Geor^^e Davidso 1325-1911 /■ 6.-.v-vH(A^ t\Nj/ <-r< a * Digitized by the Internet Archive in 2007 with funding from IVIicrosoft Corporation http://www.archive.org/details/chaptersonbankinOOdunbrich V CHAPTERS ON BANKING BY CHARLES F. DUNBAR. CAMBRIDGE : 1885. COPYRIGHT, iSSs- ISIS - 131/ ^^I^^(. 35^ PREFATORY NOTE. Of the eight chapters here published, the first four were written three years ago, and have been used since as the basis of a short course of lectures on banking, given annually to classes in the elements of political economy. These chapters are now printed, with a slight revision, in the belief that they can be made to answer their purpose best in this form. The four chapters describing the national banking system of the United States and the banks of England, France, and Germany, were written and are now added to the others, partly for illustration of the general theory of banking and partly to give to the student in convenient form a certain body of information likely to be of use. CHAPTERS ON BANKING. CHAPTER I. DISCOUNT, DEPOSIT AND ISSUE. 1. A BANK may be described in general terms as an estab- lishment, which makes to individuals such advances of the means of payment as may be required and safely made, and to which individuals entrust money, or the means of payment, whenjTotjrj3^jTed-J:^y^-tb^m for direot-ase. In other words, the business of a bank is said to be to lend or discount, and to hold deposits. To these two functions is often added a third, that of issuing banknotes, or the bank's own promises to pay, for use in general circulation as a substitute for money. The object of the present chapter is to inquire into the real nature of the operations thus roughly classified and usually described by the terms Discount, Deposit, and Issue ; and for this purpose we shall analyze the transactions attending the ordinary and simple case of a loan made by a bank to one of its customers. 2. The borrower who procures a loan from a bank does so in order to provide himself with the means, either of making some purchase, or of paying some debt. He seeks, therefore, to obtain, notjtiecessai^ily money, but a c ert ain amount of_ pur- chasing power in some available form, or of whatever may be tKe usuaTsolvent of debT^lneasured m terms of money. If we suppose him toTelTraerchant, buying and selling goods upon credit in the regular course of his business, he is likely at any given time to have in his hands a greater or less number of ndtes, not yet due, signed by the purchasers to whom he has 6 CHAPTERS ON BANKING. heretofore made siiles ; and it is by a loan upon the basis of one or more of these notes, giving him immediate command of a payment due to him in the future, that he will procure from a bank what he needs. ThisJoan_jwill_j2r9^]?lXj'^^® jbheJ!arm-Q£ wh at is-tfirmed_a dis^xuint. The rate at which the discount shall be made having been settled by agreement, the borrower is entitled to receive from the bank, in exchange for a note due' at a future time, the amount promised in the note, less the intere st on that amount comp ute d at the agre ed^ rate for the time which the note has still to mn .* The note itself becom es then the proijerty oi-the baiik, to- which the promisor is henceforward bound to make the pay- ment a LinaAuxity^-xtnd thej3aynie.nt thus made restores to the bank the amount advanced by it hi exchange for the note, togetEjjr-wit h the^uTterest which^jvvas the^jnHucement for making the exchange. It is now clear, however, that the operation which we have described, although spoken of as a loan by the bank to a borrower, is not a loan in fact. The l^otejdien given was evi dence that^its holder^ owned the right to rece ive at ajix ed date a certain sum qf_money^nd7this right j the so-ca lled, borrower ha s sold to the bank. Passing over for the present all question as to what he has received in exchange, his cession of property by sale is as distinct and complete as if he had sold a bale of cotton to another merchant, instead of selling to a bank his right to receive money in the * If e. g-.j the note discounted promises to pay $2,500, has 87 days to run and the agreed rate is 6 per cent., then the interest to be de- ducted is $36.25 and the proceeds received by the borrower are $2,463.75. But although this process is commonly known as discount, it gives a result somewhat different from that of discount in the strict sense of the term. Real discount consists in finding that sum which, if put on interest for 87 days at 6 per cent, will then amount to $2,500, or, in other words, in finding the present worth of $2,500 due under the conditions stated. As this present worth is $2,464.27, the established practice gives to the lender a slight profit in addition to that afforded by true discount. DISCOUNT, DEPOSIT AND ISSUE. 7 future. It is true that in parting with the note he probably- endorsed it, and thus bound himself to make good its amount in case the promisor should fail to do so, but he might equally bind himself by some warranty given to the purchaser, when selling any other description of property. The note has ceased to be his and now takes its place among the investments or securities of the bank, although custom may lead to its classification as a " loan orjiis4tauj it." * The operation which we have here presented in its simplest form may easily change its shape according to circumstances. Thus__imii merchmi t, instead of offerij2gjor_diEect-ildiaciiunt" ^e notes of his customers, may offer his o wn note for the^ sum whic h he wishes to obtain, and attaah_JoJlt,,a^^^ecurity; for jts p ayment a t matui'ityj^one or more of:thfijiates_iiLLhisL.caistoiimrs* In this case the principal note, his own, becomes the property of the bank, and the right to receive from him at its maturity the sum promised in it is the re al object of sale; while the attached notes, formerly given to him for merchandise and now pledged to the bank as collateral security for the perform- ance of his contract, continue to be his property, subject to the right of the bank to be indemnified therefrom in case of his failure. And^.so, too, the so-cadled _borrow^r_maj gffer_his own note , secu red by t he pledge of Jbonda^-Stocks, or jxLher y al- uable property,_the ownership of. whjch _he does not p art with, while at _ the sanie_timej_he^^ells as effectu aIlyLa&-in t he firs t case_the rightto receive fro m hiii L ^ fiftrtain sum at ajfi j^ed date. Indeed, ifwe~conside7 any of the forms in which a bank may make "advamiesL" or J^loansJljve shall find that^_every ease a right to dem an d an d r e ceiv e^ a jcert ain sum o f mon ey has been^cquired by th^e^ ban]^for ^consideratJp_n,_aad^ transaction was, therefore^n_fixchBJige. * In an account of the Bank of England, the note supposed, if taken , would have to be classified under "Other Securities," together with bonds or stocks owned by the Bank. 8 CHAPTERS ON BANKING. 3. We now have to consider what it is that the bank gives in exchange for the right to demand and receive money at a future time, acquired by it under these circumstances. To return to our first and simplest case of so-called discount; the proceeds of the note, or its nominal amount less the interest for the time for which it is to run, are in the first instance placed to the credit of the merchant, to be drawn out by him at once or at different times, as convenience or necessity may dictate. In thus crediting him with the proceeds, the bank plainly gives to him simply the right to call upon it at pleasure for that sum of money. Whether this right is exercised at once by demanding and receiving the money, or whether the exercise of it is postponed as regards the whole or a part of the amount, in either case the right to demand, or to "draw," is the equivalent received by the merchant in exchange for the right sold by him to the bank, of which the note discounted was the evidence. And the_gumjwh ich h e i s thus at j .ny time _^ntitlfid-i;o call for, sxLlong as it stand jjto. h is credit, is sai djo be depos ited i n the bank, or briefly to b e a deposit, st anding in- jiis naia e^— Soj^tpo^ in other cases of so-called *%ans" or "discounts^" i n whatever form and whatever the collateral se- ^urity hfild t)j^ the bank may be ; the operation is always essen- tially^3i._fixchange.,o£2gttSiIw5ere]^ bank acquires the right t ojieceiye money, or the legal tender of the country, at 8mn£.Jiiture-ti®e, and the individual acquires the right to call for mo ney or lega^Jtender at pleasure. The result is to give the latter that immediate command of purchasing power or of the solvent for debt which, as we have said, is the real object sought by him ; but this result is secured at the outset and the relations of the bank and the "borrower" are settled without the intervention of money, by the sale of one right for another. But the deposit may owe its origin to a different operation from that which has just been examined. It happens every day that the merchant, having cash in hand, sees fit not to hold DISCOUNT, DEPOSIT AND ISSUE. 9 it in his possession until it is required for use, but prefers to "deposit" it with the bank where he usually transacts his busi- ness, until he needs to use it. In this case, when he makes his deposit, the property in the money or substitutes for money actually paid in by him passes to the bank and he receives in exchange the right to demand and receive at pleasure, not that which he paid in, but an equivalent amount."* Here then, as in the former case, the transaction is in effect a sale, although the use of the word "deposit" seems at first to justify an entirely different idea of its character. 4. The other leading operations of banks when analyzed, can also be resolved into cases of the exchange of rights against rights, or of rights against money. As, for example, when the bank, for the convenience of its customer or depositor, under- takes to collect a note due to him by some third party and, the promisor having paid in the amount in money to the bank, it is passed to the credit of the promisee as a deposit. Here the bank has received money for the account of the depositor, and has given to him in exchange a right to draw at pleasure for the amount or any part thereof, the property in the money actually paid having passed absolutely to the bank in exchange for the right to draw. And again, when the bank buys from a merchant a bill of exchange, or when it sells a bill of exchange drawn by itself on some correspondent, it effects an exchange of money against a right, or of a right against money, strongly resembling those already considered. And so, too, if in any of these cases any substitute or equivalent for money is used, instead of money itself, the transaction is still an * It is true that money may be left as a "special deposit" with a bank, just as plate, jewels, or other valuables may be, in which case, the identical money deposited is to be returned and the bank conse- quently does not acquire the property in the thing deposited, but is merely entrusted with its temporary custody. This, however, is not a banking operation, and the deposit in this case is made with the bank, not because it is a bank, but because it owns a strong vault. 10 CHAPTERS ON BANKING. exchange af a right on the one side, and some means of pay- ment on the other, the latter becoming the property of the bank. We have thus far, for the sake of simplicity, spoken only of the "rights to receive" money, bought by the bank in one class of cases, and sold by it in another. But where there is a right to receive on the part of tlie creditor, there is a corresponding duty to pay on the part of the debtor; and these rights or credits, when viewed from the other side, are, therefore, debts or liabilities. It follows then that, as any addition to the loans of a bank is an increase of its investments or resources, so any addition to its deposits is an increase of its debts or lia- bilities. The deposit which is credited in making a loan is a liability to pay on demand, assumed by the bank in exchange for a security promising a payment to the bank in the future ; and the deposit credited upon the receipt of cash from the depositor m a similar liability, assumed in exchange for so much money or so much of its substitutes. 5. A little consideration of the manner in which notes are issued by banks will show that in the banknote we have only another form of liability, differing in appearjtii£ia_but_not_in substance, from the liability^^or^eposits. I ^e ba nkn ote is the d uly certified pro miaB-a£-th ^bank to pay on demand^ adapt ed Sr _convenie nii-4^irru1atit^T) «« a substitute for the money whicj b it promise^ . It is issued, by the bank, and can be issued, only to such persons as are willing to receive the engagement of the bank in this form instead of receiving money, or instead of being credited with a deposit. Thus the so-called borrower, who in the first instance has been credited with a deposit and to whom the bank is therefore to this extent liable, may prefer to draw the amount in notes of the bank and to use them in making his payments. But, in this case, it is plain the liability of the bank is changed only in form ; it is still a lia- bility to pay a certain sum of money on demand. And so if the depositor deposits money and receives notes, or receives notes in satisfaction of a demand of any kind against the bank, DISCOUNT, DEPOSIT AND ISSUE. 11 he, in fact, foregoes the use of th« money itself and consents to receive in its stead a promise to pay upon demand, and to receive the evidence of that promise in the form of notes rather than in another. The question, in whicli form he shall liold his right of demand against the bank, is one to be decided by the nature of his business or by his present convenience, but plainly the decision of the question in no way affects the relation between himself or any transferee of his right and the bank. The notes issued by a bank are thus a liability distinguishable in form only from its liability for deposits. 6. In the operations which have now been considered the subject-matter involved is in every case either money or con- tracts for the payment thereof. No form of dealing in meTOhandize or real property comes properly within the province of banking. And, inasmuch as a contract for the payment of money may be viewed either as a credit or as a debt, according as it is looked at from the one side or the other, banking is sometimes described as the business of deal- ing in credits and sometimes as that of dealing in debts. For the transaction of this business in the modern world both of the functions "discount" and "deposit" are indispensable. In order to be a bank, that is to say, an establishment must carry on the purchase of rights to demand money in the future, or securities; and it must also use in some form or other its own engagements for the payment of money upon demand.* If it practices the former only, it is simply an investor of its own money, as any private individual may be ; if it practises the latter only, it may indeed be said to be a bank of the obsolete type of the Bank of Amsterdam, but it would then cease to answer the chief purpose of a bank of the present age, viz., that of enabling individuals to convert into immediate pur- chasing power the debts which are due to them in the future. * See in Bagehot's Lombard Street^ p. 212, a remark that the Roth- schilds are great capitalists, but are not bankers. 12 CHAPTERS ON BANKING. The use of the third function, however, that of issue, is not indispensable to the existence of a bank, for, as has been shown, issue is but a modification of deposit, and is made for con- venience and not from necessity. There are conditions under which the liability of the bank in the form of notes is desired for use, and there are also conditions under which the liability in the form of deposits better serves the convenience of indi- viduals or of the community. Many banks, therefore, carry on a large and successful business without making any issue of notes whatever.