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                                BANKING


                                  BY

                    William A. Scott, Ph.D., LL.D.

          Director of the Course in Commerce and Professor of
           Political Economy in the University of Wisconsin


                                CHICAGO
                          A. C. McCLURG & CO.
                                 1914


                               Copyright
                          A. C. McCLURG & CO.
                                 1914

                         Published April, 1914

                     Copyrighted in Great Britain


                 W. F. HALL PRINTING COMPANY, CHICAGO




EDITOR'S PREFACE


In Europe the average man looks upon the bank as a benefactor. Through
its agency he secures capital at low rates for his business. In
America the bank is too often regarded as a necessary evil, certainly
not with affection. Yet it plays a most important rôle in the nation's
economy. Our banking laws are obsolete, unsatisfactory, and actually
in some instances detrimental to the best and widest use of the
nation's resources. Europe has many lessons for us in the problem of
how best to use our accumulations. With agriculture demanding and the
railroads calling for more capital, the question of scientific banking
assumes new proportions. This book, with its chapters on commercial
and investment banking, will help to a better knowledge.

                                                            F. L. M.




AUTHOR'S PREFACE


The purpose of this book is to supply the general reader with a simple
statement of the principles and problems of banking. Since it is
designed primarily for American readers, special attention has been
given to conditions in this country. An effort has been made clearly
to draw the line between commercial and investment banking and to
indicate the problems peculiar to each. That it may assist the average
person in understanding present-day banking problems and thus
contribute towards the formation of a sound public opinion regarding
them, is the author's hope and desire.

                                                       WM. A. SCOTT.

  _University of Wisconsin._




CONTENTS


                                                                PAGE

  Chapter I. The Nature, Functions, and Classification of
             Banking Institutions,                                 1

    1. Services Performed by Banking Institutions,                 1
    2. The Economic Functions of Banks,                            4
    3. Classification of Banking Institutions,                     6

  Chapter II. The Nature and Operations of Commercial Banking,    11

    1. Commercial Paper,                                          11
    2. The Operation of Discount,                                 13
    3. The Conduct of Checking Accounts,                          15
    4. The Issue of Notes,                                        19
    5. Collections,                                               22
    6. Domestic Exchange,                                         25
    7. Foreign Exchange,                                          31

  Chapter III. The Problems of Commercial Banking,                35

    1. The Supply of Cash,                                        35
    2. The Selection of Loans and Discounts,                      40
    3. Rates,                                                     44
    4. Protection against Unsound Practices,                      46
        (a) Capital and Surplus Requirements and Double
            Liability of Stockholders,                            46
        (b) Inflation and Means of Protecting the Public
            against It,                                           49
        (c) Other Means of Safeguarding the Interests of
            the Public,                                           59
    5.  Adequacy and Economy of Service,                          62

  Chapter IV. Commercial Banking in the United States,            68

    1. State Banks,                                               68
    2. National Banks,                                            70
    3. The Independent Treasury System,                           75
    4. The Interrelations of These Institutions,                  78
    5. Operation of the System,                                   82
        (a) Conflict of Functions and Laws,                       82
        (b) Loan Operations,                                      85
        (c) Treasury Operations,                                  88
        (d) Operation of the Reserve System,                      91
        (e) Lack of Elasticity in the Currency,                   95
    6. Plans for Reform,                                          97

  Chapter V.  Commercial Banking in Other Countries,             101

    1. Common Features,                                          101
    2. The English System,                                       104
    3. The French System,                                        111
    4. The German System,                                        119
    5. The Canadian System,                                      126

  Chapter VI. Investment Banking,                                136

    1. Saving and Savings Institutions,                          136
    2. Trust Companies,                                          141
    3. Bond Houses and Investment Companies,                     144
    4. Land Banks,                                               147
    5. Stock Exchanges,                                          163
    6. Some Defects in Our Investment Banking Machinery,         166

  References,                                                    171

  Index,                                                         173




BANKING




CHAPTER I

THE NATURE, FUNCTIONS, AND CLASSIFICATION OF BANKING INSTITUTIONS


The terms, "bank" and "banking," are applied to institutions and to
businesses which differ considerably in character, functions, and
methods, but which nevertheless have certain common features which
justify their being grouped together. We can best prepare the way for
a discussion of these differences and common features by a description
of the services which these institutions perform in modern society.


_1. Services Performed by Banking Institutions_

From the point of view of their customers these services may be
grouped under the following heads: The safekeeping of money and other
valuables; the making of payments; the making of loans; and the making
of investments. It is a common practice everywhere, and in some
countries, notably the United States, almost a universal practice for
people to intrust their money to banks for safekeeping. To a degree,
hoarding, in the sense of locking up money in private vaults and other
receptacles and keeping it under the eye and in the personal care of
the owner, is still practiced, but it is doubtless on the wane in all
civilized countries. The practice of intrusting to banks the
safekeeping of other valuables, such as important documents, jewelry,
plate, etc., is also widespread and growing.

The service of the safekeeping of money naturally leads to the second,
the making of payments. When we intrust our means of payment to a
bank, it is natural that we should also make it our treasurer and
disbursing agent, and so we do. If we have payments to make to people
at home, in other cities of our own country, or in other countries, we
usually order our bank to perform the service for us.

Loans of almost all kinds are made by banks, and certain kinds,
namely, those to business men for the everyday conduct of commerce and
industry, are made almost exclusively by them. For the most part these
are short-term loans. For long-term loans banks are also one of the
chief resorts, but in some countries these are not to so great a
degree monopolized by them as the short-term variety.

For the investment of the surplus funds of people banks are the chief
agencies. This function takes the form mainly of the sale of stocks,
bonds, and mortgages, and sometimes of the promotion of new
enterprises.

None of these services are performed by banks exclusively. For the
safekeeping of valuables, and sometimes of money, there are in some
places safe deposit companies to which the term "banks" is not
applied. In the making of payments the post office departments of
governments and express companies participate, and in the making of
loans and investments brokers, loan companies, lawyers, etc.,
participate. The peculiarity of banking institutions consists not in
the performance of any one of these services, but in the fact that
they specialize in them all, or in a combination of them. Merely to
keep money and valuables on deposit, or to act as paymaster, or to
make loans, or to sell bonds, stocks, and mortgages would not make an
institution a bank or an individual a banker; but to make a business
of performing most or all of these services for the public involves
the use of certain machinery and certain methods of procedure, and the
assumption of a rôle in the nation's economy which is distinctive and
peculiar, and which has set these institutions apart in every country
as objects of legislation and of scientific treatment, as well as in
the thought and regard of the people.


_2. The Economic Functions of Banks_

Viewed from the standpoint of the nation rather than from that of
individuals, the functions of banks may be described as those of
intermediaries in exchanges and in the investment of capital. In the
former capacity they supply the world with the major part of its
medium of exchange and serve as distributing agents for that portion
of the supply which comes from other sources. They create a medium of
exchange through a process of bookkeeping which is world-wide in
extent, and through which the mutual indebtedness of individuals,
cities, and other subdivisions of countries and nations, brought about
by purchases and sales on credit, are offset without the use of money.

The practice of depositing surplus funds with banks for safekeeping
and consequently of using them as paymasters has resulted in the
reliance of everybody upon banks for currency in any form, and has
thus thrown upon them the responsibility of directly utilizing all the
sources of money supply. Thus while the mints of the United States and
most other countries coin gold bullion, and supply subsidiary silver
and copper and nickel coins to private persons on the same terms as to
banks, as a matter of fact few private persons take advantage of this
privilege, finding it more convenient and profitable to get the coin
they want from banks. The same is true of government notes in
countries in which such notes constitute a portion of the currency.

The accumulation of a nation's capital and its investment require the
cooperation of numerous agencies of which banks are the chief. They
collect the savings of the people, combine them into amounts of
sufficient size for investment purposes, and invest them temporarily
and sometimes permanently. Cooperating agencies in this work are
insurance companies, societies of various kinds for the promotion of
saving, stock exchanges, promoters, etc. Some of these take the place
of banks in the performance of these services, while others supplement
and aid them.


_3. Classification of Banking Institutions_

Banks differ from one another chiefly in the nature and degree of
their specialization, in legal status, and in the place they occupy in
the system to which they belong. Some banks devote the major portion
of their effort to the conduct of exchanges and are called
_commercial_ banks, others to investment banking and are called
_investment_ banks. The most common subclasses under the latter head
are savings banks, land or mortgage banks, and bond houses. Savings
banks specialize in the collection and investment of small savings;
land banks are primarily intermediaries between capitalists and people
who wish to invest capital in land, building operations, and
agriculture; and bond houses are intermediaries between capitalists
and those who wish to invest capital in industrial, commercial, and
transportation enterprises, or loan it to states, cities, or other
public corporations.

Commercial banks rarely confine themselves exclusively to the conduct
of exchanges. Most of them also conduct savings departments and invest
the funds intrusted to them through such departments in agricultural,
industrial, or commercial enterprises or loan them to public
corporations. Commercial banking, however, is their main concern,
their other departments being side issues of greater or less
importance according to circumstances. Investment banks also
frequently carry on commercial banking as a side issue. These two
lines of business are sometimes mixed in such proportions as to render
classification difficult.

From a legal point of view the banks of nearly all countries may be
classified as _private_ or unincorporated, and _incorporated_,
sometimes also called joint-stock banks. Private banks are started by
individuals or firms, like any other private enterprise, without the
formality of application for permission to some public officer, and
without compliance with a set of legally prescribed regulations. They
are subject to the laws of the country governing all kinds of private
business enterprises and sometimes to special laws applying
specifically to them. In some of the states of the United States such
banks are prohibited by law.

Incorporated banks are usually started by private initiative but owe
their actual legal existence and status to a special law, to the
requirements of which they must conform before they are permitted to
do business. Their right to do business is usually evidenced by a
document known as a charter, executed and delivered by a public
officer legally endowed with the requisite authority, or passed in the
form of a law by the legislative organs of the state. Charters of the
latter kind are known as special charters and are rarely used
nowadays, except in the case of institutions of a peculiar character,
endowed with special functions. The central banks of Europe owe their
existence to such charters, as did also the first and second United
States banks. In the early history of the United States special
charters were uniformly employed by the states, but for many years
general incorporation laws have been the rule, on compliance with the
requirements of which persons who desire to incorporate banks can
secure charters.

In federal states, both the federal government and the governments of
the constituent states frequently have and exercise the right to
incorporate banks. In the United States, banks incorporated by the
federal government under the terms of a general law, originally passed
in 1863 and many times amended since that date, are known as
_national_ banks, and those incorporated by the states under the
terms of general banking acts or of general incorporation laws are
known as _state_ banks. These latter are endowed with privileges which
enable them to exercise commercial and some investment banking
functions. Other banks also are incorporated by our states under the
terms of general laws, which are known as savings banks and trust
companies. The former, as the name implies, are institutions primarily
designed for the encouragement, collection, and investment of savings.
The latter are called trust companies because the earliest
institutions of this type made the execution of trusts of various
kinds their exclusive business. Banking functions were later added and
in many cases have now assumed chief importance.

The nature of the banking business requires some kind of organization
of the individual institutions in which certain ones will assume to a
degree at least the rôle of bankers' banks. In most European countries
this position is occupied by single institutions specially chartered
and endowed with special privileges and usually described as central
banks. Examples are the Bank of England in England, the Bank of France
in France, and the Imperial Bank of Germany in Germany. Around these
are grouped the other institutions in a kind of hierarchy, certain
large banks in the larger cities forming centers about which smaller
institutions group themselves. In the United States there is no single
central institution, but a small group of banks in New York City are
the real centers of the system. Around these are grouped the banks in
the other large cities of the country and these in turn perform
important services for banks in the surrounding smaller towns and
country districts.




CHAPTER II

THE NATURE AND OPERATIONS OF COMMERCIAL BANKING


In the preceding chapter commercial banking has been defined as the
conduct of exchanges by means of a world-wide process of bookkeeping.
We must now describe this process. Its essential features are the
discount of commercial paper, the conduct of checking accounts, and
the issue of notes.


_1. Commercial Paper_

By commercial paper is meant the credit instruments or documents which
the credit system now in general use throughout the commercial world
regularly brings into existence and liquidates.

The essence of this system is buying and selling _on time_. The farmer
buys seed, implements, fertilizer, labor, etc., and pays for them
after the crops have been harvested and sold. The manufacturer buys
raw materials and pays for them after they have passed through the
transformation process which he conducts and the completed goods have
been marketed. He frequently sells them to jobbers or wholesalers on
time and these in turn sell them on time to retailers and these to
consumers. Farmers, manufacturers, and merchants both buy on time and
sell on time, and are thus both debtors and creditors, and each
expects that his sales will ultimately pay for his purchases.

The obligations involved in these transactions are represented and
recorded in the form of book accounts, promissory notes, or bills of
exchange, the latter being written or printed, or partly written and
partly printed, orders of creditors on debtors to pay to themselves or
to third parties the sums indicated. These documents are being
constantly made and constantly paid as the processes of agriculture,
industry, and commerce proceed. Indeed, their creation and liquidation
is a normal phenomenon of our modern economic life.

The term commercial paper, as we are using it, applies to such
promissory notes and bills of exchange as belong to this credit
system. It does not apply to such notes and bills when they owe their
existence to credit operations of a different kind, such for example
as accommodation loans or investment operations. Indeed, the
essential characteristic of commercial paper is not revealed in the
form of the credit document but in the fact that it is a link in this
chain of exchange operations by which modern commerce is carried on.

This use of the term should also be distinguished from the one common
among bankers and others. In this popular usage these documents are
called commercial paper because they are themselves objects of
commerce. In our use of the term the adjective "commercial" applies to
them only when they play the rôle of intermediary in a process of
exchange through credit. In this sense it is a matter of indifference
whether they pass through the hands of brokers or not, and the fact of
their being objects of purchase and sale does not confer the quality
of commercial paper upon documents having an origin and character
other than that above described.


_2. The Operation of Discount_

Every person in this chain of credit is confronted with the problem of
paying his debts as they mature by the use of the amounts due him from
other people. Since it is rarely possible to arrange maturities on
both sides in such a way that the amounts due to be paid him at a
given date shall at least equal those he is due to pay on that date,
some means of transforming claims against other people due in the
future into present means of payment must be found. The one
universally employed is the discount of commercial paper. By this is
meant the exchange at a bank of his own promissory notes due at times
when debts of equal or greater amount due him mature, or of bills of
exchange drawn against his debtors, for cash or credits on a checking
account. These latter are available as means of payment at any time.

As a consideration for this accommodation, the bank charges interest
for the period intervening before the maturity of the paper
discounted. Sometimes this charge is paid at the time the paper is
purchased and sometimes at the date of its maturity. The term
"discount" technically means taking interest in advance by making
available as means of present payment in any of the above mentioned
forms a sum less than the amount the bank expects to collect at the
date of the maturity of the discounted paper. If the interest is paid
when the discounted paper matures, the process is technically called
a loan. However, since the time of collecting interest makes no
essential difference in the nature of the transaction, the process is
commonly described as the discount of commercial paper, regardless of
whether the interest is collected in advance or not.


_3. The Conduct of Checking Accounts_

A checking account is an ordinary book account on which are credited
the cash deposited by a customer and the proceeds of collections,
loans, and discounts made on his behalf, and on which are debited
payments made to him in cash or on his behalf to other people or to
the bank itself. These payments are made on orders signed by the
customer and known as checks.

The ordinary customer of a commercial bank every day brings to the
bank the cash he receives as the result of the day's business, and the
checks received, drawn on his own and other banks, and is credited
with the amount on the books of the bank as well as on a passbook
which he himself retains. If he needs cash during the day, he presents
to the bank a check payable to himself for the amount needed, and
receives the kinds and denominations wanted; and if he wants to make
payments to his creditors in other forms than cash, he sends them
checks on his bank payable to their order, or a check drawn by his
bank on some bank in another place, usually called a draft, which he
has obtained by exchanging for it a check drawn to the order of his
bank. To the amount of these payments his account at the bank is
debited, and from time to time his passbook is left at the bank for
the entry therein of the debits made to date and its subsequent return
to him.

The customer must take care that his account is not overdrawn, that
is, that the debits on his account do not exceed the credits, since
overdrafts, except by accident or for very short periods and small
amounts, are not allowed in this country, and in other countries,
where they are allowed, they must be provided for in advance by a
special agreement between the bank and the customer, which usually
involves the deposit with the bank of ample security. In order to
avoid overdrafts, the customer in this country agrees with his banker
on what is known as a "line," that is, a maximum amount of loans or
discounts to be allowed. Whenever his credit balance falls to a
certain minimum, also established by agreement with the bank, the
latter discounts for him the paper of his customers, that is, bills of
exchange drawn on them or their promissory notes in his favor, or his
own promissory notes. The proceeds of these discounts are credited on
his account like deposits of cash or of checks for collection.

So long as the discounts are confined to commercial paper the bank's
part in these transactions consists almost exclusively of bookkeeping
between its customers and between itself and other banks. Ordinarily,
what is debited on one man's account is credited on another's, the
cash received nearly balancing that paid out. To the extent that the
cash receipts and payments do not balance, the bank either has a
surplus or is obliged to provide for the meeting of a deficit. The
means available for this latter purpose will be explained in
subsequent sections, as well as some of the details of this
bookkeeping process. For the present it is important to note precisely
how the discount of commercial paper is related to this bookkeeping
process.

As explained in Section 1, commercial paper is an essential part of
the process of exchanging goods through credit. A person buys on time
and sells on time and expects to pay for his purchases by the
proceeds of his sales. So long, therefore, as the processes of
commerce and industry proceed in a normal fashion, the paper
discounted by a bank will be paid at maturity and the credit balance
created by means of such discounts offset by corresponding debits.
Ordinarily the credits created through discounts during a given
period, say a day or a week, in favor of one set of customers will be
balanced during this same period by the payment of notes previously
discounted for other customers. Within a complete trading area this is
certain to happen, since purchases and sales of goods are equal and
what is credited to one man is debited to another.

The result is very different if a bank discounts investment paper,
that is, credit documents which represent the unproductive consumption
of individuals or of public and private corporations, or which
represent the purchase on time of the instruments of production rather
than the production of goods through the use of such instruments and
their transfer from the producer to the consumer. The means of payment
of such documents can only be created gradually by the application of
the profits of the enterprises in which the investments were made, or
by taxes spread over a series of years, or by a slow process of
saving. If a bank issues its own demand obligations in exchange for
such documents, it cannot make its books balance and it will be
constantly exposed to the danger of forced liquidation. If it attempts
to protect itself by requiring that the discounted paper shall mature
in a short period, the necessity of liquidation will be forced upon
customers who are responsible for the payment of the discounted paper;
that is, such customers will be obliged to sell at such prices as they
can command the property in which the investments were made, or some
other property. Such liquidation always results in forced
readjustments of prices and business depression, and sometimes in
commercial crises.


_4. The Issue of Notes_

As an alternative for or a supplement to the conduct of checking
accounts a commercial bank may issue its promissory notes payable to
bearer on demand. By the issue of notes is meant their transfer to
customers in exchange for cash, for checks left for collection or
drawn against a credit balance in a checking account, or for
discounted notes and bills.

By the use of these notes commercial banking can be carried on
without checking accounts. In that case the notes are issued in
exchange for cash and discounted bills, and notes are returned to the
bank in exchange for cash or when discounted bills or notes mature and
are paid. In the bookkeeping process which has been described bank
notes thus issued and returned perform precisely the same function as
checking accounts, and are related to the discount of commercial paper
and the credit system of the country in precisely the same manner as
such accounts.

Most banks of issue at the present time conduct checking accounts
also, using the one instrumentality or the other as their customers
desire. In this case notes are issued in exchange for checks drawn
against credit balances on checking accounts or deposited for
collection as well as in exchange for discounted notes and bills and
cash.

By the use of both notes and checking accounts, a bank can supply most
of the needs of its customers for a circulating medium, the notes
serving as hand-to-hand money, and the checking accounts, practically
all other purposes. Being the direct obligations of banks attested by
the signatures of their responsible officers, and being payable to
bearer on demand and capable of being issued in all necessary
denominations, such notes can be transferred without indorsement, can
be used for making change and payments of small and moderate size for
which checks are not convenient, and they do not need to be presented
at a bank for the test of their validity. If the bank or banks which
issue them are properly conducted and supervised and properly
safeguarded by law, such notes will circulate freely through the
length and breadth of a country.

Checking accounts meet in the most satisfactory manner all currency
needs for which hand-to-hand money is not well adapted, such as large
payments and payments at a distance. With a few strokes of a pen
payments of the greatest magnitude can be made through their agency.
Checks can be sent through the mails at slight expense and without
danger of loss of the amount involved. By the devices known as
travelers' and commercial letters of credit, checking accounts supply
the most convenient form of currency for travelers and for merchants
engaged in foreign trade.

