THE CANADIAN BANKING SYSTEM
[147]Financially, Canada is part of the United States. Fully half the
gold reserve upon which its credit system is based is lodged in the
vaults of the New York Clearing House. In any emergency requiring
additional capital Montreal, Toronto, and Winnipeg call on New York for
funds just as do St. Paul, Kansas City, and New Orleans. New York
exchange is a current and universal medium in Canada and is in constant
demand among the banks. A Canadian wishing to invest in securities that
may be quickly marketed commonly turns to the New York market for stocks
and bonds. Yet the American banker visiting in Canada, if he is
unacquainted with the history of banking in his own country, finds
himself in a land of financial novelties, for Canada has a banking
system unlike any in operation in the United States at the present time.
Twenty-nine banks, known as the "chartered banks," transact all the
banking business of the Dominion. They have 2,200 branches, and each may
establish new branches without increase of its capital stock. [At the
close of the year 1915 there were twenty-two banks with approximately
3,200 branches.] They issue notes without depositing security with the
Government and in such abundance that no other form of currency in
denominations of $5 and above is in circulation. Notwithstanding the
fact that the notes are "unsecured," their "goodness" is unquestioned
among the Canadian people.
THE SYSTEM NOT NEW
But to the student of the history of banking in the United States there
is little that is radically new in the Canadian system. He finds in it
many of the practices and expedients that were found excellent in the
United States in the first half of the nineteenth century, and is almost
persuaded that but for the Civil War what is now known as the Canadian
banking system would everywhere be called the American system.
The fiscal exigencies of war, which have caused changes in the banking
systems of most countries, have had no influence upon the development of
banking in Canada. During the first half of the nineteenth century the
commercial and financial interests of Canada and the United States were
comparatively intimate and the financial institutions of both countries
developed on similar lines. The safety-fund system, first introduced in
the State of New York in 1829, found favor also in Canada and is still
an integral part of the Canadian banking system. Branch banking, which
was most successfully illustrated in this country by the State Bank of
Indiana, and which now exists in some form or other in almost all
countries except the United States, has always prevailed in Canada. The
importance of a prompt redemption of bank notes as exemplified in the
old Suffolk banking system in New England before the war, was fully
realized in Canada and is probably better illustrated in the present
Canadian system than in any other country. There bank notes and bank
checks are treated as identical in nature, both being cleared with the
same regularity and promptness. The so-called free banking system, which
was first adopted in the State of New York in 1839 and thereafter
adopted by eighteen other States of the Union, was tried in Canada in
the fifties, but not on a large scale. This system, requiring that
issues of bank notes should be secured by a segregated deposit of
certain classes of stocks and bonds, has never met with approval among
the leading bankers of Canada.
The Canadian system is a product of evolution. It has taken its present
form because of the commercial and financial needs of the Canadian
people. It was not created by lawyers or statesmen to meet a fiscal need
of the Government, but has grown up gradually under the fostering care
of experienced bankers, no changes having been made until experience
proved them necessary or advisable.
The chartered banks transact the business which in the United States is
divided among national banks, trust companies, private banks, and
savings banks. They buy and sell commercial paper, discount the notes of
their customers, lend money on stocks and bonds, make advances to
farmers, and sometimes aid in the financing of railroads and industrial
enterprises. To a Canadian the word "bank" means one of the twenty-odd
"chartered banks," for the law prohibits the use of the word "bank" by
any other institution.
OTHER FINANCIAL INSTITUTIONS
The only other financial institutions in Canada which possess much
importance are the mortgage and loan companies. These usually operate
under charters granted by the provincial legislatures and do a business
similar to that of the farm and mortgage companies which once flourished
in the United States, making loans to farmers for a term of years and
taking farm mortgage for security. They also make loans upon urban and
suburban real estate and thus aid in the upbuilding of the cities and
their suburbs. The business of these institutions is made possible by
the fact that the bank act does not permit the chartered banks to accept
loans secured by real estate.
The Dominion Government maintains a double system of savings banks. One
set is managed by the post-office department, every post-office
receiving deposits. The other set is managed by the finance department.
The post-office department also sells annuities and old-age pensions.
The money received through the savings banks is regarded as a loan from
the people and is used, like money obtained by taxation, in the payment
of the Government's general expenses. The Government is required to
carry a gold reserve of 10 per cent. against the savings deposits, but
no assets are set aside for their security. The chartered banks pay the
same rate of interest and get most of the business, for they offer
facilities with which the Government does not attempt to compete. Most
of the Government's deposits come from the poorest and most ignorant
classes, people who in all countries are suspicious of banks. Some of
the Canadian cities maintain municipal savings banks, but they are of
relatively small importance.
Trust companies in Canada are not financial institutions. They are
trust companies in fact as well as in name, their business being to act
as trustee and administrator. A few of them accept deposits, although it
is not certain that they have a right to do so. The bulk of the money
they handle comes to them through the administration of estates and
trust funds.
Private banking firms are almost unknown in Canada, there being only two
or three in the entire Dominion, and these do a mortgage and loan
business rather than a strictly commercial banking business.
Hence, if any one seeks to understand the financial or banking situation
in Canada, he must devote his attention in the main to the chartered
banks. These through their branches furnish the loanable capital
necessary for the support of the Dominion's trade and industry and for
much of its agricultural enterprise. To them the Government turns when
funds are needed for internal improvements or when the exchequer faces a
deficit. The promoters of street railways, steam railways, steam
railroads, and other permanent improvements take counsel with the
managers of these chartered banks before they issue their securities.
The banks as a rule do not invest their funds in the stocks or bonds of
new enterprises, yet their managers are the men most familiar with the
world's money markets and their approval, therefore, of any financial
undertaking is highly esteemed.
THE ESSENTIALS OF THE SYSTEM
A chartered bank in Canada is a bank of branches, not a bank with
branches. The parent bank, technically known as the "head office,"
neither takes deposits nor lends money. All the banking business is done
by the branches, each enjoying considerable independence, but all
subject to the supervision and control of the head office. The law
places no restrictions upon the number or location of branches. Canadian
banks, therefore, have branches in foreign countries as well as in
Canada.