* It must be added that incorporation by law is not a neces- sary condition of the existence of a bank.f Discount and deposit, and if no legal prohibition exists, issue also, may be carried on by individuals and firms as well as by incorporated com- panies. It is true that in discussions of banking it is usual to give almost exclusive attention to incorporated banks, partly because they usually hold a more conspicuous position and partly because their affairs are in some degree open to official inspection, so that the details of their business are known, at least in part, whereas the transactions of private banks are known only to the persons concerned. It is none the less true, however, that in the economic effects of their transactions the two kinds of banks do not differ, and that neither can be neglected in an examination of the economic problems pre- sented by any community in which it is found to exist. *In November, 1882, the banks in operation in the United States, excluding savings banks, were classified as follows : — Number. Capital, State Banks and Trust Companies, 1,061 $123.1 millions. Private Bankers' 3»4i2 105.3 " National Banks 2,308 484.9 " Total 6,781 $713.3 See Comptroller's Report, 1884, p. 8. Of these banks the national banks alone are authorized by law to issue notes, t See the preceding note. CHAPTER II. BANKING OPERATIONS AND ACCOUNTS. 1. Having thus taken a general view of the nature of bank- ing operations, it is now necessary that we should enter upon the consideration of some of their details. For a bank, as well as for any other considerable establish- ment, it is requisite that a capital should be provided at the outset. There can be no constant proportion between the amount of this capital and the extent of the business which may be built up by its means. We can only say that, other things being equal, the larger the business that can be carried on with safety with a given capital, the larger will be the field from which profits can be earned and the higher the propor- tion which the profits will bear to the original outlay ; but the point at which the extension of the business passes the line of safety, must be determined by the circumstances of the par- ticular bank, by the kind of business carried on by those deal- ing with it, and by the condition of the community in which it is established. The attempt has sometimes been made to limit by law for incorporated banks the proportion of transac- tions for a given amount of capital,* but no such provision has any foundation except a conjectured average, too rough to be of service in any individual case. In this respect, as in so many others, the judgment of the persons most interested, acting under the law of self-preservation, is far more trust- worthy than any legislative decision. The capital thus to be provided at the outset is, of course, in *E. g.^ the law in Massachusetts formerly limited loans to double the amount of the capital. See Revised Statutes of i860, c. 57, § 25. 14 CHAPTERS ON BANKING. the case of a private bank, the contribution of the partners, as in any other undertaking. In tlie case of an incorporated bank the capital is divided by law into equal shares or units of fixed amount, as e. g.^ under the law of the United States, a capital of $100,000 into 1,000 shares of $100 each; and of these shares the individual shareholders contribute in such propor- tion as they please. The law may as a matter of public policy limit the proportion of capital stock to be owned by any one individual or firm, and it may also limit the liability of share- holders for debts due by the bank, in case of its failure ; but, it may be said in general that in the absence of special provisions to the contrary, the powers, rights and liabilities of each share- holder are now usually determined by the number of shares of the stock contributed or owned by him. In the election of directors and of other officers for the immediate management of the business, each share usually entitles its owner to cast one vote ; the dividend of profit is divided in the ratio of shares owned, and contributions to meet losses, if required by law, are called for in the same ratio. The capital which has been subscribed by the intending shareholders must necessarily be paid in in money or in the legal tender of the country. It is not necessary that the whole should be paid in at the outset, but the payment of the whole usually precedes the full establishment of the business; and, in the case of incorporated banks, the law is apt to require that some definite proportion, as e. ^., one-half, shall be paid in before the opening of business, in order to insure good faith and a solid basis for the business undertaken.* * The English Joint Stock Banks present some remarkable cases of partially paid capital. Thus the largest, the London and Westminster. has £20 in the £100 paid up on its shares, and the London Joint Stock has £15. In these cases, the business having been fully established by means of a part only of the nominal capital, the liability of the share- holders to contribute the remainder in case of need constitutes a species of guaranty fund of immense amount. BANKING OPERATIONS AND ACCOUNTS. 15 If, now, we undertake to represent by a brief statement of account the condition of a bank having a capital of $100,000 paid in, on the morning when it o-pens its doors far business, we shall have the following: Liabilities, Resources. Capital . . . $100,000. Specie . . . $ioo,ooOi It may at first sight appear to be a contradiction in terms, that the capital should be set down as a liability and not as a resource. But we must here distinguish between the financial liability for what has been received from the shareholders and the right of property in the thing received. The bank has be- come accountable to its shareholders for the amounts paid in by them respectively, but the money actually paid has become the property of the bank ; or, in the language of accountants, the bank has become liable for its capital, and the money in hand is for the present its resource for meeting this liability, or for explaining the disposition made of what has been received. As the bank requires banking rooms and a certain supply of furniture and fixtures for the convenient transaction of its business, we may suppose it to expend $5,000 of its cash in providing this "plant." The property thus procured, with the remaining 195,000 in cash will then be the aggregate resources by means of which the capital is to be accounted for, and the account will stand as follows: Liabilities. Resources. Capital . . . $100,000 Real estate, furniture, fixtures, etc. . $5,000 Specie .... 95,000 $100,000 $100,000 16 CHAPTERS ON BANKING. 2. The bank, however, cannot answer the pui'poses of its existence, or earn a profit for its shareholders, until its idle cash is converted into some kind of interest-bearing security. Nor is it enough that a permanent investment of the ordinary kind should be made, as by the simple exchange of its cash for government bonds or railway securities. It is the chief business of tlie bank to afford to purchasers and dealers the means of using, by anticipation, funds which are receivable by them in the future, and this implies both the purchase of private securities or "business papei*" to a considerable extent and also frequent change and renewal of purchases. Moreover, while the private capitalist finds it advantageous 1 o make simple in- vestments of a permanent sort, this would plainly be unprofit- able for the shareholders of a bank, who have to pay from its profits some serious expenses of management, and need, therefore, a larger field for earnings than the ordinary returns on their capital alone. The bank is obliged then to use its credit in some way for the extension of its operations. It is in fact, by such a use of its credit, that it becomes in reality a bank. Most of the conditions of the case are best answered by the "discount" of commercial paper as above described. The time for which such obligations have to run varies with the custom of the trade which gives rise to them, but is in most cases suffi- ciently short so that the re-payment to the bank is early. And even where custom gives the paper longer time, if the paper itself is used only as a collateral security, the note which is the actual object of negotiation with the bank is by preference usually made not to exceed four months. It is easy then to arrange the purchases of paper with reference to the times of maturity, so as to provide for a steady succession of payments to the bank, and thus facilitate the reduction of the business if necessary, or its direction into new channels, as prudence or good policy may require. The certainty of prompt payment BANKING OPERATIONS AND DEPOSITS. 17 at maturity, needed for this end, is presented in a high degree by the paper created in the ordinary course of business. * Independently of the collateral security wliich the bank may hold, the written promise of the merchant or manufacturer to pay on a fixed day is an engagement which involves the credit of the promisor so far, that failure is an act both of legal insol- vency and of commercial dishonor. Selected with judgment then, such paper is not only the investment which most com- pletely answers the purposes of the bank's existence, but is probably as safe as any investment which could be found. It may easily happen, however, that the bank may find it desirable to invest a part of its resources in some other form, either because good commercial paper cannot be procured in sufficient amount, or as a matter of policy. In this case it will purchase such other securities as oflTer, not only complete safety of investment, but the possibility of easy conversion into cash in case of need.f In this country United States bonds, and many descriptions of State, municipal and corporation bonds might answer this purpose. Stocks would more rarely answer it, being more liable to the fluctuations in price caused by mis- fortune or the ordinary vicissitudes of business. Mortgages of real estate, however, would not be admissible, except when held as a security collateral to some other more easily con vert- * The reports of a large commercial agency show that, for ten jears, 1875-84, the number of failures in the United States was a trifle over one per cent, of the whole number of houses reported as in business. For a curious estimate showing that the liabilities of failed firms in 1874 amounted to less than one-fourth of one percent, of the total com- mercial liabilities of the country for the year, see Commercial and Financial Chronicle, February, 1875, p. 129. t See in the reports of the Comptroller of the Currency, the "United States bonds on hand" and "other stocks and bonds" held by the national banks and amounting to over $109,000,000 in July, 1885. Com- pare also the "government securities" held by the banking department of the Bank of England. 18 CHAPTERS ON BANKING. ible, for even when the mortgaged property is so ample and stable as to insure the goodness of the mortgage, the conver- sion of the mortgage into ca&h by sale is not always easy, and is especially difficult at those times when the bank most needs to have all its resources at command. Indeed, the danger to be apprehended from the locking up of resources in securities, which may be solid but are not easily realized, is so great, that it has been said to be the fir&t duty of the banker to learn to dis- tinguish between a note and a mortgage, his business lying with the former. Real estate, of course, cannot be regarded as a banking security, howeyer desirable it may be a& an invest- ment for individuals, for it is not only subject to great fluc- tuations in value, but is at times unsaleable ; and the law of the United States therefore wisely prohibits investments in it by the national banks, except so far as is necessary for the accom- modation of their business.* The results of the process of investment in commercial paper and in other securities are best understood when we trace the effect in the accounts of the bank. Taking then the account as it stood on p. 15, let us suppose that the bank buys secu- rities from those dealing with it, or in the common phrase, makes "loans to its customers," to the amount of $90,000, the paper being in many pieces and having various lengths of time to run, but averaging three months. Supposing the interest to be computed at six per cent., we should have the account changed by the operation as follows : Liahilities. Resources. Capital . . $100,000 Loans $90,000 Undivided profits . 1,350 Real estate, furniture, Deposits .... 88,650 fixtures, etc. . , . 5,000 Specie 95.000 $190,000 $190,000 ♦ See Revised Statutes, § 5137. BANKING OPERATIONS AND ACCOUNTS, 19 Here we have the securities which certify the right of the bank to demand and receive $90,000 at a future date placed among the resources; the net proceeds of the securities, or the aggregate of the sums which the bank holds itself liable to pay for them on demand, stand among the liabilities as deposits ; and the interest deducted in advance, or the profit on the oper- ation, which the bank must at the proper time account for to its stockholders, also stands as a liability. This, however, is the condition of the account at the moment of making the in- vestment, when the bank has made its purchase of securities by merely creating a liability. As this liability is real and must be met, so far as the depositors who own it see fit to press it, let us suppose that depositors call for cash to the amount of 115,000, and we shall have a further change in the account as follows : Liabilities. Resources, Capital . . . . $100,000 Loans .... $90,000 Undivided profits . 1.350 Real Estate, etc . 5,000 Deposits .... 73.650 Specie .... 80,000 $175,000 $175,000 It is clear that unless the enforcement of the liability for deposits and consequent withdrawal of specie goes much farther than this, the bank can safely increase its loans or its purchase of securities, although its method of doing so is by the increase of its liabilities. We will suppose it, therefore, to have expanded its affairs until it has reached something like the average condition in November, 1884, of those banks in the United States, which, being incorporated under the laws of the several states, are not authorized to issue notes. It will then stand thus : 20 CHAPTERS ON BANKING. Liabilities. Capital .... $100,000 Surplus .... 28,000 Undivided profits . 1 1,000 Deposits . ... 294,000 $433,000 Resourcti •. Loans .... $299,000 Bonds and stocks 30,000 Real estate . . 13.000 Other assets . . 15,000 Expenses . . 1,000 Cash items . . 26,000 Specie .... 23,000 Legal tender notes 26,000 $433,000 3. Postponing for the present the consideration of some terras which here occur for the first time, it appears from the above account that purchases of securities have been made to more than three times the amount of the capital, and that this has been effected chiefly by the creation of liabilities in the form of deposits. What determines the limit to which this process can be carried? If depositors seldom demanded the payment to which they are entitled, and were contented with the mere transfer of their rights among themselves as a conventional currency, the bank might dispense with holding specie or cash in any form and keep all its resources employed in its productive securities. The expansion of the deposits would then resemble in its effects the expansion of any other currency and might go on until a check should be interposed by the consequent rise of prices and demand for specie for exportation. And it is true, as we shall see, that in communities where banking is largely practised, the use of deposits as currency by transfer from hand to hand is so extensive, that a bank in good credit can rely upon their being withdrawn so slowly, or rather to so small an extent, as to make it unnecessary to have cash in readiness for the payment of more than a small proportion at any given moment. In a period of financial disorder or alarm, withdrawals may be more frequent or more immediate, and a larger provision of cash may be needed for safety, than at other BANKING OPERATIONS AND ACCOUNTS. 