THE CURRENCY OF CUSTOM
A simple illustration has been given of how we entrust our money with
a bank and how a bank employs it. Let us in our next step analyse a
typical balance sheet of a big bank, for it will help us to get a
clearer notion of the functions of a bank and of the character and
complexity of the money market.
_Dr._
£ _s._ _d._ £ _s._ _d._
TO CAPITAL AUTHORISED 30,000,000 0 0
To Capital ISSUED 3,000,000 0 0
To Reserve Fund 1,125,000 0 0
To Amount due by the bank
on Current, Deposit, and
other Accounts 37,583,237 8 11
To Acceptances on account of
customers 3,153,328 7 11
To Rebate of Interest on Bills
discounted, not yet due,
carried to new account 53,807 1 3
To Amount of Nett Profit 225,676 10 1
---------------------
£45,141,049 8 2
=====================
_Cr._
£ _s._ _d._ £ _s._ _d._
By Cash in Hand and at the
Bank of England 5,996,667 14 8
By Money at Call and Short
Notice 5,674,476 5 1
----------------- 11,671,143 19 9
By INVESTMENTS--
Consols and other Securities
of, or guaranteed
by, the British Government,
of which £35,000
(Stock) is lodged with
public bodies 2,488,966 12 6
By Indian, Colonial Government
and other Securities 3,771,738 10 11
----------------- 6,260,705 3 5
By Bills Discounted 6,811,870 13 8
By Loans, Advances, other Accounts
and Securities 16,218,748 12 6
By Liabilities of Customers for
Acceptances as per contra 3,153,328 7 11
By Freehold and Leasehold
Premises 1,025,252 10 11
-------------------
£45,141,049 8 2
===================
On the liability side the capital issued is the amount paid up by
shareholders, capital which the bank has employed in the ordinary
course of its business. It represents a contingent liability to these
shareholders, who have invested their capital for the sake of the
return in the shape of dividends. The large sum of thirty-seven and
a half millions is the most important item. This is the real working
capital of the bank. It is apparently the aggregate amount deposited by
the public with the bank.
This is what the bank owes to its clientele.
But the deposits are not solely money actually placed with the bank.
This huge sum includes the loans the bank has made to other customers,
to its borrowers. Every loan makes an additional deposit. The man who
borrows a sum of money from the bank is credited with that sum and the
credit appears in the current accounts. The bank has security for this
loan, and, as already pointed out, this security is liquefied into bank
currency. Cheques can at once be drawn against it so long as the loan
runs and cheques are the country’s currency. Securities, therefore,
have been converted into national currency and indirectly into legal
tender.
The more, therefore, a bank lends the more do its deposit and current
accounts grow.
The reserve fund speaks for itself. It is generally a fund accumulated
annually out of profits and invested in the best securities. The larger
the reserve in proportion to the capital and business the stronger is
the bank’s position. It is a provision against future contingencies and
is not touched except for these contingencies. One purpose is to meet
depreciation in investments or other losses. The money being invested
in the highest securities these can be sold for cash whenever the need
for it arises.
The acceptances on behalf of customers are also practically covered
by securities deposited by customers, until they lodge the funds to
meet the bank’s liabilities in this direction. The net profit is the
fund due to the shareholders of the bank, who receive their dividends
therefrom.
On the asset side, the cash in hand and at the Bank of England consists
of coin and notes. A portion of this is in the tills and safes of the
bank in order to meet the ordinary daily needs, the incomings and
outgoings, while the rest is money deposited with the Bank of England
in precisely the same way as an individual deposits money with a joint
stock bank. It serves two purposes. It composes an additional reserve
there in legal tender, and facilitates the clearings between the
various banks, debits and credits being daily adjusted in the books of
the Bank of England.
It is contended by many that the banks do not keep reserves large
enough in proportion to their liabilities--reserves, that is to say, in
actual legal tender. It is contended that they trade on too slight a
margin of gold, or legal tender; but this question must be threshed out
when the way has been cleared for it.
The next item is the money at call and short notice. This is
practically the money lent by the banks to money brokers, stock
brokers, and discount houses. Money at call practically means that
the bulk of it is lent from day to day and that banks can demand
its repayment at a moment’s notice. The money is also borrowed on
security, so that while the banks owe the money to the borrowers
and the borrowers owe the money to the banks, the banks have the
securities. These securities thereby become currency. They can also
become currency if the public will accept them as currency, but the
public prefers cheques to securities. The greater convenience of
cheques need not, of course, be emphasized.