PROCESS OF INCORPORATION
The provisions of the bank act with respect to the organization of new
banks are intended to guard against the entry of unfit or inexperienced
persons into the banking business. The minimum required capital of a
bank is $500,000, of which all must be subscribed and one-half paid in
before a new bank can open. At least five men of integrity and good
financial standing must agree to act as provisional directors and secure
a favorable report on their project from the parliamentary committee on
banking and commerce. These men must agree to subscribe for fairly large
blocks of stock, otherwise the committee will be inclined to reject
their application. They must convince the committee that their project
is a well considered one, that there is need for the new bank. If they
satisfy the parliamentary committee it will be granted. The bank,
however, cannot yet begin business. Provisional directors now have
merely the right to advertise and cause stock books to be opened. If
inside of one year capital stock to the amount of $500,000 has been
subscribed and $250,000 thereof paid in, the provisional directors may
call a meeting of the shareholders, at which a board of regular
directors shall be chosen. Before this meeting is held at least $250,000
in cash must be paid over to the Minister of Finance. The regular
directors must then apply to a body known as the treasury board for a
certificate permitting the bank to issue notes and begin business and
the treasury board may refuse this certificate unless it is entirely
satisfied that all the requirements of the law have been met. Delay on
the part of the treasury board might prove fatal to the new enterprise,
for if a new bank does not obtain a certificate within one year from the
date of its incorporation, all the rights, powers, and privileges
conferred by the act of incorporation cease. These requirements make it
impossible to organize a new bank in Canada with any degree of secrecy.
NOTE ISSUES
Having obtained its charter, a new bank must open its head office in the
place designated, and may then proceed to establish branches or
agencies, upon the number and location of which the law places no
restriction. Under its charter it has authority to issue circulating
notes up to the amount of its unimpaired paid-up capital in
denominations of $5 and multiples thereof. An amendment of the bank act
passed July 20, 1908, gives the bank the right to issue what may be
called an emergency circulation during the crop-moving season (October 1
to January 31). During this period the legal maximum of the circulation
of a bank is its paid-up capital plus 15 per cent. of its combined
paid-up capital and surplus or rest fund. This emergency circulation,
which consists of notes in form and in other respects exactly like the
regular issues, is subject to a tax at a rate not to exceed 5 per cent.
per annum, the rate being fixed by the governor in council. If a bank's
circulation does not exceed its paid-up capital, it pays no tax.
SECURITY OF NOTES
The law is silent on several subjects that seem of great importance to
most bankers in the United States. For instance, it does not require
that the banks shall deposit with a government official, or in any way
set aside any kind of security for the protection of the note holder. It
does not even require that the banks shall carry a cash reserve against
either notes or deposits, nor does the law make the notes a legal tender
for any payment. A bank need not accept the notes of other banks. The
Government does not guarantee the redemption of the notes. Neither does
it bind itself to receive them in payment of dues to itself.
Nevertheless the notes of the Canadian banks are everywhere acceptable
at par, the people apparently not being at all concerned about their
"goodness." And their confidence in the note has been well justified,
for nobody since 1890 has lost a dollar through the failure of a bank to
redeem its notes. Following are the legal requirements, which for twenty
years have proved adequate protection for the note holder:
1. Every bank must redeem its notes at its head office and in such
commercial centres as are designated by the treasury board. The
redemption cities are the same for all the banks. They are Toronto,
Montreal, Halifax, Winnipeg, Victoria, St. John, and Charlottetown.
2. Each bank must keep on deposit with the Minister of Finance a sum of
lawful money (gold or Dominion notes) equal to 5 per cent. of its
average circulation; the total so deposited is called the "circulation
redemption fund." It is a guaranty or insurance fund for use, if need
be, in the redemption of the notes of failed banks.
3. Bank notes possess first lien upon the assets of a bank.
4. Bank stockholders are liable to an assessment equal to the par value
of their stock.
5. A bank must make to the Minister of Finance on or before the
fifteenth of each month a detailed statement of its assets and
liabilities on the last business day of the preceding month. This
monthly return, the form for which is set forth in the act, must be
signed by three general officers.
6. The Canadian Bankers' Association, an incorporated body of which each
bank is a member, is given supervision by the bank act of the issue and
cancellation of notes and of the affairs of a failed bank.
7. The notes of a failed bank draw interest at 5 per cent. from the date
fixed for their redemption by the Minister of Finance, who may redeem
them out of the assets of the bank or out of the "circulation redemption
fund."
IMPORTANCE OF REDEMPTION
Each of these provisions of the law has its value and significance, but
only the first is absolutely essential to the successful operation of
the system. All the other provisions might be changed or abolished
without impairment of the efficiency of the banking system. But the
abolishment of this redemption system would at once give Canada a new
banking system. The bank note is _almost the sole circulating medium_ in
Canada, and the people have confidence in it because it is tested every
day at the clearing houses and proves itself as good as gold. This daily
test would probably not take place with the same regularity as now if
the banks did not have branches or if they were obliged to deposit
security against their issues. Canadian banks are national, not local
institutions. All but a few of them have branches in every part of the
Dominion, and these branches, as fast as they receive the notes of other
banks, either send them in to the nearest redemption centre or convert
them into lawful money--or its equivalent, a bill of exchange--through
branches of the issuing banks located in the same towns. Each bank is
seeking, through its branches, to satisfy all the legitimate needs of
the people for a circulating medium. When the note of a bank is in
circulation it is earning money for the bank, but when it is in the
vault or on the counter of the bank it is an idle and useless piece of
paper. Hence every bank always pays out its own notes through its
branches and sends the notes of other banks in for redemption, thus
increasing its own circulation and _strengthening its own reserve_.
Furthermore, if the banks were not allowed complete freedom of issue
within the prescribed limit, but were required to deposit some form of
security, as is required of the national banks in the United States, an
investment or speculative risk would arise that would inevitably cause
friction. If bonds were designated as security, bankers might often be
tempted by high prices to sell their bonds and forego the profit on
circulation for the sake of making a larger profit by the sale of the
security. Thus the volume of bank notes might contract even at a time
when the people needed more currency. In such case, of course, Canada
would be obliged to import gold in order to fill the gap in the
circulating medium.