Besides bank notes and checking accounts the only forms of currency
needed in any community are standard and subsidiary coins, the former
for use as ultimate redemption material for all other forms of
currency and for the payment of international and other balances, and
the latter for small change. Even these forms of currency are supplied
by commercial banks, but since they do not create them, ways and means
of procuring them in the quantities needed constitute one of their
peculiar problems.


_5. Collections_

One of the most important functions of commercial banks is the
collection for their customers of checks and drafts drawn on other
institutions. When these documents are received, the accounts of
customers who deposited them are credited with the amounts, less a
small fee for collection, unless by agreement this service of
collection is performed free of charge. The checks are then assorted
according to the banks upon which they are drawn and the cities in
which those banks are located.

Checks drawn upon home banks are collected either through messengers
who present the checks at the counters of the banks upon which they
are drawn and secure payment therefor, or through the local clearing
house. This is a place where representatives of the banks meet for the
exchange of checks. After the representative of each bank has
distributed all the checks held by his institution against the others
participating in the clearing, and received from them those drawn
against his bank, a balance sheet is prepared showing the balance due
by or to his bank after the total of the checks distributed has been
balanced against the total received. If said balance is adverse, it is
paid to the master of the clearing house, and if it is favorable, it
is received from him.

The checks received through the clearing house or presented by
messengers from other banks and paid, are debited to the accounts of
the persons who drew them and returned to such persons as vouchers,
the net result of the entire transaction being the same as if all the
parties involved had been customers of a single bank, with the
exception that some means of paying balances had to be found. Since
balances are sometimes paid by checks on some central institution in
which credit balances may be obtained by rediscounts of commercial
paper, this necessity can be met without the use of any form of
currency other than that furnished by banks themselves.

Checks drawn upon out-of-town banks are, in this country, collected
through so-called correspondents. Each bank enters into an
arrangement with a few other banks, distributed throughout the country
and conveniently located for the purpose, by which the correspondent
bank agrees to conduct with it a checking account on which it will
credit at par or at a stipulated discount the checks sent it for
collection and debit checks drawn against such an account. A
comparatively small number of such correspondents suffices, since
certain banks in the larger cities, by making a business of such
collections, conduct checking accounts with a large number of banks,
and can thus make collections by mere transfers of credits on their
own books or by the use of the local clearing house. The so-called
reserve cities in this country constitute clearing centers for the
territories contiguous to them, and New York, Chicago, and St. Louis,
for the entire country.

Checks received from correspondents and drawn against themselves are
debited to the accounts of the customers who drew them and returned as
vouchers in the same manner as checks received through the clearing
house or paid over their own counters.

Through this interchange of checks between banks and the conduct of
checking accounts with each other, intermunicipal and international
exchanges are conducted through the bookkeeping processes of
commercial banks with the same ease and economy as are exchanges
between people living in the same town.


_6. Domestic Exchange_

The accounts of a bank with its correspondents are a record of the
transactions of its customers with the outside world, the checks they
receive as a result of sales to outsiders of merchandise, real estate
or other property, or as a result of gifts by outsiders to them being
credited on such accounts, while the checks they draw or the drafts
they purchase in payment for merchandise, real estate or other
property purchased of outsiders, or of gifts made to them are debited.
When in a given period, say a day or a week, the receipts of the
customers of a bank from outsiders, as a result of current or past
sales and gifts, exceed the payments made by them as a result of
purchases and gifts, its credit balances with its correspondents will
increase, and under opposite conditions they will decrease. If the
payments should continue in excess for a considerable period, the
credit balances of a bank with its correspondents would be exhausted
and some means of replenishing them would have to be found, and under
the opposite conditions too large a portion of the bank's resources
would accumulate with its correspondents and some means of withdrawing
funds would have to be found.

When a bank needs to replenish its credit balances with its
correspondents, it may ship cash or purchase drafts from other home
banks, which it can send to its correspondents for collection like
checks deposited in the ordinary course of business. The latter
resource will of course be available only when these other banks'
balances with their correspondents are not exhausted. Should the
balances of all the banks of a town with their out-of-town
correspondents be nearly or quite exhausted, shipments of cash to
correspondents could not be avoided. If a bank wishes to withdraw
funds from its correspondents for home use, it may order cash shipped
or it may, perhaps, be able to sell drafts for cash to other home
banks.

The expenses involved in shipments of cash, loans, or purchases or
sales of drafts for the purpose of replenishing balances with or
withdrawing them from out-of-town correspondents, give rise to what is
called the _rate of exchange_. If, in order to make out-of-town
payments for its customers, a bank is obliged to pay the expense of
shipping cash to its correspondents or to pay a premium on drafts
purchased from other banks, the natural method of reimbursement will
be a premium charge on drafts sold equal to the amount of the expense
incurred. If it wishes to withdraw a balance with its correspondent,
since to order cash shipped will involve expense, it will be glad to
sell drafts for cash at a discount not to exceed such expense.

The rate of exchange, or the price of drafts on a given point, may,
therefore, fluctuate between a premium equal to the cost of shipping
cash to that point and a discount of the same amount. Beyond these
extremes, these fluctuations cannot ordinarily go, because customers
may demand cash of their banks in payment of checks against their own
credit balances and ship it to their out-of-town creditors at their
own expense, and would do so if the rates charged on drafts should
make such procedure profitable. The actual rate of exchange will not
ordinarily reach either of these extremes, on account of competition
either between the banks which are desirous of selling drafts on their
correspondents or between those which are forced to buy as an
alternative to cash shipments. If the aggregate balances of the banks
of a town with their out-of-town correspondents are large and
increasing, the pressure to sell drafts will be greater than that to
buy and the rate of exchange will go to a discount, the amount of
which, however, will be fixed by competition between the selling
banks. In the opposite case, the rate will go to a premium and be
fixed by competition between the buying banks.

In most towns in the United States there is little or no competition
between banks in the business of buying and selling drafts and
consequently no open market for exchange and no quotations of exchange
rates. In such cases each bank acts more or less independently;
shipments of cash to or from correspondents are the ordinary means of
regulating balances; and the cost of such shipments are charged to the
general expense account of the bank and taken out of customers either
by a fixed and more or less invariable charge on drafts sold, or in
other ways.

Since the balances of the banks of a town with their out-of-town
correspondents depend primarily upon the commercial and gift relations
of their customers with the outside world, it is pertinent to inquire
whether as a result of a long continued excess of purchases from
outsiders over sales to them and of gifts to over gifts from them, the
cash resources of a community might not be completely exhausted, and
if not, how such an outcome is prevented.

Bankers have no direct control over the purchases and sales of their
customers, but through the rate of interest they charge on loans and
discounts and their ability absolutely to discontinue such
accommodations they exert a very potent indirect influence. The rates
of interest and discount charged are an important element in the cost
of doing business and, if loaning and discounting is discontinued,
sales of property to meet maturing obligations are forced, with the
result of price readjustments between the town in question and the
outside world which speedily change the relations between purchases
and sales.

When the cash resources of the banks of a town approach the limit of
safety and their balances with their correspondents fall to an
ominously low point, the normal method of procedure is to raise the
rates on loans and discounts, and if conditions grow worse, to raise
them higher still and as a last resort to cease temporarily to make
them at any price. By increasing the cost of doing business this rise
in the rates will check purchases by diminishing or annihilating the
profits resulting, and will stimulate sales by rendering it more
profitable for some customers to secure funds by sales to outsiders at
lower prices than were formerly asked rather than by borrowing from
banks. Under ordinary circumstances this procedure will be sufficient
to change an unfavorable into a favorable balance of indebtedness with
the outside world, with the result that more checks on outside
institutions will be deposited with the banks and a smaller amount of
drafts purchased. Bankers' balances with their correspondents will,
therefore, increase, and with them their ability to command cash in
case of need. The demands made upon them for cash will also decrease,
since the volume of loans and of business transacted will fall.

If the banks stop discounting, a more or less violent readjustment
with the outside world results. Business men who have obligations to
meet, and most of them will belong to this class, are obliged to sell
their goods and property at whatever prices are necessary and to stop
purchasing entirely. The outcome, so far as the banks are concerned,
is as above indicated. If conditions are such that sales at any price
cannot be forced, a crisis ensues; that is, business operations are
temporarily suspended and transfers of property in settlement of
obligations are made through bankruptcy and other court proceedings.


_7. Foreign Exchange_

The business relations between banks located in different countries do
not differ in any essential respect from those between banks located
in the same country. Interchange of checks, the conduct of checking
accounts, shipments of cash, and borrowing and lending proceed in the
same manner as between domestic institutions. The chief peculiarities
of the foreign exchanges are due to the fact that different units of
value and sometimes different standards must here be reckoned with,
and that the precious metals, chiefly gold, are used in the settlement
of balances. Drafts drawn in the United States on English points, for
example, call for the payment of pounds sterling, those on French
points for francs, and those on German points for marks, while all
must be paid for in dollars.

The translation of the language of values of one country into that of
others thus involved requires the calculation of a so-called _par of
exchange_. By this is meant the relation between the weights of pure
metal contained in their respective units of value, if the countries
in question have the same standard, and the relation between the
market values of the metallic content of their units, if their
standards are different. Thus the par of exchange between this country
and England is $4.8665, since our dollar contains 23.22 grains of pure
gold and the English pound sterling 4.8665 times as many grains, or
113.0016. Our par of exchange with France is 19.294 cents, the
quotient of 4.4802, the number of grains of pure gold in the French
franc, divided by 23.22. Between China and the United States the par
of exchange is the market value in our dollars of the amount of silver
contained in the tael, the Chinese unit.

Another technical term employed in connection with the foreign
exchanges is _the gold points_. These are the points above and below
the par of exchange fixed by the addition in the one case, and the
subtraction in the other, of the cost of shipping gold between the two
places in question. They are the points between which the rates of
exchange fluctuate, or the points at which, when the rate of exchange
reaches them, gold moves between gold standard countries. Assuming
for example, that the cost of shipping gold between New York and
London is two cents per pound sterling, the gold points are 4.8865 and
4.8465, it being profitable to ship gold from New York to London when
sterling exchange reaches the former figure and to import gold from
London when it reaches the latter figure.

In the conduct of the foreign exchanges several classes of bills are
employed upon which the quotations differ, in part on account of
differences in their quality and in part on account of the interest
element entering into the value of time bills. For example, New York
regularly quotes on London _cables_, _demand_, and _sixty-day_ bills.
The rates on a certain date were: Cables, 4.8860; demand, 4.8790; and
sixty days, 4.8370. Inasmuch as these are all bankers' bills and
consequently of the same quality, the differences in their quotations
are due to the interest element and to the fact that in the case of
the cables the cost of the cablegram is included.

When a New York banker sells a cable on London, his balance with his
correspondent is reduced by the amount in a few hours, and the
interest he receives on such balances is proportionately diminished at
once, and he is also out the cost of the necessary cablegram. When he
sells a demand bill, his account with his London correspondent remains
undiminished during the time required for sending the bill by mail
across the Atlantic and for its presentation for payment. He draws
interest on his entire balance during this period. When he sells a
sixty-day bill, his balance does not suffer diminution on its account
for sixty days. In order to place these bills on a footing of equality
so far as he is concerned, therefore, he must quote demand and
sixty-day bills lower than cables; the former by the cost of the
cablegram plus interest on the amount of the bill, say for ten days,
at the rate he receives on his London balance, and the latter by the
amount of the cablegram plus interest on the amount for sixty days at
the same rate.

Trade, or mercantile, as well as bankers' bills are also frequently
and, in some markets, regularly quoted. Being of a quality ranked as
inferior to bankers' bills, they must be negotiated at a lower rate
and are quoted accordingly.




CHAPTER III

THE PROBLEMS OF COMMERCIAL BANKING


The conduct of commercial banking presents problems both to the
bankers and to the public, the methods of solution of which will be
given attention at this point. The problems concerning the bankers
primarily may be grouped under the heads, supply of cash, selection of
loans and discounts, and rates; and those which primarily concern the
public may be grouped under the heads, protection against unsound
practices, and adequacy and economy of service.


_1. The Supply of Cash_

The credit balances on checking accounts and the notes of commercial
banks are payable on demand in the legal-tender money of the nation to
which they belong, and such banks must at all times be prepared to
meet these obligations.

The term employed to designate the funds provided for this purpose is
_reserves_, and in this country they consist of money kept on hand
and of credit balances in other banks. In other countries there is
also included under this head commercial bills of the kind which can
always be discounted. The term _secondary reserve_ is sometimes
employed in this country to designate certain securities, such as
high-class bonds listed on the stock exchanges, which can be sold
readily for cash in case of need.

The amount of reserve required can be determined only by experience.
In ordinary times it depends chiefly upon the habits of the community
in which the bank is located regarding the use of hand-to-hand money
as distinguished from checks and upon the character of its customers.
These habits differ widely in different nations, and considerably in
the different sections and classes of the same nation. In most
European and Oriental countries, for example, checks are little used
by the masses of the people, while in the United States and England
they are widely used. In these latter countries, however, they are
less widely used by people in the country than in the cities, and by
the laboring than the other classes in the cities. Within the same
city one bank may need to keep larger reserves than another on account
of the peculiarities of the lines of business carried on by its
customers and the classes of people with whom it deals.

In times of crisis and other periods of extraordinary demand, bank
reserves must be much larger than in ordinary times. Hoarding,
unusually large shipments of money to foreign countries and between
different sections of the same country, and payments of unusual
magnitude, increase the demands for cash made upon banks at such
times.

The manner in which clearing and other balances between banks are met
also has an influence on the amount of reserves required. If such
balances are paid daily and always in cash, the amount needed for this
purpose is much larger than if they are paid in checks on some one or
a few institutions and at longer intervals.

The note issue privileges of a bank also affect its reserve
requirements. Since, if not prohibited by law, notes may be issued in
all denominations needed for hand-to-hand circulation within a nation,
and since for all purposes except small change such notes are as
convenient as any other form of currency, a bank with unrestricted
issue privileges can supply all the demands of its customers for
currency for domestic use, except those for small change, without
resort to outside sources of supply. In this case, however, it needs
to keep a reserve in order to meet demands for the redemption of
notes. Such demands arise on account of the need of coin for small
change or for shipment abroad or of means for meeting domestic
clearing and other bank balances. The aggregate needed for the supply
of such demands, however, is much less than would be required if the
privilege of issuing notes did not exist.

In the maintenance of reserves the chief reliance of commercial banks
is the circulation of standard coin within a nation and the
importation of such coin. The coin within the borders of a nation
passes regularly into the vaults of banks by the process of deposit,
and on account of the credit balances they carry with foreign
institutions, the loans they are able to secure from them, the
commercial paper they hold which is discountable in foreign markets,
and the bonds and stocks sometimes in their possession which are
salable there, they are able to import large quantities in case of
need. Since the standard coin in existence in the world adjusts itself
to the need for it in substantially the same manner that the supply of
any other instrument or commodity adjusts itself to the demand, banks
ordinarily have no difficulty in supplying their needs, and under
extraordinary circumstances, though difficulties along this line
sometimes arise, means of overcoming them are available which will be
discussed in the proper place.

If, as is the case in the United States, certain forms of government
notes are available as bank reserves, these find their way into the
banks' vaults by the process of deposit in the same manner as coin.
The possession of such notes by a bank enables it, to the extent of
their amount, to throw the responsibility for the supply of standard
coin upon the government, and in the circulation of the country such
notes take the place of an equivalent amount of standard coin. Whether
or not a government ought to assume such a responsibility is a
question which will be discussed in a subsequent chapter.

For the nation as a whole, the balances in other banks and the
discountable commercial paper and bonds which a bank may count as a
part of its reserves are not reserves except to the extent that they
may be employed as a means of importing gold. They are only means
through which real reserves of standard coin are distributed. The
payment in cash of a balance with another bank or the discount of
commercial paper with another domestic bank or the sale of bonds on
domestic stock exchanges do not add to the sum total of the cash
resources of the banks of a nation. Their only effect is to increase
the cash resources of one bank at the expense of another.

Adequate facilities for the distribution of the reserve funds of a
country, however, are second in importance only to the existence of
adequate supplies of standard coin. If such facilities are lacking,
existing reserves can be only partially and uneconomically used, with
the result that much larger aggregate reserves are required than would
otherwise be necessary and that the entire credit system is much less
stable than it otherwise would be.


_2. The Selection of Loans and Discounts_

The problem of the reserves is vitally connected with that of the
selection of loans and discounts. As was shown in the preceding
chapter, the chief business of a commercial bank is to conduct
exchanges by a process of bookkeeping between individuals, banks,
communities, and nations. This process consists primarily in the
converting of commercial bills and notes into credit balances and
bank notes, in the transfer of such balances and notes between
individuals and banks, and in the final extinguishment of such
balances and the return of such notes at the maturity of the
commercial bills and notes in which the process originated.

In this process there is little need for cash, provided the
arrangements between banks for clearing checks and for the interchange
of notes are complete and efficiently administered. But when a bank
accepts investment in lieu of commercial paper, its need for cash at
once increases, because the demand obligations created by the credit
balances or the bank notes into which this paper was converted are not
extinguished by payments for goods purchased, but must be met by cash.

To distinguish between commercial and investment paper is, therefore,
one of the chief problems confronting commercial bankers. For its
solution an accurate knowledge of the business operations of customers
is necessary. An inspection of the paper presented and a general
knowledge of their wealth and business capacity are important, but not
sufficient. The forms of the paper employed in both commercial and
investment operations may be the same, and the possession of wealth
does not ensure the payment of the paper at maturity.

The chief means available for the acquisition of this knowledge are
the requirement from customers of frequent statements of their
operations, on properly prepared forms; the use, wherever possible, of
the documented commercial bill of exchange; and the maintenance of
credit departments equipped with the means of accurately studying
commercial, industrial, and agricultural operations, and of diagnosing
economic conditions. The study of carefully prepared statements of
customers made at frequent intervals reveals to the banker not only
the nature of the operations represented by the paper presented for
discount, but the trend of the business of his customers and, through
them, of the entire country. With such knowledge, he is not only able
to protect his institution against improper loans and discounts, but
to give valuable advice to his customers, advice which no one else is
in a position to give so accurately.

By a documented bill of exchange is meant a bill drawn by a seller
upon the purchaser of goods, accompanied by documents evidencing the
transaction; such, for example, as bills of lading, warehouse
receipts, and insurance policies. The names on such bills guide the
banker in his efforts to trace the transaction in which it originated
and the documents enable him absolutely to identify it, and constitute
security for the loan.

Instead of such bills, promissory notes made payable to banks are
commonly used in this country, greatly to the disadvantage of the
banking business. Such a note reveals nothing to the banker concerning
the purpose for which the loan is made, while a commercial bill, even
without documents, reveals the names of the principals of the
transaction in which the banker is asked to participate. Acquaintance
with these men and knowledge of the business in which they are engaged
at once suggests the probable origin of the bill and furnishes the
clue needed for subsequent investigation.

A properly equipped credit department will keep on file and at all
times available for use the data requisite for the information of the
officers upon whom the responsibility of selecting the loans and
discounts rests. Such data will not only concern the character and
business of each customer and the bank's previous dealings with him,
but general economic conditions, the operations and experiences of
other banks, other business institutions, governments, etc.


_3. Rates_

Besides rates of exchange considered in the preceding chapter,
commercial banks are concerned with loan and discount rates.

Rates on deposits, though sometimes employed, have no place in
commercial banking, since commercial deposits are only the credit
balances resulting from loans and discounts or from funds intrusted to
the bank for temporary safekeeping or disbursement in the interest of
the depositor. In every case they represent a service rendered the
depositor for which the bank must be paid, and, when interest is
allowed, the depositor must repay it in some form with an increment
sufficient to remunerate said service.

Commercial banks may and usually do conduct savings accounts also, for
which an interest payment is not only defensible but in every sense
desirable, but in so doing they are going beyond the sphere of
commercial banking, which alone is under consideration at this point.

Rates charged on loans and discounts are the chief means through which
commercial banks are remunerated for the services they perform. In the
long run these rates are determined by competition, and represent the
current market value of the services performed by bankers. Custom
often affects them temporarily and sometimes for long periods prevents
their response to influences tending to produce change, but in the
long run they yield to economic force and conform to the laws of
value.

Variations in the rate of discount are the most efficient means
employed by commercial banks for the regulation of the volume of their
loans and discounts and for changing the percentage their reserves
bear to deposits and note issues. An increase of these rates tends to
check loans and discounts, to decrease deposits and note issues, to
increase reserves, and consequently to raise the percentage of
reserves to deposits and issues.

