<h2>CHAPTER 48</h2>
<h3>BANKING AND CREDIT</h3>
<h4>§ I. FUNCTIONS OF A BANK</h4>
<div class="sidenote">The essential banking function</div>
<p>1. <i>A bank is a business whose income is derived chiefly from lending
its promises to pay.</i> Banks have passed through many changes in the past
three centuries. Originating on the street corner for exchange of money,
they have evolved into great institutions of many forms, and performing
many functions. The definition seems paradoxical, but it expresses what
in modern thought is the essential feature of a bank: the lending of its
credit. A reserve of money is needed by the man of business. But for the
banks each man would have to keep his reserve in his own till. Except
the small sum needed for current uses, a bank can keep this reserve more
economically than individuals can. It has the advantages of large
production similar to those of a large factory. The process of lending
credit is called deposit and discount. It grew out of the deposit of
actual money for safe keeping and the loaning to borrowers by the method
of discounting their notes. The term now has a somewhat different
meaning, for a merchant may obtain a deposit to-day without putting any
money in the bank. He gets the bank to discount his notes or collateral
security, and to enter the sum to his credit as a deposit. He becomes a
depositor by borrowing, not by lending to the bank. The sum is under the
borrower's control; he can check it out when he wishes; but he usually
keeps a certain balance to his credit. The bank's gain is larger than
ordinary interest, because it<span class="pagenum"><SPAN name="Page_463" id="Page_463">[Pg 463]</SPAN></span> gets a discount on the large sums left in
its possession. The bank increases its funds also by attracting deposits
from those who do not care to borrow.</p>
<div class="sidenote">Other functions usually performed</div>
<p>2. <i>Functions not essential to banking are ordinary money-lending,
money-changing, exchange to distant points, safe deposit, and issue of
bank-notes.</i> Banks often lend in the ordinary way, allowing borrowers to
draw the money out at once, but this is not the business they prefer.
Many individuals and corporations, such as endowed charities, colleges,
insurance companies, lend great sums of their own money without thereby
partaking in any degree of the peculiar character of banking.
Money-changing (the exchange of coins of different countries) is done by
banks, but likewise by many other agencies not sharing the essential
banking character. Foreign and domestic exchange is the issue and
cashing of "drafts" for money payments between distant places. Most
banks are well fitted to perform this function, but some banks do not
undertake it, and it is performed also by some business houses that are
not banks. Safe deposit is the keeping of things to be returned in
identical form, as silverware, notes, and papers. By banks in small
towns this is sometimes done freely, sometimes for a slight charge; but
in large cities safe-deposit vaults are generally quite unconnected with
banks. Even bank-note issue is not essential to banking; most banks in
the United States issue no notes, others issue very few. All these
functions may be united under one management, but the essential banking
function is deposit and discount.</p>
<div class="sidenote">Sources of the income of banks</div>
<p>3. <i>The income of banks is derived from discounts, interest on their own
capital, charges for exchange and collection, rents on investments, and
profit from the loan of their bank-notes.</i> The income of banks is drawn
from different sources, according to the size of the community, and the
nature of the banks. While in the villages and smaller cities they
perform a number of functions, in the larger cities they usually
specialize in a far greater degree. Like every other enterprise,<span class="pagenum"><SPAN name="Page_464" id="Page_464">[Pg 464]</SPAN></span> a bank
must start in business with some paid-up capital as a guarantee of
credit. Further security is afforded by the limited liability of
shareholders for losses, in proportion to their capital stock. The same
amount of money could be loaned with less trouble and more cheaply
without starting a bank, but used as a banking capital a part of it can
be loaned while still serving to attract money deposits. Charges to
smaller customers for exchange are a source of income to some banks, but
in many cases this service is freely performed for regular customers and
becomes a considerable expense. Banks make few investments in real
estate or other physical property; it is, in fact, their duty to keep
out of ordinary enterprises, but they are forced sometimes to take for
unpaid debts things that have been held as security. Profits on
bank-notes have at times been the main, possibly the sole, motive for
starting banks; but that is not the case to-day when the right of issue
is so strictly limited.</p>
<div class="sidenote">Productive services of banks</div>
<p>4. <i>Banks are productive economic agents performing important industrial
services.</i> False ideas have long been entertained about the magic power
of banks to produce wealth from nothing. To many, banks are a mystery
much like paper money. Their opponents sometimes have pictured them as
vampires fattening on the blood of industry. That they have shown abuses
at times is undeniable, but, like other economic agents, they are to be
judged by their net efficiency. The bank is a tool performing services
similar to those of money. For some purposes money is an awkward and
costly agent in comparison with banks. For remitting payments from New
York to San Francisco or Hong Kong, money is a medieval device. Money
can more safely be entrusted to a bank than to a strong chest in one's
own house. The man who refused to make use of banks in this day would
isolate himself economically, and would soon find himself out of any but
the smallest business. He could no more get along without the banks than
without the post, the telegraph, or the telephone.</p>
<p><span class="pagenum"><SPAN name="Page_465" id="Page_465">[Pg 465]</SPAN></span></p>
<div class="sidenote">The bank as a labor-saving device</div>
<p>The gathering of loanable funds by the banks, making them available at
once, reduces hoarding, makes money move more rapidly, and creates a
central market between borrowers and lenders for the sale of credit.