THE CIRCULATION REDEMPTION FUND
The 5 per cent. insurance fund for the redemption of the notes of failed
banks is theoretically an important and prominent part of the system,
yet practically it would seem to be of little consequence, for not once
since 1890 has it been necessary to use a dollar of the fund. Banks have
failed, to be sure, but the notes of these banks have always been
redeemed either out of the assets or by recourse to the double liability
of the shareholders. It is a mistake to suppose that the people of
Canada have confidence in bank notes because of the existence of this
redemption fund. The average business man knows nothing about the fund
and if his attention were called to it as being a source of security for
the bank notes, he would probably think a 5 per cent. reserve altogether
too small. The real reason why the people have faith in bank notes is
because the notes are always honored by the banks and never fail to
stand the test of the clearing house. In other words, they believe that
bank notes are good for about the same reason that they believe the sun
will rise in the east every twenty-four hours, and do not bother
themselves about reasons.
Nevertheless this redemption fund does contribute to the strength of the
banking system. It makes each bank to a certain extent liable for the
mistakes of other banks, and as a result gives rise to a spirit of
mutual watchfulness and helpfulness. Other features of the system
contribute to the same result, especially the fact that a Canadian bank
accepts from a depositor without indorsement the notes of other banks.
Since the banks have branches in agricultural and mining communities,
often distant from the railroad by several days' journey, and these
branches are accepting the notes of other banks and giving credit for
them as if they were gold itself, it is evidently important that each
banker should have all possible information with regard to the status
and business of his competitors. As a result one finds among the bankers
of Canada a surprisingly intimate knowledge of each other's affairs.
TWO NEGATIVE QUALITIES
The two negative qualities of the Canadian bank note--its lack of a
legal-tender quality and of a government guaranty--at first sight may
seem to readers in the United States a source of weakness. Yet Canadian
bankers would doubtless all agree that nothing would be gained by making
bank notes legal tender for any kind of payment or by making the
Government in any measure liable for their ultimate redemption. Such
measures would probably be rejected as likely to prove harmful. It would
be like hampering a flying machine with unnecessary bars of steel. Bank
notes, like bank checks, are mere promises to pay money and are more
convenient than money because they can be created as need for a medium
of exchange arises. When either has done the work that called it into
existence, it should disappear from circulation and be redeemed. If it
is made a legal tender like money itself, or if its redemption is
guaranteed by a strong government, there is always the danger that
ignorant classes of people will regard it as money itself and withdraw
it from circulation.
The Canadian Government has nothing to do with the daily redemption of
bank notes and does not guarantee that they shall be redeemed. It is
custodian of the 5 per cent. redemption fund and is under obligation to
redeem the notes of failed banks out of this fund, but if a series of
bank failures should exhaust it the note holder has no guaranty that
government funds will be used for his relief.
The possession by the note holder of a first lien upon the assets of a
bank, including the funds that may be collected from shareholders on
account of their double liability, gives rise to such general confidence
in the ultimate convertibility of a bank note that the notes of a failed
bank, on account of the interest they bear, sometimes command a premium.
As a rule, the notes of such a bank are collected by the other banks and
held until the date of redemption has been named by the Minister of
Finance.
CANADIAN BANKERS' ASSOCIATION
The Canadian Bankers' Association is an incorporated body with powers
and duties prescribed in an amendment to the Bank Act passed in 1900.
Each chartered bank is represented in the membership and has one vote.
The association is required by law to supervise the issue of bank notes
and to report to the Government all over-issues, to look after the
destruction of worn and mutilated notes, and to take charge of suspended
banks. Its headquarters are in Ottawa. The expenses of the association
are apportioned among the banks and do not apparently constitute a very
heavy burden, for the secretary has an exceedingly small staff. All
expenses incurred by the association on account of a suspended bank are,
of course, a charge against the assets of the bank.
When the notes of a bank are so worn or mutilated that it wishes to
replace them with new notes, notice is sent to the secretary of the
association, a date is fixed, and in the presence of the secretary the
old notes are duly counted and taken to a furnace, where they are
consumed in the presence of the secretary and other witnesses. After
this solemn operation has been performed and the signatures of all
parties observing it have been duly attested, new notes are issued by
the association to replace those that have been destroyed.
The clearing houses in the Dominion are subject to regulation by the
association. It also has the power to establish sub-sections and to do
educational work by providing for lectures, competitive papers,
examinations, etc. The _Journal of the Canadian Bankers' Association_, a
quarterly publication of excellent quality, is edited by the secretary
and is at present the only educational force at work among bank
employees.
ELASTICITY OF THE CIRCULATION
While the amount of notes that the chartered banks may issue is limited
by the Bank Act to the amount of their paid-up capital, experience has
proved that this legal limitation is only nominal and that the real and
effective limit is imposed unconsciously and automatically by their
customers and themselves. Each constantly seeks to increase its issue of
notes to the legal limit, yet the combined efforts of all are never able
to force into circulation more notes than the people need.
The reason why an excessive issue of bank notes in Canada is impossible
is found in the two following facts:
1. Every bank must redeem its notes on demand in seven commercial
centres in different parts of the Dominion.
2. The monetary circulation of Canada, exclusive of $1 and $2 bills, and
"change" consists entirely of bank notes.
The redemption system is an automatic and effectual check against
inflation. It is easier to get notes redeemed in Canada than it is to
secure payment of checks in the United States, for the notes are
redeemable at different points throughout the Dominion and no exchange
is ever charged. If a country merchant accumulates more currency than he
desires to keep on hand, he deposits it, together with his checks and
drafts, in the local branch of his bank. This branch immediately sorts
out the notes of other banks and treats them as it does checks and
drafts upon other banks, either sending them to the nearest redemption
agency or using them as an offset in the local clearing house if the
issuing banks have branches in the locality. The branches of a bank are
not obliged to redeem the notes of the parent bank, but must accept them
at par in the payment of all dues. Thus each bank is doing its utmost to
bring about the redemption of the notes of other banks. At the same
time it is paying out its own notes to all customers who ask for cash,
seeking to bring its circulation up to the limit. As a result of these
operations, two powerful forces are constantly at work, one putting
notes into circulation, the other retiring them, and the people of
Canada always have on hand just the amount of currency they need and no
more. It is the people, not the banks, who determine how much the
circulation of the banks shall be.
