_Origin of banks._—Attention has been called to the banks of the country
as a most important part of the machinery of exchange. It is proper to
describe more fully the nature of the machine and its operations. A clear
understanding of the character and process of banking on the part of all
the people both extends its influence and diminishes its dangers. Banking,
like everything else in civilization, has had a natural growth. The
different steps in its growth have been devised for the sake of meeting
the needs of a growing commerce, and banking can exist only where
commercial transactions are frequent and constant.
The word bank, distinctly related to the English word bench, is supposed
to have been adopted from the fact that early Jewish dealers in money sat
by a bench in the streets of Italian cities. The commercial city of Venice
is supposed to have been the seat of the first organization distinctly
named a bank. This was a corporation of money lenders who handled their
capital in the form of coin by exchanging it for notes of individuals.
This was as early as the twelfth century. Since that time in every
civilized community there has been experiment upon methods for quickening
exchanges through such organizations, some of which have been of great
advantage and some have brought disaster. The modern system of banking is
the result of all these centuries of experience, a history of which cannot
be given here.
_Bank described._—A brief description of the most modern form of banks
under state or national restrictions will help to understand how these
institutions serve the world of commerce.
In simplest terms, a bank is a company founded for the sole purpose of
dealing in coin and current certificates of credit of every form, the
prime object being the convenience of people in making exchanges of any
kind. Sometimes a bank is called upon simply to make change, or, as we
say, to break a valuable coin or a bill of large denomination into smaller
pieces. On the border land between two countries the banker serves a
traveler by exchanging the coins of the country he leaves for coins of the
country he enters.
Often the bank, equipped with safe protection against fire or robbers,
receives the wealth of others in any form of money for safe keeping, with
provision for its being paid when it is needed, whenever and wherever the
owner directs. The same bank may be asked to exchange the money in its
possession for notes of individuals payable on demand or at definite
future time. It may even issue notes of the firm in place of the
individual notes received, acquaintance of a community with the standing
of the bank as a dealer in money making its notes circulate where
individual notes would not. In this case the wider credit of the bank is
exchanged for the limited credit of individuals. In the end a well
established bank in close association with a system of banks is expected
to do any service that has to do with either money or credit, so long as
the credit approximates cash transactions, and has not drifted into
overdue debts requiring courts and officials for collection.
So important are all these functions of a bank to the interests of society
that distinct provision is needed in the law of the land for establishing
the bank and maintaining its efficiency. The double system of government
in our country known as state and national leads to two classes of banks,
called state or national according as they are organized under authority
of state government or under national laws.
_State banks._—The independent laws of any state are supposed to provide
such restrictions as the people desire for the management of banks. Any
bank chartered by the state government is subject simply to the laws of
the state pertaining to banks and is called a state bank, whatever the
name under which it does business.
The laws of the different states vary indefinitely, but the essentials of
a banking law quite recently established in one of the states may serve to
illustrate the modern ideals as to safe, legitimate banking. Under this
law a bank must be a corporation of not less than five persons who have
subscribed for the entire stock and have paid at least 50 per cent of the
value of this stock before beginning business, with provision for payment
of 10 per cent each month until the whole of the capital stock is paid for
in cash. Each stock-holder is individually liable to an amount equal to
the value of his stock for any debts of the bank in excess of its original
stock. Having settled upon a name distinct from all others, its
application is made to a bank commissioner for a charter to do business in
banking according to the laws of the state. Under the charter issued by
the commissioner, the bank is required to be managed by a board of
directors, from five to thirteen in number, which board elects the needed
officers and appoints the necessary clerks. It cannot increase its capital
except by fully paid stock, and can do no other kind of business, like
buying and selling of goods and lands, or managing factories and
railroads. It is authorized to receive deposits and make loans at interest
not above legal rate, provided it keeps on hand available funds, including
bank balances, amounting to 20 per cent of its total deposits, and never
loans to one individual or firm more than 15 per cent of the paid up
capital of the bank. A penalty of fine and imprisonment follows conviction
of any officer for receiving deposits after general insolvency is known.
Each bank is required to report to the commissioner at least quarterly,
and whenever called upon to publish its report; while failure to comply
with requirements of the commissioner in report or otherwise brings
immediate forfeiture of the charter. The commissioner or his deputy must
visit each bank at least once a year and whenever occasion may require.