It checks loans and discounts by increasing the expense of conducting
business operations on a credit basis, thus diminishing profits and
sometimes causing losses, checking enterprise and decreasing the
volume of commercial transactions. A decrease of loans and discounts
correspondingly diminishes deposits or note issues, or both, since
these are simply the counterpart or representative of such loans and
discounts in the form of credit balances in the checking accounts
conducted by the banks or the equivalent of such balances in a
hand-to-hand money form. An increase in the rate of discount at a
given point tends to attract funds from other points where the rates
are lower and thus to increase reserves. A decrease of rates produces
opposite effects all along the line.


_4. Protection against Unsound Practices_

Commercial banks are an essential part of the machinery by which the
agriculture, industry, and commerce of a country are carried on, and
their proper conduct is, therefore, a matter of public concern. On
this account they have long been subjects of legislation and of public
supervision and control. The methods evolved for safeguarding the
public against abuses and unsound practices differ considerably among
different nations and to some extent among the different states of the
United States, and could only be adequately explained by a history of
banking in each nation. Only the more important and most widely used
of them will be described here.

(_a_) _Capital and Surplus Requirements and Double Liability of
Stockholders._--A very common, indeed, almost universal, legal
requirement is that before beginning business the proprietors of a
commercial bank shall contribute a fund to be known as the _capital
stock_, and that an additional fund, usually called the _surplus_,
shall afterwards be set aside from profits. These funds are required
to be maintained intact, so long as the bank continues in business,
and to be used for the payment of losses in case of failure or
liquidation for any reason. In this country it is also customary to
hold the proprietors legally liable in case of failure for an
assessment equal to the amount of their capital stock. In foreign
countries it is a common practice to have the subscribed considerably
in excess of the paid-in capital, the balance being subject to call by
the directors at any time, and being available for the payment of
losses in case of failure.

These funds serve not only as a protection against loss to the
customers of a bank in case of failure, but also as a restraining
influence on the managers in the everyday conduct of the bank's
affairs. They constitute the proprietors' stake in the business, what
they are likely to lose if the management is imprudent, dishonest, or
inefficient. The absence of such funds would put a premium on rashness
and speculation and tempt into the business the unscrupulous and the
unfit.

In the determination of the size of capital and surplus funds and of
the amount of the liability of stockholders for subscriptions in case
of failure, no well-founded principles have been developed for the
guidance of legislators. They should be great enough to cover
prospective losses and to induce conservatism, honesty, and efficiency
in management, and not so great as to prevent the free flow of an
adequate amount of capital into the business. Unfortunately, the
statistics of losses in cases of failure are not a sufficient guide.
In some cases they bear a large proportion to the volume of business
transacted and in others a very small one, and the number of cases
available are too small to give much value to averages. The amount
necessary to secure the best possible management is also purely
problematical.

In lieu of well-founded principles, the practice has developed in this
country of making the minimum capitalization permitted depend upon the
population of the town in which the bank is located. This seems to be
a very crude and indirect method of proportioning capital to the
volume of business transacted. The fixing of such a proportion, or of
a proportion which no bank should be permitted to exceed, is probably
the best method of solving this problem, but it should be done
directly and not by the roundabout method which has been mentioned
above.

A proportion of ten to one between capital and aggregate demand
obligations would probably be justified by American experience. The
present practice of fixing the surplus fund at twenty per cent of the
capital would be justifiable if the capital fund were properly
regulated in amount.

(_b_) _Inflation and Means of Protecting the Public against It._--The
greatest abuse to which the business of commercial banking is subject,
and against which the public most needs protection, is inflation. This
is a condition difficult to diagnose, and not well understood by the
general public and even by bankers. The most easily recognized symptom
of its existence is the forced liquidation of credits; that is, forced
sales of property in order to meet maturing obligations to banks.
When, for example, the people whose notes or bills have been
discounted by banks default in large numbers, and the collateral
deposited as security has to be sold, or, in the absence of
collateral, the courts must order the sale of their property, the
presence of inflation may be suspected.

The chief cause of inflation is the issue by commercial banks of
demand obligations against investment securities. The means of
liquidating such securities are the profits of the enterprises in
which the investments were made and in the nature of the case several
years are required for the accomplishment of this end. Meantime the
demand obligations of the banks issued against them in the form of
balances on checking accounts or notes must be met and, the funds
regularly deposited with them as a result of the operation of such
enterprises being inadequate, other means must be found. The only one
available is the sacrifice, at forced sales, of the property in which
the investment was made or of some other property in the possession of
the persons responsible to the bank.

The banks usually protect themselves against such forced liquidation
by the requirement that the paper they discount shall mature at short
intervals, usually not to exceed four to six months, and accept the
long-time securities, such as bonds, stocks, and mortgages, only as
collateral. By this means they are able to force the liquidation on
their customers. Otherwise they would be obliged themselves to endure
it, with the result that their capital and surplus funds would be
impaired and perhaps exhausted; and, if they should prove inadequate,
failure would be inevitable.

The evil involved in the forced sales of property caused by inflation
is the readjustment of prices through which it is accomplished, and
the depression and, sometimes, panic which follow. When the prices of
many kinds of property must be greatly depressed in order to induce
their transfer to other hands, the machinery of commerce and industry
is thrown out of adjustment and is sometimes rendered temporarily
useless. This result is due to the fact that the relations between
costs of production and the returns from the sale of finished products
are so changed that profits are reduced or annihilated, and many
persons are financially ruined. Readjustments of the prices of raw
products, labor, and finished goods, and the transfer of plants to new
hands, are, therefore, necessary before industry, commerce, and
agriculture can again operate in a normal way, and during the period
of readjustment some enterprises must entirely stop operations, and
all must slow down. At such times many laborers are thrown out of
employment, many more work part time only, the wages of nearly all
are lowered, and most other classes of income are cut down. Depression
and, in extreme cases, panic are the result, and these have serious
consequences other than financial.

The means employed for the protection of the public against inflation
are crude and inadequate. They may be grouped under the heads:
regulations regarding investments, reserves, and note issues. Under
the first head belong in the banking legislation of this country
limitations on real estate investments and on the amount that may be
loaned to a single firm or individual. Our national banking act and
most of our state banking acts prohibit banks from holding real estate
except for their own accommodation, and as a means of reimbursing
themselves for defaulted loans, and our national banking act prohibits
the taking of real estate security for loans, and many of our state
banking acts limit the amount of such security that may be held. Our
national banking act limits the amount that may be loaned to a single
firm or individual to one-tenth of the bank's capital and surplus, and
similar regulations are common in state banking legislation.

The purpose of these regulations is to confine the investments of
banks to what are called liquid securities, but they fail to evince a
proper conception on the part of their authors of what really makes a
security liquid. Apparently legislators and their advisers have felt
that if the securities held by the banks mature in short periods, or
are listed on a stock exchange, they are liquid; but such is not
necessarily the case.

Commercial paper only is really liquid, since it represents a current
commercial process which will soon be completed and the completion of
which automatically provides the means for its payment. Such paper
usually matures in short periods, but the characteristic of liquidity
results not from the date at which it is made to mature, but from the
commercial process which called it into existence and will ultimately
retire it. In this country very often paper of short maturity is so in
form only, its makers expecting to renew it, instead of pay it, at
maturity.

Bonds and stocks, even though they may be listed on a stock exchange
and daily bought and sold, are not liquid securities in the proper
sense of that term. An individual bank may be able to sell them in
case of need, but such sale is simply the transfer of the investment
to another bank or person, and not its liquidation. The security
still exists and must be paid, while its liquidation would take it out
of existence.

Foreign legislators have approximated more closely than ours what is
needed in the regulation of bank investments. In the case of their
central banks, many of them, notably those of France and Germany, have
recognized the fundamental distinction between commercial and
investment paper, and have required them to hold the former against
their demand obligations, especially their notes.

The regulation of reserves has become a subject of legislation in this
country only. Our national banking act classifies national banks into
three groups, called country, reserve city, and central reserve city
banks, and requires those in the first mentioned group to keep cash in
their vaults to the amount of at least six per cent of their deposits,
and balances in approved reserve city banks sufficient to bring the
total amount up to fifteen per cent of their deposits.

Banks in reserve cities are required to keep in their vaults cash to
the amount of at least twelve and one-half per cent of their deposits,
and balances in central reserve cities sufficient to bring the total
up to twenty-five per cent of their deposits. Banks in central reserve
cities are required to keep at least twenty-five per cent of their
deposits in cash in their vaults. When the reserves of a bank fall to
the prescribed minimum, all discounting must cease. Regulations
essentially similar are found in the banking laws of most of our
states.

The purpose of these regulations is to set a limit to the extent to
which banks may expand the volume of their loans and discounts, in the
belief, apparently, that, if at least the prescribed proportion of
cash is all the time kept on hand, the banks will be able to meet
their obligations. As in the case of the regulations concerning
investments, the authors of these failed to recognize the
significance, from the point of view of the cash demands likely to be
made upon banks, of the kind of paper admitted to discount. If
discounts be confined to commercial paper, the demand obligations they
create will be met for the most part by transfers of credits on the
banks' books or by the return of the notes issued, and, as foreign
experience has demonstrated, the adjustment of cash resources to needs
can safely be left to the judgment of the bankers themselves, who,
through variations in the discount rate, rediscounts, and other means,
can regulate it with ease. If investment paper is admitted to
discount, reserves less than one hundred per cent of the demand
obligations thereby created are unsafe, since a less amount is likely
to force liquidation on the banks' customers, with the results above
indicated.

The most elaborate regulations for the prevention of inflation have
been developed in connection with legislation concerning note issues.
The reason for this is the fact that commercial banking was at its
origin and for a long time thereafter carried on almost exclusively
through note issues, the conduct of checking accounts being a
comparatively recent development. The phenomenon of inflation was,
therefore, first observed in connection with note issues and
associated with them. Even now the essential similarity of note issues
and checking accounts as banking instrumentalities is not universally
recognized.

The means of safeguarding note issues which have been incorporated
into legislative enactments are the prior lien on assets, the safety
fund, the requirement and sometimes the mortgaging of special assets,
and the limitation of the total issues. By the prior lien is meant the
provision that in case of failure the note holders shall be paid in
full before any of the assets are distributed among other creditors.
By the safety fund is meant a required contribution from each bank,
usually a percentage of the amount of notes issued, placed in the
hands of some public official and kept for the redemption, in case of
failure, of such of the notes of failed banks as cannot be redeemed
out of the assets of the banks themselves. Additional contributions
from the solvent banks are required for the replenishment of the fund
when it has been depleted.

The practice of different countries regarding the requirement of
special assets to be held against note issues, as well as regarding
the mortgaging of such assets, is not the same. Germany and France,
for example, require their banks to cover their note issues by
designated proportions of commercial paper and coin, while the United
States requires its banks of issue to cover their notes by government
bonds and to contribute a five per cent redemption fund in addition,
and England requires the Bank of England to cover a designated amount
of its issues by government and other securities and the remainder by
coin. Unlike the others, the United States mortgages to the note
holders the securities, that is, the government bonds, required to be
held against the notes, by providing that in case of failure these
securities shall be sold and the proceeds used for the settlement of
their claims.

In all of these provisions, the protection of note holders against
loss in case of failure has been an influential consideration, and in
the cases of the prior lien and the safety fund, the only one. The
prevention of inflation may have entered into consideration in the
other cases, but among the states mentioned the regulations of France
and Germany alone are efficient in this direction, since they alone
prohibit note issues against investment securities. The above
mentioned regulations of England and the United States tend rather to
promote, than to prevent, inflation, since they require the holding of
investment securities against note issues.

The limitation of the aggregate amount of notes that may be issued is
a common legislative regulation. In the United States the limit set is
the amount of the capital stock, and in France it is an arbitrary
figure from time to time changed as the needs of the bank seem to
require. As a safeguard against inflation, the value of such
limitation depends upon the basis of the issues. If it is investment
securities, as in the case of the United States, limitation to a low
figure, not in any case to exceed the capital stock, is desirable,
since such limitation keeps the inflation within such bounds that the
banks themselves may be able to withstand the effects of it by selling
upon foreign markets, without great and perhaps without any loss, the
securities in which their capital and surplus funds are invested. If
the basis of issues be commercial paper, such limitation is
unnecessary, since inflation in such a case is improbable, and
pernicious, unless it be placed above the point which the volume of
issues is likely in ordinary cases to reach.

(_c_) _Other Means of Safeguarding the Interests of the
Public._--Experience has shown that publicity is a valuable safeguard
against bad bank practices, and legislation has, therefore, provided
for it by the requirement that statements of banking operations shall
be published from time to time. The national banking act of the United
States and many of our state banking acts, for example, provide for
the publication five times a year of bank balance sheets, drawn up
according to prescribed forms.

The inspection of banks by public examiners and the requirement of
detailed reports to public officials are also provided for in our
federal and state legislation. Canada requires the reports but not
the inspection by public officials, on the ground that the latter
cannot be thorough and efficient, and is, therefore, likely to mislead
the public and cause it to be less vigilant than it otherwise would be
in the use of other means of safeguarding its interests.

Legislation in this country has also concerned itself with the duties
of bank directors and the enforcement of their performance, and with
the relations of bank officers to their banks, particularly those
involved in borrowing for their own uses or for firms or corporations
in which they are interested.

A recent legislative experiment along quite a new line has been
undertaken in this country in the form of laws providing for the
mutual insurance of depositors. Oklahoma started this experiment, and
her example has been followed by other states. The essence of the
experiment consists in the provision of a fund out of which is paid to
the depositors of failed banks that portion of their claims which
cannot be met from the liquidation of the assets of the defunct banks,
such fund to be contributed by the other banks belonging to the
system.

The protection of depositors against loss is a commendable aim of
legislation, but this method of attaining this aim is open to the
serious objection that it removes from depositors all concern
regarding the proper management of the bank with which they do
business, and thus gives the unscrupulous, dishonest, and plunging
banker an advantage. Attraction of depositors is the chief field in
which competition between banks is carried on, and when the power of
good management in this direction is removed, high rates on deposits,
high lines of credit, low or no rates of exchange, extravagance in
equipment, etc., remain the only attractions, and in the offer of
these the unscrupulous and plunging banker will always outdo the
conservative.

It is impossible to overcome this objection by public supervision, and
more frequent and rigid examinations. No public officer can equip
himself to pass judgment on the relations of a bank with each
customer, or to detect secret contracts and unwritten understandings,
or to keep unscrupulous people out of the banking business. There can
be no doubt that a reputation for conservatism, good judgment, strict
integrity, and careful management is, at the present time, the most
valuable asset a banker can have, because customers know that they are
in danger to the extent that these qualities are lacking. To
substitute for the present basis of competition between banks that
established by mutual insurance laws is to undermine the foundations
of our credit system and to invite disaster and ruin.


_5. Adequacy and Economy of Service_

From the point of view of adequacy and economy of service, two types
of banking systems require attention; namely, that characterized by a
large number of relatively small local independent banks, chartered
under general laws, and exemplified in this country; and that
characterized by a relatively small number of large banks endowed with
the privilege of establishing branches, and exemplified in the other
leading nations of the world.

Under our system each community is encouraged to look after its own
banking needs. Local initiative in the establishment of new
institutions is given free play and local capital and local talent is
attracted. Outside promoters and outside capital are not excluded,
but, if they come, they do so as colonists expecting to cast in their
lot with the community and to become identified with it. The managers
of our banks for the most part are local men who are the real heads of
the institutions they manage and whose careers and prosperity depend
on the success of these institutions.

The localism which characterizes this system contributes elements both
of strength and of weakness. It develops local talent, and promotes
mutual understanding and cooperation between the banks and the
business enterprises of the community, and conformity of organization
and methods to local needs. Its weakness consists in the financial
isolation and the narrowness of vision and training which are its
natural accompaniments. Under this system capital does not easily and
quickly move from place to place and readily distribute itself
according to the relative needs of different communities. In
consequence, rates of interest are apt to vary widely, some
communities to be under- and others over-capitalized, and the capital
of the nation as a whole to be inefficiently employed. Under this
system the opportunity of bankers for training is meager, since the
broader and more fundamental aspects of the business are rarely
brought to their attention, and in the smaller towns and country
districts they are apt to be recruited from people of mediocre ability
and often from those not well fitted by nature and education for this
branch of commercial enterprise.

The system of branch banking, almost universally employed elsewhere,
is strong where our system is weak, but it has weaknesses of its own.
It promotes distribution of capital according to relative needs, and
consequently efficiency in the application of a nation's capital as a
whole, and it offers a wide field of training for the people engaged
in the business, and draws its recruits from every quarter. It can
readily supply banking facilities to communities too small or too poor
to provide for an independent bank, and more readily than our system
can adjust itself to rapidly growing communities.

Its chief weakness consists in the lack of independence of the
managers of the branches and the consequent danger that local needs
may not be fully satisfied. The manager of a branch is usually granted
freedom of action only in routine matters. Any business out of the
usual order must be referred to higher authorities connected or
associated with the main office; and, even with the advice of the
manager, who alone is familiar with local conditions, the decision
cannot be made with that intimacy of knowledge of and sympathy with
the business and aspirations of the individual or firm under
consideration that full justice to him and his town may require. In
the matter of adequacy and character of service, therefore, the city
in which the main office is located has an advantage over those in
which the branches are located.

In this connection it should also be noted that, while the branch
banking system is able to adjust itself to the capital requirements of
towns of all sizes more readily than the independent banking system,
and thus to secure a better distribution of the banking capital of the
community, it does not follow that it will do so. On account of
ignorance of conditions, insufficiency of capital or inability readily
to increase it, or inertia on the part of the head office, a town may
have to wait for the establishment of a branch longer than it would
for the establishment of an independent bank.

Whether or not this will be the case, however, depends to a
considerable extent upon the keenness of the competition between the
big banks with branches. The big central banks of Europe, which have
no competition within their field, have been slow to establish
branches. The coercive force of the government has been necessary in
many cases to secure their proper expansion. In the case of the other
big banks, however, both of Europe and of Canada, competition has
resulted in very rapid expansion during the last half century,
probably as rapid as could be desired.

Regarding adequacy of service, the method of granting charters and the
attitude of the government towards private banking is important. If
banks are allowed to spring up spontaneously, like manufacturing and
commercial establishments and farms, they are likely to be plentiful
and to be located wherever needed. Experience, however, has shown that
private banks cannot be adequately regulated in the interest of the
public and that incorporation under public auspices should be
required.

Two methods of incorporation are employed, those of the special
charter and of the general law. Except in the case of special
institutions, like central banks, the former is objectionable, since
it opens the doors to political favoritism and is likely to result in
bad distribution, lack of uniformity in regulation, and lack of
steadiness and regularity in development. Incorporation under general
laws, or the free banking system, as it is sometimes called in this
country, is unquestionably the best from every standpoint. All the
necessary checks and balances can be incorporated in these laws, and
the supervision of public officers, together with the necessary
administrative machinery, provided for. This is the only practicable
method to employ in an independent system like ours.

The special charter method works best in connection with the branch
bank system, in which the question of chartering new institutions only
occasionally arises, and in which delay is not so serious.




CHAPTER IV

COMMERCIAL BANKING IN THE UNITED STATES


The commercial banking system of the United States consists of several
elements which have been contributed at different periods in our
history. The most important of these are state banks, national banks,
and the independent treasury system.


_1. State Banks_

From the very beginning of our national history institutions enjoying,
among others, the privilege of commercial banking have been chartered
by our states. For several years after the adoption of our
constitution it remained an open question whether the incorporation of
such institutions was not their exclusive privilege, but in the case
of McCulloch v. Maryland, in 1819, the Supreme Court decided that the
federal government also had this right.

During the years 1791-1811, and 1816-1836, the state banks had as
competitors the first and second United States banks, and in 1863
so-called national banks entered the field, and, more recently still,
trust companies. Private banks have also existed from the beginning,
but their number and relative importance have declined in recent
years. At the present time the number of state banks exceeds that of
all other classes of banking institutions combined, but in capital and
resources they are inferior to both national banks and trust
companies.

Since each state has had a free hand in the matter of legislation
concerning the banks chartered under its auspices, uniformity in the
regulations imposed upon and in the kind and degree of supervision
exercised over this class of institutions, is lacking. In most cases,
however, as compared to national banks, the amount of capital required
is smaller; they have greater freedom in the making of loans,
especially upon real estate security; and they are not so carefully
examined and supervised by public officials. The most frequently
imposed legislative requirements are: the accumulation of a surplus
fund from earnings; double liability of stockholders; a minimum cash
reserve to be kept in the vaults, and an additional reserve on deposit
in other banks; the organization of a banking department for the
administration of the laws pertaining to them; regular reports and
examinations; and some limitation on real estate holdings and on the
amount of loans to be made on real estate security. On account of the
relatively low capital requirements imposed upon them, and the
liberality of the laws concerning them in other respects, state banks
have been able to prosper where national banks and trust companies
could not exist, and on this account in many parts of the South and
West they do most of the banking business in small towns and country
districts. They generally perform a wide range of banking functions,
including those of investment and savings as well as of commercial
banks.