BANK NOTES HAVE NO COMPETITION
The fact that the bank note has exclusive possession of the monetary
field in Canada is most important. His ignorance of this fact is one
reason why the average banker or business man in the United States has
been unable to get a practical understanding of the Canadian system. Its
significance is easily seen. If Canada, like the United States, had in
circulation a lot of government notes in denominations of $5, $10, $20,
the Canadian banks would be able to increase their issues of bank notes
almost without limit, for their new notes would simply take the place of
the government notes, the latter going into bank reserves. The people of
Canada in making deposits would not discriminate against bank notes, but
would deposit the government paper quite as freely as the bank paper. As
a result, the amount of the government paper in circulation would
gradually decrease and the amount of bank notes would increase. The
volume of Dominion notes in the vaults of the banks would expand, and as
these notes are redeemable in gold the banks would feel justified in
larger extension of their credit, so that an increase in deposits and
current loans would ensue. Under such circumstances such freedom of
issue as is enjoyed by the Canadian banks would doubtless result in
inflation.
But such conditions do not exist in Canada. All the paper currency in
the hands of the people, excepting $1 and $2 bills, is in the form of
bank notes. There is no chance to substitute bank notes for government
notes. Hence, if at any time business relaxes and the need for money
among the people grows less, an increasing tide of bank notes flows into
the banks. The people who bring these notes do not ask for money in
exchange, for to them the notes are money. They take bank notes to the
banks just as people in the United States take greenbacks and silver
certificates--to be exchanged for a deposit credit or account.
NO LIMIT OF ISSUE REALLY NECESSARY
Theoretically there is no reason why any limit should be fixed upon the
amount of notes which a bank may issue. Even though a bank has a
monopoly of issue in a country--like the Bank of France--it nevertheless
is unable to expand its circulation beyond the people's needs. Such a
bank, unless it should adopt a reckless policy of lending which would
bring ruin quickly upon itself, can exercise very little influence upon
the amount of currency in circulation. In a country like Canada, where
several banks are issuing currency, no single institution can enlarge
its issue of notes beyond the needs of its own customers. If it should
endeavor to do this by lending freely to customers who promised to use
its notes in different parts of the country, the effort would be futile.
The notes would quickly find their way into the branches of other banks
and be sent in for redemption.
Like most other countries, however, Canada has placed a limit on the
note-issuing privilege, fixing it at the amount of a bank's paid-up
capital. While there is no scientific necessity that such a limit be
fixed in order to prevent the over-issue of notes, nevertheless there
are other considerations which justify it. It is an indirect method of
compelling banks to increase their capitalization _pari passu_ with the
growth of their business. Inasmuch as the capital of a bank is the
stockholder's contribution toward its assets, it is exceedingly
desirable that this contribution be made as large as possible, for,
other things being equal, the strength of a bank varies with the amount
of its capital. It is not unreasonable, therefore, to require that banks
in return for the useful note-issuing privilege should be required to
keep their capital resources large.
When a Canadian bank has reached the limit of its note issue--which has
rarely happened--it begins at once to treat the notes of other banks
very much as if they were its own. Instead of going to the expense of
sending them in for redemption, it uses them as counter money, paying
them out to depositors in response to their calls for cash. If all the
banks in Canada should issue notes up to the limit, as some of them did
during the exciting months of 1907, and if the current rate of interest
did not warrant the issue of the taxed notes provided for by the
amendment of 1908, the note circulation would immediately lose its
elasticity. As further expansion would be impossible, the banks would
have to meet any increasing demand for currency by paying out gold and
Dominion notes, thus depleting their reserves. Such a situation would
doubtless lead to a sharp advance in the discount rate and to the
importation of gold.
THE PRACTICAL LIMIT UNDER THE LEGAL
It should be noted that the practical limit of note issue is about 10
per cent. below the legal limit. The manager of a bank having a paid-up
capital of $1,000,000 begins to get nervous when his circulation equals
$900,000. His office may be in Montreal and his bank may have branches
in the far East and in the far West and in the mining wilderness of the
North. Some of these branches he can not reach by telegraph and some are
distant a week by mail. He immediately sends warning to all the branches
and cautions them against any large out-giving of notes and against
entering into transactions which will be likely to lead to unusual
demands for currency. On account of this situation, even in times of
greatest pressure, the total issue of the banks is usually 10 per cent.
below the authorized limit.
DEPOSITS
The liabilities of Canadian banks, like those of commercial banks in
Great Britain and the United States, furnish a fairly correct index to
the expansion of the country's credit. Since the Canadians, like other
Anglo-Saxons, make free use of the check book in the settlement of both
business and private accounts, any increase of bank loans and discounts
is usually attended by a corresponding increase in deposits. When a
Canadian business man discounts his note at his bank he almost
invariably leaves the proceeds on deposit with the bank. As he makes
his payments by check his own deposit account declines, but the bank
accounts of his creditors increase, so that the net result of borrowing
in Canada is an increase in the total of bank deposits. Consequently, in
good times, when the banks are freely extending credit, the deposits
grow, and in periods of dullness and liquidation they decline. A growth
of deposits, therefore, is commonly accepted as an indication of
business and industrial activity.
If a business man in Canada has temporarily a large balance in his bank
and realizes that he will not need the money for several months, he will
either arrange for its entry as a time or savings bank account, or for
the payment of interest on his balance as a current account. Of course,
the bankers do not encourage this practice, nor can it be indulged in by
a depositor who is also a borrower. Depositors of the class who are paid
a small rate of interest--usually 2 per cent.--by national and state
banks in the United States, usually have savings department accounts in
Canada and get 3 per cent.
SAVINGS DEPOSITS ALWAYS PAID ON DEMAND
On account of the fact that the time or savings bank deposits contain
such a large proportion of money likely to be needed in business at any
time, the banks regard both classes of deposit as being essentially the
same form of liability. Practically all the deposit liabilities of a
Canadian bank are payable on demand, although payment on two-thirds of
them at the present time can not legally be demanded until after notice.