21 times; the kind of business carried on by depositors may expose one bank, or the banks in one place, to unusually heavy occa- sional demands, or may on the other hand make demands steadier, than is the case elsewhere; a city bank may be more subject to heavy calls from depositors than a country bank ; still, for every bank in its place and under the circumstances of the time there is some line below which its provision of cash, or reserve as it is now called, cannot safely fall. And the necessity of maintaining this minimum reserve fixes a limit to the ability of the bank to increase its securities. For obviously, in the account last given, any increase of securities, that is of loans or bonds, must be effected, either by an increase of deposits, or by an actual expenditure of cash. In the one case the proportion of reserve to demand liabilities would be weakened by the increase of liabilities ; in the other it would be weakened by the decrease of cash. If, then, the reserve were already as low as prudence would allow, or were threat- ened by approaching heavy demands from depositors, no increase of securities could be made without serious risk. What proportion the reserve should bear to the liabilities which it is to protect is a question which the law has sometimes attempted to settle, by requiring a certain minimum,* leaving it to every individual bank to determine for itself how much is required in addition to this minimum. And this is no doubt as far as any general rule can go. As has already been sug- gested, the requirements for safety of different banks and of different places must vary, and so must the requirements of the same bank at different times. f It can only be said that * The law of the United States, under which the national banks are established, recognises twenty-five per cent, as the minimum reserve for city banks, and fifteen per cent, as the minimum for country banks. Revised Statutes, §5191. t The Bank of England may be content with a reserve amounting to 33 percent, of its deposits, as in October, 1885, or it may be uneasy with a reserve amounting to 44 per cent, as in August, 1881. 22 CHAPTERS ON BANKING. the reserve should be large enough, not only to insure the im- diate payment of any probable demand from depositors, but also to secure the bank from being brought down to the "danger line" by any such demand. If twenty-five per cent, is the minimum consistent with safety, the reserve should be far enough above this to be secure from reduction to a point where any further demand or accident may make the situation hazardous.* 4. In the arrangement of its reserve the bank itself necessarily feels a strong conflict of interests. On the one hand it is impelled to increase its securities as far as possible, for it is from them that it derives its profits, and the retention of a large amount of idle cash is felt as a loss. On the other hand, the maintenance of a reserve sufficient, not only to con- tinue its payments but to inspire the public with confidence in its ability to do so, is a necessity of its existence, even though a part of its resources do thus appear to be kept permanently idle. As a natural consequence, the actual settlement of the question in favor of a large or of a small reserve in any par- ticular case will depend largely on the temperament of the managers. In every banking community may be found "con- servative" banks, the caution of whose managers forbids them to take risks by extending their business at the expense of an ample reserve; and by their side may be seen the more "active" banks, whose managers habitually spread all possible sail, and provide for the storm only when it comes. It is to be observed that the necessity of providing a cash reserve is not met by the excellence of the securities held by the bank. Although the certainty of payment at maturity be abso- lute, still the demands upon the bank are demands for cash, and cannot be answered by the offer of even the best securities. If the depositor or creditor does not receive cash in full for * For a discussion of this subject, see Bagehot's Lombard Street^ ch. xii. BANKING OPERATIONS AND ACCOUNTS. 23 his demand when it is made, the bank has failed, and any satisfaction of his claim by the delivery of a security is, as it were, only the beginning of a division of the property of the bank among its creditors. Specie, or the paper which is a substitute for it as a legal tender for debts, form the only real banking reserve. The reserve of the bank may, however, be greatly strengthened by a judicious arrangement of its securi- ties. P'or example, if, in the account above given, the "bonds and stocks" are, as they should be, of descriptions which are readily saleable, they afford the means of replenishing the reserve in case of need, without foregoing the enjoyment of an income from this amount of resources for the present. In extreme cases of general financial panic, it is true, even the strongest government securities may find but few purchasers ; * still such a provision is the best support which can be had in the absence of, or as an auxiliary to, a sufficient reserve of actual cash. The natural method of securing the proper apportionment of resources between securities and reserve, under ordinai-y circumstances, is by increasing or diminishing the loans, or, in other words, the purchases of securities made from day to day in the regular course of business. That part of the secur- ities which consists of the promises of individuals or firms to pay to the bank at fixed dates, is made up of many such pieces of commercial paper^ maturing, if properly marshalled, in tolerably regular succession. The payment of one of these engagements when it becomes due may be made either in money, or by the surrender to the bank of an equal amount of its own liabilities, as will be shown in the next chapter. In the former case, the payment of the maturing paper to the bank is in fact the conversion of a security into cash, and increases the reserve without change in the liabilities ; in the * In the London market in the panic of May, 1866, there was a moment when even "consols were unsaleable." Patterson^ Science of Finance^ 223. M CHAPTERS ON BANKING. latter, the reduction of securities is balanced by a reduction of liabilities which raises the proportion of reserve. If, then, the bank stops its "discounts" or the investments in new securities, or if it even slackens its usual activity in making such invest- ments, the regular succession of maturing paper will grad- ually strengthen its reserve ; if it increases its activity in investment, it will lower or weaken its reserve; and if it adjusts the amount of its new investments to the regular stream of payments made by its debtors, it may keep the strength of its reserve unaltered, until some change in the condition of affairs brings cash to it or takes cash away by some other process. This natural dependence of the reserve upon the more or less rapid reinvestment of its resources by the bank is distinct- ly recognized by the law of the United States, which provides that when the reserve of any national bank falls below the legal minimum, such bank "shall not increase its liabilities by making any new loans or discounts," until its reserve has been restored to its required proportion.* By a less harsh applica- tion of the same principle, the Bank of England operates upon its reserve by lowering or raising its rate^f ^discount and thus encouraging or discouraging applications for loans. And it was with a view of facilitating the replenishment of the reserve by the curtailment of loams, that the law of Louisiana formerly provided that the banks established by that State should hold a considerable proportion of ''short bills," or paper maturing within ninety days, so that the constant stream of payments of such paper might always insure the early command of a large part of its resources by the bank.f 5. To return in conclusion to the account given on p. 20; we have there among the liabilities certain sums classified as "surplus" and as "undivided profits." Taken together these ♦ Revised Statutes of the United States, § 5 191. t See some remarks on the excellent effects of the Louisiana system by Samuel Hooper, Theory and Effects of La-ws regulating specie in Banks, i860. BANKING OPERATIONS AND ACCOUNTS. 25 sums represent profits which have been made, but not divided among the stockholders, and which are therefore to be accounted for by the bank. The surplus is that portion of these profits which as a matter of policy it has been deter- mined not to divide and pay over to the stockholders, but to retain in the business, as in fact, although not in name, an addi- tion to the capital. The remainder, the undivided profits, is the fund from which, after payment of current expenses and of any losses which may occur, the next dividend to the stock- holders will be made. The current expenses are for the present entered on the other side of the account, as they represent a certain amount of cash which has disappeared ; but at the peri- odical settlement of accounts they will be deducted from the undivided profits and will thus drop out from the statement. "Other assets," here set down as an investment, is supposed to cover any form of property held by the bank and not other- wise classified, but especially^doubtful securities, or such prop- erty, not properly dealt in by a bank, as it may have been necessary to take and to hold temporarily, for the purpose of securing some debt not otherwise recoverable. For example, although the bank could not properly invest in a mortgage, it might be wise for it to accept a mortgage in settlement with an embarrassed debtor, and in this case t,he mortgage would stand among the "other assets." And, finally, "cash items" include such demands on individuals or other banks as are to be collected in cash and are therefore deemed the equivalent of cash in hand. In the absence of any legal provision limit- ing the treatment of such demands as reserve by the creditor, they may be regarded as virtually a part of the reserve, which in the case before us may therefore be treated as made up of cash items, specie, and legal tender notes. To illustrate what has been said in this chapter we will now suppose the bank, with its affairs standing as on p. 20, to make the following operations : a. To add to its securities by discount of three months 26 CHAPTERS ON BANKING. paper 120,000, of which three-fourths are purchased by the creation of liabilities, and one-fourth by the expenditure of cash. The account would then stand as follows : Liabilities. Resources. Capital . . . . Surplus . . .- . Undivided profits . Deposits . . . . $100,000 28,000 11,300 .. 308,775 Loans .... $319,000 Bonds and stpcks 30,000 Real estate . . 13,000 Other assets . . 15,000 Expenses . ► . 1,000 Reserve. . . . 70,075 -f- /'c/ c^ $448,075 $448,075 h. To retrace its steps by diminishing its "discounts" or holding of securities to the extent of $50^,000, of which four- fifths are paid to it by the surrender of demands for deposits to a like amount and one-fifth in cash ; to pay $1,250 for current expenses; and further to increase its reserve by the sale of bonds and stocks to the amount of $10,000» The following would then be the state of the account : Liabilities. Capital . . . . Surplus . . . . Undivided profits Deposits . . * . . $IOOjOOO 28,000 11,300 268,775 $408,075 Resources. Loans .... $269,000 Bonds and stocks 20,000 Real estate . . 13,000 Other assets . . 15,000 Expenses . . . 2,250 Reserve .... 88,825 $408,075 c. To sell $2,000 of its other assets for cash with a loss of $500 ; to make a semi-annual dividend of four per cent., of which one-half is credited to stockholders who happen to be deposi- tors also, and one-half is paid in cash ; and to caiTy ther emain- der of its undivided profits to surplus. The account would then stand at the beginning of the new half year, as follows: Liabilities. Resources. Capital .... Surplus . . . . Deposit . . . . $100,000 32,550 270,775 Loans .... $269,000 Bonds and stocks 20,000 Real estate . . 13,000 Other assets . . 13,000 Reserve. . . . 88,325 $403,325 $403,325 CHAPTER HI. THE CHECK SYSTEM. 1. In the preceding chapter reference has been made more than once to the transfer of deposits by one holder to another, and to their consequent use as currency. It is now necessary to examine more closely the simple machinery by which this transfer is effected. The depositor, or the creditor of the bank, having to make a payment to some other person, has his choice between two methods of making it. He may demand money from the bank, in the exercise of his right as a creditor, and deliver this money; or, with the assent of the person to whom he has to make payment, he may give to this person an order on the bank for the money, or what is commonly called a che^k. If he adopts the latter method, a payment for goods or of a debt is effected as between the parties, by the simple transfer of a right to demand money from the bank; and so if the recip- ient of the check gives it in payment to some third person, and he to a fourth, and so on. To this extent the check is plainly made a substitute for the sum of money for which it calls. It represents no particular-jnp ney in eyi stftnf>.p, for, as we have seen, the deposit is likely to have b^^" creat-^d by thft hank in e^U^han ^e for some security bought by it, and is, therefore^ a naked rig ht to demand, and not a clairi f^ t.9 any p artinnlar f>ftsh; and even if the deposit originated in the lodgment of money by the depositor, it has in this case also become a naked right to demand and not a claim to the money actually deposited. But the transfer of this naked right is made by the agreement of the parties to serve the same purpose as the transfer of money, and th^ right thus becomes a substitute for money. 28 CHAPTERS ON BANKING. The effectiveness of this substitution, however, is vastly in- creased and the use of the deposit prolonged, where it is the practice for the transferee himself to deposit the check, instead of either making a fresh transfer of it or of demanding its pay- ment by the bank. If we suppose all the parties concerned to keep their accounts with a single bank, and suppose a check for |2,000 to have been drawn by A against his deposit in the bank and given by him to B in payment for goods, B may deposit this check to his credit as he would money. The transfer of the right by A to B has now been made complete, for the bank has become a party to it, and has cancelled its liability for $2,000 to A by recognizing a liability for a like amount to B. This novation, or change of creditors, has not only secured B against the possibility of finding that, before his own check was presented, A's deposit in the bank had been exhausted by other checks drawn fraudulently or by mistake by A, but it has also made B's right of demand against the bank divisi- ble at pleasure, since this has now become a right to draw his own check or checks to an amount not exceeding $2,000 in all. Checks become, therefore, the instruments by which rights to demand money may be transferred from one individ- ual to another in such amounts as the transactions between them may require ; and when we consider the great security and convenience of transfer by such means as compared with actual payment in money, there is little need of furthur expla- nation of the astonishing extent to which they are now used, especially in English-speaking communities.* *It has been found by observation that in New York, at two different dates, 97.7 per cent, of the total receipts of the banks were in checks and similar instruments calling for money at sight. In the United States as a whole the proportion was 94.6 per cent. In London it has been reported as 97.2 per cent. See Comptroller's Report for 1 881, pp. 13-23 for an important investigation of this subject. THE CHECK SYSTEM. 