_2. National Banks_

Our national banking system owes its existence to financial exigencies
of the federal government experienced during the Civil War. For a
considerable period preceding the outbreak of that struggle the
expenses of the government had exceeded its receipts. The deficit was
greatly increased as soon as the war began, and Congress did not find
it possible immediately to devise adequate new sources of revenue,
including a market for government bonds. It was, therefore, forced to
the issue of legal-tender notes under authority of an act passed
February 25, 1862.

After three issues of these notes, amounting to $400,000,000, had been
exhausted, and the value of the notes had depreciated to such an
extent that persistence in this method of financiering portended
speedy financial disaster, Congress adopted a suggestion made early in
the war by Secretary Chase, to the effect that a market for government
bonds might be created by compelling banks to purchase them as
security for their note issues. An act passed February 25, 1863,
provided for the incorporation of banks with the right to issue notes
on condition that they purchase government bonds and deposit them with
an official to be known as Comptroller of the Currency.

It was the expectation of the authors of this act that the state
banks, then numbering over one thousand, would exchange their state
for national charters and purchase bonds sufficient to secure their
circulation under the terms of the new act, but, since they showed
reluctance so to do, in 1865 force was applied in the form of a tax of
ten per cent on bank notes otherwise secured. Under this pressure most
of the state banks reorganized as national institutions, but a few
retained their state charters and formed the nucleus of the state
system of the present day. On account of the ten per cent tax,
however, the issue of notes by this remnant became unprofitable, and
the new national banks have to this day remained the sole banks of
issue in the country.

The act of 1863 has been amended several times, notably in 1864, 1870,
1874, 1875, 1882, 1887, and 1900. In its present form it permits the
organization of banks with a capitalization as low as $25,000 in towns
of 3,000 inhabitants or less, and with a capitalization as low as
$50,000 in towns of 6,000 or less. Banks organized under this act must
put ten per cent of their profits into a surplus fund until said fund
amounts to twenty per cent of the capital; must invest at least
twenty-five per cent of their capital, if it is less than $200,000,
and at least $50,000, if it is $200,000 or more, in government bonds;
and may deposit said bonds with the Comptroller of the Currency and
receive circulating notes to the amount of their par value, provided
their market value is par or above.

The rights and privileges of these banks are stated in very broad and
general terms, a fair interpretation of which permits them to engage
in both commercial and investment banking under certain specified
limitations, of which the most important are the following: they must
not invest in or hold real estate beyond their owns needs for suitable
quarters, or temporarily for the purpose of collecting debts due them;
they must not accept real estate as security for loans; they must not
loan more than ten per cent of their capital and surplus to any one
person or firm; and they must keep reserves to the amount of fifteen
per cent of their deposits, if they belong to the group known as
country banks, and to the amount of twenty-five per cent of their
deposits, if they belong to either the reserve city or the central
reserve city group.

In the case of country banks, at least two-fifths of the required
reserves, and in the case of reserve city banks, at least one-half,
must consist of specified forms of money in their own vaults. The
remainder may be balances payable on demand in approved banks in
reserve or central reserve cities in the case of country banks, and in
the central reserve cities in the case of reserve city banks. In the
case of banks in central reserve cities, the entire reserve prescribed
by law must consist of money in the vaults. These required minimum
reserves must not be infringed upon. When a bank's cash and balances
with its reserve agents fall to the prescribed minimum, discounting
must be stopped under penalty of suspension of privileges and
liquidation by the Comptroller of the Currency.

At five dates each year, selected by the Comptroller of the Currency,
national banks must make detailed reports of their condition on
prescribed blanks and publish abstracts of such reports in local
newspapers. They must also submit to examination by persons appointed
for that purpose by the Comptroller as often as this official may deem
necessary and proper.

National banks have been organized in every state of the Union, and in
Maine, Massachusetts, and Vermont they have completely supplanted the
state banks. Elsewhere they exist side by side with state banks and
compete with them. In some states they are more and in others less
numerous than state banks. In the kind of business transacted the only
important difference between the two classes of institutions consists
in the loans on real estate security, which national banks are
prohibited, and state banks allowed, to make. The latter, therefore,
share this class of business with the trust companies only, and where
it predominates have a distinct advantage in competition over the
national institutions.


_3. The Independent Treasury System_

While not a banking institution, the Treasury of the United States
handles its funds in such a manner and performs such functions with
reference to the currency that it has become an important part of the
banking system of the country.

Previous to 1840 the funds of the federal government were kept on
deposit in banking institutions, during the greater part of the time
in the First and Second United States banks. Friction between
President Jackson and the Second United States Bank resulted in their
withdrawal from that institution in 1834 and their deposit in selected
state banks, several of which failed and all of which suspended specie
payments during the crisis of 1837. The embarrassment which the
treasury experienced in consequence, combined with previous
unsatisfactory relations between the government and its depositories,
convinced President Van Buren that the Treasurer ought himself to keep
and to disburse the funds of the government. He made a recommendation
to this effect to Congress, which in accordance therewith enacted the
first independent treasury act in 1840. The revival of agitation for a
third United States Bank led to the repeal of this act the following
year, but in 1846 it was reenacted and with modifications has remained
upon our statute books to the present day.

In its original form this act provided for the acquisition of vaults
in certain cities, in which should be deposited the funds of the
government as soon as possible after they came into the hands of the
receiving officers, and out of which should be taken, upon drafts
issued by the Secretary of the Treasury, the money needed for the
payment of the government's obligations. It further provided that all
dues to the government in the future should be paid either in coin or
in currency issued exclusively by the government, and that all
expenses should be paid in the same forms of money.

Important modifications in this act were made during and after the
Civil War. In 1863 permission was granted the Secretary of the
Treasury to deposit in national banks funds accumulated in the
treasury, and derived from any source except duties on imports,
provided the banks selected for this purpose should deposit with him
government bonds for their security. Subsequently the discretionary
power of the Secretary in this direction was extended so that at the
present time he is authorized at his discretion to deposit in national
banks surplus funds derived from any source, trust funds alone
excepted, and to accept as security therefor other securities than
government bonds. Other laws have made national bank notes acceptable
for certain public dues, and have given the Secretary authority to
issue gold and silver certificates against gold coin and silver
dollars deposited in corresponding amounts, and to redeem United
States notes in gold coin and to keep on hand for that purpose a gold
reserve of $150,000,000.

In its operation, this independent treasury system affects the
reserves of the banks and through them their discounts and the
commerce of the country. Whenever the receipts of the government
exceed its expenditures, money accumulates in the treasury and the
reserves of the banks are diminished; and, under opposite conditions,
they are increased. The return of accumulated surplus funds to the
banks is possible when the Secretary of the Treasury decides that such
return is desirable or necessary and when the banks are able and
willing to supply the bonds demanded as security. In case a deposit is
agreed upon the funds go to a relatively small number of national
banks selected as depositories by the Secretary of the Treasury, the
amount allowed each depository also being determined by him.

Through its ability to issue gold and silver certificates, its
obligation to redeem United States notes in gold on demand, its
administration of the United States mints and assay offices and the
laws regulating the supply and distribution of subsidiary coin, the
United States Treasury cooperates with the banks in the supply and
distribution of the circulating medium of the country. The people
apply to the banks for the forms of money and currency desired and
these institutions meet the demand by means of the funds deposited
with them or by their exchange at the various subtreasuries, if the
forms of money deposited do not correspond with these demands.


_4. The Interrelations of These Institutions_

Under the operation of the national banking act, New York, Chicago,
and St. Louis have been designated as _central reserve_, and
forty-seven other cities as _reserve_ cities. The national banks in
these reserve cities act as reserve agents for national banks in the
cities and towns not so designated and ordinarily receive on deposit
the major part of their reserves plus surplus funds not needed for
local purposes. Banks in the central reserve cities act as reserve
agents for the banks in the reserve cities as well as for country
banks, and on account of their importance as commercial and investment
centers receive and hold in the form of bankers' balances a large part
of the reserve funds as well as the surplus investment funds of the
national banks of the entire country.

State banks and trust companies manage their reserve and surplus
investment funds in substantially the same manner as national banks,
using national banks in the reserve and central reserve cities as
their reserve agents. State laws usually allow approved state banks
and trust companies also to act as reserve agents for the banks and
trust companies under their jurisdiction, but these approved banks are
generally located in the reserve and central reserve cities, and
themselves employ the national banks there located as their reserve
agents, thus forming simply an additional conduit through which the
reserve and surplus investment funds of state banks and trust
companies reach the central money reservoirs administered by national
banks in the central reserve cities.

National banks in the reserve and central reserve cities are also
clearing centers for the enormous volume of checks and drafts which
the administration of the checking accounts of the banks and trust
companies of the country bring into existence. They act as
correspondents as well as reserve agents for these other banks and
trust companies, and in this capacity collect out-of-town checks and
drafts and conduct checking accounts for them. Within these cities, as
well as in hundreds of others, clearing house associations conduct the
local clearings and also act as agencies through which national and
state banks and trust companies cooperate in the promotion of common
interests.

The center of the entire system is in New York City. The clearing
house association of that city, consisting of over fifty national and
state banks and trust companies, includes the banks the vaults of
which constitute the central money reservoir of the country and which
constitute the center of the country's clearing system. Through the
New York subtreasury pass the greater part of the receipts and
disbursements of the government, and the chief assay office in the
country is located there. The New York stock exchange is our only
stock and bond market of national scope, and consequently the
investment center of the country.

The Associated Banks of New York City, as the members of the clearing
house association are called, hold the greater part of the reserves of
the banks and trust companies not required by law to be kept in the
local vaults, as well as the greater part of the surplus investment
funds of the entire country. It is through the operation of the New
York subtreasury on the reserves of the Associated Banks that the
chief influence of the independent treasury system on the banking
business of the country is exerted, the greater part of the
government's receipts coming directly out of those reserves, and a
large part of the expenditures going into them, and the greater part
of the money deposited in national banks by the Secretary of the
Treasury going directly or indirectly into New York institutions. Most
of the exports and imports of coin and bullion pass through New York,
and the major portion of the foreign exchanges of the entire country
are there effected. The New York Assay Office receives and distributes
the greater part of the new supplies of gold and silver bullion which
come from our mines and transforms into bullion the major part of
these metals that come to us from abroad and do not find employment as
foreign coin. The New York Stock Exchange is the medium through which
a large part of the surplus savings of the country are invested in our
industries or loaned for the use of our national, state, municipal,
and other local governmental agencies.


_5. Operation of the System_

The most noteworthy features of the working of this machinery may be
discussed under the heads: conflict of functions and laws; loan
operations; treasury operations; reserve system; absence of elasticity
in the currency.

(_a_) _Conflict of Functions and Laws._--The two classes of banking
institutions which have been described (state banks and national
banks) and trust companies, described in a subsequent chapter, exist
side by side in many communities, and in the performance of certain
services compete for the patronage of the public. As has already been
pointed out, state and national banks differ little in their functions
except in their relation to real estate loans, and in some states
trust companies perform all the functions of these institutions and
many others besides. In the performance of these common services,
however, they are rarely regulated by the same laws or subjected to
the same kind or degree of public supervision. The competition between
them, therefore, is not always on a fair basis and the temptation to
violate restraining laws and administrative regulations is strong. The
supervising officers recognize the situation as a rule and go to the
extreme limit of leniency in administering laws and regulations which
operate to the manifest disadvantage of the institutions over which
they have jurisdiction, but even then it is often impossible to render
the basis of competition fair and equitable.

This condition of affairs has resulted in the devising of ways and
means of circumventing obnoxious laws and in some cases in practices
which are pernicious in themselves. As examples may be mentioned the
widespread practice of national banks, which are prohibited by law
from making loans on real estate security, of making loans to
customers who can offer no other collateral, on the security of their
personal notes only, or of making loans secured by real estate by a
three cornered operation utilizing a director or officer or some other
third party as intermediary. All three classes of institutions
compete in soliciting the savings deposits of the community, with the
result that the trust companies and savings banks, which often have
the advantage here, sometimes force upon their state and national bank
competitors a higher rate of interest on such deposits than they ought
to pay. The differing regulations in some places in force regarding
the amount that may be loaned to a single individual or firm has also
resulted in some cases in devious and uncommendable practices.

For the remedy of these conditions the first desideratum is the
careful differentiation of the various functions performed by all
these institutions, and the devising of appropriate legal and
administrative regulations for each one. These regulations should then
be incorporated into the legislation and the administrative practices
of the federal government and of each state, and any institution which
performs any of these functions should be obliged to submit to the
regulations pertaining thereto. The difficulties in the way of
securing such a differentiation of functions and such community of
action between the federal government and our states are too obvious
to require statement, but they should not prevent the formulation of
ideal conditions, and a conscious and persistent effort to attain
them.

(_b_) _Loan Operations._--In making loans, a typical method of
procedure for a business man is to arrange with a bank for what is
technically called a "line," that is, the maximum amount he may expect
to be able to borrow under normal conditions. This "line" determined,
he borrows from time to time according to his needs, giving as
security his personal note, payable in one, two, three, four, or six
months. Sometimes an indorser is required, and sometimes the deposit
of collateral, mortgages on real estate, bonds, stocks, and warehouse
receipts being the most commonly used securities employed in such
cases. Ordinarily, when a note falls due, he expects the bank to renew
it, if its payment at the time is not convenient, the agreement on a
"line of credit" ordinarily carrying with it that implication, though
not legally, probably not morally, binding the bank so to do. Indeed,
the customer ordinarily counts the amount of his "line" as a part of
his working capital and expects to keep it in use a large part, if not
all, of the time.

In the determination of the amount of these "lines of credit," the
judgment of some one or more bank officers, assisted by a discount
committee and sometimes, though not as a rule, by a specially
organized credit department, rules. In forming these judgments, the
bankers of the United States as a class are not guided by any
universally recognized and well established principles. The best ones
require from their customers carefully prepared statements showing the
nature and volume of the business they transact, and a careful
classification of their assets and liabilities. Others, and these are
a large majority, rely upon the knowledge they already possess, gained
by general observation, and supplemented by verbal inquiries made from
time to time and by the voluntary statements of the customers
themselves.

The significance of the distinction between commercial and investment
operations in the business of banking is not generally understood, and
is consequently little regarded. The dominant question in the mind of
the average banker, both in determining the amount of a customer's
line and in making loans to him after the line is fixed, is how much
he is "good for," and on this point the total net worth, rather than
the nature of the business operations, of the customer is likely to be
decisive. Of course, the banker is also influenced by the customer's
reputation for both integrity and business ability.

This method of procedure has the advantage of rendering access of
people to the banks easy and of promoting their extensive use, but it
has the grave disadvantage of opening the doors wide to inflation of
credit. The majority of our bankers do not know whether more or less
than their savings deposits and their capital and surplus, the only
funds which can safely be invested in fixed forms, is so invested. The
promissory notes of their customers, which constitute the major part
of their assets, give no information on this point, and they have not
made the investigations necessary to determine with certainty the
destination of the funds they have loaned. They are satisfied with the
knowledge or the conviction that their loans can be collected, not at
maturity--they know very well that many, probably most, of them can
not--but ultimately. The result is that unconsciously and gradually
the banks create their demand obligations in the form of balances on
checking accounts against fixed investments in machinery, buildings,
lands, mines, etc., and, when the payment of these obligations is
demanded, the reserves fall below the danger point and they are forced
to require payment at maturity of paper which the maker had counted
upon having renewed indefinitely, and the payment of which is only
possible by the forced sale of the property in which the borrowed
funds were invested, or of some other property in his possession. If
only a single bank or a comparatively few banks find themselves in
this condition, relief may be found in the rediscount of paper with
other banks, in direct loans, or in the sale of securities on the
exchanges; but, if the condition is general, relief by these means is
impossible, and widespread forced liquidation becomes necessary. An
aggravated situation of this kind causes panic and results in a
commercial crisis.

(_c_) _Treasury Operations._--The operation of our independent
treasury system produces arbitrary fluctuations in the reserves of the
banks and prevents that degree of prevision which is essential to the
most economical and the safest practices. The funds needed for current
purposes are withdrawn from the banks and kept under lock and key in
the treasury vaults, thus diminishing reserves to the extent of their
amount. Surplus funds likewise accumulate in the vaults with the same
result, until the Secretary of the Treasury sees fit to deposit, and
the banks find it possible to receive them. Even then the depository
banks alone are directly benefited, and no one of these knows long in
advance how much it is going to receive or when funds left on deposit
will be withdrawn.

Since the volume of the business of the government is very large, the
effects produced by the movement of its funds are of such magnitude as
to give them national importance, the ability of banks to loan and to
meet obligations already incurred being profoundly affected by them.
Among these effects must also be noted the inability of the banks to
calculate these movements in advance, as they to a degree can those
produced by the operations of their commercial customers, and the
relation between them and the Secretary of the Treasury, which
results. The relation between the receipts and the disbursements of
the government vary greatly from month to month and year to year, so
that, on the basis of past experience, it is impossible to predict
when the banks will gain from or lose to the treasury. The action of
the Secretary of the Treasury regarding deposits of surplus funds is
equally uncertain and unpredictable. No fixed policy regarding this
matter has yet been established by precedent or determined by law.
Each secretary follows his own judgment and is influenced by current
events and conditions.

The uncertainty which results creates a speculative atmosphere about
the money market and renders the banks dependent upon the secretary
and the secretary influential on the money market in a manner which is
unfortunate for both. Since they cannot be indifferent to the
operations of the treasury, and cannot predict them, banks are obliged
to speculate regarding them, and, if they err, they are likely either
to over-extend their credit operations or unduly to contract them. The
former will result when they expect an increase in their reserves from
treasury sources and do not get it, and the latter when contemplated
withdrawals of funds do not occur.

The Secretary of the Treasury is not in a position properly to
exercise the power conferred upon him. He is outside the channels of
commerce and industry, and must, therefore, secure at second hand the
information necessary for intelligent action. Such sources of
information are frequently unreliable and inaccurate and their use
subjects him to the charge of favoritism and to the danger of acting
in the interest of special groups or special localities.

(_d_) _Operation of the Reserve System._--Each national bank now keeps
locked up in its vaults money to the amount of at least six to
twenty-five per cent of its deposits and a balance with banks in
reserve and central reserve cities sufficient to bring the total to at
least fifteen per cent of deposits in the case of country banks, and
twenty-five per cent of deposits in the case of reserve city banks. In
addition, it is customary for most banks to carry as a secondary
reserve high-grade bonds which can be readily sold in case of need.
The practice of state banks is practically the same as that of
national, and that of trust companies differs only in the amount of
reserves carried and in the proportion between the different items.

This system has many disadvantages. Among them the most obvious,
perhaps, is the withdrawal of enormous sums from the current use of
the agriculture, industry, and commerce of the country. That portion
of these reserve funds which is required to be kept under lock and key
in the vaults, amounting in the aggregate to a billion and a half of
dollars or more, is not available for use in ordinary times, and is
practically useless even in times of stringency, since according to
present law, when the reserves fall to the minimum prescribed by law,
banks must stop discounting, under penalty of being put in the hands
of a receiver. The other portions of these funds, namely, those
deposited with banks in reserve cities and those invested in bonds,
are likewise withdrawn from the uses of current commerce, since a
large part of the former is only available for use on the New York
Stock Exchange, and the latter are invested in railroads, mines,
factories, land, etc.

The explanation of the devotion of the redeposited portion of the
reserves to the operations of the New York Stock Exchange is to be
found in the fact that that exchange furnishes a regular market for
call loans on a large scale. Since these funds are held subject to the
call of the banks which deposited them, and interest at the rate of at
least two per cent is paid upon them, the depository banks are bound
to seek investment for them, and call loans on collateral listed on
the exchange under ordinary circumstances are best suited to their
purposes.

Another disadvantage of this reserve system is the dangerous situation
in which it places banks from time to time, and the tendency to panic
which it fosters. The demands made upon banks for both cash and credit
vary with the seasons. In the fall and spring they are much greater
than in the winter and summer. They also vary regularly through
periods of years, increasing during the up-grade of a credit cycle and
decreasing for a longer or shorter period after a crisis. Irregular
and unexpected events also cause variations. On account of the
rigidity of this reserve system and the lack of elasticity in our
currency, the means available to banks for meeting increased demands,
especially those of an irregular and unexpected character, are
inadequate, and their employment is often dangerous. These means are:
keeping in the vaults in slack times a large amount of unused cash, a
practice too expensive to be employed; keeping surplus balances with
correspondents at two or three per cent interest, not a sufficiently
remunerative practice to be employed on a sufficiently extensive
scale; rediscount with correspondents of some of their customers'
paper, or loans from them on the security of their own signatures or
on such security supplemented by collateral; and sale of bonds at such
prices as they will bring.