Custom has made it imperative that a Canadian bank shall pay any and all
of its depositors on demand. For any bank to refuse to let a depositor
have his money when he calls for it would be regarded by the public as
an acknowledgment of weakness. Certainly no Canadian bank would take the
risk of making the experiment.
Canadian bankers feel that 3 per cent. is too high a rate of interest to
pay depositors. This rate is a matter of tacit agreement among the banks
and no single bank can afford to lower it, for such action would cause
it a loss of business. On the other hand, if any bank, hoping to
increase its deposits, should offer to pay 3-1/2 per cent. or 4 per
cent., its conduct would be looked upon with grave disapproval by its
competitors. Some of the new banks in recent years have obtained
business in this manner and have been severely criticised by the
managers of the older institutions.
SAVINGS DEPOSITORS NOT PROPERLY REWARDED
To an outsider it would seem that the savings bank depositor in Canada
is not generously treated. In the United States he gets 4 per cent. on
his savings even in the large cities. In Canada, a country where real
estate mortgages yield from 7 to 9 per cent. and the bonds of new
corporations are selling at prices giving the investor a higher return
than he can get in the United States, it is certain that a real savings
bank could well afford to pay depositors 4 per cent. It is doubtless
true that 4 per cent. is a higher rate of interest than most of the
savings depositors in the chartered banks have a right to expect. A
large part of these deposits are not savings deposits at all.
Nevertheless it is doubtful if the banks would be justified in a
reduction of the rate.
The right solution of the problem seems to lie in another direction,
namely, in the making of a sharper distinction between demand and
savings deposits. The funds received from both classes of depositors
should not be treated alike. The money of savings bank depositors should
be invested in bonds and mortgages and then could be made to yield a net
return of over 5 per cent. If the depositors were not allowed to check
upon their accounts they would be a source of such little expense to a
bank that it could easily afford to pay them interest at the rate of 4
per cent. At the present time the banks are paying 3 per cent. interest
on money which they are lending to commercial borrowers and for the care
of which they are maintaining an expensive force of clerks. Depositors
who have checking accounts might be allowed 2 per cent. on large
balances, but out-and-out savings depositors, people who make no use of
the check book, are certainly entitled to a 4-per-cent. rate in a
country where investment capital is as fruitful as it is in Canada.
Strictly speaking, the savings departments of the chartered banks are
not savings banks, for they do not pretend to devote their time funds
to long-time investments. The amount of securities held by the banks is
never equal to the amount of time deposits.
A thorough reorganization of the savings departments of the chartered
banks, to equip them for the real business of a savings bank, would not
be possible without an amendment to the Bank Act, which now prohibits
them from loaning money upon real estate or upon the security of
real-estate mortgages. It is generally believed that this prohibition is
commonly evaded by the banks through the acceptance of such mortgages as
"additional security" after loans have been made. A savings bank, of
course, must have the legal right to accept such security.
NO BANKERS' BANK
The indebtedness of banks to banks is not large in Canada. The branch
system makes it unnecessary for banks to carry balances in other
institutions located in the financial centres. Nearly every bank has a
branch in either Montreal or Toronto and in these branches carries the
major proportion of its cash reserve, so that branches in the far West
or in the maritime Provinces are always able to sell exchange on
Montreal or Toronto. Canada has no bankers' bank. The Bank of Montreal,
which is the largest bank in the Dominion, its assets being equal to
about 25 per cent. of the total, is often spoken of as the government
bank because it is the largest government depositary, yet it holds a
very small amount of funds belonging to other banks.
AMOUNT OF THE RESERVE FIXED BY EACH BANK
It must not be supposed that the Canadian banks do not carry adequate
reserves. On the contrary, every bank manager gives to this subject
daily and most conscientious thought. To the Canadian banker the word
"reserve" means a fund immediately available for the liquidation of
liabilities. How much this fund ought to be depends altogether upon the
amount and character of the liabilities to be protected.
A Canadian bank manager, having before him the amount of time deposits
and demand deposits, respectively, knowing the probable future needs of
the various depositors, being in constant touch with branch managers
both by wire and by letter, and having back of him information born of
many years' experience, easily determines how much his bank's reserve
ought to be in order to assure its safety. The law neither helps nor
hinders him; it simply requires that the bank shall satisfy the demands
of depositors in accordance with the terms of the contract and that it
shall redeem its notes on demand. The public by force of custom expects
a bank to do a little more than the law requires, for its credit is
bound to suffer if it take advantage of its legal privilege to delay
payment upon time deposits. The manager is a hired man, sworn to do his
utmost to protect the credit of the bank, trained for many years in its
service, familiar with its history and its policy, anxious to guard his
own reputation and character against criticism. Under these
circumstances it would be remarkable if he did not fix the amount of his
bank's reserve nearer the ideal figure--if an ideal banking reserve is
possible--than could possibly be done by a body of lawmakers or of any
other men outside the bank.
COMPETITION IS NOT LACKING
In many respects banking competition is quite as active in Canada as it
is in the United States. Apparently there are only two things which the
banks do not like to do in order to attract business--lower the discount
rate, or advance the rate paid on depositors' balances. There is no
express agreement among the bankers on these points, but every banker
knows that he would become _persona non grata_ among his brethren if he
should discount certain kinds of paper at less than 6 per cent., or pay
his depositors on their monthly minimum balances more than 3 per cent.
per annum. In Montreal and Toronto large borrowers can get money at 5
per cent., but the average merchant and manufacturer must pay 6. In
Winnipeg borrowers can do almost as well, but farther west the usual
rate is 7 per cent., and in some of the remoter districts merchants and
farmers alike pay 8 per cent. Bankers do not believe in lowering the
discount or interest rate unless they are compelled to do so in order
to find a market for their funds.
Some of the older institutions would like to prevent competition from
absorbing the minor profits which come from collections and transactions
in exchange, but they are not entirely successful. The nominal or
schedule charges for collections and exchange are frequently cut for the
benefit of business men whose favor it is desired to propitiate.
In their efforts to get new business, to be the first to open a branch
in a promising new community, or to keep their regular customers from
being dissatisfied, there seems to be the keenest kind of competition.
