “free”
money is largely responsible for the fluctuations of his dividends.
But a banker cannot trade with all his deposits. He has to keep a
certain sum lying idle in his safes and tills, and with his London
agents or the Bank of England. He further requires a good list of
securities which can be either converted or pledged with the Bank of
England should occasion arise, and such a list will not return him
much more than 3 per cent. upon the sum devoted to that purpose. Then
he employs a portion of his funds in the short-loan market, so he has
only about 60 or 70 per cent. of his deposits to advance in the shape
of loans, overdrafts and discounts to customers. In other words, a
well-managed bank has to devote a large proportion of its resources to
insuring its business.
Take the bank in our second illustration. Its paid-up capital amounts
to £2,800,000, and its reserve fund to £1,600,000, so the shareholders’
funds come to £4,400,000. Deposits and other accounts are £26,652,300,
making its total working resources £31,052,300. Now the net profit
earned during the half-year was £207,869, so the bank cleared ·669 of
a pound upon each £100 with which it was trading; and seeing that the
trader expects to make 10 per cent. on his turn-over, it is pretty
evident that bankers’ profits shrink into insignificance when compared
with his. But the bank’s paid-up capital is only £2,800,000; and as
£14,000 will pay 1 per cent. per annum for the half-year on that, this
profit of £207,869 enables the bank to declare a dividend at the rate
of 14 per cent. per annum, and to carry a large amount forward to
the profit-and-loss account of the next half-year; yet it can hardly
be said that its earnings on £31,000,000 are enormous; still, they
look it when metamorphosed into a rate of 14 per cent. But this is
only another illustration of how easily the crowd can be deceived by
statistics.
It would be absurd to attempt in a short chapter to discuss the price
of bank shares; but as the banking companies, unless they enjoy an
exceptionally sheltered position, earn less during those periods of
depression which from time to time overtake the trade of the country,
it follows that their dividends, like their deposit rates, rise and
fall with the Bank of England rate. Bank shares, therefore, can be
bought cheaply when trade is bad and loanable capital cheap. As the
so-called gilt-edged securities, during normal times, should then be
dear, it often pays to sell out of the latter, invest in bank shares,
and wait for the turning of the tide.