None of these expedients is certain at all times and under all
conditions, and some of them are precarious at all times. Surplus
balances with correspondents are most reliable, but they occasionally
fail on account of the inability of correspondents to realize upon
their call loans. When calls for the payment of balances are large and
general, it is impossible for brokers whose loans are called by one
bank to transfer them to another. The collateral deposited as security
must, therefore, be offered for sale on the stock exchange, and the
very stringency which resulted in their being so offered renders their
sale, even at slaughter prices, difficult and sometimes impossible.
The result at the best is a heavy fall in the prices of stock-market
securities, and at the worst a stock-market panic and a suspension of
payments by the banks.

Rediscounts and loans from correspondent banks cannot be depended on.
Correspondents are under no obligation to make them. They will usually
do so as a favor, if their condition warrants, otherwise not. Sales of
bonds on the stock exchange are difficult and sometimes impossible in
times of emergency, and are usually attended with loss.

On account of this uncertainty and the danger attending it, when new
and unusual conditions likely to result in increased demands upon them
arise, banks are likely to act "panicky"; to call in their balances
from correspondents; to sell bonds; to call loans; and greatly to
curtail or absolutely to cut off new discounts. This action spreads
the panicky feeling among their customers, and creates such pressure
at the reserve centers as to cause curtailment of accommodations and
panic there.

At the very best, this reserve system is accompanied by high discount
and loan rates and by speculation on the stock market. High rates
result inevitably from the hoarding of currency which it involves, the
supply of loan funds being abnormally diminished, and speculation
follows from the concentration in slack times of funds in New York
City, which can only be employed in call loans on stock-exchange
collateral. Stock brokers regularly take advantage of this situation,
speculate themselves and inspire speculation among their customers.
The mutual dependence of the stock and money markets thus produced by
this reserve system is disadvantageous to both, fluctuations in
values, uncertainty, and irregularity on both being the result.

(_e_) _Lack of Elasticity in the Currency._--The money of the United
States consists of four main elements, gold and silver coin, United
States notes, and national bank notes, and none of these fluctuate in
volume in accord with the needs of commerce.

The gold element depends primarily upon the output of our gold mines
and upon the international movement of gold, increasing when that
output increases and when our imports of gold exceed our exports, and
decreasing under opposite conditions. These fluctuations, however, are
quite independent of our commercial needs. Silver dollars, which
constitute the major part of our silver currency, for several years
have been unchanged in quantity, and the volume of United States notes
has remained at $346,681,016 since the resumption of specie payments,
January 1, 1879.

National bank notes fluctuate in volume as a result of changes in the
number of national banks and in the prices of government bonds.
Whenever a new national bank is organized, a specified portion of its
capital must be invested in government bonds, which bonds are usually
deposited with the Comptroller of the Currency in exchange for notes;
and, when the price of government bonds rises, banks holding more than
the minimum required by law frequently retire a portion of their
circulation in order to recover their bonds for sale at the enhanced
price. When the price of government bonds falls, many banks purchase
additional quantities and increase their circulation.

Changes in the price of government bonds and in the number of national
banks, however, have no connection whatever with changes in our
currency needs, and no more do the fluctuations in the volume of the
currency as a whole, made up of these various elements combined. As a
result of this condition, rates on loans and discounts fluctuate
greatly on account of wide variations between the demand and the
supply of loan funds, and commerce is hampered at certain seasons and
overstimulated at others. As was indicated above, this lack of
elasticity in our currency aggravates the defects of our reserve
system and also aids in the production of financial panics.


_6. Plans for Reform_

On account of the defects in our system of banking, there has been
long-continued agitation for reform, increasing in scope and intensity
in recent years. After the crisis of 1907, which revealed these
defects to many persons who had not observed them before, Congress
appointed a commission to make investigations and to prepare a reform
measure. In January, 1912, this committee submitted a report which
embodied a bill for the incorporation of a National Reserve
Association, to be made up of a federation of local associations of
banks and trust companies. The purpose of this association was to
supply a market for commercial paper, an elastic element in the
currency, a place for the deposit of the bank reserves of the country
and of the funds of the government, as well as proper machinery for
the administration of this market and these funds.

For various reasons, the plan of the monetary commission did not meet
with universal favor. It was condemned in particular by the Democratic
party, which was victorious at the polls in the fall elections, and
installed a new administration in Washington, March 4, 1913. A special
session of the new Congress was called to consider the tariff
question, and to it was submitted another plan for the reform of our
banking system, which was enacted into law December 23, 1913.

This law provides for the incorporation of so-called "Federal Reserve
Banks," the number to be not less than eight or more than twelve. The
country is to be divided into as many districts as there are Federal
Reserve Banks, and the national banks in each district must subscribe
six per cent and pay in three per cent of their capital and surplus to
the capital stock of the Federal Reserve Bank located in that
district. State banks and trust companies may contribute on compliance
with the same conditions as national institutions. If, in the judgment
of the organization committee, the amount of stock thus subscribed is
inadequate, the public may be asked to subscribe, and as a last resort
stock sufficient to raise the total to an adequate figure may be sold
to the Federal Government. Cooperation between these Federal Reserve
Banks and a degree of unity in their administration are provided for
through a Federal Reserve Board of seven members, two ex officio and
five to be especially appointed by the President of the United States.
For the administration of each Federal Reserve Bank, a board of
directors of nine members is provided for, six to be appointed by the
member banks and three by the Federal Reserve Board, one of those
three to be designated as Federal Reserve Agent and to be the
intermediary between the Federal Reserve Board and the bank of whose
directorate he is a member.

The proposed Federal Reserve Banks are to hold a part of the reserves
of member banks and to rediscount commercial paper, administer
exchange accounts, and conduct clearings for them. They are also to
serve as depositories for the United States government, and to issue
treasury notes obtained from the Federal Reserve Board in exchange for
rediscounted commercial bills, these notes to be redeemable on demand
by them and to be a first lien on all their assets. Their retirement,
when the need for them has passed, is provided for by the requirement
that no Federal Reserve Bank shall pay out any notes except its own,
all others being sent in to the issuing bank or to the treasury for
redemption. Against outstanding note issues a reserve of at least 40
per cent in gold must be maintained, and against deposits one of at
least 35 per cent in gold or lawful money.

This law provides remedies for the chief defects of our system;
namely, a market for commercial paper which will enable a properly
conducted bank at any time, through rediscounts, to secure notes,
legal-tender money, or checking accounts in the amounts needed; a
system of note issues which will fluctuate automatically with the
needs of commerce for hand-to-hand money; a more economical
administration of the reserve funds of the country, unattended by the
dangers of the present system, and an administration of the funds of
the federal government which is free from the evils of the independent
treasury system.




CHAPTER V

COMMERCIAL BANKING IN OTHER COUNTRIES


In contrast with that of the United States, the characteristic
features of the commercial banking systems of Europe are the central
bank performing important functions for all other financial
institutions and for the government; a relatively small number of
large institutions with many branches mediating between the central
bank and the people; and the use of commercial and bank bills instead
of promissory notes as the chief instruments of loans and discounts.


_1. Common Features_

The central banks differ considerably in organization and business
methods, but perform essentially the same functions; that is, they act
as financial agents for their respective governments; discount
high-grade commercial and bankers' bills for other banks and usually
for private persons; administer the cash reserves of the entire
country; and furnish the greater part and, in some cases, the entire
supply of bank notes.

The other large banks do most of the business with the public, the
central bank's relations being chiefly with them and with the
government. They conduct checking accounts with merchants,
manufacturers, farmers, and others; receive and invest savings
deposits, and deal in certain classes of investment securities;
conduct the domestic and foreign exchanges; discount various kinds of
commercial and banking bills, frequently those not available for
discount at the central bank; and make advances on personal and other
kinds of security. Their main offices are located either in the
central money market of the country or in important financial centers,
and their branches are extended to all places in which banking
facilities are supposed to be needed. As a rule, they are less
restricted by legislative provisions than are the national and state
banks and trust companies of the United States, and are less carefully
supervised and inspected by public officers.

Commercial and bankers' bills are widely used as credit instruments
between buyers and sellers and between bankers and their customers. A
common method of procedure, when a sale is made on time, is the
drawing of a bill for the amount due, by the seller upon the buyer,
payable at the end of the credit period agreed upon, and accepted by
the buyer, and the discount of the bill by the seller's bank. In
foreign and in some branches of domestic trade, the banker's bill is
used on account of its more general acceptability as an object of
discount, such bills usually being discountable by the central bank
and by banks far distant from the place in which the bill originated.

In case a buyer desires to furnish his creditors with bills of this
kind, he arranges with his banker for a line of "acceptance" credit,
which permits people who sell goods to him to draw bills upon his
banker instead of himself, the banker agreeing to accept the bill and
guaranteeing its payment at maturity. The seller will usually have no
difficulty in discounting such a bill at his own bank, no matter how
far removed it may be from the home of the buyer, the character of the
accepting bank being known throughout the financial world. "Acceptance
lines" are usually granted only on condition that the customer agrees
to supply the bank with the funds necessary for meeting the accepted
bills as they fall due, and to pay a fee for the accommodation. Ample
security that these obligations will be met is usually demanded.


_2. The English System_

In the English system, the central bank is the Bank of England, with
the possible exception of a few private banks, the oldest financial
institution in the country. It is privately owned and privately
governed. Its board of directors, chosen by the stockholders, consists
of twenty-four persons, a portion of whom are practically life
members, being regularly reelected when their terms of office expire.
The others usually serve alternate years only, vacancies being filled
by promising young men selected from the business houses of London.
The oldest director is regularly elected to the office of governor of
the Bank, and the next oldest to that of deputy governor, both serving
two years, the deputy governor regularly succeeding to the office of
governor, and the ex-governors forming the life members of the board
and constituting a kind of advisory council to the governor, and known
as the Board of Treasury.

The head office of the Bank of England is in London, and there are
eleven branches, two in London and nine in the provinces. By a law
passed in 1844, the Bank was divided into two departments, called
respectively the banking and the issue departments, the latter having
exclusive charge of the issue of notes, and the former of all other
branches of the bank's business.

This same law prescribed the conditions under which notes could be
issued. It provided that the Bank of England might issue £14,500,000
of notes in exchange for securities, and any amount in addition in
exchange for an equal amount of coin or bullion. Additions to the
amount issued in exchange for securities might be made by order of the
government to the extent of two-thirds the amount of issues
relinquished by the other issuing banks, all such banks in existence
at the time the act was passed being permitted to retain, without
increasing, their existing issues. Most of these other issues having
been abandoned since 1844, the Bank of England is now permitted to
issue in exchange for securities £18,450,000. The securities against
which these issues are made were transferred to the issue department
by the banking department, and consist of the debt owed by the
government to the bank and of other government or governmentally
guaranteed securities. The issue department freely issues additional
notes in exchange for an equal amount of gold coin or bullion, and on
demand redeems notes in gold coin. Since the amount of notes all the
time outstanding greatly exceeds £18,450,000, the business of the
issue department is confined to the exchange of notes for gold coin
and bullion and the redemption of notes in gold.

The banking department receives and disburses the funds of the
government, manages the public debt, and serves as the government's
agent in most of its other financial operations; receives on deposit
from other financial institutions the money which comes into their
possession, and supplies them with such money funds as they need from
day to day in payment of checks drawn against their balances;
discounts bills of exchange with a minimum maturity of four, and in
exceptional cases six, months; and to a limited extent makes advances
on and invests in high-grade public and other securities. Besides the
English government and financial institutions, it has other customers,
but it is to be presumed that these are of a special character, since
the conditions under which it does business with private persons are
in most cases more onerous than those prescribed by other banks, and
consequently not attractive to the ordinary business man.

The so-called English Joint-Stock Banks are classified into three
groups, known as metropolitan, metropolitan and provincial, and
provincial banks. The metropolitan banks have their head offices in
London, and do not, as a rule, extend their branches beyond the
suburbs of the metropolis. The metropolitan and provincial banks have
their head offices in London and branches scattered throughout the
provinces, as well as in various parts of the city and suburbs, and
the provincial banks have their head offices in the larger provincial
cities, and each one confines its branches usually to the town and
country districts tributary to the city in which its head office is
situated. Often the provincial banks establish branches in London.

For banking purposes, these banks are the chief reliance of the
agriculture, industry, and commerce of the country, but competing with
and supplementing them are the bill brokers and discount houses, the
private banks, and the foreign and colonial banks. The bill brokers
and discount houses make a business of dealing in foreign and domestic
bills of exchange. They buy in the first instance a large percentage
of the bills brought to market, keep some of them until maturity, and
sell the remainder to the other banks, usually indorsing them first. A
large part of the capital employed in their business is obtained by
loans made from the other banks, subject to call and secured by the
bills they purchase deposited as collateral.

The private banks are the remnant left of the oldest group in the
country. There were private banks in London centuries before the Bank
of England was incorporated, and previous to 1826 the Bank of England
was their only competitor. Since 1844 their number has steadily
diminished. Those which remain have, as a rule, built up a special
constituency, to the special interests of which they cater. Among them
are strong institutions, but as a class their importance in the system
is not great, and is waning.

The foreign and colonial banks are branches of important institutions
in foreign countries and the English colonies which have a
considerable volume of business to transact in London. They serve as
intermediaries between their respective countries and the English
money market, and on account of the enormous volume of foreign
commerce which is financed in London, their number is large, and the
rôle they play on that market is important.

In the operation of this machinery, the most noteworthy features are
the reserve system, and the administration of the discount rate of the
Bank of England. There is no law on the English statute books
prescribing the amount of cash which banking or other financial
institutions shall keep in their vaults. The custom of these
institutions regarding that matter is to keep on hand relatively small
sums and to rely upon the Bank of England or some other London banking
house for the replenishment of their supply as needed. For this
purpose, London and many provincial banks keep balances with the Bank
of England, and other banks maintain balances with other London
institutions. These balances may be obtained by the deposit of coin or
Bank of England notes or by rediscounts. Another widely used resource
is the calling of loans made to bill brokers or discount houses. Such
loans or a considerable volume of bills of the kind discounted by the
Bank of England, or both, are regularly carried by London banks and
counted as a part of their reserves.

On account of these practices, surplus cash not needed in the conduct
of the current business of the country speedily finds its way into the
vaults of the Bank of England, and additional supplies, when needed,
come from this source. The administration of the cash reserves of the
country thus becomes one of the important duties of the Bank of
England, in the performance of which variation of the rate charged on
discounts is the most important device.

Many years' experience has enabled the Bank to determine with a
considerable degree of accuracy the volume of the demands for cash
likely to be made upon it from day to day, and consequently the amount
that it should keep on hand in the vaults. Whenever this amount
approaches the minimum regarded as consistent with safety, the
directors raise the rate of discount, and when the amount on hand
becomes excessive, they lower it. The efficiency of this procedure in
increasing the reserves in the one case and in decreasing them in the
other is due to certain conditions and practices which deserve
attention at this point.

Long-established custom has made the rate of interest paid on deposits
in London and other parts of England vary with the discount rate of
the Bank, and on this account the market rate of discount also varies
in the same manner. The Bank of England is thus ordinarily able to
regulate the market for commercial paper. Since paper payable in
London is a favorite form of investment for continental bankers, by
raising its rate of discount and with it the market rate above the
level of the rates of some or all of the continental centers, the
Bank of England is able to induce these bankers to send money to
London for investment and thereby to increase her reserves, and by
lowering its rate below the level of the rates in these continental
centers, she is able to induce them to sell some of the paper they
already hold, and thus to furnish a market for her surplus funds and
diminish her reserves.

On account of the readiness with which the international gold movement
responds to variations in the discount rate of the Bank of England,
the need for an elastic system of bank note issues is not felt in
England to the same extent as in other countries. It is this fact,
doubtless, which explains the retention to the present day of the
essentially inelastic bank note system created by the act of 1844.


_3. The French System_

In France, the Bank of France is the central institution. It is the
oldest of the important French banks of the present day, having been
established in 1800 by Napoleon the First. Its capital, amounting at
the present time to 182,500,000 francs, or approximately $36,500,000,
is supplied by about 30,000 private stockholders, about 10,000 of
whom own only one share each.

The two hundred largest stockholders appoint a General Council,
consisting of fifteen regents and three censors. Five regents and all
the censors must be chosen from the commercial and industrial classes,
and three of the remaining ten regents must be selected from the
_tresoriers payeurs généreaux_, an important group of representatives
of the public treasury scattered throughout the country. The General
Council as well as the stockholders' assembly is presided over by a
governor, who, together with two sub-governors, is appointed by the
President of the Republic upon the nomination of the Minister of
Finance. The governor is the chief executive officer of the bank and
the final source of authority in most matters of vital importance. He
is responsible to the government rather than to the stockholders, and
is subject to removal only by the power which appointed him.

The Bank of France has about two hundred branches and sub-branches
located in Paris and all the important cities and towns in the
Republic, also over three hundred so-called agencies located in
smaller places and transacting only a limited line of business. Each
branch has a manager appointed in substantially the same manner as
the governor, and the sub-branches and agencies are administered
through the branches. Through this network of offices, every part of
the country is brought into direct and easy access to the Bank.

The Bank of France is the only institution in the country privileged
to issue circulating notes. The maximum allowed it is regulated by law
and is increased from time to time. At present it amounts to
5,800,000,000 francs, or approximately $1,160,000,000. The bank is
obliged to redeem these notes on demand in gold coin or silver
five-franc pieces, but it is free to determine how much cash it shall
keep on hand for that purpose, and when and under what conditions it
shall issue them.

Its discount operations are limited by law to bills maturing in not
more than three months, and bearing the signatures of at least three
solvent persons, or two signatures and secured in addition by
specified forms of collateral. It is also permitted to make loans or
advances, as they are called, on securities of the French government
maturing at fixed dates, gold and silver bullion, and the money of
foreign countries, and obligations of the French railroads, French
cities, and departments, the Crédit Foncier, and the Société
Algerienne. It is also obliged to loan 180,000,000 francs
($36,000,000) to the government without interest.

One of the chief branches of the business of the Bank of France is the
service of the public treasury and the performance of other financial
duties imposed upon it by the government. It serves as the depository
and disbursing agent for the government, and performs important
functions connected with the public debt, the mints, the savings
institutions, and publicly administered trusts of various kinds. It is
also the depository for the banking reserves of the country. In
France, as in England, it is not the custom of banking and other
financial institutions to hoard money in their vaults, but to depend
upon the Bank of France for supplies as needed. To this end they keep
funds on deposit there, and regularly rediscount the paper of their
customers when balances need to be replenished.

Through its network of branches and agencies spread over the entire
country, the Bank of France is able economically and expeditiously to
conduct the intermunicipal exchanges of the country. It participates
in local clearings through membership in the clearing houses, at which
balances are paid by checks drawn against credits on its books
maintained for that purpose by all members, and it conducts so-called
transfer accounts with other banks and financial institutions against
which drafts can be drawn payable at any place where one of its
offices is located. Such drafts constitute the chief means through
which transfers of funds are made between different places.

The business of the Bank of France with private persons is limited by
the requirement that all paper discounted must have three signatures,
or two signatures and collateral security, and that advances can only
be made on the security of the forms of collateral indicated above.
Most business men find it either inconvenient or impossible to comply
with these conditions, and consequently transact most of their
business with other banking institutions. The third signature on paper
discounted by the Bank is, therefore, usually supplied by these
institutions, which thus act as an intermediary between the Bank and
the commercial world.

Next to the Bank of France, the most important banking institutions of
the country are the Crédit Foncier, the Crédit Lyonnais, the Comptoir
d'Escompte de Paris, the Société Générale, and the Crédit Industrielle
et Commercial. The Crédit Foncier is principally engaged in extending
credit based on real estate security, but it also discounts large
amounts of commercial paper. Its organization is modeled after that of
the Bank of France, and, like that institution, it is controlled by
the state. Since it is primarily an investment bank, a description of
its principal operations will be deferred to the next chapter.