Few villages of 500 people can complain that their banking facilities
are less than they deserve, and many of them, with barely enough
business to pay the expenses of one branch, are supplied with two. The
recent rapid increase in the number of branches has been caused by the
great expansion of the West and by the competition among the more
progressive and energetic general managers, each desiring that his bank
shall be the first in a promising field, even though his enterprise lead
him to establish branches which at first do not pay expenses. In a new
mining camp the first bank, like the first saloon or the first boarding
house, usually begins business in a tent. Some of the more conservative
bank managers in Canada think that new branches are being started in
excess of the country's needs, but others are willing to take chances on
the country's future and to charge considerable sums to the debit side
of the profit and loss account in order to keep their institutions at
the front in the great and developing West.
BANKING IN DIFFERENT PROVINCES
It is generally known that the Eastern branches get heavy deposits and
are creditors of the head office, and that the funds they collect are
forwarded to the Western branches, whose loans greatly exceed deposits.
Bankers will admit that this transference of funds takes place, but
there is considerable grumbling about it in the old communities of the
East, and the bankers fear that a monthly or even annual publication of
the facts would keep them perpetually in hot water. A glance at
clearing-house statistics leaves no doubt as to the banking importance
of the Western Provinces or as to the relative financial quietude of the
East. Between 1900 and 1909 the total of Canada's bank clearings
increased 227 per cent., but Halifax gained only 23 per cent., St. John
only 90 per cent., and Quebec only 68 per cent. On the other hand,
Toronto's clearings increased 179 per cent., Winnipeg's 600 per cent.,
and Vancouver's 524 per cent.
EASTERN PROVINCES HAVE SUFFERED
This transference of funds from sluggish to active communities is the
inevitable result of a system of branch banking and is the cause of the
tendency of the rate of interest toward uniformity in all parts of
Canada. Whatever may be said against a system of branch banks, there can
be no question that it does bring about a more even distribution of
capital in a country than is possible under a system of independent
local banks. Canadian bank managers are anxious to put out their money
where it is most wanted, for there they get the best possible rate of
interest and obtain paper of the best quality. No matter where a
manager's headquarters may be, he is most deeply concerned in three
questions: (1) Where is idle money accumulating? (2) How can he best
draw it into his bank? (3) In what parts of the Dominion is money most
needed? In localities of both kinds he establishes branches; in the one
the branches accumulate deposits often much in excess of their loans, in
the others the loans exceed the deposits. Thus it happens that the
savings of the Eastern Provinces, where the growth of industry and trade
is slow and the demand for new capital is not increasing, are sent
westward and loaned out to merchants and manufacturers and farmers of
the new territories. The people of the East supply the capital for the
development of the West, though many of them perhaps are entirely
ignorant of the useful purpose their savings are made to perform. In the
western cities of Canada one hears no talk among business men about the
scarcity of capital. A merchant or manufacturer in Manitoba gets the
money he needs as easily as does the merchant or manufacturer in
Toronto or Montreal.
Justifiable as the bank's policy is from a national point of view, one
can not help believing that the branch banking system has really checked
the development of business and industry in the maritime Provinces. If
Canada during the last thirty years had depended, like the United
States, upon independent local banks, there would have been a plethora
of capital in the East, and Montreal, Quebec, and Halifax, like Boston,
New York, and Philadelphia, would years ago have had 4 and 5 per cent.
money, while Winnipeg and other Western cities, less populous than now,
would still be paying 1 per cent. a month. The relative cheapness of
capital undoubtedly helped build up the prosperous industries of
Massachusetts. The same cause operating in the maritime Provinces of
Canada would doubtless have led to the establishment there of industries
of which the people under existing conditions have not ventured to
dream.
LARGE USE OF DEPOSIT CURRENCY
It is sometimes assumed that a free and large use of bank notes tends to
discourage the use of the check book and the growth of bank deposits. On
the continent of Europe, for instance, where the notes of central banks
supply all the currency the people need, the check book is comparatively
little used. This fact is sometimes explained by the ease with which
people can obtain bank notes for use in making all payments. Experience
in Canada makes one doubt the validity of this explanation. The check
book is almost as popular there as in the United States, and would
probably be used still more than it is if the banks would adopt a policy
as liberal as that in vogue in the United States. The Canadian banks not
only charge exchange on checks and drafts payable in other localities,
but even charge exchange on checks drawn on their own branches. The
charge is a small one and probably has no great effect one way or the
other, yet it certainly does not encourage the increase of deposits or
the use of the check book. When a Canadian starts on a journey it is in
a small way economical for him to fill his wallet with all the cash he
expects to need. The notes of his bank will be taken at par everywhere
throughout the country; his checks, even though he presents them at a
branch of his bank, will be cashed only at a discount.
Notwithstanding this discrimination against the check, the deposits of
Canadian banks have grown much more rapidly than the note circulation
and the inference is that the volume of deposit currency has increased
at the same rapid pace. Since 1900 the volume of notes has increased
approximately 60 per cent., while the deposits by the public showed a
gain of 155 per cent. These figures prove that business men in Canada
appreciate the advantages of the check as a means of payment, and that
the proportion of business transactions settled by it is steadily
increasing.
BANKS SILENT PARTNERS IN INDUSTRY
A large part of the so-called commercial paper of Canadian banks is
secured practically by title to goods in warehouses, factories, and
wholesale stores. Such security is more saleable than stocks and bonds,
and paper having such security back of it is therefore better banking
paper than notes secured by stock-market collateral. So far as would
seem possible the Canadian Bank Act makes merchandise of all kinds a
sort of collateral security for bank advances. It assumes that if a bank
advances capital for the conduct of a business it should have a claim
upon all the assets of the business and upon all goods as they come and
go in the course of trade. No matter how a merchant's stock may change
in character, it all belongs to his bank in case he fails to take up his
paper or meet his engagements. In the same way a manufacturer's stock of
goods, the raw material and the finished products, no matter how they
change from day to day and month to month, will become the property of
his bank if he fails to pay his note. The law practically makes every
bank a silent partner in many wholesale and manufacturing businesses and
gives it many rights which no ordinary silent partner can acquire. It
has the effect naturally of making bankers keep a close eye upon
business conditions as well as upon the affairs of their individual
borrowers. Canadian bankers are interested in the lumber market, in the
prices of metals, in changes in the tariff, and in the acquisition of
foreign markets for Canadian manufactures and products, even as the Wall
Street banker is interested in the prices of stocks and bonds. He is in
a sense the owner of merchandise of all kinds, and both trade and
financial news has equal significance to him.