29 If, now, we suppose the parties concerned to keep their ac- counts with different banks in the same city, we shall have results a little more complex but not different in kind. In this case we may suppose the check drawn by A upon Bank No. 1 to be deposited by B in Bank No. 2, If the transaction stands alone, the latter bank collects the money called for by the check, and holds itself liable to make payment to B on demand in sums to suit his pleasure. Then has there been a change, not only of creditors, but of debtors, and yet at the close, after the payment by A to B has been completed, we have in existence a bank liability of the same amount as that with which we started. Probably, however, in a community where there were several banks, the transaction would not stand alone. - At the end of a day's business each bank would be likely to have in its possession, received in deposit, checks upon several, and perhaps all, the others; each would then have checks to meet as well as checks to collect; and in this case each would make its settlement with another, not by making mutual demands and mutual payments, but by the off- setting of demands and the payment only of such balance as might then remain due from the one or the other. If, at the end of the day Bank No. 1 had received in deposit checks upon Bank No. 2 to the amount of 125,000, and Bank No. 2 in like manner, checks upon Bank No, 1 amounting to $23,000, the account as between the banks would be settled easily by the payment of |2,000 by Bank No, 2 to Bank No. 1, while Bank No. 1 would have made itself liable to p.iy $25,000 to its depositors upon demand, and Bank No. 2 would ha^ become liable to its depositors for $23,000, And the result is the same if the operation here traced is multiplied by the number of banks carrying on business with each other in a great city. The settlement of accounts by the banks with each other still leaves the banks collectively under the same liability for pay- ment on demand as before. The liability rests upon the banks, 30 CHAPTERS ON BANKING. it may be, in different proportions, and is differently distributed among the creditors ; but so long as payments are made by checks and checks deposited, the right to demand from a bank which is called a deposit continues to exist in somebody's pos- session, and is as well fitted to discharge the office of money as when it was first created. 2. This medium of payment acquires great perfection wherever the Clearing House system is adopted. Under this system a daily meeting takes place, at which all the banks carrying on business at any common centre are represented. Each bank turns in at the central office all the checks and cash demands which it holds against the others and is credited therewith; the checks and demands which have thus been brought together against each are then summed up and charged against it; and the balance found to be due from each bank or to it is then paid to or from the central office in money. By this means a great mass of transactions, which would other- wise require a series of demands by each bank upon every other, are settled at once and the transportation of large sums in cash from one bank to another is to a great extent dispensed with.* Under this arrangement the bank deposit, circulated by means of checks, becomes the most convenient means of pay- * For a further notice of the Clearing House systerh, see Note on p. 37- The transportation of cash referred to in the text is reduced to its minimum by the practice sometimes adopted of using "Clearing House certificates" instead of money or legal tender notes. These certificates represent %ioney or notes deposited with the Clearing House, or with some bank which is its representative for this purpose, and are payable on demand; being made in convenient denominations they are used in payments between the banks, and for the purposes of reserve are rec- ognized by the law of the United States as the equivalent of the cash which they represent. Revised Statutes, § 5192. The same object is secured in London, where banks and bankers keep their cash balances at the Bank of England, by transfers at that Bank. THE CHECK SYSTEM. 61 ment yet devised. A stroke of the pen transfers it in whatever amount is needed for the largest transaction, and this transfer instantly becomes the basis for fresh operations, with security against accidental loss as complete as can be imagined. In the strict economic sense this medium, no doubt, has rapidity of circulation in a high degree, while in the sense of actual activity of movement in a given time it far outstrips money or notes, and has been well said to be the most v^atil^'of all the mediums of exchange. Of the entire circulating medium of this country it forms incomparably the greatest, although the least considered, part. Depending for its efficiency solely upon convention and issued as well by private firms as by in- corporated banks,* it for the most part eludes tbat regulation which legislatures so industriously enforce upon the other con- stituents of the currency. Indeed, beyond the requirement of a minimum reserve to be held by incorporated banks, as for example in the United States, we may say that the subject is not touched by legislation. The necessity for payment in specie upon demand, which is the most important safeguard of value, is the result of the general provision for the payment of debts of any kind. And the chief assurance against exces- sive expansion on the part of any single establishment is given by the certain demand for prompt and frequent settlement, occasioned by the voluntary establishment of the Clearing House, or by the habits of the community, but not by law. 3. What natural limit is to be found then to the continued, circulation of a liability for deposit when once it is created and set in motion by the process of "discount?" Plainly, if at any stage the holder of a check, instead of de- positing it, demands its payment in money by the bank on * Of the twenty-seven members of the London Clearing House, twelve are private banking houses. "The joint-stock banks were not admitted until 1854, nor the Bank of England until ten years later." Gilbart, Prtnctj>les and Practice 0/ Banking (edition of 1873), 452. 32 CHAPTERS ON BANKING. which it is drawn, the payment to that extent extinguishes the liability. It is quite possible that the money, after a brief circulation, may find its way back, in the deposits of cash made by one or more individuals, and so a new liability similar to the old one may come into existence; but, nevertheless, we may fairly say that the use of the deposit as a substitute for money came to a natural close with th« payment of the check* Except, however, in the eases where money is required for some special purpose, as to be sent abroad or to some other part of the country, or for the increase of the stock in the hands of the public,, this limit to the circulation of deposits is not of great importance. For^as the withdrawal of specie under ordinary circumstances is merely the exchange of one medium of payment for another, any withdrawal on a large scale would imply such a change in the habits and preferences of the public as is not often or easily made. A most important limit is found, however, in the use of de- posits for the payment of debta due to the bank. That the depositor can, to the extent of his deposit, pay a debt due from himself to the bank by the relinquishment of the bank^s debt to him, needs no explanation. In practice he draws his own^ check in favor of the bank and exchanges it for the obligation held against him by the bank, this mutual release being for each side as effectual a discharge of liability as a payment in money could have been. The payment in this manner of the debt due by the depositor and standing among the securities or loans of the bank, finally cancels a liability of the bank, equal in amount to that which was created when the loan was raade.* It matters little by what process the deposit, or right of demand, finally used by the depositor in payment came into his possession. If he is a merchant he has probably collected smaller sums which were due to him, for the purpose of his payment to the bank, and these smaller sums are likely to have ♦ Compare the statement of account for operation b. on p. 26. THE CHECK SYSTEM. 33 come to his hands to a great extent in the shape of checks, which, as we have seen, were the instruments for transferring to him the rights of demand which others held against the bank. If he borrowed the means of payment, he in all prob- ability received the amount in a check. Nor is the case differ- ent when there are several banks, and the depositor has received his collections in checks drawn upon other banks than his own. As was seen when we were considering the payment by check in § 1, the deposit of these checks to his credit effected a transfer of the liability from the other banks to his own ; and here also this liability is finally extinguished when he uses it in payment of his debt to the bank. It is possible, indeed, that the payment should be made by the debtor to the bank in money, or by a check drawn against a fresh deposit of money, and in this case there is either no extinguishment of bank liability by the payment, or only the new liability created by the fresh deposit is extinguished. But in a community where banking is firmly and widely es- tablished, the great payments of commerce and of general business are certain to be made, for the most part, in the medi- um which is most accessible and most convenient for use in large sums, and this medium is undoubtedly that which is com- monly termed bank deposits. It appears then that deposits are created by the act of the bank, when loans are increased, and that they are cancelled when loans are paid.* There is, therefore, a rough correspon- dence between the movements of loans and of deposits. This correspondence may be weakened by the actual flow of money to or from the bank, but in the ordinary movements of busi- ness it is tolerably close, .and where it fails the apparent excep- tion will be found to be explained by some special condition of ♦ For some striking remarks on this subject, see Hamilton's report on a National Bank, Works, III. 109. 34 CHAPTERS ON BANKING. the case.* It will be found in general that, at times when banks are increasing their operations, their deposits swell, and that when they are contracting, their deposits fall. The true connection between these movements is often forgotten, but its nature cannot be mistaken by anybody who will observe the steps by which an ordinary "discount" is placed at the command of the borrower. 4. It has already been suggested that the use of deposits and checks is most highly developed among the English-speak- ing peoples. That the scattered branches of the English race should in this respect have followed the example of the mother country is not surprising; but the reasons for the difference in practice between England and the Continent are not so clear.f The difference itself, however, is strongly marked. The Amer- ican or Englishman who is in the habit of receiving and niak- * The weekly statement of the New York banks which is at hand as the above is revised, is a good illustration of the effect of such special conditions as are referred to above. _, . ., Specie and Deposits. L,/ai Tender. • • S87.3 . . • 137- - . 387-8 . . . 133-5 . . 385.2 . . . 127.3 • - 384-5 - • - 124.5 It appears from other evidence that during these three weeks $6.7 millions were withdrawn and paid into the United States Treasury and $3.6 millions sent to the interior. These withdrawals go far towards accounting for the reversed movement of deposits. See Commercial and Financial Chronicle. t Mr. Bagehot plausibly conjectures that the immunity of England from foreign invasion and domestic revolution has made the growth of confidence possible, in a degree not permitted by the disturbed condi- tion of the Continent for generations past. Lombard Street, p. 90. But this explanation appears unsatisfactory, in view of the frequently- robust faith of continental traders and speculators, and of the ease with which English-speaking people establish deposit banks under the most untoward circumstances. 1885. Loans. October 10 . • 331-9 '* 17 - - 335-5 24 . • 340-2 " 31 . - 344-4 THE CHECK SYSTEM. 35 ing frequent payments avoids the keeping of cash in hand, deposits his receipts and pays nil except the smallest sums by- checks. As a consequence the establishment of a bank is an early symptom of the growth of trade in a small community of English blood. But even in large cities the French or German trader adheres to the old practice of keeping his own strong box; even large establishments arlopt but slowly the habit of depositing. And in Italy, where banks of deposit flourished long before their introduction into England, they are sparingly used and make their way with some difficulty against a settled national habit. In these cases the silent choice of <}u^om, which leads one people to prefer coin and another notes and a third to prefer a mixed currency, also leads to the personal custody and direct delivery of cash. The effect is to be seen, not only in the distribution of banking institutions, as to which the difference between the countries named is extreme, but also in the proportion which the deposits of the great banks in those countries respectively bear to their loans or private securities,* Upon th« continent there is a marked preference for holding the engagement of the bank in the form of a note, rather than in that of a deposit, but in England or America, where the note is used for anything beyond the small purchases of everyday life, it is usually from necessity rather than choice. * The published accounts of several great banks, at nearly the same time in October, 1885, afford the following comparative statement, the several currencies being reduced to dollars, at the rate of £1 or 25 francs for $5, and the amounts given in millions and tenths of millions : Loans. Deposits. Notes. Bank of England, III. 4 148.3 128.5 " " France, 187.8 67.4 561.3 " " Belgium, 57-5 12.7 67.8 " " Netherlands, 34-2 5-9 79-9 Imp. Bank of Germany, 117. 4 5^-5 240.8 Nat. " '^ Italy, 83.1 22.5 109.3 Banks of New York, 331-9 387-3 9.9 36 CHAPTERS ON BANKING. Peculiarities of national character are not the only condi- tions, however, which affect the use of deposits as currency in a given country. The extended use of a deposit and check system necessarily implies convenient access to banks and also a certain extended scale of operations. Ceteris paribus^ then, the system will naturally be stronger where population is dense or communication easy, than in a sparsely settled country or where intercourse is difficult; manufactures, commerce, and general trade will afford it a better field than agriculture ; and, comparing one period with another, its development in a coun- try with increasing population and capital, and with diversified pursuits will be progressive and rapid. Accordingly we find that in the United States the city banks have extended the deposit system much farther than the country banks ;* that in 1885 the system is developed much farther than in 1875; and that, to compare the banking of half a century ago with that of to-day, the United Statues Bank at the height of its prosperity was in this respect in as marked contrast with the national banks of to-day, as are the banks on the continent of Europe.! The full extent to which this development has now gone is seen, not in the mere amount to which bank de- posits have risen on the average, but in the vast aggregate of transactions effected by this rapidly circulating medium, as * The reports of the national banks for July i, 1885, show the com- parative standing of the city banks and of the country banks to have been as follows, taking equal amounts of capital, represented in each case by 100 : City. Country. Capital 100 100 Loans 315 199 Individual deposits . . 