The four other banks mentioned are a product of the commercial life of
modern France, all having been established since the revolution of
1848. They are all heavily capitalized, the smallest, the Crédit
Industrielle et Commercial, having a capital of 100,000,000 francs
($20,000,000), and the largest, the Société Générale, having a capital
of 400,000,000 francs ($80,000,000), and all extend their business by
means of branches. The Crédit Lyonnais and the Comptoir d'Escompte
have branches in France itself, the French colonies, and a number of
foreign countries; the Société Générale, throughout France, in London,
and San Sebastian, Spain; and the Crédit Industrielle et Commercial,
in Paris and its suburbs. Taken together, these four institutions
supply the French people in Paris and the Provinces with banking
facilities for both their domestic and their foreign business. While
in some of the larger provincial cities local banks with branches in
surrounding towns and sometimes in Paris are to be found, branches of
one or more of these four institutions are the chief reliance in
nearly all places.

These institutions cater to all the financial needs of their
constituents. They supply their needs for cash and for exchange;
conduct checking accounts for them, although these are not used in
France to the same extent as in the United States; discount their
commercial paper and make loans to them on personal and other
security; and receive on deposit their savings and provide them with
investments. In performing these functions they make extensive use of
the Bank of France and of the stock exchanges of the country. With the
former they conduct checking and transfer accounts and rediscount
their customers' bills, by these means procuring the coin, bank notes,
and exchange needed; and from the latter they obtain the investment
securities required for the satisfaction of both their own and their
customers' needs.

Gold and silver coin and the notes of the Bank of France constitute
the hand-to-hand money of the country. The latter form the elastic
element, and their operation approximates perfection. When demand for
money increases for any reason, more commercial bills are presented
for discount to the banks, which, after indorsement, exchange them at
the Bank of France for the notes with which they supply their
customers' needs. The note issues of the Bank thus expand in direct
and immediate response to the needs of the country for more currency.
When such needs have passed, the discounted bills, in exchange for
which these notes were issued, mature and are paid in greater volume
than new bills are created and presented for discount, and notes, or a
corresponding amount of coin, accumulate in the vaults of the Bank.
The notes are cancelled and destroyed and the coin is kept in store
until it again passes into circulation through exchange for notes
still outstanding, or for discounted bills.

On account of the elasticity of its note issues, and the extent to
which they are used in the commerce of the country, the Bank of France
has occasion to change its rate of discount less frequently than any
other bank in Europe. The result is that the country enjoys the
advantage of steady and low rates, since in France, as in England, the
discount rate of the central bank controls the market rate, and the
ease and inexpensiveness with which the notes are issued make low
rates possible.


_4. The German System_

The Imperial Bank, with head offices in Berlin, and about one hundred
branches and more than four hundred sub-branches scattered throughout
the country, plays essentially the same rôle in the German banking
system that the Bank of England and the Bank of France play in the
English and French systems, respectively. It was established in 1875
by an act which also profoundly affected the entire banking system of
the country, and its development has been aided and directed by
several acts passed subsequently.

Its capital, supplied by the general public, amounts at the present
time to 180,000,000 marks ($45,000,000), and it is governed by three
boards, known respectively as the Curatorium, the Direktorium, and the
Central Ausschuss.

The Curatorium is composed of five members, of which body the
Chancellor of the Empire is ex-officio chairman. A second member is
appointed by the Emperor, and for that position he has always selected
the Prussian Minister of Finance, and the three remaining members are
appointed by the Bundesrath. It meets quarterly and reviews all the
operations of the bank. It, or rather, the Chancellor, its chairman,
has supreme power, which, however, he has never exercised except on
one occasion, when he ordered the bank not to accept Russian
securities as collateral for loans, an order since revoked.

The administration of the bank's affairs is chiefly in the hands of
the Direktorium, consisting of a president, vice president, and seven
other persons, all of whom are appointed by the Emperor for life, from
a list of candidates recommended to him by the Bundesrath. This board
selects the staff of bank officers and clerks, and superintends the
daily conduct of the bank's business.

The Central Ausschuss is a committee of fifteen persons elected by and
representing the stockholders. It holds monthly meetings; has the
right to demand complete information concerning the bank's operations,
to discuss all matters freely, and to tender advice and counsel; but
it has no power to control except regarding two matters: it can set a
limit to the amount of securities the bank can purchase, and can veto
any proposed transactions with the Imperial Government or with the
governments of any of the states.

Like the other central banks described above, it receives on deposit
and disburses the funds of the Imperial Government; administers the
coin reserves of the country; conducts the domestic exchanges, and
serves as a bankers' bank. It is free to do business with the general
public, but the legal and other limitations under which it must
operate give the other banking institutions of the country the
advantage in competition for this kind of business.

It shares the right of note issue with four other banks, which, out of
thirty-two that retained that privilege at the time the Imperial
banking system was established, alone retain it at the present time.
The issues of these four institutions, however, are relatively small
in volume, and the Imperial Government has the right to deprive them
of it January 1, 1921, or any tenth year thereafter, on condition of
giving one year's notice of its intention so to do. The issues of the
Imperial Bank are subject to the following regulations: they must be
covered by cash and discounted bills maturing in not more than three
months, and signed by at least two solvent persons, the proportion of
cash being not less than one-third of the total. If the total amount
issued exceeds the Bank's holdings of gold bullion, specie, and
government notes by more than 750,000,000 marks at the end of March,
June, September, and December, and 555,000,000 marks at other times, a
tax of five per cent per annum is levied on the excess.

The law confers upon the Bank the following powers:

     a. To buy and sell gold and silver coin and bullion.

     b. To discount, buy and sell bills of exchange whose
     maturity shall be three months at the longest, and for which
     usually three, and in no case less than two, accredited
     vouchers shall stand good; furthermore, to discount, buy and
     sell bonds of the Empire or of any German state, or domestic
     municipal corporations, provided such bonds mature within
     three months at the longest and conform to the new standards
     of value.

     c. To grant interest-bearing loans for terms no longer than
     three months, upon movable security (lombard, or deposit
     loan business), such as: gold and silver, coined or
     uncoined; interest-bearing or non-transferable bonds
     maturing within a maximum term of three months, whether of
     the Empire, a German state, or of domestic municipal
     corporations; interest-bearing non-transferable bonds on
     which the interest is guaranteed by the Empire or by any one
     of the German states; capital stock and stock priority
     shares, fully paid up, of German railway companies in
     actual operation; mortgage bonds of the provincial,
     municipal, or other land credit institutions of Germany that
     are subject to state control, including shares of German
     mortgage banks to an amount never exceeding three-fourths of
     their market value; interest-bearing non-transferable bonds
     of foreign states, and foreign railway priority bonds,
     covered by state security, in amounts not exceeding 50 per
     cent of their market value; bills of exchange of recognized
     soundness, after deducting at least 5 per cent of their
     market value; and pledges of native merchandise, in amounts
     within two-thirds of their value.

     d. To negotiate collections for the account of individuals,
     institutions, and governing boards; and upon security, as
     before mentioned, to furnish payments, and make orders or
     conveyances on the branch banks or on correspondents.

     e. Upon prior security, to buy on behalf of outside parties,
     effects of all kinds, including the precious metals; and
     after delivery to sell the same.

     f. To receive money for circulation or on deposit, with or
     without interest, the sum of interest-bearing deposits not
     to exceed that of the capital stock and reserve fund.

     g. To accept the custody or other management of objects of
     value.

Besides the Imperial Bank there are in Germany eight very large and
powerful banking institutions and a considerable number of smaller and
less powerful ones. The eight great ones have each its head office in
Berlin, and connections, through branches, agencies, and controlled
institutions, in other parts of the Empire, the German colonies, and
foreign countries. Together they control about eighty per cent of the
entire banking capital of the Empire. In reality they are federations
of banking institutions, many of which were once independent, and some
of which were promoted and established in the interests of the group.

While these eight institutions are primarily engaged in commercial
banking, they are also promoters on a large scale of German industry
and commerce, both at home and abroad. Through interlocking
directorates, stock ownership, and in other ways, they are closely
allied with the leading industrial and transportation interests of the
Empire, and they have been and are leaders in the promotion of these
interests in other parts of the world, notably in the Orient, South
America, and Africa. They are, therefore, leaders on the stock as well
as the discount markets of the country, and are widely influential in
investment as well as commercial banking affairs.

These, as well as the other commercial banks, consisting for the most
part of local institutions and those catering to special interests,
use the Imperial Bank for rediscounts, for transfers of funds between
different parts of the country, and as a depository for surplus funds.
They do not normally keep on hand more cash than is needed for till
purposes. Being in easy reach of an office of the Imperial Bank,
supplies can be obtained at any time by checks drawn against credit
balances or through rediscounts of commercial bills. Special accounts
are carried for transfer purposes and are used even in the transfer of
funds between different offices of the same institution.

On account of its right to issue notes against commercial securities,
the Imperial Bank has the power to meet the demands made upon it and
to supply the country with an elastic medium of exchange. The levy of
a tax upon the excess of the issues above a prescribed maximum
prevents perfect elasticity, unless this maximum be kept above the
highest point which the circulation would normally reach, since the
actual levy of the tax forces the rate of discount to such a point as
to seriously restrict commercial operations. However, since the line
between commercial and investment banking is not drawn by the great
Berlin banks with the care that is desirable, and since they have been
able at times, especially on account of their foreign connections, to
embarrass the Imperial Bank in its efforts to maintain adequate specie
reserves, such a tax is probably a desirable safeguard against
over-expansion of credit.


_5. The Canadian System_

In important respects the Canadian banking system differs from those
of the European countries which have been described and from that of
the United States. It consists of a varying number of relatively large
institutions, each with several offices administered from a common
center, but without a central bank. For some time the total number has
decreased, since 1900 from thirty-six to twenty-seven, in spite of the
fact that the Canadian law, like that of the United States, provides
for the formation of new banks at any time, on compliance with certain
prescribed conditions, including a subscribed capital of at least
$500,000 and a paid-up capital of at least $250,000. The number of
branches, however, has increased rapidly, much more rapidly than the
population.

The most noteworthy legal provisions pertaining to the banking
business in Canada concern note issues and loans and discounts.
Regarding the establishment of branches, the amount, and, with one
exception, the composition of the reserves, and many other matters
carefully regulated by law in the United States, Canadian bankers are
left free to follow their own judgment. Neither is there public
examination of banks in Canada. Reports must be regularly made to the
Minister of Finance, and he may call for special reports whenever he
desires so to do; but neither he nor any other public officer has the
right to examine a bank's books or to quiz its officers or directors.
In contrast with banking legislation in the United States, another
peculiar feature of Canadian law is the incorporation of the Canadian
Bankers' Association, an organization resembling in essentials the
American Bankers' Association, and the assignment to it of important
functions connected with the issue of notes and the winding up of the
affairs of failed banks.

Regarding note issues, the chief provisions of the Canadian law are as
follows: Each bank is permitted at any time to issue circulating notes
to the amount of its capital stock, and between October 1 and January
1 an additional amount, equal to fifteen per cent of its combined
capital and surplus, may be issued on payment of a tax to be assessed
by the Governor in Council, not to exceed five per cent per annum.
The notes are a first lien on all the assets of the bank that issued
them, and must be redeemed on demand at the head office and at such
other places as are designated by a committee of public officials
known as the Treasury Board. As such redemption centers, this board
has named Toronto, Montreal, Halifax, Winnipeg, Victoria, St. John,
and Charlottetown. Each bank must also deposit with the Minister of
Finance a sum of money equal to five per cent of its average
circulation. The aggregate of the amounts thus deposited by all the
banks is known as the "circulation redemption fund," and may be used
in the redemption of the notes of a failed bank. In case the fund is
so used, and the liquidated assets of the bank prove to be inadequate
for its complete replenishment, a tax sufficient to meet the deficit
is levied on the solvent banks in proportion to their circulation.

Regarding loans and discounts, the law aims rather to protect than to
restrict the operations of the banks. They may "deal in, discount, and
lend money, and make advances upon the security of, and may take as
collateral security for any loans, ... bills of exchange, promissory
notes, and other negotiable securities, or the stocks, bonds,
debentures, and obligations of municipal and other corporations,
whether secured by mortgage or otherwise, or Dominion, provincial,
British, foreign, and other public securities." The only important
restriction placed upon their loaning activities is the prohibition of
making advances on the security of landed or other immovable property.

In making loans to wholesale dealers and shippers of produce, the law
safeguards the banks by allowing them to take a blanket lien on the
goods dealt in by the borrower. This lien applies not only to the
goods in possession at the date of making the loan, but to any others
which may be substituted for them or manufactured out of them. This
lien is prior to that of any other unpaid vendor, except one acquired
before the bank's lien was established.

The chief officers of a Canadian bank are the general manager, the
chief accountant, the superintendent of branches, the inspector, and
the secretary, all connected with the head office, and the managers of
the branches.

The general manager is the chief executive and the chief in authority.
While he is subject to the board of directors, on account of his wide
experience and knowledge his judgment is usually followed. The other
officers are appointed by him with the approval of the board, but,
almost without exception, from persons who have served the bank in
subordinate capacities. The general manager himself is nearly always a
man who has passed through the hierarchy of positions from the bottom
up, and is therefore thoroughly familiar with every detail of the
bank's business and history. The inspector has charge of the
examination of the branches, and this work is so carefully and
thoroughly done that examination by public officials is not considered
necessary, or regarded as desirable by most Canadian bankers.
Regarding this matter, however, there are differences of opinion, and
changes in the near future are not improbable. The managers of the
branches are in strict subordination to the authority of the general
manager, though they are necessarily allowed a large amount of
discretionary authority in matters pertaining to the branch over which
they preside. Unless prevented by distance, they are in daily
communication with the head office or with one of its representatives.

In the operation of the Canadian system, noteworthy features are the
methods of controlling credits, of managing the issues and the
reserves, and of securing unity or at least harmony of action. It is
the usual practice in Canada for a business man to do all his banking
with one institution. This practice is rendered possible because most
of the banks are large enough to take proper care of almost any
business establishment in the Dominion, and because experience has
demonstrated its wisdom.

The banks compete vigorously for new business but do not attempt to
attract one anothers' customers. Indeed a customer who desires to
change his banking connections is looked upon with suspicion and is
subjected to a very careful examination by the bank that is asked to
take him on, including a careful discussion of all the aspects of the
matter with the bank he desires to leave. The result of this practice
is that a man's banker is thoroughly familiar with his affairs,
especially his credit relations, and at the same time feels under
obligations to render him such support and guidance as he deserves. On
account of this practice, also, commercial paper brokerage does not
flourish in Canada.

The notes of the Canadian banks constitute practically all of the
hand-to-hand money of the country in denominations above two dollars.
The one and two dollar denominations are supplied by Dominion
notes--all but $30,000,000 of which are represented by gold coin or
bullion--and the lower denominations by subsidiary silver supplied by
the government.

Each bank pays out its notes freely to supply the cash demands of its
customers, and receives from them on deposit, without hesitation or
depreciation, the notes of other banks as well as its own. The former,
however, are either sent in for redemption as soon as received or used
in making payments to the banks which issued them. Thus notes are
cleared as readily as checks and the volume in circulation expands and
contracts in automatic response to business needs. The fact that these
notes are neither legal tender nor guaranteed by the government does
not interfere with their circulation--daily clearings, the first lien
on assets, and the redemption fund amply protecting holders against
the possibility of loss--but does prevent their being hoarded as
reserves or for any other purpose and thus contributes towards their
elasticity.

The connection now established by law between the maximum volume of
bank note issues and the capitalization of the banks renders necessary
the increase of the latter in correspondence with the expansion of
commerce in order to prevent a contraction of credit. Present law,
however, does not provide for such an increase. It is left to the
voluntary action of the banks, which seem inclined to increase surplus
funds rather than capital. The permission granted in 1908 to extend
issues beyond the amount of capital during the crop moving season, on
payment of a tax, is a makeshift and not a solution of the difficulty,
since a tax on issues is a means of forcing contraction of credit and
not of adjusting issues to legitimate needs.

Since Canadian banks are able to meet the greater part of the public
demand for hand-to-hand money by means of their own notes, they do not
need to carry in their vaults large amounts of gold and silver coin
and Dominion notes. They keep on hand only so much as experience
indicates they are likely to be called upon to supply to their
customers, plus a reasonable margin for safety and for the payment of
clearing house balances. The greater part of their reserves consists
of balances in banks outside of Canada, especially in the United
States and England, call loans in New York City, and easily salable
securities. In case of an emergency of any kind these resources may be
transformed into gold or their customers supplied with foreign
exchange, which is often as much or even more needed. Gold can at any
time be exchanged for Dominion notes if that is the currency wanted.

The lack of a central bank and of a rediscount market is to a degree
compensated by unity of action among the banks. This is the result not
so much of law as of conditions, among which the most important are:
the fact that the six largest banks do fifty per cent of the business
and that one of these, the Bank of Montreal, holds most of the
deposits of the government and is generally spoken of as the
government bank; the fact that the general managers are experts, in
first-hand touch through their branches with business conditions in
Canada and other parts of the world, and in possession of the same
data concerning these conditions, and through the same kind of
acquired skill and similar experiences likely to draw the same or at
least similar conclusions from this data; common interests in the
prosperity of the country and in the prevention of speculative
excesses and mutual interdependence in the successful conduct of their
everyday business as well as in times of emergency and stress: and the
Bankers' Association, which through its journal gives authoritative
expression to the best banking opinion and actually acts for the banks
in many matters of common interest. To what extent this community of
action takes the form of rediscounts for each other in ordinary times
it is impossible for an outsider to say, but that it is operative in
times of stress is indicated by the manner in which the failures of
the Bank of Ontario in 1906 and the Sovereign Bank in 1908 were
handled.

In both of these cases the public was protected against loss and panic
was averted by the cooperative action of the other banks in assuming
the obligations of these institutions to the public, and in winding up
their affairs in such a manner as to occasion little disturbance.

While Canadian banks are free to carry on investment as well as
commercial banking operations, their published reports indicate that
they take care to avoid confusion of the two, or the infringement of
one upon the other. Their holdings of investment securities are kept
well within the limits set by their aggregate capital, surplus, and
savings funds, and their method of handling commercial business, based
as it is on accurate knowledge of their customer's operations and upon
the lien upon produce heretofore described, prevents their acceptance,
through ignorance, of investment securities under commercial
disguise.




CHAPTER VI

INVESTMENT BANKING


In the economy of nations the encouragement and promotion of saving
and the accumulation, distribution, and investment of capital are as
essential as the conduct of exchanges, but the performance of these
functions has not been segregated and institutionalized to the same
extent as has commercial banking. Vast amounts of capital are invested
directly by the people to whom it belongs without the aid of middlemen
and large amounts are also invested through brokers of one kind and
another who can hardly be classed as bankers. The most important types
of institutions which have been developed in connection with these
functions are savings banks, trust companies, bond houses and
investment companies, land banks, and stock exchanges.


_1. Saving and Savings Institutions_

Saving is an individual matter for which the essential conditions are
the development of the instinct to make provision against
uncertainties of future income and to better the material condition of
one's self and family, and a surplus of income above necessary daily
expenditures. In order to secure the realization of these conditions
to as great an extent as possible, many agencies cooperate in all
modern nations, among them savings institutions. Included among these
are various forms of provident associations, sometimes independently
organized and sometimes connected with other organizations, insurance
associations of many kinds, building and loan societies, and savings
banks.

The need for savings institutions varies greatly among the different
nations and among different classes of people in the same nation.
Among people of great wealth the surplus of income above expenditures
is so great that large savings can hardly be avoided, and among all
the well-to-do classes the margin from which savings are possible is
sufficiently large and the desire to save sufficiently great to insure
large accumulations of capital. Among these classes there is little or
no need for institutions designed primarily for the development of the
saving instinct. What they need are institutions for the safe keeping,
accumulation, and investment of the savings which they are constantly
making. The principal work of savings institutions, therefore,
pertains to the classes of people who are not well-to-do and who need
encouragement and help in their efforts to improve their material
condition, if they are so inclined, and stimulus to make such efforts,
if they are not so inclined.

The means available to savings institutions for the accomplishment of
these ends are the urging of the importance of saving upon the
attention of people who do not adequately appreciate it, the placing
at their easy disposal of facilities for making savings when they have
the ability and inclination to save, and the application of pressure
of various kinds to compel or induce saving.

In the application of these means the methods employed by the various
groups of institutions mentioned differ widely and they are efficient
in different degrees, partly because they have other objects in view
besides the promotion of saving and partly because they deal with
different classes of people. Savings banks constitute the only group
to which the term bank can properly be applied and consequently the
only one to which attention will here be given.

In a book entitled, _Savings and Savings Institutions_, written by
Professor Hamilton of Syracuse University, the following definition is
given:[Pages 161 and 162.]

    Savings banks are institutions established by public
    authority, or by private persons, in order to encourage
    habits of saving by affording special security to owners of
    deposits, and by the payment of interest to the full extent
    of the net earnings, less whatever reserve the management may
    deem expedient for a safety fund; and in furtherance of this
    purpose bank offices are located at places where they are
    calculated to encourage savings among those persons who most
    need such encouragement.

