SOUND BANKING
If it is indisputable, therefore, that the confidence of the
individual, and therefore the confidence of the nation, is based in
the soundness of banking, we must see if that confidence be justified
or not. I have, indeed, already said that it is justified. I must give
reasons why I think so.
What is banking? What is soundness of banking? These terms must be
defined.
I do not know if a definition of banking has been given that is
universally acceptable. I know what the vague conception of banking is,
but if a precise, explicit definition has ever been given, agreed upon
unanimously by economic theorists, and accepted as the right and only
formula, I am ignorant of that fact.
I consult Nuttall, and he describes a bank as an establishment which
trades in money, by receiving, lending, exchanging, etc. He does not
say it is an establishment which trades in credit, by receiving,
lending, and exchanging credit, etc. This definition may be false and
misleading, and Mr. Nuttall may have been deplorably ignorant of the
functions of a bank, but as, in my opinion, it is as good a definition
as I have met with in economic and financial works, I will accept it.
At any rate, I consider it in no wise false or misleading.
A bank trades in money. This is indisputable. A bank receives money.
This is indisputable. A bank lends money. This is indisputable. A bank
exchanges money. This also is indisputable.
What money does it trade in? We know there are various kinds of money.
Legal tender currency is but one kind of money. Cheques, bills of
exchange, securities, and even commodities are other kinds of money.
Even if the legislature declared that only legal tender shall be money,
the legislature could not by this declaration alter the laws of nature
and of economics. It can make one kind of money legal tender, but it
cannot destroy the law that anything used for exchange purposes is
money. If a beggar steals a watch and afterwards exchanges the watch
for a decent shirt, the watch and the shirt become money. They perform
the functions of money and the functions prove that they are money.
A bank trades in money subscribed by its own shareholders and money
deposited with it by the public. A bank in the course of time finds
itself in the possession of what it describes as its deposit and
current accounts. These accounts, it is popularly supposed--included
in the populace are political economists and City financiers--are the
aggregate of the money placed with a bank by the public and the money
with which it mainly trades.
These are called a bank’s liabilities, its immediate liabilities the
redemption of which can legally be demanded at a moment’s notice. It is
because they can be so demanded that banks are ever faced with a grave
potential peril.
It is necessary to clear the way by destroying a delusion. This money
on deposit is not entirely money placed in the keeping of a bank in the
same fashion as one would keep money in a safe. This fact, in my view,
is of great importance. Only a portion of these deposits is what we may
call in an indefinite way pure deposits. By pure deposits I mean money
placed with a bank that is not a direct loan. If I place £100 of my
savings in a bank, instead of investing it, I call that a pure deposit,
and this money I can withdraw without the subtraction of a farthing at
a moment’s notice.
But we have already seen, from our analysis of a bank’s balance
sheet in Chapter III, that these deposits are not all pure deposits.
A considerable portion of them consists of loans to all kinds of
people, loans made on the security of various kinds of wealth. That
is to say, the bank owes money to these so-called depositors and the
depositors owe that money to the bank. The depositors have the power,
of course, to withdraw the entire sum of money lent to them temporarily
by the bank; but the bank, in due course, has the power to claim the
redemption of the loans. Not only has it this power to call in these
loans, but it actually possesses the equivalent of the loans in a
portion of the country’s wealth.
It is possible--but the wisdom or unwisdom of it need not be discussed
here--for the legislature to enact that only pure deposits should
be withdrawable at a moment’s notice, and that borrowers should be
compelled in times of panic or vital urgency to give long notice. I
merely say that this is within the power of the legislature to enact,
but I do not say here that it is practicable, necessary, or wise.
I merely throw out the hint here in order to emphasize the importance
of the distinction between pure deposits and loan deposits. The latter,
I have already urged, may be regarded as the product of the machinery
for converting wealth into currency, or liquid capital. From a sound
banking standpoint the vital question to be considered and answered is
as to the kind of wealth that is so converted.
Sound banking is to be tested by the nature of the wealth so converted,
or, in the language of the financial community, the wealth on which
loans are made.