319 157 Notes 36 59 t A comparison of the second United States Bank, at the height of its expansion in 1832, with the average condition of the city national banks THE CHECK SYSTEM. a? shown in the reports of the Clearing House. These reports contain the record of a mass of business, inconceivable in its amount and complexity, such as, it is certain, could not have come into existence without the aid of this powerful agent. NOTE. To illustrate the working of the Clearing House system, we will sup- pose the case of six banks carrying on business in the same town. On a given morning we will suppose the messengers of these banks to meet at the Clearing House, each bringing the checks received by his bank in deposit on the previous day, as follows : No. I , checks on No. 2, $6,500 No. 4, checks on No. I, $8,750 (( (.(■ il 3' 9,200 u (( <( 2, 4.700 u a K 4. 7,100 it (< (( 3. 6,740 il il ' 11 5. 6,250 *' it ic 5. 5,820 (( a il 6, 4>5oo tt « 6, 5.140 $33,550 $31,150 No. 2, checks on No. I, $7,800 No. 5, checks on No. I. $8,740 (( u " 3. 4,100 (( (( u 2, 4,620 iX il il 4> 5.760 " " li 3. 9^250 tl li li 5. 6,340 (( ti (1. 4. 7,680 Xi n 6, 5.870 $29,870 <( 11 <( 6, 5.940 $36,230 No. 3, checks on No I, $6,750 No. 6, checks on No. I, $3,700 (( It It 2, 4,270 <; (( (( 2, 4,100 il a K 4, 5.900 il (( (( 3. 6,740 it 11 " 5= 6,400 a *' " 4. 9,250 xt n t^l 6, 5.940 $29,260 it li (( 5. 7.850 $31,640 in July, 1885, taking the proportions for an equal amount of capital, shows the following contrast : 1832. f88s. Capital, 35 millions. 35 millions. Loans, 70 " no " Individual deposits, 9 '* H2 " Notes, 36 " 13 " 38 CHAPTERS ON BANKING. The sum of all the checks present is $191,700. If, now, we credit each bank with the checks which it presents against the others, and charge it with the checks presented by them against it, we shall find that No. I is charged with $35,740 and credited with $33,550, that No. 2 is charged with $24,190 and credited with $29,870, and so for the others, and, therefore, that, No. I owes a balance of $2,190 No. 2 IS owed $5,680 No. 3 owes 6,770 No. 4 4.540 No. 5 is owed 3>57« No. 6 is owed 4.250 $13,500 $13,500 If, then, the debtor banks, Nos. i, 3, and 4, pay into the Clearing House the sums due from them amounting to $13,500 and the Clearing House pays out to the creditor banks, Nos. 2, 5, and 6, the sums due to them, of like amount, the result will be that t\&ry bank will, in effect, have collected payment of all the checks which it had received, and will have made payment of all the checks drawn against it. This set- tlement of checks amounting in all to $191,700 will have been made by the payment of $13,500, and transactions apparently involving thirty separate demands, each bank being the creditor of five others, will have been settled by a series of additions made at a central office fol- lowed by three payments to and three payments from a common fund. An account of the transactions of the New York Clearing House, now by far the largest in existence, is given in the Comptroller's Re- port/or 1884, p. 51. In 1884 that Clearing House settled the balances of sixty-one banks, and of the Assistant Treasurer of the United States. In 1881, the year of largest business, the average daily exchanges were $159,232,191, the transactions on some days approaching $300,000,000; and these exchanges were settled by the payment of balances averaging daily only $5,823,010. Since the foundation of the establishment in 1853, the balances actually paid have amounted on the average to only 4.4 per cent, of the exchanges effected. For the details of the process of clearing, see Bolles, fraclical Banking; for the c\ed.ring houses of the United States ; and Gilbart^ Principles and Practice of Banking, for the London Clearinsr House. CHAPTER IV. BANKNOTES. 1. It has already been said that the notes of a bank are a liability distinguishable in form, but not in substance, from its deposits. The creditor of a bank of issue has his choice be- tween taking the evidence of his right in the form of a note, and taking it in the form of a bank account. For his use the one form may be preferable to the other ; if he desires to make payment in small sums, as for wages, he may prefer to take notes ; if he is to make larger payments, or expects a little delay in the use of his funds, he is quite certain to prefer being cred- ited with a deposit. But whatever his choice, the liability of the bank to make payment in money on demand is the same, and it is under the same necessity of providing itself with a reserve sufficient to meet any demand, which experience shows to be probable. To illustrate this part of the subject we will take again the account given on p. 26 and suppose the deposi- tors to have drawn one-third of their deposits in notes of the bank, which have thus been thrown into circulation : Liabilities. Resources. Capital . . . . $100,000 Loans .... $269,000 Surplus . . . . 32,550 Bonds and stocks 20,000 Deposits .... 180,516 Real Estate . . 13,000 Notes 90.259 Other assets . . 13,000 Reserve . . • 88,325 $403,325 $403,325 It is obvious from inspection that any demand upon the bank which weakens its reserve, whether the demand is from 40 CHAPTERS ON BANKING. depositors or noteholders, produces the same effect; the secu- rity of the remaining liabilities, of whatever kind, is impaired and the same precautionary measures for rej^lenishment will have to be taken. And so, if fresh loans are made, the relation of reserve to demand liabilities is altered, whether the loans are effected by an increase of deposits or of notes. The law does not always recognize this precise similarity of the two kinds of liability. It has sometimes required a reserve for the protection of notes alone, under the apparent impression that this must secure the solvency of the bank, and it sometimes makes a provision for a reserve of different amount for the notes, as in the national bank system of the United States, having in view the different degrees of strength of the prob- able demand for payment of notes and of deposits.* Aj^art, however, from considerations like the last, the two forms of liability seem to stand upon the same footing. The bank itself finds the same advantage in the one as in the other. Its profit is made from the securities which it holds, and whatever profit it makes beyond the mere interest on the investment of its capital, results from the holding of securities purchased by means of its credit; but the rate of this profit is in no way dependent upon the form in which that credit is transferred from one creditor to another. The bank, in short, is interested simply in providing that form of credit which is most convenient for the use of the community on which it depends, for it is by that means that the greatest amount of securities can be held. Hence we see a remarkable difference in the issues of city and of country banks, carried on under the same system and with the same * The national banks are now required by the Act of 1874, to have only a reserve of five per cent, for the protection of their notes, which is held by the Treasury as the central redeeming agency. 18 Statutes at Large^ 123. The bonds deposited to secure the circulation against insolvency, it is to be noticed, are in no sense a reserve and are not so described by the law. BANKNOTES. 41 privileges.* The deposit, transferred by check, is more conven- ient for large transactions than the note, being more expedi- tious and safer ;t it is in the cities that transactions occur on the largest scale, as well as in the largest number; and it is in the cities, therefore, that the strongest need is felt of the medium of exchange best adapted for the transfer of great sums. It is in the cities, moreover, that the condition of con- venient access to banks, needed for the full development of the deposit and check system, is realized in its highest degree. City banks, therefore, on the whole, use their right of circulat- ing notes but sparingly as compared with country banks, and in some cases forego its use altogether, while their deposits attain an enormous expansion. Country banks, on the other hand, dealing on a smaller scale and in communities which have more need of a medium transferrible without recourse to the bank, find the expansion of their deposits much restricted in comparison with the circulation of their notes. It is for the same reason that, as time goes on, the relative importance of the banknote tends generally to diminish in comparison with * See p. 36, note, A striking illustration of the same point is to be found in the condition of the national banks of New York city, com- pared with those of Massachusetts, outside of Boston, the amounts of capital being nearly the same. The figures here given only in millions, are for September 30, 1884. See Comptroller's Report^ 18S4. New York. Massachusetts. Capital ..... $46.2 $45.7 Loans and securities 239 128.6 Notes 13.2 35.8 Individual deposits . 184.6 45.4 t The safety of the deposit is due to the fact that the check, being usually payable "to order," especially when the amount is considerable, cannot be drawn or credited to its holder unless endorsed by the payee. If lost or stolen, therefore, it cannot be paid unless the bank is deceived by a forged endorsement, in which case the loss falls upon the bank itself. Banknotes, however, being payable to bearer, are nearly as difficult to trace as money. 42 CHAPTERS ON BANKING. that of deposits. The swift development of modern commerce is expanding in liigh proportion the field for the most conven- ient and efficient medium, while the small transactions, in which notes find their use, are growing in slower ratio. It becomes more and more the business of banks, therefore, to extend the use of their credit in the form of deposits, the in- crease in their issue of notes being, in the most progressive communities, no longer a matter of great concern.* 2. That governments have so frequently felt it their duty to take measures for the protection of the holders of bank- notes against the insolvency of the bank, but have so seldom legislated for the protection of depositors, is probably due to several reasons. Legislators have generally failed to per- ceive the similarity of the two kinds of liability; moreover, the appropriate measures for the protection of the noteholders are more obvious and of easier application ; and it is doubtless true also that depositors, as a class, are better informed and can more easily protect themselves, and so have less claim upon the sympathy and guardianship of the legislature. At all events, provision for the safety of notes is not infrequently made by law, and when made is apt to consist either of the easily understood requirement of a certain reserve of cash for the payment of the notes, or of a preferential claim to some portion of the assets^ allowed to the holders of notes in case a bank becomes insolvent. The effect of provisions for giving holders of notes a pre- ferred claim may be illustrated easily, if we take the statement of account last given, and, without any change of liabilities, suppose the bank to have been led to make a change of invest- ments and to diminish its other assets and its reserve, until the account stands as follows: * Compare the condition of the State banks from 1834 to 1863 with that of the national banks in recent years. Comptroller's Report for 1876, p. 94. See especially the remarkable development of the New York banks during the former period. Ibid^ p. 102. Liabilities. Capital . Surplus . Deposits . BANKNOTES. T^f Resourcts $IOO,OCX) Loans .... $217,000 32,550 Bond and stocks 101,000 180,516 Real estate . . 13,000 90,259 Other assets . . 4,000 Reserve .... 68,325 $403,325 $403,325 The liabilities of the bank are plainly of two classes; the liability to stockholders for capital and surplus, and the liabil- ity to outside creditors for deposits and notes. If the affairs of the bank were to be wound up, by reason of losses or for any other reason, it is clear that in case of any deficiency of resources, the outside creditors should be paid in full first, and that only the residue after such payment can be said to be the property of the stockholders and so divisible among them. If, for example, it proved that by reason of failures and losses, the loans, bonds, real estate and other assets, instead of being worth $335,000, which was their cost, were worth only $225,000; we should then have a total of resources amounting to $293,325, leaving, after the payment of deposits and notes, only $22,550 to be divided among the stockholders, the disas- ter having swept away their supposed surplus, and about three- quarters of their capital. We may go further and suppose the depreciation to have reduced the value of the total re- sources to $250,000, in which case the creditors must be satis- fied with a dividend of a fraction more than 92 per cent.* and the stockholders are seen to have lost all that they had -embarked in the business. * If we suppose the law to make the stockholders liable as individuals for the debts of the bank, thej would under these circumstances be sub- ject to an assessment, in order to make full payment to the depositors and noteholders. For the liability of stockholders under the national bank system of the United States, see Revised Statutes, § 5151. See also Comptroller's Report^ 1884, 44- 44 CHAPTERS ON BANKING. In these cases the depositors, holders of notes and other outside creditors, all, in short, who can properly be regarded as creditors in the settlement, stand upon the same footing, one with another, and have similar rights, neither class hav- ing any preference unless some special legislative provision intervenes to that end. We maynow suppose that the legisla- ture, for the protection of the holders of notes, had given them a right to be paid in full in preference to other creditors, if the assets of a bank in liquidation should fall short.* In that case, from the total resources amounting to $250,000, we should first have the notes paid in full, amounting to $90,'259; and then the remaining $159,741 would be divided among the de- positors, giving them a dividend of a little more than 88 per cent* A provision of law, then, giving the holders of notes a pre- ferred claim to the assets of the bank would be a natural and easy method of insuring this class of creditors, except in case of a very large issue or a very bad failure. But we may suppose the legislature to wish to go farther than this and to give the noteholders, not a general claim in preference to others, but a claim to specific property of the bank, supposed to be of solid value and suflicient to insure payment of the notes in any case. Thus, to return to the account on page 43, it appears that the bank holds bonds and stocks to the amount of $101,000 as a part of its securities. Suppose, then, that the law requires the bank to hold these bonds and stocks pledged to secure the ultimate payment of its $90,259 of notes. Under such an arrangement, the securities would not cease to be the property of the bank and the earnings of the securities would remain, as before, a part of the profits of the bank. The pledged property would be enjoyed, however, subject to the provision that in case of the failure ol the bank, the proceeds of the securities should be applied first to tlie payment of the * E. g. see New Hampshire Compiled Statutes of 1853, ch. 148 § 30. BANKNOTES. 45 outstanding notes. If the law should go farther and provide that only certain approved classes of securities should be used for this purpose, and that the securities pledged should be lodged for safe-keeping in the hands of some public officer, the tsubstance of the transaction would still be unchanged. It would still remain a simple case of the specific appropriation of a certain part of the property of the bank to the payment of a particular class of its liabilities in a given contingency. The essential structure of the bank would be unchanged and the sources of its profits would be neither more nor fewer than they were in the absence of this pledge of securities. The method just described, of protecting the issue of notes by a deposit of securities in the hands of some public officer, is that which was adopted by the state of New York in 1838, and was long known as the "free banking" system. Many other States followed the example of New York, and finally in 1863 the New York plan was adopted by Congress as the basis for the national banking system.''