If, upon examination, a bank is found insolvent the commissioner himself
takes charge of the business for final settlement of its affairs. These
important restrictions and careful inspection are thought necessary to
secure the public interests in banking. The state through its bank
commissioner gives guaranty to the public of legitimate and safe banking.
The value of that guaranty, of course, depends upon the honesty,
experience and executive ability of the bank commissioner, whose term of
office and compensation should make him as independent as possible of any
weakening influence. Under present arrangements no state banks issue their
notes as currency because of a national tax of 10 per cent, which prevents
a possible profit from its issue. Present state laws, therefore, make no
provision for that function, unless by statutes existing before the
organization of national banks. The states still have the constitutional
right, apparently, to charter banks of issue, but the advantages of
uniformity throughout the nation are so evident as to make such action
very improbable.
_National banks._—The so-called national banks organized under authority
of United States government have been in existence since 1863, and have
proved, so far as currency is concerned, such an improvement upon anything
preceding in the way of bank issues, that few have advocated any return to
former methods. The system as now existing places the authority of the
United States in an officer called the comptroller of the currency. The
law requires an association of five or more persons with a definite name
and location, having not less than $100,000 capital ($50,000 in small
towns) all paid within six months of beginning business. Share-holders are
individually responsible for debts of the bank, aside from their stock, to
an amount equal to their stock.
In banks having over $5,000,000 capital a surplus of 20 per cent may take
the place of this individual responsibility. Not less than one-fourth of
the capital stock, usually one-third, is deposited in the United States
Treasury in the form of registered bonds of the United States, to be held
exclusively for security of circulating notes. These notes are issued to
the bank by the comptroller to the amount of not more than 90 per cent of
the market value of the bonds deposited. These notes, printed by the
government, signed, registered and sealed in the United States Treasury,
in denominations from five dollars to one thousand dollars, become money
when signed by the officers of the bank whose name they bear. The cost of
these notes, together with the cost of restoring when worn out, as well as
the expenses of the comptroller’s office, are met by a tax of 1 per cent
per annum, paid semi-annually, upon the average amount of notes in
circulation during the previous six months. Such notes are not a legal
tender, but are received at par for all dues to the United States except
duties on imports, and for all demands against the United States except
interest on the public debt and in redemption of currency. Any other issue
of notes is prohibited, and worn out notes are cancelled and burned in the
Treasury of the United States, being replaced by new.
The banks in sixteen principal cities are required to hold a reserve equal
to 25 per cent of their circulating notes in lawful money of the United
States, namely coin or treasury notes, and all other banks must have a
reserve equal to 15 per cent of their circulating notes in the same form.
This reserve is held for the redemption of the notes, provision being made
for such redemption at the Sub-treasury of the United States in New York
city, bank balances and clearing house certificates in the larger cities
being counted as part of the reserve. The object of this is to secure
ready redemption of any note in all parts of the nation.
The comptroller’s office includes expert examiners, and to it each bank
must report at least five times a year, with other special reports as
called for. Each bank is subject to examination at the pleasure of the
comptroller, and in case of failure to redeem bills or comply with the
law, the comptroller has power to take possession of the bank and close
its business. The usual banking business of any national bank proceeds
according to the laws of the state in which it exists, the legal rate of
interest of the state being compulsory.
_Advantages and disadvantages of national bank currency._—The advantage of
such a uniform system of bank notes is evident. The bills are secure
beyond the possibility of doubt as to their final redemption, and
therefore circulate freely without reference to the failure of the bank
issuing them. In case of failure, all the banks form a ready machinery for
collecting the bills for final redemption at the United States treasury.
The frequent reports and expert inspection give as satisfactory means of
maintaining safe management as can be secured by law. The possibility of
connivance between examiners and bank officers is reduced to a minimum.
At the same time, there are disadvantages from several sources. First,
United States bonds do not form a permanent basis. Second, the market
value of these bonds and the low rate of interest make the use of capital
in the shape of circulating notes less profitable than other capital in
the bank. This is especially true in the newer communities where interest
is high, and banks so located are likely to surrender their circulating
notes at times when money loaning is most profitable, and thus cause a
fluctuating volume of currency in the country. Third, the national banks
are easily made objects of suspicion as to matters of legislation with
reference to money.