Others argue that this is a matter of quite secondary and even
third-rate importance. They contend that the matter of supreme and
vital importance is the amount of gold a bank holds in proportion to
its liabilities in deposits. Should there be some differentiation
here? Should it be the amount of gold held in proportion to its pure
deposits, and not in proportion to its aggregation of pure deposits
and loan deposits? For the loans, as we have seen, are automatically
redeemable.
If, say, a bank habitually holds gold to the proportion of 15 per
cent. of its aggregate deposits, and if half these deposits are loans,
then the gold Will be equal to 30 per cent. of its pure deposits, a
proportion much higher than the figure advocated by those who agitate
seriously and zealously for higher gold reserves.
We have seen many small banks go under in recent years. This was in
some cases because they lent their money on what I will call bad
wealth. In other words, because they gambled and speculated with the
money of their depositors. Here we have some evidence that the general
public are unable to discriminate between sound and unsound banking.
This may be deplorable ignorance, but it is not culpable ignorance. It
is to a great degree inevitable ignorance.
The matter is dismissed by the quidnuncs saying that fools deserve
their misfortune, they should have placed their money in sound banks.
We should not so readily denounce them as fools. The Government is
not without its most serious responsibility in the matter. It should
not allow such money-lending establishments to describe themselves as
banks. The Government has a moral duty to protect the public, and it
would not be at all difficult to take steps to this end. It should
allow only those establishments to call themselves banks that are
conducted upon sound banking principles.
Joint stock banks have a legal safeguard. Though they are under
compulsion to repay deposits, they are under no legal compulsion to
repay them in gold. They must repay them in legal tender, and they can
fulfil their legal obligations by paying out in legal tender notes.
These, of course, are Bank of England notes and now the new Treasury
emergency notes.
This being so it is immaterial, or it should be immaterial, whether
the reserve of a bank consists of gold or legal tender notes. If it
can redeem its liabilities in notes and has sufficient notes for its
purpose, it can consider itself safe and can securely stand in a
crisis. The notes can, of course, be taken to the Bank of England and
be exchanged there for gold; but this is immaterial to a bank which has
successfully met the peril of a run.
Soundness of banking consists in the soundness of the wealth that
constitutes a bank’s assets. We know there are infinite degrees and
categories of wealth. But it is easily possible to discriminate and
know exactly which is the highest class of wealth in the country.
Banks do and must speculate to some extent. It is unavoidable. If they
did not speculate they would not incur bad and doubtful debts. But
they must keep their speculations within the most prudent limits. This
most of them undoubtedly do. Traders complain that they are, indeed,
too cautious in this respect, that they do not lend freely enough.
There have been, indeed, most bitter complaints on this head since the
outbreak of the war.
But we cannot reasonably insist upon banks being ultra-cautious, and in
the same breath complain of their cautiousness. We cannot reasonably
insist upon them keeping large gold reserves, thereby diminishing their
loan capacity, and with equal reason insist that they shall lend with
increased liberality.
This is as impossible as trying to reach two goals simultaneously, when
each lies in a direction opposite to the other. The man in the street
would say you cannot eat your cake and have it.
When a bank lends to a man or firm on good security, it cannot be sure,
of course, that that man or firm will be able to pay off the loan when
it falls due.
We may, if we wish, call this a speculative chance, but the bank is
considerably safeguarded by the security it possesses.
Public confidence is based, therefore, upon the soundness of banking
methods. It is an article of belief with us that banks become gravely
imperilled when confidence breaks down. It is when confidence is
destroyed that runs on banks commence. Fear seizes the public, it
develops into panic, depositors clamour for their deposit money, and
banks either successfully meet these runs, or close their doors. But so
long as confidence is strong and unimpaired, sound banks keep safe.
The safety of banks depends, therefore, upon this feeling of confidence
in them, and this feeling of confidence, in its turn, is based upon
the intelligence and common sense of the public. Up to now this
intelligence and common sense have been triumphant. They have triumphed
in a crisis unparalleled in the history of the British Empire, in that
very crisis, in fact, which the prophets always feared would show their
superficiality and vulnerability.
The predictions of the prophets have not been realized. This is because
human genius and human wisdom have been mightier than human fear and
apprehension, because the nation had supreme faith in the Government,
in the economic strength of the Empire, and in the might of its navy
and army.
And if the prophets have prophesied falsely in this supreme situation,
they are just as likely to prophesy falsely in other potential
emergencies.