Professor Hamilton classifies these institutions as trustee,
cooperative, municipal, and postal savings banks. In the first group
he places institutions managed by boards of philanthropically inclined
persons who serve without pay; in the second, those managed
cooperatively by the people who make use of them; in the third, those
established and administered by municipalities; and in the fourth,
those connected with the post-office departments of governments. The
strength of trustee savings banks lies in the comparatively low costs
of their administration and in the fact that in their investments
they are likely to enjoy the advantages of the judgment and enthusiasm
of people skilled in the investment business; that of cooperative
savings banks, in their adaptability to the special needs of their
constituents and in the education which cooperative administration
involves; and that of municipal, and especially of postal savings
banks, in their capacity to place their services within the easy reach
of all who need them and in the confidence which their public
character inspires.

In the investment of the funds intrusted to savings banks, safety and
as large returns as are consistent with it, rather than ease of
liquidation, are the prime considerations, and hence they usually take
the form of high grade investment securities rather than of commercial
paper. Their deposits are usually subject to withdrawal only after due
notice, and, being savings deposits, their withdrawal usually follows
only after the lapse of a considerable period of time.

The purpose of their withdrawal is frequently investment and this is
sometimes made through the agency of the bank which held the deposit
and may involve merely a transfer of securities.

Outside of the New England and middle states, savings banks were rare
in this country previous to the inauguration of our postal savings
bank system in 1911. The explanation of this condition is doubtless to
be found chiefly in the wide extension of private, state, and national
banks, and trust companies, practically all of which conduct savings
departments and solicit the patronage of savers. These institutions
have coveted this field and have not encouraged the establishment of
savings banks. There is reason to believe, however, that they have not
worked the field as thoroughly as savings banks would have done and
that, on account of the dominance of their other interests, they are
not as well fitted as savings banks to work the field thoroughly.
Moreover it is probable that they are not able to pay as high a rate
on deposits as well conducted savings banks would be able to pay.
There seems, therefore, to be room, and probably need, here for the
development of savings banks of some at least, if not all, of the
types above described.


_2. Trust Companies_

Within a comparatively short period of time the trust company has
developed into an institution of prime importance in the United
States. In the beginning of its history it was, as its name implies,
simply an institution for the administration of trusts of various
kinds, such as the execution of wills, the guardianship of minors and
other dependent persons, the administration of the estates of persons
either unable or unwilling to administer them for themselves, and
trusteeship under corporate mortgages, especially those of railroads.
In the latter capacity they became mortgagees in trust for
bondholders, registering the bonds, collecting the interest as it
became due, paying the bonds at maturity, and in case of default
taking the legal steps which were necessary for the protection of the
bondholders.

The execution of these trusts involved in most cases the custody and
investment of funds, so that investment banking became a part of their
business almost from the beginning, and, in time, in states in which
the laws passed for their regulation did not prevent, they added
commercial banking to their other functions. In some cases they have
also become promoters of enterprises, taking the initiative in the
organization of corporations for various industrial and commercial
purposes. In New York City, and in individual cases in some other
large cities, the commercial end of the business has become the
dominant one; in the former case on account of the ability of these
companies, unrestricted by certain laws applying to state and national
banks, to offer to commercial customers better terms than their
competitors. In most states, however, especially in the large cities
in which they chiefly flourish, trust companies have become primarily
investment banking institutions, their other functions being carried
on as side lines and assuming, of course, in some cases greater
importance than in others.

Since they are still in the early stages of their development, the
status of trust companies in the banking system of the United States
is not yet definitely determined. Legislation concerning them varies
considerably in different states, as do also their relations with
other banking institutions. The competitive character of these
relations has resulted in some cases in legislation which has aimed to
differentiate and define the various functions which all these
institutions perform, and to prescribe the conditions under which each
one or each group must be performed, regardless of the way in which
they are combined, and in others, in their practical consolidation
with national or state banks, or both, through community of stock
ownership, interlocking directorates, etc.

From the point of view of the convenience of the public there are
advantages in the combination of all the banking functions in a single
institution, and the success of trust companies to some extent has
been due to this cause, but they have also profited from the unequal
competition which exemption from certain limitations imposed on state
and national banks has enabled them to enjoy. The removal of the
conditions which result in this unequal competition, a process already
in progress and likely to continue to completion, will reveal the
strength of the advantages of combination versus specialization of
functions. Previous to such a revelation it will be impossible to
determine whether or not the trust company form of organization is
destined to become the dominant one.


_3. Bond Houses and Investment Companies_

A large part of the business of investment banking in the United
States is conducted by corporations and firms organized for the
purpose of buying and selling investment securities, especially bonds
and mortgages. Rarely, if ever, do these concerns conduct savings
accounts. Ordinarily they confine their attention exclusively to the
investment end of the business and act in the capacity of jobbers, or
brokers, or both.

Within the investment field some of them specialize closely and others
deal in a wide range of securities. The specialties most frequently
followed are government, state, and municipal bonds, railroad bonds,
public service securities, timber bonds, irrigation bonds, and real
estate mortgages. Specialization involves the development of expert
knowledge of the class of securities dealt in and thus of special
serviceableness to both investors and the promoters of the enterprises
or the public bodies which issue the securities. These specialists
sometimes serve as middlemen between the issuers of securities and
other investment banks, as well as between them and the real owners of
the capital invested, their expert knowledge being of service to the
former as well as the latter.

Until recently there have been few attempts to regulate the operation
of these institutions by law, but the fraudulent practices of some of
them, and the ignorance and weakness of perhaps the majority of
investors, have recently created in some quarters a strong public
sentiment in favor of such regulation. In several states legislation
has resulted, of which the most noteworthy is the so-called "blue sky
laws" of Kansas and some other states.

In details these laws differ widely from one another, but they are
alike in that they impose upon some branch of the state government the
obligation of supervising both companies which issue securities and
those which offer securities for sale. The Kansas law, the first of
this kind passed in the United States, has been considered too drastic
by most of the companies that have attempted to operate under it, but
the Wisconsin law, which went into effect October 1, 1913, is looked
upon with more favor.

In formulating these and other laws for the proper regulation of these
concerns, it has been found difficult to provide adequate protection
to the investing public without unduly hampering the issue and
negotiation of securities, but this difficulty should, and in time
doubtless will, be overcome. A free and open market for bonds, stocks,
and other evidences of indebtedness is essential to freedom of
enterprise and mobility of capital, which are in turn essential to the
economic prosperity of any country. On the other hand, investors
undoubtedly need and deserve the protection of the state against
misrepresentation and fraud. It is practically impossible for them in
many, perhaps in most, cases to obtain the information necessary for
self-protection. The matters and conditions to be dealt with in such
legislation are so complex and subject to such frequent change that
laws are apt to be imperfect, inefficient, or obstructive. It seems
probable that those which do not attempt to be specific and detailed,
but give wide powers and discretion to administrative boards or
commissions, are most likely to be successful.


_4. Land Banks_

In Europe an important group of institutions has developed for the
supplying of agriculture and the building industries with the capital
needed in their operations. The greatest number and variety of these
are in Germany, in which their development has been continuous since
the days of Frederick the Great.

In order to assist in the recuperation of his kingdom from the
devastation caused by the Seven Years' War, Frederick caused the land
owners of certain provinces to be organized into associations called
Landschaften, which were authorized to issue mortgage bonds on the
joint security of the lands of all the members of the association in
exchange for mortgages on the lands of individual members who needed
funds for the improvement of their estates. These mortgages were made
payable to the association in the form of small annuities, to which
were added the interest paid on the bonds and an increment for the
payment of the expenses of the association.

These associations were governed by the members through a general
assembly, representative boards, and elected officers, and were
supervised by the state and carefully regulated by law. Regulations
were carefully worked out pertaining to the ratio that the loan should
bear to the value of the estate mortgaged, methods of valuation, ways
and means of maintaining an equilibrium between the bonds issued and
the mortgages held, the treatment of defaulting members, etc., etc.
Machinery for the sale of the mortgage bonds delivered to members was
also created, and in some cases later on these sales were made
directly by the associations themselves, and cash paid to the maker of
the mortgages.

Five of these original Landschaften have continued to the present day,
and others modeled after them were subsequently established. In 1909
in all Germany twenty-five were in operation, of which eighteen were
in Prussia. The newer ones have not in all respects followed their
models. Unlike the original five, membership in them is not limited to
the nobility and is not compulsory; the liability of the members for
the payment of the bonds issued has in some cases been limited to a
percentage of the total; the loans are usually paid in cash; and the
bonds are sold directly by the associations; but the principles of
mutual liability and mutual control which were basic in the old
organizations have not been violated in any case. Both old and new are
organized in the interests of borrowers on real estate mortgage
security, and aim to secure funds for these on the lowest possible
terms and for long periods of time, by making the security offered the
lenders greater than any single borrower could supply.

The degree of their success is indicated by the fact that in 1909 the
amount of their outstanding mortgage loans amounted to nearly a
billion dollars, and that their mortgage bonds rank on the exchanges
with Prussian state bonds and have at times outranked them.

Another type of land bank appeared in the early part of the
nineteenth century as a result of the movement for the freeing of the
serfs and their transformation into freehold peasants. The lands of
these cultivators were burdened with a variety of feudal dues and
charges which had to be commuted before they could become freeholds.
In order to facilitate this process banks were established which
assumed the obligations of a peasant towards his feudal superior in
return for a mortgage on his holding, repayable with interest in the
form of an annuity, and in amount equal to the sum to be paid to the
feudal superior for the total extinguishment of all feudal
obligations.

Some of these banks were established and administered by states,
provinces, and communes, and some by private parties. The public ones
obtained the funds they needed partly from subsidies and partly from
the sale of guaranteed mortgage bonds and the private ones wholly from
the sale of mortgage bonds.

The completion of the work for which these banks were originally
established put an end to their development about 1883, but similar
institutions have since been established in Prussia to assist
colonists in the purchase and equipment of their farms, and in central
and western Germany to promote general agricultural and urban real
estate operations. The colonists sent into Poland for the
Germanization of that province were in this way assisted by the
Prussian government, and in some parts of Germany the same means have
been employed for the purpose of aiding in the process of breaking up
large estates into small holdings, in the construction of dikes,
roads, and reservoirs, and in changing the courses of streams.

Next to the Landschaften the most important intermediaries between
capitalists and investors in real estate in Germany are the so-called
Hypothekenaktienbanken, or joint-stock mortgage banks. These are
private corporations, capitalized by the sale of stock shares to the
general public, and controlled by their stockholders through
directorates, like industrial corporations the world over. Their
business is the making of long-period loans on real estate security,
and the funds thus employed are obtained by the sale of mortgage bonds
secured by the real estate mortgages in which the proceeds are
invested and by their own capital, surplus, and other funds.

They differ from the Landschaften in that they are not cooperative or
mutual institutions, but strictly business enterprises run in the
interests of their stockholders. Their primary aim is to earn
dividends rather than to secure the lowest possible loan rates and
other favorable terms for borrowers. As a matter of fact they are
forced by competition and by the principles of good business to make
loans at reasonable rates and on favorable terms regarding repayment
and other matters, and they successfully compete with the Landschaften
and other cooperative credit institutions of Germany. Their mortgage
loans are usually made repayable on the annuity plan, one-half per
cent each year being the common rate of payment, and they loan about
the same percentage of the value of the lands mortgaged, as do the
Landschaften and other land banks, and the rate of interest charged is
the market rate, into the determination of which, of course, the
competition of all other institutions enter.

While these institutions loan in the aggregate enormous sums on farm
property, their chief field of operations is urban real estate, and
particularly the industry of residence, or as we would call it in this
country, apartment-house construction. It is on this account that the
period of their most rapid development coincides with that of the
recent rapid industrial and commercial development of Germany, which
dates back only to the establishment of the Empire in 1870. Most of
them began operations in the decade 1862-1872, but the most rapid
growth in the magnitude and scope of their business operations has
come in recent years.

In 1899 there were forty institutions of this kind in operation in the
German Empire. The number at the present time is probably considerably
greater, since for obvious reasons combinations among them are not
promoted by the same kind of economic pressure that in recent years
has operated so efficiently in Germany in the field of commercial
banking.

Two other groups of German institutions merit attention in this
connection, namely, the so-called Schulze-Delitzsch and the Raiffeisen
Credit Associations.

The Schulze-Delitzsch societies were the direct outcome of the period
of dearth and famine through which Germany passed in the years
immediately preceding the revolution of 1848. The first one was not a
credit association, but a cooperative buying society, organized by a
local judge named Schulze for the aid of his needy neighbors of the
small trading class in the town of Delitzsch. In 1850 a credit
association on the same plan was organized. Others followed, in rapid
succession in and after the seventies, until at the present time they
are numbered by the thousands and their members by millions, and they
are scattered throughout the entire empire.

The principle of their organization is the association of a
comparatively small group of neighbors, or of people who know one
another well, or who may easily come to know one another well, by each
making a contribution to a common fund to be loaned out to individuals
on personal security chiefly, and which, together with the credit of
the entire group, may be made the basis of security for larger funds
to be borrowed on the open market. They are carefully organized on the
cooperative principle, each member having an equal voice in a general
assembly which chooses a board of directors and a small administrative
board, to which is intrusted the actual management and administration
of the affairs of the society.

Loans are made to members only, usually for short periods of time, on
the personal security of the borrower and of others who are willing to
vouch for him, and on the unusually favorable terms which the credit
of the entire organization and very low costs of administration render
possible. The knowledge which each member has of the character and
business methods of his fellow members who borrow, and of the use to
which borrowed funds are put, and the stake which each one has in the
financial stability and success of the organization, bring the
percentage of losses to a very low figure, and make it possible for
these societies to grant their members maximum accommodations at
minimum prices.

To the funds accumulated from initiation fees, membership dues and the
sale of the associations' credit have been added, in constantly
increasing amounts in recent years, the savings of the members
themselves. Many societies have such an amount of funds intrusted to
them in this way that they are not only entirely freed from the
necessity of borrowing, but are obliged to seek opportunities for
investment outside their own group.

This condition of affairs, in addition to many other common interests,
led to the federation of the Schulze-Delitzsch societies into larger
groups, and these in turn into state and national associations,
through which surplus funds in one could be made to serve the needs of
others inadequately supplied, and through which all the societies
could be brought into efficient connection with the general money
market of the country. For a number of years these federated
societies conducted a large central institution, first in Frankfurt
and afterwards in Berlin, known as the Deutsche Genossenschaftsbank.
In 1904, however, this institution was absorbed by the Dresdener Bank,
one of the eight great private banking corporations of Germany, which
now serves as the central agency for all these societies.

The membership of these associations is not restricted to any class of
persons, and they actually include a very large number of small
farmers. An inquiry made in 1885 showed that in 545 of them, with a
total membership of 270,808, there were 72,994 farmers, and that
one-fifth of the total loans of these associations were made to this
class of their members. They must, therefore, be numbered among the
land banks of the Empire, or at least among the institutions which are
helping to solve the credit problem for the agricultural classes.

The Raiffeisen societies resemble the Schulze-Delitzsch in many
particulars and differ from them in others. Like them they are
strictly cooperative in character, and, when organized for credit
purposes, designed to supply members with loans on the most favorable
possible terms. Their development was also due to the hard economic
conditions of the period immediately succeeding the revolution in
1848.

They differ from the Schulze-Delitzsch societies chiefly in the
following particulars: They charge no initiation fees and do not rely
to the same extent on the proceeds of the sale of shares, the amount
of which they place at a very low figure, often the lowest permitted
by law; they make long-period as well as short-period loans, indeed
the former chiefly; they do not pay dividends on their share capital,
but instead put all profits into reserve funds or prevent their
accumulation by keeping the loan rates low; they exercise more care
than do the Schulze-Delitzsch associations to keep their societies
small, laying great emphasis upon the importance of personal
acquaintance between members and thus upon mutual watchfulness; and,
in their origin, they were peasant organizations pure and simple, and
hence more strictly land banks.

Their founder, F. W. Raiffeisen, Burgomeister of a small village in
Westphalia, Prussia, wanted to rescue the poor peasants of his and
other districts from the clutches of the usurers, into whose hands
they had fallen and by whom they were being exploited in a most
shameful manner. Since it was loans that these people needed and
since their cash resources were always very low and in many cases nil,
he felt that to require, as a condition of membership, entrance fees
and the purchase of one or more shares of stock, however small, would
be fatal to the success of his plans. He also firmly believed that in
the integrity, industry, frugality, and agricultural skill of these
people was the basis for sound credit and that cooperation was a means
by which these elements of sound credit could be made available and
attractive on the money market. At the beginning, therefore, no
entrance fees or share subscriptions were required. Later Prussian law
made share subscriptions compulsory and they were, of course,
introduced, but they were made so low, and the acquisition of the
money for their purchase so easy, that they have not been a serious
obstacle.

From the beginning Raiffeisen invited to membership in his societies
the well-to-do and substantial people as well as peasants. Of course
these people did not require the society for the satisfaction of their
own credit needs, but Raiffeisen saw that they would greatly
strengthen the credit of the societies and he was able to appeal to
them on philanthropic grounds. This class of people have a leading
part in the administration of the societies of which they are members
and have contributed greatly to their success.

At the outset the Raiffeisen societies had to rely chiefly on
borrowing for the acquisition of the capital needed, but with time and
success savings deposits, surplus funds accumulated out of profits,
and lastly the proceeds of the sale of shares have played an
increasing rôle. At the present time many societies are not obliged to
borrow at all, and not a few have surplus funds which are placed at
the disposition of other societies which are still obliged to borrow.

Like the Schulze-Delitzsch societies the Raiffeisen associations have
federated. At present there are thirteen so-called unions, and at the
head of all is a central bank with head office at Berlin and branches
at Königsberg, Danzig, Breslau, Cassel, Frankfurt, Coblenz, Brunzwick,
Strassburg, Nuremberg, Posen, and Ludwigshafen. The central bank is a
joint-stock company, organized on the principle of limited liability,
the stock of which is owned by the local societies. It formerly had
close relations with the Imperial Bank, but is now associated with the
so-called Centralgenossenschaftskassa, endowed by the state of
Prussia, in such a way that advances and discounts are extended to it
on favorable terms.

The Raiffeisen societies rival the Schulze-Delitzsch in the rapidity
of their growth and in the rôle they play in the economic life of
modern Germany. In 1908 they numbered 5,047, of which 4,340 were
credit associations. The collective balance sheets of these societies
in 1907 showed 490,734,834 marks assets, 489,234,357 marks
liabilities, and a membership of 405,819.

While Germany was the pioneer in the establishment of land credit
institutions, and while such institutions have attained a greater
variety of form and a higher degree of perfection in that country than
in any other, other countries have advanced along similar lines and
now have institutions and a fund of experience well worthy of study.
The institutions of Germany have in most cases served as models in
these other countries, the mortgage banks and the Schulze-Delitzsch
and Raiffeisen societies having been most frequently copied. These
models have been adapted to foreign conditions and modified in
interesting and instructive ways as well as copied without essential
change.

Among the mortgage banks developed outside of Germany the Crédit
Foncier of France is especially noteworthy. In its organization it
was modeled after the Bank of France and is second only to that
institution in the magnitude of its operations and the scope of its
influence. Its head office is in Paris and it has at least one branch
in each department. Its capital stock owned by private parties amounts
to about $40,000,000, its surplus to over $4,000,000, its loans
secured by mortgage to over $400,000,000, and its total resources to
about $1,000,000,000.

Like the German mortgage banks, it secures the greater part of its
loan funds through the issue of mortgage bonds and a large percentage
of its loans are made on mortgage security for long periods of time
and are repayable on the annuity plan. However, it transacts a greater
variety of business than does the typical mortgage bank of Germany. It
loans on city and farm real estate and to communes, and it transacts a
large commercial banking business, though this is distinctly a side
issue, incorporated with its other business in order to give
profitable employment to funds, sometimes large in amount, which are
temporarily on hand awaiting investment.

At various times it has absorbed competing institutions and at times
it has established collateral institutions to transact lines of
business for which its own constitution and legal limitations did not
fit it. Among these the most important are the Crédit Agricole and the
Foncier Algierienne. It was obliged ultimately to absorb and liquidate
the former, but the latter still flourishes in the colony of Algiers.

Mortgage banks have also gained a footing in most of the other
countries of continental Europe. In Italy they passed through a period
of storm and stress, owing to their connection with the issue banks of
that country and the consequent confusion between commercial and
investment banking which resulted, but they have recently been
established on an independent basis and are now developing along right
lines and with apparent success.