_Government banks._—Similar institutions under direct management of
government officers have often been thought of as bringing the banking
machinery within the direct judgment of the people, and so best meeting
the wants of the community as a whole. The advantages of unity and
publicity in such a system seem evident, and yet in actual practice the
safeguards against misuse of power have proved on trial less satisfactory
in such methods than in several others. The history of debased coinage
already referred to shows that men in power may easily disregard the
interests of the people, and under popular government both officers and
legal restraints are subject to changes in the interest of localities and
parties. It is possible that a stable body of experts might manage such an
institution under laws as stable as the Constitution with success. But the
restraints of law are most effective upon institutions outside official
circles.
A government bank is subject to extreme pressure from popular demand under
any financial distress to issue currency for general improvements in
public buildings, parks, etc., which can bring no return and afford no
means of redemption. Even the demand of unfortunate debtors for extended
loans may push the bank into excessive issues, and finally lead to the
scaling of debts and currency together in an effort to escape the results
of over-issue.
_Bank business._—Whatever the organization of a bank, its business must be
essentially the same. It receives deposits from its customers for safe
keeping and for convenience in use by means of checks. A check is simply
an order to pay, and, if the receiver is a customer of the bank, amounts
to merely a transfer of deposits from one owner to another on the books of
the bank. A thousand dollars safely kept in the bank vault may thus change
owners a hundred times by means of checks properly recorded. In large
transactions the check, because of its economy, takes place of any other
form of currency. The bank must also deal in drafts, by which exchanges
can be made in different cities, and in bills of exchange, distinguished
from ordinary drafts by special reference to foreign trade. It may also
hold, as a part of its available machinery, clearing house certificates,
which are statements of balances due in the daily settlement between the
banks belonging to a clearing house association.
All these form a part of the machinery of every-day exchange, and together
with a complete system of book-keeping make the utmost facility in the use
of money.
They also greatly economize in the use of money by saving cost of counting
and of transfer, and by securing against losses. If the system offered no
more advantages than this safe and ready use of good money, the banks
would be practically indispensable. But they have a still greater use in a
safe extension of credit. The perfection of system in banking makes it
possible for one who habitually fulfils his promises to purchase anywhere
in the world on the shortest notice with the simple guaranty of credit in
the bank where he does business. A traveler wishing to have funds in
safe-keeping, and yet available on a journey around the world, may obtain
through a bank familiar with his business standing a letter of credit,
upon which he can draw, wherever he may be, against the deposit in his
favor, and his draft will be paid, through a series of banks, at the bank
near his business connections. Thus the credit of the world is bound
together by the banking system grown up to meet the necessities of trade.
_The clearing house._—All forms of credit referred to above, where dealers
are customers of a single bank, are easily brought together upon the books
of that bank, and will practically cancel each other. The customers of
many banks in large cities may have their checks and drafts brought into a
single system of book-keeping through a clearing house, which is simply a
bank of banks. At a certain hour each day, in the larger cities twice a
day, each bank of the city brings to the clearing house all checks and
drafts against any other banks. These are quickly sorted, charged to the
several banks against which they are drawn, and credited to the banks from
which they are brought. The balance of debit and credit is settled then
and there, either by transfer of cash, or by issue of a clearing house
certificate that a bank has a balance in its favor, and so only a small
amount of cash is used in settling all transactions of an immense
business. The clearings of a single day reach hundreds of millions of
dollars, and form an index of the business prosperity of the country.
The system saves the risk and cost of transferring back and forth immense
amounts of coin and currency, and brings the business men of the country
into ready contact with each other. It is an essential part of the means
of settlement between different cities and different countries. A debt in
any part of the world can be paid through a draft on London, which by
means of the clearing house and its associated banks can be purchased
anywhere and paid without delay. Since the purchasing power of any part of
the world is chiefly in what it has to sell, the constant motion of checks
and drafts in opposite directions will balance each other. If there were
no long time credits, the purchases of any city would essentially equal
its sales; and so with perfect clearance all trade would be quickly
adjusted with but little use of money except for retail business.