A CUSTOMER'S LINE OF CREDIT
In Canada the banks are managed by men whose long experience in the
business has taught them to avoid certain banking practices that are in
vogue in other countries. Realizing how important is the relation
between a bank and its customer, they believe that this relation should
be made as intimate and helpful as possible. Among Canadian bankers,
therefore, it is part of the law and gospel of banking that a bank is
entitled to full knowledge of the financial condition and business
operations and prospects of its customers. Hence a bank insists that its
customers shall rely _entirely upon itself_, that they shall make a full
statement of their affairs at least once a year, and that they shall
begin each year with a clean slate.
As a result of this policy a business man in Canada deals exclusively
with one bank. Once a year he arranges with his bank for a line of
credit and learns exactly the amount of paper he will be able to
discount. If he happens to need less than he anticipated, he will not
exhaust the credit allowed by the bank and will pay interest, of course,
only upon such portion of the bank's funds as he actually utilizes. If,
on the other hand, his business is unexpectedly large, giving
opportunity to make bigger profits and creating the need for more
capital, he will find the bank ready to increase his line of credit,
provided the manager is satisfied that business conditions and prospects
warrant expansion. Under no circumstances, however, must the customer of
a bank seek to raise funds elsewhere unless he first gets the consent of
his bank. If he sells his notes in the open market, he must do it with
the full knowledge of his bank or run the risk of being placed upon the
"black list."
As one would naturally expect, there is very little commercial paper
floating about in the Canadian money market. The bill broker is unknown.
Wholesalers and manufacturers, unless shipping to foreign countries, do
not draw upon their customers. If credit is granted, it takes the form
of a book account or of a promissory note.
The promissory notes received by a manufacturer or wholesaler are
deposited with his bank. The book accounts under ordinary conditions
remain entirely at the disposal of the business, but in extraordinary
cases, when the situation is not satisfactory, or if an additional
credit at the bank is desired, an assignment of the book accounts to the
bank may be required.
During the harvest season heavy drafts are made upon the resources of
the banks to provide for the movement of the grain crops of the West. In
its advance of money for this purpose the law makes it possible for a
bank always to have abundant security. Under section 88 of the Bank Act
the buyer makes assignment to his bank of the grain purchased. When the
grain is delivered to a railroad, the bill of lading becomes the
property of the bank. When it reaches Port Arthur, or some other
distributing point, and is stored in an elevator, the bank receives a
warehouse receipt in exchange for the bill of lading; and when shipment
is made to New York, to Montreal, or to Europe, the bank receives on
surrendering the warehouse receipt the shipper's draft on the consignee,
the bill of lading, and other documents. Throughout the entire
transaction, from the purchase from the farmer to the final sale to the
Eastern consumer, the bank practically has title to all agricultural
products which are being moved by means of its funds.
LOANS TO FARMERS
The branches of Canadian banks in agricultural districts quite commonly
lend assistance to farmers. They do not make a practice of taking
mortgages on farm property, but lend outright on the farmer's credit,
depending for their security upon his character as a man and ability as
a farmer, and often as well upon a neighbor's indorsement. Farmers'
paper ranks high among the Canadian bankers and constitutes a
considerable proportion of the assets of some of the banks. The banks,
of course, do not undertake to supply the farmer with anything more than
working capital. They do not help him pay for his land and buildings,
but they do let him have at least part of the money he needs for tools,
wages, seed, stock, etc. Despite the fact that these advances are
unsecured by mortgage, the banks suffer very little loss on farm paper.
CALL LOANS IN CANADA AND ELSEWHERE
After "current loans in Canada" the next largest item among the assets
is "call and short loans elsewhere than in Canada." The call loans
outside of Canada consist mainly of loans in the New York market and are
as a rule secured by collateral easily convertible into cash. These
loans are regarded by Canadian bankers as equivalent to cash and are
figured by them as part of their reserve. Only the larger banks make a
practice of loaning on call in New York.
THE BANKS AS FINANCIAL INSTITUTIONS
That the chartered banks of Canada are financial as well as commercial
institutions is evidenced by their holdings of stocks and bonds. These
securities represent partly an investment carried as a secondary reserve
and partly a business carried on for the benefit of their customers. In
Canada the demand for long-time investments is not large, but whatever
market there is for securities is mainly in the hands of the chartered
banks. An investor seeks the advice of a bank manager and often is able
to obtain from him securities which satisfy his needs. The banks do not
publish a list of their holdings, but it is generally taken for granted
that they carry only gilt-edge securities. If a customer desires to
obtain second or third rate securities, being eager for a high rate of
return, a bank can accommodate him, not by selling him out of its own
stock, but by negotiating the purchase of the desired securities in New
York or London.
As the wealth in Canada increases and idle capital accumulates in excess
of its immediate needs, this financial side of the business of Canadian
banks will doubtless expand. It may, indeed, during the next generation
or two greatly expand and become an important feature of the chartered
banks. They are in a position to take care of the business as it
develops and will doubtless be able to prevent the establishment of any
purely financial banking houses in Canada.
THE REVISION OF THE BANK ACT, 1913[148]
The Canadian Bank Act, as is well known, is subject to decennial
revision. The last revision was due to take place in 1910; but owing to
circumstances which it is not necessary here to describe, it was not
until the present year that the work was finally undertaken. The leading
features of the Canadian banking system are so well known that they may
be passed over, and the nature and causes of the recent changes in the
act alone described. There were many minor modifications, but the
essential changes effected were: (1) provision for a shareholders'
audit, (2) the creation of central gold reserves, and (3) the providing
of additional facilities for making loans to farmers.