The Schulze-Delitzsch and Raiffeisen societies have been imitated in
Austria, Hungary, Belgium, Switzerland, and, to some extent, in France
and India. The so-called "Banche Populari" and "Casse Rurali" of Italy
are respectively modified forms of these two German types, and rank
among the most important means employed in that country for the
improvement of the condition of the peasants and small tradesmen.
State, provincial, and communal aid for these institutions has been
more frequently evoked and more extensively employed outside than
inside of Germany, and other important modifications of the German
prototypes have been made in Italy and elsewhere.


_5. Stock Exchanges_

An essential part of the machinery of investment banking is the stock
exchange. This is a place where the buyers and sellers of securities
or their agents regularly meet for the transaction of business. It may
be a portion of a street or a market place or a room in a building. A
fully equipped modern exchange contains a large room equipped with
telegraphic and telephonic communication with the most important parts
of the country in which it is located and of the world, with apparatus
for registering prices and easily communicating information to its
members, and with the offices needed for the accommodation of the
clerks and other employees required. Either by posts or in some other
manner the precise places in it in which each security or group of
securities is to be dealt in is also usually indicated.

The purpose of the stock exchange is to facilitate and to regulate
dealings in securities. It facilitates such dealings by providing as
nearly perfect means as is possible for putting buyers and sellers
into communication with each other, and for collecting and making
available to them the information they need. To this end they provide
for daily meetings at fixed hours; they make and publish lists of the
securities dealt in; they speedily record and, through the telegraph
and the telephone, communicate to all quarters of the globe the prices
at which securities change hands; and through the meeting room
equipped as before described they make it possible for buyers and
sellers, no matter where located, to communicate with each other in a
very short period to time. They regulate such dealings by establishing
and rigidly enforcing rules and regulations for listing, transferring,
clearing, and paying for securities and for other matters pertaining
to the conduct of their members.

These institutions serve investment banks as well as private
investors, constituting the machinery which connects them all. They
thus enlarge the area and scope of the markets for securities, and
greatly increase the mobility of capital. Without them the surplus
savings of one locality would only very slowly and with difficulty
find their way to other localities where they are needed, with the
result that capital would lie idle or be very inefficiently employed
in some places while in others natural and human resources would be
undeveloped or very inefficiently developed.

Existing stock exchanges differ considerably in the manner in which
they are organized and managed, in methods of doing business, and in
the scope of their operations. Some of them are incorporated and
others unincorporated; some restrict their membership to a prescribed
number, others admit as many as are able and willing to comply with
the conditions imposed; some are local in their scope, some national,
and others international. In this country all the exchanges deal in
local securities chiefly, except the one in New York City, which is
national in its scope. The London exchange does a larger business in
international securities than any other, but the Paris and Berlin
exchanges, as well as those located at the other important European
capitals, and the one at New York share in it to a greater or less
degree.

Stock exchanges have suffered in reputation, and their real functions
and merits have been obscured by the abuses to which they have been
subjected. Connected with their legitimate business of facilitating
the investment of capital, various forms of speculation have
developed which in some cases have degenerated into gambling pure and
simple. The better managed ones have striven to rid themselves of
these abuses, and in some countries, notably in Germany, legislative
bodies have taken a hand. The results, however, have proved only
partially successful.

Some forms of speculation are not only legitimate but necessary in
modern business life, and these shade into the illegitimate,
unnecessary, and positively harmful forms by such short and easy steps
as to render it difficult, and perhaps impossible, to draw a line
between the two which can serve as a guide for regulations of an
administrative or legislative kind.


_6. Some Defects in Our Investment Banking Machinery_

A comparison of our investment banking machinery with that of European
countries, especially Germany, reveals important differences. Among
these the most notable are the wide use there and the almost complete
absence here of the following: (a) the resort to cooperation as a
means of revealing and making available the basis for credit of large
numbers of people who lack capital but could use it to the advantage
of themselves and of the nation; (b) the long-period mortgage loan
repayable on the annuity plan and the mortgage bond as a means of
accumulating capital for such loans; and (c) the cooperation of the
state and other public bodies and of capitalists and philanthropically
disposed persons in developing the credit possibilities of the masses
and in directing the flow of proper portions of the stream of capital
in their direction.

In the development of investment banking institutions in this country,
individual initiative prompted by self-interest has been the chief,
and except in the case of savings banks, the sole motive force. The
result is that most of them have been organized in the interests of
lenders rather than borrowers and serve best the purposes of big
business and of persons already possessed of large credit by virtue of
their wealth or their business reputations. Under these conditions,
while enormous amounts of capital in the aggregate have been invested
in agriculture and urban real estate, the former has suffered
relatively in comparison with transportation, manufacturing, and
speculation.

Contributory causes in the development of this situation have been the
great need for capital for the development of our transportation
system, the stimulation of manufactures by high protective duties, and
the enormous area of our public domain which was given or sold to
settlers on very easy terms. Inasmuch as our transportation system and
our manufacturing industries have now attained a high degree of
development, our public domain has been nearly exhausted, and land
values and the cost of living are rapidly rising, the needs of
agriculture are pushing themselves into the foreground, and we are
beginning to look to European experience for suggestions regarding the
best methods of diverting to that industry a larger part of our
rapidly accumulating capital resources.

There are obvious difficulties in the way of the application of
cooperation to the solution of the problem of agricultural credit in
this country. In spite of the fact that immigration is constantly
bringing to us people from the very foreign countries in which
cooperative credit associations flourish, our agricultural population
is still dominated by the spirit of individualism which has been and
is one of our dominant national traits. Our farmers are also more
widely scattered than is the case in Europe, and consequently less
closely knit together in social units. Their holdings are also
larger, their capital needs greater, and their business instincts more
highly developed.

There seems to be no good reason, however, why the joint-stock
mortgage bank should not flourish here as well as in Europe. It is a
purely private business enterprise of the kind with which we are
perfectly familiar. The mortgage bond ought to appeal to our
investors, many of whom have exhibited a strong predilection for
mortgage security and real estate investments, and long-period
mortgage loans, repayable on the annuity plan, would meet the needs of
many land purchasers and of people who need to invest considerable
sums in drainage, irrigation works, etc., better than our present
methods. In most, if not all, of our states, trust companies could
develop these new lines of finance without prejudice to the other
branches of their business.

The use of state, county, and municipal subsidies or credit in
enterprises of this kind is rendered difficult, if not impossible, in
this country, by strong prejudice against the use of public funds in
private enterprises, and in some states by constitutional
prohibitions. This prejudice is based upon unfortunate experiences,
and is at least partially justified by the laxness of our
administrative methods and the prevalence of graft, which expose us
to the danger of the improper use of public funds devoted to
enterprises of this kind. There is no reason, however, why our states
should not take the initiative in the improvement of our investment
banking machinery and why private capitalists and philanthropists
should not turn some of their energy into this channel.

Suggestion and leadership are needed in this field quite as much as
legislation tending to restrict and regulate the operations of
existing institutions.




REFERENCES


The following books are comprehensive in character, treating most of
the subjects covered in the foregoing chapters:

  MACLEOD, H. D., Theory and Practice of Banking.
  GILBART, J. W., History and Principles of Banking.
  BAGEHOT, WALTER, Lombard Street.
  DUNBAR, CHARLES F., History and Theory of Banking.
  SCOTT, WM. A., Money and Banking. Rev. Ed.
  WHITE, HORACE, Money and Banking.
  FISK, A. K., The Modern Bank.


The subject of clearings and the exchanges are discussed in the
following books:

  CANNON, J. G., Clearing Houses.
  CLARE, GEORGE, The A, B, C of the Exchanges.
  CLARE, GEORGE, A Money Market Primer and Key to the Foreign
          Exchanges.
  MARGRAFF, A. W., International Exchange.
  ESCHER, F., Foreign Exchange.


The following cover the history and present condition of banking in
the leading countries:

  CONANT, C. A., Modern Banks of Issue.
  KNOX, J. J., A History of Banking in the United States.
  SUMNER, WM. G., A History of Banking in the United States, being
          Vol. I of a History of Banking in all the leading nations.
  KIRKBRIDE & STERRETT, J. E., The Modern Trust Company, Its Functions
          and Organization.
  BRECKENRIDGE, R. M., The History of Banking in Canada.
  LAUGHLIN, J. L., Editor, Banking Reform.
  JOHNSON, J. F., The Canadian Banking System.
  WITHERS, HARTLEY, PALGRAVE, R. H., and others, The English Banking
          System.
  LIESSE, A., Evolution of Credit and Banks in France.
  NATIONAL MONETARY COMMISSION, The Reichsbank, 1876-1900.
  RIESSER, J., The German Great Banks and Their Concentration.


On investment banking see:

  WOLFF, H., People's Banks.
  PETERS, E. E., Co-operative Credit Associations.
  HAMILTON, J. H., Saving and Savings Institutions.
  PRATT, S. S., The Work of Wall Street.
  CONANT, C. A., Wall Street and the Country.




INDEX


  "Acceptance" credit and lines, 103

  Accommodation loans, 12, 13

  Accounts overdrawn, 16

  Agriculture, capital for, 168;
    individualism in, 168

  Assets, prior lien on, 56;
    special, 57


  Balances, 16, 17, 23, 28

  Banche Populari, 162

  Bank of England, 104-111

  Bank reserves, 35-40

  Bank of France, 111-119

  Banker's banks, 9;
    bills, 33, 34;
    most valuable assets, 61;
    making loans, 86

  Banking, act, 54, 78;
    adequacy and economy of service, 62, 66;
    branch, 64, 65;
    business, 9;
    commercial, nature and operation of, 11-67;
    commercial in the United States, 68-100;
    commercial in other countries, 101-135;
    Canadian, 126-135;
    defects and reforms in banking systems, 97-100;
    English, 104-111;
    French, 111-119;
    functions in single institutions, 144;
    German, 119-126;
    incorporation, 66;
    investment, 136-170;
    Kansas "blue sky laws," 146;
    problems of commercial, 35;
    reserve, 78;
    services rendered by, 1-3;
    Wisconsin regulations, 146;
    local, 62, 63

  Bank notes, see _notes_

  Banks, bond houses, 6;
    Canadian, 126-135;
    central of Europe, 101;
    central reserve, 78;
    classified, 6;
    classification of national, 54;
    collections, 22;
    commercial, 6, 7;
    cooperative, 139;
    correspondent, 24, 25;
    England, bank of, 104-111;
    European land banks, 147-163;
    European central, 9;
    federal, 8;
    federal reserve, 98-100;
    France, bank of, 111-119;
    French land, 160-163;
    functions of, 4;
    German Imperial, 119-123;
    German land, 147-163;
    incorporated, 7;
    inspection of, 59;
    interest charges, 14;
    investment, 6, 7;
    Italian land, 160-163;
    joint stock, 7;
    land, 6;
    loan-making, 86;
    municipal, 139;
    national, 8, 70-75;
    note issue privileges, 37, 38;
    of issue, 20, 21;
    postal saving, 139;
    private, 7;
    protection against unsound practices of, 46-62;
    real estate, 6, 52;
    savings, 6, 136-141;
    services rendered by, 1-3;
    state, 9, 68-70;
    supply currency, 22;
    trustee, 139

  Berlin stock exchange, 165

  Bills of exchange, 12, 17;
    documented, 42

  "Blue sky laws" of Kansas, 146

  Bond houses, 144-147

  Bonds, government, 96, 97;
    mortgage, 148, 150, 169

  Bonds and stocks, not liquid securities, 53

  Book accounts, 12

  Branch banking, 62, 64, 65

  Bullion, 81, 82;
    in Canada, 132;
    in England, 105;
    in France, 113;
    in Germany, 122

  Buying and selling on time, 11, 12


  Cables in foreign exchange, 33

  Canadian banking system, 126-135

  Capital and surplus requirements for banks, 46-48;
    stock, 47, 48

  Cash, supply of, 35-40;
    demands on banks, 55;
    resources, 29

  Casse Rurali, 162

  Central banks of Europe, 8, 9, 65, 101;
    England, 104-111;
    France, 111-119;
    German, 119-123

  Charters, 8;
    special, 66, 67

  Checking accounts, 15, 20, 21, 24, 35

  Checks, 15, 16, 21-24;
    abroad, 36

  Chicago, clearing center, 24;
    central reserve banks, 78

  Clearing house, 22-24;
    center in New York, 80

  Coin, 21;
    and bank reserves, 38;
    in England, 109;
    in France, 117;
    in Germany, 121, 122;
    standard and subsidiary, 21;
    supply, 40

  Collections, 22, 25

  Commercial banking, collections, 22;
    currency, 21, 22;
    domestic exchange, 25;
    nature and operations of, 11-67;
    other countries, 101-135;
    problems of, 35;
    promissory notes, 19;
    protection against unsound practices of, 46-62;
    savings accounts, 44;
    in the United States, 68-100

  Commercial paper, 11-14;
    discount of, 14, 15, 17;
    and investment paper, 41, 42;
    liquid security, 53;
    market for, 100

  Competition in banking, 83

  Comptoir d'Escompte de Paris, 115, 116

  Conflict of functions and laws, 82

  Cooperative banks, 139

  Correspondent banks, 24, 25

  Credit "acceptance" line, 103;
    balance, 16, 18-20, 23, 25;
    cooperation in, 166-168;
    department in banks, 43, 86;
    inflation of, 87;
    "line" of, 16, 85, 86;
    subsidies, state, county, and municipal, 169;
    system, 11-13

  Credits, forced liquidation of, 49

  Crédit Agricole, 162;
    Foncier, 113;
    Industrielle et Commercial, 115, 116;
    Lyonnais, 115, 116

  Crisis, commercial, 19, 31, 88

  Currency, 21, 22;
    lack of elasticity, 95-97


  Debt paying, 13, 14

  Debits, 15-18

  Demand in foreign exchange, 33, 34

  Deposits, 2-4

  Depositors, mutual insurance of, 60-62

  Discount, defined, 14;
    loans and discounts, selection of, 40-43;
    loans and rates, 44;
    operation of, 13;
    rate, Canadian, 128, 129;
    bank of England, 108;
    bank of France, 113;
    reserve system, 95, 97;
    stopped, 30

  Discounted paper, 14, 15, 17-19, 55

  Documented bill of exchange, 42

  Domestic exchange, 25

  Drafts, 16, 27, 28;
    foreign payments, 31


  England, bank of, 9, 104-111;
    banking system, 104-111;
    foreign and colonial, 108;
    joint stock banks, 106;
    metropolitan, 107;
    private, 108;
    provincial, 107;
    reserve system, 108

  Europe, commercial banking in, 101-126;
    central banks of, 101-126;
    land banks, 147-163

  European investment banking machinery, 166

  Exchange operations, 11-13;
    checks, 22-24;
    domestic, 25-31;
    foreign, 31-34


  Federal Reserve Banks, 98-100;
    Federal Reserve Board, 99, 100

  Foncier Algierienne, 162

  Foreign exchange, 31-34;
    _par of_, 31, 32;
    classes of bills used, 33

  France, bank of, 9, 111-115

  French banking system, 111-119


  German banking system, 119-126;
    hypothekenaktienbanken, 151, 152;
    investment banking machinery, 166;
    land and mortgage banks, 147-161;
    landschaften, 147-149;
    Schulze-Delitzsch, 153-162;
    Raiffeisen, 156-162

  Germany, bank of, 9, 119-123

  Gold element of currency, 5, 96;
    points, 32, 33;
    and silver coin in England, 105, 106;
    in France, 113;
    Canada, 133


  Incorporation, 7;
    should be required, 66

  Independent treasury system, 75-78

  Inflation, 49-53, 56-59;
    of credit, 87

  Inspection of banks, 59, 60

  Insurance, mutual of depositors, 60, 62

  Investment, banking, 136-170;
    commercial paper, 41, 42;
    confined to liquid securities, 52;
    defects in machinery, 166;
    improvement of machinery, 170;
    paper, 18, 35, 41, 55;
    of surplus funds, 3

  Italy, land banks, 162, 163


  Joint-stock mortgage banks, 169;
    English joint-stock banks, 106;
    German, 151-159


  Kansas "blue sky laws," 146


  Land banks, 147-163

  Letters of credit, 21

  "Line" of credit, 16, 85, 86

  Liquidation, forced, 19, 88;
    of credits, 49, 50;
    protection against, 52

  Liquid securities, 53

  Loan operations, 85-88

  Loans, 2, 3, 15, 86;
    and discounts, selection of, 40-43;
    Canadian system, 128, 129;
    fluctuations, 97;
    German land bank, 147-162;
    in the interest of big business, 167;
    limits to, 52, 55;
    long-term, 2;
    pernicious practice of national banks, 83;
    and reserve system, 95;
    short term, 2

  Local banking, 62, 63

  London stock exchange, 165


  Mints, 5

  Monetary commission, 97, 98

  Money of the United States, 95

  Mortgage banks, 169;
    France, 160-162;
    Germany, 148-163;
    Italy, 162;
    mortgage bonds, 169;
    mortgage loans, long period, 167

  Municipal banks, 139


  National banks, 8, 9, 54, 70-75, 80, 82;
    federal reserve, 98, 99;
    money in vaults, 91;
    notes, 96;
    pernicious loan practices, 83;
    subscribed to federal reserve banks, 98

  National Reserve Association, 98

  New York City, assay office, 81;
    central reserve bank, 78;
    clearing center, 24, 80, 81;
    stock exchange, 81, 82, 92, 165

  Notes, bank, 19-21;
    central banks of Europe and supply of, 102;
    Canadian, 126-133;
    bank of England, 105;
    of France, 117, 118;
    of Germany, 121;
    issue of, 19-21;
    issue privileges, 37, 38;
    government, 39;
    limitation of issue, 58;
    promissory notes, 43;
    regulations regarding, 52;
    safeguarding issue, 56;
    volume of United States, 96


  Oklahoma, mutual insurance plan, 60

  Overdrafts, 16


  "Panicky" conditions and feeling, 94, 95, 97

  Par of exchange, 31, 32

  Paris stock exchange, 165

  Passbook, 15, 16

  Postal savings banks, 139, 141

  Promissory notes, 12, 14, 19-22, 43

  Prior lien, on assets, 56, 58

  Protection against unsound practices of banks, 46-52; 59-61

  Publicity, a safeguard, 59


  Rate of discount, law in France, 118;
    of exchange, 26, 27

  Rates, 44-46;
    raising on loans and discounts, 29

  Real estate and banks, 52

  Reserve banks, Federal, 98-100;
    central reserve, 78;
    cities, 24, 78

  Reserves, administration of funds, 100;
    bank, 35;
    English system, 108-110;
    in national banks, 73;
    operations of system, 91-94;
    regulations regarding, 52, 54;
    secondary, 35-40;
    in state banks, 69;
    in country banks, 73


  Safety, in savings banks, 140;
    fund, 56, 57

  Savings banks, 6, 9;
    defined, 139

  Saving and saving institutions, 136-141

  Secretary of the Treasury and surplus funds, 88-90

  Securities, dealings in the stock exchange, 163, 164

  Security, liquid, 53

  Silver dollars, 96

  Sixty-day bills in foreign exchange, 33, 34

  Société Algerienne, 114

  Société Generale, 115, 116

  State banks, 9, 68-70, 79, 82;
    and Federal reserve, 99

  St. Louis, central reserve bank, 78;
    clearing center, 24

  Stock exchanges, 163-166

  Stockholders, liability of, 46-48

  Surplus, 17, 47


  Trade or mercantile bills, 34

  Treasury of the United States, 75-78;
    operations, 88-90

  Trust companies, 9, 141-144

  Trustee banks, 139


  United States, notes, volume of, 96;
    subtreasury, 80, 81;
    treasury, 75-78

  Units of value and foreign exchange, 31


  Vouchers, 23


  Wisconsin, regulation laws, 146




                  The National Social Science Series

               _Edited by Frank L. McVey, Ph.D., LL.D.,_
                          _President of the_
                     _University of North Dakota_


                              Now Ready

    MONEY. WILLIAM A. SCOTT, Director of the Course in Commerce,
    and Professor of Political Economy, University of Wisconsin

    TAXATION. C. B. FILLEBROWN, President Massachusetts Single
    Tax League, Author of _A B C of Taxation_

    THE FAMILY AND SOCIETY. JOHN M. GILLETTE, Professor of
    Sociology, University of North Dakota

    BANKING. WILLIAM A. SCOTT


                            In Preparation

    THE CITY. HENRY C. WRIGHT

    TRUSTS AND COMPETITION. JOHN F. CROWELL

    THE COST OF LIVING. WALTER E. CLARK

    STATISTICS. W. B. BAILEY

    BASIS OF COMMERCE. E. V. ROBINSON

    PUBLIC FINANCE. CARL C. PLEHN


                        Each, Fifty Cents Net


               A. C. McCLURG & CO., PUBLISHERS, CHICAGO