_Other clearing systems._—So evident are the advantages of clearing houses
in banking that the system extends to many other interests. Railroad
corporations balance accounts against each other by exchange of tickets
issued by the different roads. Large combinations of dealers in implements
or other goods find a similar service available where they can work
together with confidence. Express companies sharing in a common service
divide the final proceeds upon the same principle. So evident is the
advantage that the growth has been rapid during recent years, and seems
likely to extend still further.
Some effort has been made to establish farmers’ exchanges upon a similar
plan, but as yet with little success. The obstacles are chiefly in the
want of business confidence in business habits among the farmers
themselves. Since the system is strictly a credit system, exact promptness
in meeting engagements and constant dealing in the same channels are
absolutely necessary. Most farmers, having comparatively few transactions
from day to day, are loath to attach themselves as constant customers in
any association. With larger experience and more neighborly contact they
are finding it possible to work in association for various purposes, and
will doubtless enlarge their means of business credit as their progress in
mutual understanding increases.
_Government inspection._—The principal support of universal credit through
banking is the assurance that uniform methods, honest in principle and
accurate in execution, are followed. To secure these results a system of
government inspection and guaranty seems absolutely necessary. If the
public faith is to be maintained, the ground of that faith must be
publicly established. The more complete the examination by trusted
officials and the more frequent the publication of official reports, the
better the public credit. It seems possible that even individual
trustworthiness may become a matter of government record as it is now of
private consideration in all business circles. One chief guaranty of
credit through the banks is the strict inquiry made by the banks
themselves into the business standing of their customers. If the record
were perfect, the chief weakness of the credit system would be largely
removed.
_The balance of trade._—The bulk of trade between countries, that is of
dealers in different countries, is settled in the usual routine of banking
as has been indicated; but since under present systems the standards of
value are given in different terms in different countries, somewhat more
of friction remains in such trade. A greater attention is given to the
fact of final settlement in coin or bullion. The price of exchange from a
country whose dealers owe more than is due them, under the law of supply
and demand, soon arises to an amount sufficient to cover the cost of
transporting gold or silver. When these metals are used in payment by
transportation from one country to another they are said to indicate the
balance of trade; that is, they show that more of other property comes
into the country than goes out. This balance of trade is supposed to show
the relative prosperity of a nation, and is said to be against it when the
nation buys more than it sells.
It is usually sought in the difference between the value of coin or
bullion exported and of that imported. In two sets of circumstances a
large correction is necessary to show the actual condition of trade. One
is where a nation is buying on long credit, as in case of great
enterprises like railroads or factories, constructed by sale of bonds in
foreign countries or by sale of any other securities, government or
individual, in a foreign land. The other is where a country like our own
is a large producer of gold and silver by mining. In this case the
products of the mines are as proper an article of export as the products
of the farms or of the factories, and should be estimated as a part of the
natural exports. For these reasons the balance of trade must be carefully
scrutinized before being accepted as proof of a nation’s progress in
poverty or wealth.
_Bank loans._—So far, in dealing with the subject of banking, no mention
has been made of the function of extending individual credit by time
loans. One of the original purposes of banking was to make a convenient
office for the meeting of borrowers and lenders. The banks are still the
go-betweens of those who have money to lend and those who have to borrow.
In fact, every banking association is assumed to be a corporation of money
lenders. Under ordinary circumstances this corporation is able to loan to
individuals whose credit is good all of its capital not otherwise employed
in the machinery of the bank, a considerable portion of deposits from its
customers, and to a certain extent its own credit in the commercial world.
In the case of a national bank a portion of capital is loaned to the
government in the purchase of bonds, which are the basis of its
circulating notes. The circulating notes, from 60 per cent to 90 per cent
of the value of the bonds, are an extension of credit; that is, the
capital already loaned on time to the government is partially loaned again
to individuals. Again, the deposits of the customers, to be drawn as
needed, in ordinary circumstances are not needed the same day. The bank
soon learns by experience what portion it is safe to lend from day to day
to individuals who are sure to make payments when promised. Double
signatures, or endorsements, double the surety of prompt payment.
Thus the banks are enabled to provide safe keeping for money without
charge, and even to pay a low rate of interest upon considerable deposits
when times are good. In this way legitimate borrowers and legitimate
lenders find a close connection in the bank. A legitimate lender is one
who has property not needed at present for his own use. A legitimate
borrower is one who can use capital to advantage in production. Any
producer may at one part of a year be a lender and afterward a borrower to
advantage of everybody. If the banks are thoroughly satisfactory the
proceeds of the fall crops may serve the busy manufacturers as circulating
capital during the winter. Again, the proceeds of the spring sales of
goods and machinery may tide the farmers over the season of growth.