^ If, now, we vary our suppositions so far as to imagine the property pledged for the protection of the notes to consist, not wholly of securities, but of securities to a certain amount and of specie for all notes issued in excess thereof, we shall have in substance the provision made by law in 1844 for the pro- tection of the notes of the Bank of England. 3. Beside other reasons already adverted to, for seeking legislative protection for banknotes, the belief has been com- mon that banks are under a special and dangerous temptation to overissue notes, thus causing their depreciation with loss to the public. The question whether really convertible notes can be issued in excess has been the subject of much wearisome * For an account of the New York {system and its adoption by other «tates, see Comptroller's Report for 1876, 23-36. 46 CHAPTERS ON BANKING. and futile discussion,* tending to secure for the notes far more than their proper share of attention. It has already been shown, however, that the question whether notes shall be issued or not, is one which in modern banking is not settled affirmatively by the bank, but by the creditor, who determines for himself and with an eye to his own convenience, whether to hold his right, as against the bank, in the form of a note or of a deposit. If he and creditors generally prefer the lutter, the bank cannot force its notes into circulation. The really serious question would be whether the bank can extend the use of its credit, by deposits as well as by notes, in excess. This is as much as to ask whether the bank can go too far in the purchase of securities, or in other words, unduly stimulate borrowers, the making of loans being the purpose for which the bank extends its credit. But this question cannot be answered without qualification. If we observe any period of ten years, we shall find some years in which banks have found the public depressed and spii'itless, to such a degree that, with every motive for increasing their business, it has been found impossible to find sound commercial paper in sufficient amount. So far from being able to extend their credit in excess, banks have at such times often reduced their capital because employ- ment for it could not be found. Other years we shall find in which the public spirit was buoyant and adventurous, and in which the banks have fostered and increased the general tendency to speculation, by the facility with which they have given the use of their credit. It is true then that banks can- not extend their liabilities of either sort except in response to a demand from the public ; it is also true that in certain states of business this demand may be unduly stimulated by their action, and that issues made in response to such a factitious * For convenient citations on this subject, see Walker on Money, ch. xix. BANKNOTES. 47 demand may be said to be in excess of the proper needs of the community. In any such expansion of bank credit, however, banknotes play the least important part.* NOTE. Of the writers on banking, McLeod, Theory and Practice of Bank- ings has made the most careful analysis of the exchange which under- lies every banking operation. Notwithstanding eccentricities of method and style, his exposition of the real meaning of "loans" and the ambiguities incident to our use of that term, the origin and pur- port of bank liabilities and the substantial identity of the liabilities for deposits and notes, is clear and important, and might be cited in con- firmation at many points in these pages. Reference may also be made with advantage to McLeod's smaller work, Elements of Banking. Among earlier discussions attention is specially called to a striking letter by James Pennington, Tooke's History of Prices, II. 369, in which the strong analogy between the deposit accounts of the London private bankers and the notes of the country bankers is forcibly stated and explained. * The condition of the national banks in December, 1878, was one of great depression and may be compared with their expanded state in October, 1881. December 6, 1878. October /, i88j. Capital $464.9 $463.8 Loans 826 ii73'8 Deposits. .... 598.8 ....... 1071. Notes 303.3 320.2 CHAPTER V. THE NATIONAL BANKS OF THE UNITED STATES. 1. The national banking system of the United States owes its existence to the civil war. Although in the majority of the States the banks incorporated under State authority were badly organized and insecure, and altliough even such as were on a solid foundation could enjoy only a restricted local credit, the current of opinion before the war was by no means favorable to any consolidation of banking interests. Discontent with existing systems more frequently took the form of opposi- tion to the existence of any banks of issue at all ; the party then apparently holding permanent control of the administration cherished with pride the traditions of its victorious struggle with the United States bank, and of its devotion to a gold cur- rency; and probably neither the friends nor the o})ponents of banking would have thought at that time of finding in the gov- ernment of the United States a power able to reorganize upon a common plan the note issues of all the States. The imperious necessity of finding a market for United States bonds for the supply of a Treasury drained by war was the favoring condition needed for such a reorganization, and the assumption of unusual powers by the United States govern- ment, which had become habitual under the pressure of a struggle for existence, made the resort to federal authority practicable. In 1860 a majority of the people would have thought the establishment of a third United States bank dan- gerous and of doubtful constitutionality. In 1863 a system of national banks, indefinitely more powerful than the bank which NATIONAL BANKS OF THE UNITED STATES. 49 waged an almost equal war with Jackson, was established with widespread, although not unanimous, consent, and without solid opposition except that of some existing interests threat- ened or alarmed by the change. It was, indeed, urged by some that, as the wants of the Treasury were the real control- ling motive in the establishment of the new system, it would be better for the government to issue its own notes to the ex- tent of the proposed bank circulation, and to occupy the whole of the field, of which it had already taken a part, and so enjoy the full advantage of a non-interest-bearing debt. Fortunately these views gained little support, and the dangerous expedient of relying solely upon the issue of government notes was not pushed beyond the limit of possible return to specie payment.* 2. The adoption of a system of Tiational banks, having their notes secured by the deposit of United States bonds, had been proposed by the Secretary of the Treasury in 1861, and strongly urged by him in 1862. An act for the purpose was passed in February, 1863,t but in many points of detail this proved to be so unsatisfactory and incomplete, that only 134 banks were organized under it in the next nine months and the number had risen to less than 450 in sixteen months. A re- vised act, making important changes, was therefore passed in June, 1864,$ and ample provision having been made, under which banks chartered by the States could be reorganized as national banks, the extension of the new system went on rapidly. Its adoption was further stimulated by an act laying a tax of ten per cent, on all notes of State banks paid out by any bank after July 1, 1866; || and at that date the number * See Report on the National Bank Currency Act, written by the late John E. Williams, and made to the New York Clearing House banks, November 28, 1863. t 12 Statutes at Large, 665. » 1 SSH X 13 Statutes at Large, 99. II 13 Statutes at Large, 469. 50 CHAPTERS ON BANKING. of national banks, then 16S4, easily reached the level at which it stood for several years.* The general provisions of the national bank systeraf restrict the right of issuing notes to the national banks, but do not in- terfere with the performance of any of the other functions of banking by banks chartered by State authority, or by private banks. The issue of notes is to be secured by a deposit of reg- istered bonds of the United States, the bonds being transferred to and held by the Treasurer at Washington, but the interest thereon collected by the banks, whose property the bonds continue to be. The deposit of bonds under these provisions entitles the bank making such deposit to receive from the Comptroller of the Currency, who has the general charge of the system, notes to the amount of ninety per cent, of the market value of the bonds deposited, but not exceeding ninety per cent, of their par value. These notes when received are in blank, certifying only the fact that the security for them is in the hands of the government; but when signed by the proper officers of the bank, they become its promises to pay upon demand, and can then be issued for circulation. They are, of course, to be paid by the issuing bank whenever pre- sented, are also to be received in payment by all other national banks, and can be paid to or be used in payments by the gov- ernment in all cases where specie is not required by law; but they have never been a legal tender as between individuals. * A summary statement of the number and condition of the national banks, at four or five dates in every year, and for every year since the adoption of the system, is given annually in the Comp^roHer^s Reports t The legislation on this subject down to 1873 is embodied in §§ 5133- 5243 of the Revised Statutes of 1878. The subsequent acts of impor- tance are the Compromise Act of 1874, \^ Statutes at Large, 123; the Resumption Act of 1875, ^^^di 296 ; the act of 1880 concerning gold banks, 21 Id. 66; and the act of 1882 extending the existence of the banks, 22 Id. 162. NATIONAL BANKS OF THE UNITED STATES. 51 These provisions have secured for the notes a uniform value and give to the notes of every bank an unimpeded circulation in every part of the Union, If, indeed, the law, as in the act ■of 1863, still made no further provision for redemption than tto require every bank to redeem its own notes when presented at its own counter, the return of notes for payment and their substantial convertibility would be nearly destroyed. But the law of 1864 made jjro vision for redemption by all banks at -agencies in the principal cities, and this arrangement continued in force until June, 1874,* when the present system was adopted, making the Treasury of the United States the sole redeeming agency for all of the national banks, and requiring every bank to keep in the Treasury, to be used in redemp- ^ tion of its notes, a reserve equal to five per cent, of its circula- tion. The chief effect of the present system of redemption, however, is the easy removal from circulation of notes which are worn, soiled, or otherwise unfit for use,t For the establish- ment of a system which should test effectively and continuously the power of every bank to convert its notes into specie on demand, it would probably be necessary to require that no national bank should pay out any notes except its own.J For the general purpose of maintaining the convertibility of the aggi-egate note issue of the banks and its ready diminution * i8 Statutes at Large, 123. t During the 3'ear ending with October, 1884, the notes received at the redemption agency amounted to $136,577,732 ; of them $33,080,300, an unusual proportion, were returned to the banks as "fit for circula- tion." Comptroller's Report for 1884, p. 71- X Such a prohibition was the basis on which the '"Suffolk bank system" of New England rested, from 1819 to 1866, and maintained at par a note circulation which had otherwise but slender provision for convertibility. Massachusetts General Statutes oi i860, ch. 57, § 55; but compare also § 124. And see D. R. Whitney, The Suffolk Bank. 52 CHAPTERS ON BANKING. when requirecl by tlie condition of business, the present arrange- ment is well devised. The national banknote when issued is the promise of the issuing bank, and must be punctually met by it, as any other liability must be. The note, however, carries with it certain engagements binding upon the government of the United States. The provision for redemption at the Treasury binds the government to pay on demand all notes when presented in due form, and not merely notes to the extent of the reserve. And in case of the failure of a bank, the law provides for the immediate redemption of all its notes at the Treasury. The government has thus made itself fully liable in any event for the whole amount of the notes. On the other hand, it has taken ample security for its reimbursement, by requiring the de- posit of bonds as above stated, by requiring that this deposit shall be increased if the value of the bonds declines, by the provision for a reserve of cash to be held by the Treasury, and also by taking for itself a first lien upon all the assets of a bank for the purpose of making good any possible deficiency in the security already provided. An ingenious provision in the act of 1882 also secures for the government any gain that may ultimately accrue from the destruction of notes while out- standing, or the failure for any reason to call for their redemp- tion. And finally, although the expenses of printing the notes (but not of engraving the plates) of superintending the system, and of providing for the safe-keeping of the bonds deposited, are paid by the government, these charges are offset by a tax of one per cent, per annum on the average amount of notes in circulation. On the whole, therefore, whatever may be gained by the banks from this system, it cannot be said that the liabil- ity of the government is onerous. 3. Although in its general theory the national banking sys- tem is one of "free banking," under which the business of banking in all its branches shall be open to all persons who comply with the formalities provided by the law, it was never- NATIONAL BANKS OF THE UNITED STATES. 53 theless felt to be dangerous to allow the issue of an unlimited circulation so long as the currency remained irredeemable. The attempt to restrict what was in theory free led, therefore, to a series of contradictory and in some respects remarkable provisions. Without restricting the establishment of banks, the acts of 1863 and 1864 limited the aggregate amount of notes to f 300,000,000 ; and while no bank was allowed to issue notes exceeding in amount its capital stock, every bank was required to deposit bonds amounting to at least one-third of its capital. Apprehending that the rapid reorganization of the numerous State banks in the Eastern and Middle States might fill up the prescribed aggregate of circulation, before the West should be able to organize a due proportion of banking capital, the act of 1863 also required one-half of the total circulation to be apportioned among the States according to their repre- sentative population, and one-half "having due regard to the existing bank-capital and resources." The reluctance of the banks to reorganize as national banks, however, caused the omission of this provision in the act of 1864; but Congress in 1865, while encouraging the immediate reorganization of existing banks, revived the provisions for apportioning the aggregate circulation and fixed a narrower limit for that of banks of the larger -class. As early as November, 1868, notes bad been issued to nearly *he amount allowed by law, and the West and South soon began to complain of the difficulty of organizing banks, without the right of issue; in sparsely settled States. In 1870 a chance was offered for the increase of banknotes without increase of the aggregate paper currency of the country, by the contem- plated payment of certain obligations of the Treasury hitherto used by the banks as a part of their reserves, for which legal tender notes would now have to be substituted and thus with- drawn from circulation. Congress therefore seized the oppor- tunity of extending the aggregate limit of notes for circulation 54 CHAPTERS ON BANKING. by 854,000,000, to be apportioned among States having less than their due proportion, and further required that, after this increase of note circulation should have been made, a redistri- bution of the right of issue should be made by the withdrawal to the extent of $25,000,000, from States having more than their due proportion, and the apportionment of the same among States having less. The limit for each bank thereafter organ- ized was reduced to half a million dollars, and provision was even made for allowing the removal of existing banks to States having less than their due proportion of note circulation. By the end of 1873 the new limit of $354,000,000 was nearly filled and finding itself impelled to legislate upon the cur- rency by the financial revulsion of that year, Congress after painful debate elaborated the Compromise Act of June, 1874, in which provision was made for the immediate withdrawal of circulation from States having an excess and its distribution among banks in States having a deficiency, as fast as application should be made by the latter, to the extent of $55,000,000, in- cluding the $25,000,000 already provided for. Arrangements for carrying this act into execution, however, had hardly been made, when this series of crude and futile measures was brought to an abrupt close, by the hasty passage of the act of January, 1875, for the resumption of specie payments. This act fortunately swept away all the provisions limiting and ap- portioning the aggregate amount of banknotes to be authorized, as w^ll as those calling for the withdrawal and redistribution of issues already authorized, and thus established the national banks for the first time on the basis of freedom, required by the theory of the original measure. No change was needed to adapt the system to a resumption of specie payments, its details having been arranged at the outset so as to admit of easy translation into terms of specie. 