While not creating more physical wealth directly, it adds to the
efficiency of wealth; it oils the bearings of the industrial machine. To
abolish banks would be to destroy labor-saving machinery. Banks perform
incidentally a further service in developing better business methods in
the community. In supplying credit to active business, banks are
constantly passing judgment on the collateral security presented to them
and on the solidity of the enterprises that are seeking support. They
enforce promptness and exactitude in business dealings.</p>
<p>Because in their public nature banks are very analogous to money, they
have always been looked upon as properly subject to more supervision
than most private business, and government has always exercised a
considerable measure of control over them, sometimes for good, sometimes
for evil.</p>
<h4>§ II. TYPICAL BANK MONEY</h4>
<div class="sidenote">Nature of typical bank money</div>
<p>1. <i>Typical bank money consists of notes issued by banks on the credit
of their general assets, without special regulation by law.</i> As no two
leading countries have quite the same system of bank-notes, the subject
is a difficult one. It is well to begin, therefore, with a clear
conception of typical bank money, unregulated by government. Such a form
of note is one with which few now living in the United States have had
any experience, as the present national bank-notes differ in essential
ways from the typical form. Typical bank-notes are notes issued by banks
as a means of loaning their credit. The borrower, instead of receiving a
credit balance at the bank subject to check, gets notes which he hands
on to other men. These notes are returned for redemption to the issuing
bank as soon as any one wishes specie in their stead. The limit of the
issue of such notes<span class="pagenum"><SPAN name="Page_466" id="Page_466">[Pg 466]</SPAN></span> is the need of the community for that form of
money, and if they are promptly redeemed in gold on demand, they never
can exceed that amount. A holder of a note (in the absence of special
regulations) has the same claim on the bank that a depositor has. As it
is to the interest of the bank to keep in circulation as many notes as
possible, there is a temptation to abuse the power of note-issue, to
which many banks yielded in the period of so-called "wild-cat banking"
before the Civil War.</p>
<div class="sidenote">Bank-notes viewed as commercial paper</div>
<p>2. <i>Bank-notes are viewed by some as a form of commercial credit.</i>
Typical bank-notes are not legal tender, and every one has the legal
right to take or refuse them as he pleases. It is therefore said by some
that bank-note issue is of no special concern to the state, that it can
safely be left to individual self-interest. It is said that if one has
little faith in a note, he may refuse to accept it. But in reality every
one is compelled to take the money that is current. The average citizen
cannot know the credit of distant banks, and thus has not the same power
of judging wisely in taking bank-notes that he has in making deposits in
the bank of his own neighborhood. Between bank-notes and ordinary
promissory notes, there are other differences of a nature pretty
generally recognized. Bank-notes pass without endorsement and thus
depend on the credit of the bank alone, not like checks, on the credit
of the person from whom received. They yield no interest to the holder.
They are intended to be used as money and are so used. Thus they come
near to paper money in their nature, and the banks are near to
exercising the right of coinage.</p>
<div class="sidenote">Bank-notes viewed as a form of political money</div>
<p>3. <i>By others, bank-notes are considered to be almost identical with
government paper money.</i> Some opponents of bank-note issue declare that
it is a usurpation of the prerogatives of government, and that no power
but the sovereign state should issue money. While many in America to-day
hold this view, the comparison probably is false and strained. Typical
bank-notes, unlike inconvertible paper money, depend<span class="pagenum"><SPAN name="Page_467" id="Page_467">[Pg 467]</SPAN></span> for their value on
the credit of the bank, not on their legal-tender quality and on
political power. They must be redeemed on penalty of insolvency;
government notes need not be, and yet will circulate at par if properly
limited.</p>
<p>While these differences mark off government paper money pretty sharply
from typical bank-notes, it must be noted that in many cases actual
bank-note issues have been far from this typical form. In the days of
"wild-cat" banking, bank-notes were issued in excess and fell below par,
yet the man in a Western community who dared to ask the bank to redeem
the notes in specie was not only frowned on by the bank, but condemned
by the public, which felt that business was endangered by such a demand.