In this way labor of every kind is sustained by labor of every other kind.
In all these ways the banking power of a country is extended to several
times the coin money in circulation, and that with perfect safety. But it
is possible for banks to be tempted through the very perfection of their
own credit. The note of an individual has no established market value. A
deposit in the bank is valued as cash. It is possible to secure the credit
of having a bank deposit by discounting an individual note. If that note
is a time note the bank has increased its immediate liabilities by the
amount of a nominal deposit, with only a promise to pay in the future to
rest upon. To lend to an individual is practically to enter into
partnership with his fortune. The fortunes of the group of individuals
representing the bank is less doubtful than that of any one person. The
borrower in this instance pays in the discount of his note the difference
in risk between his fortune and that of the combination. Such deposits
purchased upon credit must be distinguished from deposits of cash, lest
the bank should nominally increase its power to lend while in fact it has
already lent up to its ability. Sometimes such nominal deposits are
maintained by persons deeply in debt for the sake of paying a larger rate
of interest than is allowed by law.
_Safety of banking._—In times of business prosperity a bank with usual
business caution as to customers, is safe for all concerned. And yet, in
the very nature of extended credit, it has promised to pay on any
particular day, if demanded, far more than it has cash in hand. Its
liabilities embrace the whole of its deposits except a small portion made
for a definite time, and all its issues of currency subject to redemption.
To meet these engagements its immediate resources are whatever currency in
any form of coin or bills it may have at hand. This amount, since its
profits are made from lending, not from holding, must be small in
proportion to its liabilities. The bulk of its means of payment is in
notes not yet due, and to be collected when due. Of other property it is
likely to have bonds of municipalities or of great corporations, and these
are supposed to be a more available form of resources than individual
notes, because they usually have a definite market value and can be sold
or used as security for loans in any money market. If real estate forms a
part of the capital, it can never be made available for immediate use.
Hence any bank dealing in mortgages on real estate invests its funds where
they cannot be had when wanted. All banking schemes based upon security in
land have necessarily failed, because land has no current use in trade.
Under the pressure of panic, from whatever source, each depositor is sure
to demand every cent due him from the bank, and just as certainly the
bank’s own resources are insufficient to meet those dues without the sale
of bonds and notes in other markets. For these reasons in any great period
of distrust the banks are obliged to suspend payments. Since all the banks
of the community are in similar circumstances they cannot help each other,
and time must be given for the collection of loans, according to
agreement, that the gradual accumulation of ready cash may return to the
vault, and so to the depositors, all that has been loaned. Because of this
necessary instability bankers watch most carefully the tendencies of the
money market, and necessarily reduce their loans for safety when any
anxious pressure begins. For the same reason legitimate banking is limited
to short time loans—on demand, thirty, sixty, ninety days—the shorter
being the safer. Laws sometimes prohibit a bank from dealing in any other
business, where a stock of goods must tie up funds, or from speculation in
real estate, which confines capital more certainly.
In most banks the amount to be loaned to a single individual or firm is
limited to a small portion, one-tenth to one-fifth, of the total capital.
The principal causes of failure in banking are defalcation of officers,
misuse of funds in speculative enterprises, dealing in speculative
securities or on boards of trade, careless loaning to poor paymasters,
investment in long time securities not readily marketable, or sacrifice in
hurried sale of stocks and bonds under the pressure of panic.
The better the customers of a bank understand its condition and
management, the less is its danger, for the basis of banking, as of the
credit of the world, is the public confidence. Farmers who acquaint
themselves with the workings of neighboring banks by making use of their
aid in business benefit both themselves and their neighbors. The progress
of the world demands of every farmer a closer contact with business and,
therefore, a greater familiarity with business methods. Even the burden of
debts will be lessened when farmers understand and appreciate the
advantage of systematic credit. The dangers from over expansion of credit
are lessened when all the people clearly understand the essential
conditions for maintaining credit. The final perfection of a banking
system depends upon the interest of the whole people, with a fair
knowledge of the growth already made.