4. In its regulation of the discount and deposit business of the national banks, the law does not follow the example of NATIONAL BANKS OF THE UNITED STATES. 55 some previous legislation, by fixing a limit to the amount of securities to be held by any bank,* but simply prescribes a minimum reserve to be held for the protection of the liability for deposits. For banks in sixteen "reserve cities," named in the act of Congress,! the reserve must be twenty-five per cent, of the deposits; for all other banks, fifteen per cent. The pro- visions for determining what shall be counted as reserve are, however, less simple. The general requirement is that it shall be "lawful money," or in other words specie or legal tender notes of the United States, so long as a^aper legaf tender exists. But Clearing House certificates, which represent lawful money specially deposited for the purposes of the Clear- ing House association, of which the bank owning them may be a member, and the cash reserve of five per cent, of its circula- tion, which every bank is required to keep in the Treasury, are also to be counted as a part of the reserve against deposits. And it is further provided that, for any bank in a redemption city one-half of its reserve may consist of cash J[eppsits in the city of New York, and for any bank outside of the redemption cities three-fifths of its reserve may in like manner consist of deposits with banks in those cities. The permission thus given, to count certain demands for cash as cash itself, has a marked effect upon the composition of the reserve held by the banks as an aggregate, and therefore upon the strength of the whole mass of banks at any given moment. If we take the returns of the national banks for October 1, 1883, we find their deposits amounting in the aggregate to * See e. g. Massachusetts General Statutes of i860, c. 57, § 25; New York Revised Statutes of 1859, H- 5^8; Maine Revised Statutes of 1857 ch. 47, § 19. f The reserve cities are Boston, Albany, New York, Philadelphia, Pittsburgh, Baltimore, Washington, New Orleans, Louisville, Cincin- nati, Cleveland, Detroit, Chicago, Milwaukee, St. Louis, and San Fran- cisco. The list included Leavenworth, until the passage of the act of March 1,1872. 56 CHAPTERS ON BANKING. 1168.7 millions of dollars, requiring a reserve of 234.4 millions. They are returned as holding 328.9 millions of reserve in all, and were therefore, on the average, far above the legal minimum. But this great apparent reserve was composed as follows: Specie Other lawful money . Redemption fund . . Due from reserve cities 107.8 millions. 80.6 15.6 " 124.9 Total $328.9 Of actual cash, then, the banks of the country at this date held but 204 millions, much less than the amount of reserve required for their liabilities, — the remaining sum, which appar^ ently made their condition remarkably strong, consisting merely of debts due from one bank to another. The ability of the mass of banks, therefore, to meet the pressure of a financial crisis was dependent on the ability of the debtor banks to pay upon demand the suma deposited with them and relied upon by the others as a part of their reserve, or in other words on the ability of the banks of New York city to meet their liabil- ities.* The reserve of those banks, however, on which all the * The reserve October 1, 1881, was divided between city and coun4:ry, and classified as follows : Classification of Reserve. Reserve Reserve «;_-,^-- Legal Ten- 5p'rc't Due from required. held. ^pccic- der etc. fund. banks. New York City, 67.2m. 62.5 m. 50.6m. 10.9 m. i.om. Other Res. cities, 83.9 100.8 34.6 21.9 3.7 / 40.6 Country 76.1 158.4 27.5 27.1 11.4 \92 i\] Totals, 227.2 321.7 12.7 59-9 16.1 I33 0- The published reports make it probable, althougii not certain, that in the middle of October, 1873, when the reserves of the New York banks had fallen to less than eleven per cent, of their liabilities and payments had been generally suspended, the reserves of the rest of the country were above the line required by law. NATIONAL BANKS OF THE UNITED STATES. 57 others rested, was but little above the legal minimum at the date named, and sometimes under similar conditions has been below that point, so that with an apparently high reserve for the country at large, there was such weakness at the central WV S and most exposed ^Qinjt. as to seriously impair the value of this precaution. The relation of the New York banks to the other banks of the country, as the depository of their reserves, is plainly quite analogous to that of the Bank of England as the depository of the joint stock and private banks of London, and the effects seen in the w^eakening of reserves and the concentration of risks is the same in both cases.* As regards the national banks the tendency to centralize the reserves, favored by the law, is heightened by the practice, long established among the New York banks and also existing elsewhere, of inviting de- posits by country banks by the payment of interest.f The opportunity of converting a barren reserve into an interest- bearing resource, and yet counting it as reserve, has always been attractive and has caused an habitual transfer from the country banks to those of New York, sometimes estimated at not far from 180,000,000. The employment given to the funds thus held subject to call is a topic of serious interest on which it is impossible to enter now. 5. For the enforcement of the provision as to reserve, the law provides that whenever the reserve of any bank falls below the prescribed limit, the bank shall neither "increase its liabil- ities by making any new loans or discounts," otherwise than by the purchase of sight bills of exchange, nor shall it make * See Bagehot's Lombard Street, 160-173; Dun's British Banking Statistics, 129. t This practice was condemned by resolution by the banks of the New York Clearing House in 1857, 1873, and 1884. See Banker's Mag- azine, April, 1858, p. 322; Commercial and Financial Chronicle, ^o- vember, 1873, P- ^S^ > Banker's Magazine, August, 1884, p. 129. Resolutions alone, however, have never proved to be a cure. 58 CHAPTERS ON BANKING. any dividend, until the reserve has been restored to its due proportion. The Comptroller of the Currency is also author- ized to notify any bank whose reserve is insufficient that it must be made good, and in case of failure to comply within thirty days, he may, with the concurrence of the Secretary of the Treasury, appoint a receiver to wind up the business of the bank. Although the ample discretion thus given to the Comp- troller has been used with great moderation,* the prohibition of further discounts, when the reserve falls below a given pointy makes a hard and fast line, the approach to which never fails to cause uneasiness and in some conditions of affairs is viewed with serious alarm. In any actual crisis, the declaration that in a given contingency like this the usual accommodation of the public must stop and liquidation must begin, is the surest means of increasing the pressure for loans and of thus convert- ing a cri&is into a panic. For ease in operation and greater safety, some more elastic provision is needed, which shall insure a sufficiently high average of reserve and yet make no harsh break in operations at a given point. The Bank of England has in its hands a superior instrument for this purpose in the slidin^scale of discount, by which it can encourage or dis- courage borrowers and thus deplete or replenish its reserve^ without ceasing its operations altogether at any point yet reached. This expedient, however, is inapplicable in the United States, partly because of the traditional prejudice against the adjustment of rates of discount by the demand in the market, widely prevalent among our people, and partly be- cause Congress has been obliged by probable lack of authority to forego the establishment of a general law respecting interest, and to recognize in each State the rates there prescribed by the local legislature. A suggestion of an elastic limit is con- tained in certain provisions of the German bank law which, * See the course pursued in September and October, 1873, when the reserve of the banks of New York were far below the line and both city and country banks had suspended payment. NATIONAL BANKS OF THE UNITED STATES. 59 after a prescribed line, tax the operations without, however, prohibiting them; but this expedient, devised long after the establishment of the national banking system by Congress, has not yet had such trial as to thoroughly test its capabilities. 6. Much controversy has been excited by the question as to the rate of profits Avhich the national banks have obtained from their right of issuing notes secured by a deposit of bonds. It has already been shown that their case is in no respect differ- ent as regards profits from that of banks which use their credit in the form of deposits, in order to make investments in interest-bearing securities. The notion often entertained, that the national banks have some peculiar opportunity of mak- ing a double profit, "by receiving both interest earned by "their bonds, and interest earned by the loan of the notes "issued upon'the bonds," overlooks the fact that every bank uses, as its means for obtaining securities, its cajntal and what- ever credit it can employ in addition.* The conclusive prac- tical answer to the idea of a supposed double profit is to be found, however, in the conduct of the banks themselves, especially since the passage of the act of 1874, already referred to. That act, recognizing the desire of many banks to reduce their circulation and secure possession of their bonds, provided that any bank might deposit "lawful money" with the Treasurer of the United States to enable him to redeem its notes, and thereupon withdraw pro tanto the bonds deposited, provided the amount of its bonds left in deposit were not reduced below $50,000.t Several important national banks had never chosen * The actual profit earned by the banks from their right of circulation ■was estimated by the Comptroller of the Currency in 1883 not to exceed $46 on $90,000 of notes. See Comptroller's Report, 1883, 13. tFor an objection made at the Treasury to the working of this pro- vision, see Finance Report, 1880, 331 ; 1881, 221. For the connection Ijetween this provision and the "bank panic" of March, 1881, see Comptroller's Report for 1881, p. 39; Atlantic Monthly, February, 1882, p. 195. 60 CHAPTERS ON BANKING. to issue notes, although required by the law to maintain a de- posit of bonds ; under this provision a considerable number reduced their notes to the $45,000 which the required minimum deposit of bonds would support. The withdrawals of notes continued for several years, and although new banks were formed and the note circulation increased in some sections, under the authority for free banking given by the resumption act, the total banking capital and note circulation alike declined, until the summer of 1878. Both increased after the resump- tion of specie payments, but the circulation of bank notes, although open to all banks, and to any amount, never reached its old point. This course of things was entirely inconsistent with the existence of large profits arising from the issue of notes under the national system. It is impossible to believe that, if such profits were reaped, existing banks would have neglected or renounced the opportunity of making them, or that the multitude of private bankers, and of State banks would have failed to seize upon an opportunity which was free to all,* by organizing under the national system. That a good rate of profit has been made by the national banks upon their general business is no doubt true. Especially during the period of irredeemable paper their harvest was lai'ge, as is usually the case with the dealers in money and credit during a period of non-payment and of fluctuation. The law has from the first required of every bank that a part of its profits should be reserved, until an surplus amounting to one-fifth of the capital should be accumulated. A solid foundation was laid for their surplus in many cases, by the sale at a high premium of the gold held by State banks before their reorganization, and retained by them until the adoption of the paper system had plainly become definitive. The banks * Until the spring of i88i, two-thirds of the bonds held by the banks to secure their circulation bore interest at not less five per cent, and a considerable amount at six. NATIONAL BANKS OF THE UNITED STATES. 61 had thus on the average accumulated the surplus required by law before the end of 1869, since which time their accumula- tion has increased or diminished as the times were prosperous, or the reverse, their surplus varying from 26.6 per cent, of the capital in October, 1875, to 25 per cent, in December, 1878, and again to 28.3 per cent, in December, 1883.=* The annual dividends paid from earnings after the reservation for sur- plus, also stood at their highest point during the period of most rapid accumulation, and have varied from a maximum of 10.58 per cent, of the capital to a minimum of 7.59 per cent. Without doubt this rate of dividends shows a prosperous busi- ness, but how far the prosperity is due to privileges enjoyed under the national system may be judged, from the near ap- proach which State banks make to national banks in their earning capacity.f 7. There is no doubt that, in adopting the national banking system the majority of Congress understood themselves to be establishing the agency by which the sole paper currency of the country should be issued in the future. The legal tender issues were still regarded as a temporary expedient, resting upon * For many years the largest surplus held has belonged to a bank which issues no notes, but has accumulated many times the amount of its capital. It is true in general that the banks of largest surplus have not owed it to their issue of notes. t In New York, where there are nearly loo banks organized under the laws of the State, the percentage of surplus and undivided profits to capital under the two systems respectively was in September, 1879, 1882, and 1884 as follows : National hanks. State banks. September, 1879 45 37 1882 58 52 1884 57 54 See Report of State Banking Department for 1884, and Comp. iroller's Report. 