It will be seen that a bank’s “investments” are a large sum. They
include the reserve fund, and the bank’s annual income is, of course,
swollen by the interest it receives on these investments, in the same
way as an individual’s income is increased. These investments are of
the very highest class and strengthen the assets the bank possesses
against its liabilities on deposits. It is presumed, of course, that
they can be readily sold for cash should the need for the conversion
arise.
Bills discounted reveal the character of another source of income. They
represent investments in another high-class security. A few bills may
be discounted directly on behalf of customers, but the bulk are bills
re-discounted from the discount houses. Bill brokers discount bills at
a certain price and the banks re-discount them at a lower price, and
both, therefore, make a good aggregate profit out of the business. Bill
brokers are practically the middlemen between merchants and the banks.
These bills of discount being an investment and a sound security
are thereby liquefied into ordinary currency and ordinary capital,
capital which the merchant is able to use in the ordinary course of
his business, while the nation at large benefits from the increased
capital employed and the greater production and consumption that are
the immediate fruits of it.
The largest item on the asset side is the composite one of “loans,
advances, other accounts and securities.” These include customers’
overdrafts and advances to customers on all kinds of security and
estate, and may, perhaps, be regarded as the least liquid or the least
readily realizable assets a bank has. In this item are its chief risks,
and, perhaps, the soundness of banking is best judged by the size of
this account. The larger the size the greater, presumably, are the
risks; the smaller the size the less are the risks.
But the aggregate forms a portion of the wealth of the community. A
customer gives some kind of security when he overdraws his account. But
all this composite wealth, of whatever class its component elements may
be, is, by the machinery of the bank, converted into currency. These
loans amount to nearly half the liabilities on deposit and current
accounts, therefore additional currency to this amount can be placed
in circulation. If no banks lent on such wealth there would be less
potential capital in circulation; the capital would be as stationary
and as unfruitful as hoarded coin. While, therefore, the bank owes this
sum to the borrowers, giving them power to draw cheques against it or
to take out the whole sum in cash, the borrowers owe the money to the
bank; for the loans interest has, of course, to be paid according to
the class of security lodged. This interest is one of the chief sources
of a bank’s income.
The liabilities of customers for acceptances has been explained. They
offset the item on the liability side. They may be regarded as a
moderate source of a bank’s income, and this class of business has to
be done with great care. As for the bank’s premises, this is its own
property in which it must do its business, and it is self-explanatory.
Having analysed a typical bank balance sheet, we are able to see the
kind of business a bank conducts and the valuable functions it performs
on behalf of the community. A bank is in reality a manufacturer of
currency--not of legal tender currency, but the currency of custom.
The Government does not provide this necessary machinery, so the banks
provide it, and we can imagine what would happen to the country if the
machinery broke down, or if it were compulsorily stopped.
This custom currency has become so much an integral part of the
economic and financial structure of the country, that even our
tax-gatherers will accept a cheque as readily as sovereigns. Our
currency is to all intents and purposes a paper currency, the soundness
of which is rarely questioned. It is not legal tender currency, but it
is as vital to the well-being of the nation as legal tender currency.
The other paper currency is Bank of England notes and, since the war,
Treasury £1 and 10_s._ notes. Even though the whole of these notes may
not be convertible into cash, they are legal tender simply and solely
because the legislature has enacted that they shall be legal tender.
This is, of course, something outside custom. If the legislature were
pleased to do so, it could enact that cheques on certain specified
banks should be legal tender, just as it arbitrarily enacted that the
new Treasury notes, issued without any gold backing at first, should be
legal tender, equal to the amount of their face value in gold.
I wish to emphasize the distinction, therefore, between the currency of
custom--something that has grown up out of the needs of the community,
something essential to its welfare and progress, the product of an
advanced stage of economics and of civilization--and the currency
called legal tender. Though debts are paid and are payable in custom
currency, the power of this currency to redeem debt could be destroyed
in certain circumstances, the circumstances of a panic. They may be
remote circumstances, but, remote as they are, they raise deep problems
which to this day are discussed with energy and heat.
Ought the Government to provide machinery more adequate than that it
does provide to meet the currency needs of the nation? This is one
aspect of the problem. Some say it ought to provide it, some say this
does not come within its province. It is left to the banks to provide
that currency as best they may and quite apart from their methods
of providing it, it is indisputable that they administer to a vital
economic need. If, therefore, they administer to that need, should the
Government come to their assistance in those circumstances which cause
a collapse of their machinery?
This question has been answered in part by the Government since the
outbreak of the war. It helped the machinery to work, and provided
against a possible collapse by issuing “emergency” currency notes.
The Government having acknowledged an emergency and established a
precedent, the problem is now much simplified.