In the recent revision of the act the public was most deeply concerned
with the problem of securing an adequate system of bank inspection. The
immediate reason for this was the disastrous failure of the Farmers'
Bank. This institution had gambled away its resources on the Keeley
mine; and had, in its failure, brought many farmers as well as others to
the verge of ruin. For several years previous, however, there had been
an insistent demand for some sort of external bank inspection....
The banks as a whole have been opposed to any change in the method of
inspection. The reason they advance is that the keynote of the
organization of Canadian banks has always been the centralization of
responsibility; and they do not think it wise to divide that
responsibility with any outside authority....
As far as the public is concerned it has no means of judging of the
soundness of a bank except by examining the monthly returns which are
required by law from each bank. These returns are fairly comprehensive,
and have been made more so by the revision of the act this year. The
Minister of Finance may call for supplementary information from any
bank, whenever, in his judgment, such data are required to afford a
fuller knowledge of a bank's affairs. Of course, these returns can be
taken only for what they are worth. In the case of several failed banks
the returns were made with every degree of falsification, because no
independent checking of the figures was possible.
Nevertheless, in obedience to the strong demand for some sort of
independent bank examination, provision was made in the recent revision
of the act for a shareholders' audit of each bank's affairs. The
auditors are to be chosen by the shareholders from a list of forty names
selected by the whole body of the general managers of the banks. The
list must be submitted to the Minister of Finance for his approval. If
one-third of the shareholders of a bank are dissatisfied with the
auditor appointed by the majority, they may appeal to the Minister for
the appointment of another auditor.
The auditors must submit a statement of their findings to the
shareholders at the annual meeting, or on any other occasion the
necessity may require. In addition the Minister of Finance may require a
special return to be made to him, the cost of the service rendered being
paid for by the Government.
Canadians would be wise not to expect too much from this system of
external examination. After all, it can do no more than verify a bank's
statements and books.... In every large undertaking, the soundness of
the transaction must depend, as before, upon the judgment of the general
manager and the board of directors.
The establishment of central gold reserves is the most important feature
added to Canada's banking system by the legislation of 1913.... Under
the new act each bank may issue any amount of notes that it may desire,
provided that it deposits with a board of trustees, at Montreal, gold or
Dominion notes to the full amount of the notes issued. These notes are
to be identical in form with the ordinary notes of the bank. The gold or
Dominion notes deposited with the trustees shall be returned to the bank
whenever the notes which the bank has outstanding do not amount to the
paid-up capital of the bank together with the amount of legal-tender
money deposited with the trustees. In other words, the banks can still
issue their notes up to the full amount of their paid-up capital, and an
additional amount from September 1 to the end of the following February,
which may equal 15 per cent. of a bank's combined capital and surplus.
It is only for notes issued in excess of these amounts that legal-tender
money must be deposited with the trustees at Montreal. It should be
observed, however, that the banks pay a tax of 4 per cent. on the extra
issue during the crop-moving period, whereas there is no tax upon
gold-reserve notes. And as Canadian banks are not required to keep a
legal reserve against their demand liabilities, there is no reason why
the idle gold in their reserves should not be sent to Montreal to form
the basis of new note issues, especially when it is considered that the
gold may be recalled at once when no longer needed to cover notes.
The ability to issue notes to any amount required, on a gold basis, will
greatly strengthen the position of the banks.
The third important new feature in the revision of the act is the power
given to the banks to make loans to farmers on grain which is stored on
the farm and still in the farmer's possession.... The permission granted
them to loan money to farmers on stored grain in the latter's possession
is an attempt to extend to the farmers aid similar to that hitherto
granted to manufacturers and wholesalers alone. It should not be
thought, however, that the banks have not always granted loans liberally
to farmers....
The possibility of making advances to the farmers on their grain is
expected to be of especial benefit to the West.... It is hoped that,
under the new legislation, the farmer will be able to hold his grain for
higher prices; and in the meantime secure accommodation from the banks
to meet his obligations. Many bankers, however, refuse to see any remedy
for the situation in the new legislation. They maintain that it will
involve too much risk to extend loans on grain over which the farmer
continues to assert control. Only the operation of time will enable us
to estimate the value of this feature of the act.
COMPARATIVE FIGURES OF CONDITION OF CANADIAN BANKS[149]
ASSETS
Nov. 30, 1915 June 30, 1914.
Gold and subsidiary coin--
In Canada $41,831,732 $28,948,841
Elsewhere 29,527,921 17,160,111
----------- -----------
Total $71,359,653 $46,108,952
Dominion notes 140,751,331 92,114,482
Deposit with Min. of Finance for security
of note circulation 6,770,645 6,667,568
Deposit in central gold reserves 15,100,000 3,050,000
Due from banks 169,429,330 123,608,936
Loans and discounts 881,101,540 925,681,966
Bonds, securities, etc. 121,953,898 102,344,120
Call and short loans in Canada 83,203,787 67,401,484
Call and short loans elsewhere than in Canada 135,530,562 137,120,167
Other assets 76,993,424 71,209,738
-------------- --------------
Total $1,702,194,170 $1,575,307,413
LIABILITIES
Capital authorized $188,866,666 $192,866,666
Capital subscribed 114,422,866 115,434,666
Capital paid up 113,987,275 114,811,775
Reserve fund 112,718,473 113,368,898
------------ ------------
Circulation 124,153,685 99,138,029
Government deposits 36,001,548 44,453,738
Demand deposits 538,764,279 458,067,832
Time deposits 714,219,286 663,650,230
Due to banks 30,973,072 32,426,404
Bills payable 5,081,059 20,096,365
Other liabilities 14,007,918 12,656,085
-------------- --------------
Total, not including capital or reserve fund $1,463,200,847 $1,330,488,683
NOTE.--Owing to the omission of the cents in the official reports, the
footings in the above do not exactly agree with the totals given.
FOOTNOTES:
[147] Adapted from Joseph French Johnson, _The Canadian Banking System_,
Publications of the National Monetary Commission, Senate Document No.
583, 61st Congress, _2d Session_.
[148] W. W. Swanson. _The Revision of the Canadian Bank Act_, American
Economic Review, Vol. 3, December, 1913, pp. 993-998.
[149] _The Commercial and Financial Chronicle_, Vol. 102, January 1,
1916, p. 13.