62 CHAPTERS ON BANKING. the overwhelming exigency of the moment for their justifica- tion; the bank act is entitled "An act to provide a national currency," emphasizing by its title the permanence of the sub- stitute which was to fill the place left vacant by the legal ten- der notes when paid ; and the text of the act plainly looks forward to the return of specie payment, which should leave specie the only tender for debt.* Establishing a ])ermanent system of banks Congress undertook to surround them by the ordinary safeguards needful to give them full credit, providing minutely for their organization and superintendence, and for the publication of their accounts at rather short intervals, and laying down rules, wholesome so far as they go, restricting the kinds of business in which the banks should engage. It was provided also that the diareholders should be responsible ra- tably for the debts of the banks, each to the amount of his stock in addition to the capital actually invested by him.f A system of banks thus guarded and under the charge of ♦In 1870 when the return to specie payments finally seemed to have been postponed indefinitely, an act was passed authorizing the estab- lishment of gold banks, issuing notes redeemable in gold coin, and secured by the deposit of " United States bonds bearing interest pay- able in gold " with the treasurer of the United States. The notes were not to exceed eighty per cent, of the value of the bonds, and were not to be subject to those provisions of law which then limited the aggregate circulation of bank notes. Several gold banks were organized, chiefly in the Pacific States ; but after the return to specie payments the dis- tinction between them and other banks ceasing to be of importance, provision was made by the act of 1880 for their conversion into national banks of the usual type. 21 Statutes at Large, 66. t From this liability to contribution beyond the amount invested, the law made an exception in favor of the stockholders of any existing State bank, having a capital of not less than five millions and a surplus of twenty per cent., in case of its reorganization as a national bank. This exception was made in order to secure the adhesion of the Bank of Commerce of New York city, — the only bank in the United States which could meet these conditions. NATIONAL BANKS OF THE UNITED STATES. 63 the government itself could hardly be treated by Congress as unworthy of being entrusted with the public funds, as the State banks had been under the independent treasury act of 1846, and provision was therefore made for designating banks as depositories of public money when occasion should require, and for their employment as financial agents of the govern- ment, upon their giving satisfactory security, by the deposit of United States bonds and otherwise, for the faithful discharge of these functions. The framers of the measure no doubt looked forward at one time to a more consolidated system of banks, and to a closer intimacy with the government than was in fact established; but their action as it stands marks an extraordinary change of policy, made under the pressure of war, by a government which, hardly more than two years be- fore, trusted no agency whatever with the custody of its funds, recognized no>medium of payment except specie, and carefully disclaimed all connection with, or responsibility for, any possi- ble system of banks. CHAPTER VI, THE BANK OF ENGLAND. 1. The Bank of England owes its origin to the financial straits to which the government of William and Mary found itself reduced in carrying on its war with Louis the Fourteenth. The revenues of the kingdom were small, the public credit weak, and the very title of the dynasty unsettled. The gr ow- iBg_:we«lth nnd bufiinnnn Sii ih^ fionntry_hnrl caused pvivntp bankingJmusesjto^^ng np> The paper given by those houses to their creditors had acquired a circulation, limited indeed^ but sufficient to show its convenience, and projects for the es- tablishment of a public institution ^n tha--jS.cal%_ iJLjiot ojijthe model, of the, great j£OBtinentaIJiaakSa_had^beenjiscussed for m any yea rs>^ Under these circumstances, as an expedient for raising a million sterling, for which no other resource could be found, the government in ^69^ adopted the scheme proposed by William Patterson, a Scotch adventurer, and proposed to Parliament that a loan should be offered for public subscription and made attractive by a grant of incorporation with banking privileges, to be enjoyed by the subscribers and their suc- cessors- The measure seems to liave been contested chiefly, although not wholly, on party grounds, and was passed after a * McLeod, Theory and Practice of Banking, I, 210, prints a "gold- smith's note" which is still preserved, dated 1684. And s,ee Macaulay's History, VII, 134. The plan of establishing a national bank had been agitated as far back as 1660. THE BANK OF ENGLAND. 65 severe stiuggle, and thus the Bank of England came into exis- tence as a Whig corporation * The act of 1694 provided for a loan to the government of £1,200,000, bearing interest at eight per cent., and incorporated the subscribers, with this amount of nominal capital, as the Governor and Company of the Bank of England, — a title which has never been changed. The_j2fiiq^oration__was__e3ii- p_OLB:er£d-Jia_daaLin coin, b^niQIL _and exchange, and to lend upon security, but was forbidden to deal in merchandise in a ny form. It could no t borrow nor give security by bill, bond or agreement, for an amount exceeding its capital ; no p rovisi on was made tor the transfer of its bills, "oblig atory or of credit'* ■ — f ■ e xcept by indorsement ; nor was any monopoly created in its favor. In this form the charter of the Bank gave little promi se of its future importanc e. Three years later, however, the nec- essities of the government and the embarrassments of the Bank, which had been obliged to suspend payment in 1696, led to a revision of the charter, in which the outlines of the great struct- ure appear.f The issue of n o tes payable to bearer on de mand wasjiuthorizedj thus laying the found ation for n, trne hanlcm^tp circulation, $ th e monopoly of corporate orga nization was grante d^by provid ing tha t, during the continnnnce o£ the * The fiscal character of the measure is very well shown by its title. "An Act for granting to their Majesties several duties upon tonnage of Ships and Vessels, and upon Beer, Ale and other Liquors, for securing certain Recompenses and Advantages in the said Act mentioned, to such Persons as shall voluntarily advance the sum of fifteen hundred thousand Pounds towards carrying on the War against France. 5 Wil- liam and Mary, ck. 20. For the political relations of the Bank of England, at and after its es- tablishment, see Macaulafs History, VII, 147. t 8 and 9 William III. ch. 20, X The notes issued under the act of 1794 appear to have borne inter- est, and being made to order, could have had but a limited circulation No notes of less than £20 were issued until the act of 1759 authorized the issue of notes for £15 and £10. 66 CHAPTERS ON BANKING. f'.|if ^rt,prj no other h^nV nr pnrpnrati^^p in tlip. nature of a ban k> s hould be allowed in the kingdom j and o n the othe rJiaflj(L-the capital was d oubled by a fresli, advance fron^ the stor-kholfjer!-; "to the governmen t, and the interest payable by the latter w as reduced to siv per pent. From this jjoint the growth of the Bank and the increase of its influence were rapid. The corporation became the chief depository of the goyernment moneys, and the agent of the Treasury in many financial operations. In 1720 J t carried on a mad struggle with the South Seii n^^mpnny for the control of the business of refunding the national debt, and managed, although with difficulty, to save its own credit in the crisis which destroyed its rival. Further loans to the government and additions to the capital of the Bank were made in quick succession. In 1722 its capital stood at nearly nine millions, and it was also able to establish from its profits the surplus fund now called "the Rest," and thus to save its dividends from great fluctuation. In 1782 the capital had risen to more than eleven millions and a half, and in 1816 it had risen to £14,553,000, at which figure it has stood ever since. Of the loan to the goyernment, which had risen in nearly the same proportion as the capital, one-fourth was repaid in 1834, re- ducing it to £11,015,100, which is its present amount. By the year 1750 the government had succeeded in reducing the in- terest on most of its debt to the Bank to three per cent., and it has since used the opportunity afforded by the periodical necessity for a renewal of the charter, to lessen still more the burden of its interest, by requiring from the Bank an annual bonus and other pecuniary concessions, in consideration of the extension of its monopoly. 2. This monopoly, dating, as has just been said, from the act of 1697, and confirmed by the act of 1709, was further de- fined by the act of 1742* as the right of "exclusive banking," ♦ i6 Anne, ch 22 ; 15 George II, ch. 13. THE BANK OF ENGLAND. 67 the true intent being, as is declared in the latter year, that *' no other Bank shall be erected, established or allowed by "Parliame nt, and that it shall not be lawful for nny Rndy " Politick or Corporate -whatsoever, erected or to be prpptprlj " or for any other Persons whatsoever, united or to be united , "in Covenants or Partnership^ exceeding the number of six " Persons, in that Part of Great Britain called England, t o " borrow, owe, or take up, any Sum orSuiP s pf Mr>Tif>y on tlii^ir "Rills or "N'/^tes^ pa yable at Demand^ or a^ anjMe ss Time th^ fi "six Months from the borro yyir^o;- tlifrpof^ du rino; the Continu- " ance of such said Privileg-e to the said (rovernor and Co m - "pany. " Qt is clear from this language that Parliament understood by "banking" only the issue of notesj and that the exclusive privilege of the Bank did not prevent the issue of such notes by partnerships having only six partners or less, nor the performance of the other banking functions by com- panies or partnerships of a greater number of partners. Xotes were accordingly issued by the London private banking houses, some of which were of longer standing than the Bank of Eng- land itself, and by country bankers, of whom the number in- creased rapidly in the second half of the eighteenth century.* The London bankers, it is true, began not far from the year 1772 to discontinue the issue of notes, finding the check system identical in its advantages and more convenient in prac- tice ; but their right of issue was merely in abeyance, until it was formally taken away in 1844. The country bankers, however, with many vicissitudes of fortune, have continued the issue of notes to this day, subject to the restrictions con- tained in the Bank Charter Act of 1844, presently to be described. That the Bank monopoly in its strict interpretation also permitted the exercise of all banking functions, except issu g<^*A * McLeod's Dictionary of Political Economy, p. 89. In his Theory and Practice of Banking, I, 211, Mr. McLeod says that the latest Lon- don banker's note preserved is dated 1793. Q8 CHAPTERS ON BANKING. by joint stock banks and companies of more than six persons, had indeed been noticed, but seems to have been little con- sidered, until the discussions of 1826, renewed upon the revi- sion of the charter in 1833. The growing demands of the country for banking facilities and the slowness with which the Bank of England responded to these demands by the estab- lishment of branches, caused much unsound banking by private firms, while a lingering doubt as to the meaning of the mo- nopoly prevented the foundation of joint-stock banks with large capital. Lord Liverpool is reported as declaring in 1826, that the effect of the law "is to permit every description of banking, except that which is solid and secure." The result of this state of things was that, notwithstanding the resistance of the Bank of England, an important exception was made to the monopoly enjoyed by the Bank. An act passed in 18g 6, g^ave to— companies of m ore than six person s the righL of TRsning Tint pa, when established at a greater di sta nce th an sixty-five miles from London j_ and t he act of 1833 for renew - m g the cj i arter, expressly declared tha t comp anies and pa rt- nerships, althoug h composed of more than six persons^ might c^rry on the bu sines s of banking in London^ or within the radiiia_Qi_sixly=five Tnjlpg^rovidpd t.hpy Rhnnlfl ifi«ne no rn-c,"- Jating notpjj* This legislation was followed by a great extension of joint- stock banking. The London and Westminster Joint-Stock Bank, now the largest bank of deposit in existence, was es- tablished the next year,t and many banks of issue began business outside the geographical limit. The extension, however, was too rapid to be sound ; the disturbed condition * 7 George IV., ch. 46; 3 and /^ William IV., ch. 98. t The London and Westminster was for many years under the man- agement of James W. Gilbart, author of several works on banking, and owes its existence largely to his sagacity. For a short account of its early struggles, see Gilbart, Principles and Practice of Banking, 462. THE BANK OF ENGLAND. 69 of business affairs for a large part of the next decade stim- ulated agitation ; and the general opinion found in a vicious note circulation the cause of the repeated commercial crises. The necessity for a renewal of the charter of the Bank of England in 1844 gave to the government of Sir Robert Peel an opportunity both for revising the orgnnization of the Bank, and for putting an end to the increase of their issues by the joint-stock banks, and the result was the passage of the measure known as the " Bank Charter Act of 1844," or " Peel's Act," in which are embodied the leading provisions by which the bank-note circulation of England and Wales is now regu- lated.* By this act. Parliament undertook to make the notes of the Bank of England secure, and to limit the issue of bank- notes of all other kinds in England and Wale; 3. To accomplish the first of these objects the act provided for the division of the Bank into two departments, the Issue Departme nt and t he Banking Departmen t. The former was charged exclusively with the issue and redemption of notes ; the latter was restricted to the ordinary business of discount and deposit; and in all dealings with each other the two depart- ments were made as independent as if they belonged to distinct corporations. For all notes issued by it the Issue Departme nt w as required to hold e ither government securities , or coin or bullion ; and the amount of securities which it could hold bein g limited by the o_r i ginal pro vision f.n £14,000,000, it fo llow ed that jor all notes outs t anding in excess of that amount it mus t have an equivalent in the prppinna ^y^^^t^^^it -^s experience * 7 and 8 Victoria, ch. 32. For abstracts of this important act, see McCulloch, Commercial Dictionary (edition of 1857), 84: Gilbart, Principles and Practice of Banking, 428; Fenn, Compendium of the Fuftds, (ed. 1883) 77. t The act provides that of the cofn and bullion held hy the Issue Department one-fifth may be silver. For the reason for this provision see Hansard's Debates, May 20, 1844, p. 1334- The bank ceased to hold silver for this purpose in September, 1853. 70 CHAPTERS ON BANKING. had shown that the ordinary uses of the country never failed to require an amount of notes higher than £14,000,000, this provision insured the presence of coin or bullion for the redemption of all notes whose presentation for payment could be deemed morally possible, and made it unnecessary to fix any limit to the issue. The ordinary business of the Issue Department was then reduced to the automatic function of giving out notes for coin, or coin for notes,* as the public might demand. Under this arran g ement the Banking Department carri es on its business of buying securities and using its cr^