Redemption on demand would have required a reduction of the amount of
money in circulation and would have caused a fall in prices. Inflation
of the bank currency went on with results almost identical with those
following an excessive issue of government paper money. Not formal law
but public opinion made such bank-notes essentially political money.</p>
<div class="sidenote">Policy of public regulation of bank-notes</div>
<p>4. <i>The public nature of bank money has led to many forms of public
regulation of their issues.</i> Bank-notes thus stand midway in their
economic nature between political money and private notes, sharing
something of the character of each. An extreme analogy in either
direction is misleading. It is of great social importance that the
circulating medium should be reliable. The least possible amount of the
citizen's energy and thought should be required to decide whether the
money is good or bad. Nevertheless, those opposed to state interference
in industry declare that if the citizen is not left to look out for
himself, the growth of stupidity will be encouraged; and they say that
it is no more essential for the state to guarantee the quality of
bank-notes than the quality of woolen cloth or of sugar. Few, however,
take so extreme a view, and it is generally held that it is a function
of the state to insure in a greater or less degree the quality of the
money in circulation. The<span class="pagenum"><SPAN name="Page_468" id="Page_468">[Pg 468]</SPAN></span> actual bank-notes of the leading countries
are thus of many varieties. The Canadian notes are the most nearly
typical bank-notes issued to-day; those of Germany come next, while
those of the United States have little of the typical character.</p>
<h4>§ III. BANKS OF THE UNITED STATES TO-DAY</h4>
<div class="sidenote">Forms of banks in the United States</div>
<p>1. <i>The three forms of banks in the United States are private, state,
and national.</i> Any one with a little capital may become a private
banker. There are "curbstone brokers" in almost every town, and some of
the great financial houses are private banks. But the law will not allow
this to go very far. Some states will not allow a man to put up a sign
announcing himself as a banker unless he complies with certain banking
laws. In some states even private banks are subjected to the same
inspection as the state banks and are required to make the same reports
to the state officials. State banks are those organized under special
state banking laws. They are usually subject to inspection by state-bank
commissioners, must make regular reports, and are required to comply
with certain rules as to their reserves, rates, and investments. In any
case they do not issue bank-notes, because the national laws now tax the
notes of state banks so heavily that they are unprofitable. National
banks, the largest and most important portion of our banking system,
were authorized by law in 1863, during the Civil War. They are subject
to stricter regulation and inspection than are other banks, and that
regulation is perhaps an advantage to them, as it strengthens public
confidence in their stability. Yet this regulation does not insure the
depositors against loss, as some national banks fail every year. They
may be organized with twenty-five thousand dollars capital in towns of
less than three thousand population, with fifty thousand dollars in
towns of less than six thousand, with one hundred thousand dollars in
cities of less than fifty thousand, and with two hundred thousand
dollars in larger cities.</p>
<p><span class="pagenum"><SPAN name="Page_469" id="Page_469">[Pg 469]</SPAN></span></p>
<div class="sidenote">Nature of our national bank-notes</div>
<p>2. <i>Our national bank-notes have no essential mark of typical bank
money.</i> The one marked peculiarity of the national banks of the United
States as compared with those of other countries, is their mode of
note-issue. They perform all the other functions of banks, essential and
unessential, and perform them well, but the issue of bank-notes is
optional with them, and some of them do not issue any bank-notes. The
legal condition to their issue is that bonds of the United States shall
be purchased in the open market and deposited with the treasurer of the
United States. Until 1900, notes might be issued only to ninety per
cent. of the value of the bonds deposited; but now they may be issued up
to the par value of the bonds. The notes, being secured by the value of
the bonds, rest on the credit of the government, not on the credit of
the bank. These notes are not promptly sent back for redemption to the
banks issuing them, as is done with typical bank-notes. They may
circulate thousands of miles away from the bank that issued them, and
for years after that bank has gone out of business. They are not an
"elastic currency" increasing or diminishing with the needs of business.
The changes in their amount depend upon the chance of the banks to make
more or less in this way than by any other use of their capital, and
this in turn depends largely on the price of bonds and on the rate of
interest they bear. From 1864 to 1870, fortunes were made from this
source, but in recent years there has been little opportunity of gain
from note-issues. Our present bank-note issues are not on a logical
basis, and satisfy no one entirely. They are of importance neither to
the bank, to which they afford little or no profit, nor to the public,
for which they do a service equally well done by silver certificates,
greenbacks, or coins.</p>
<div class="sidenote">Suggested reforms of the bank-note system</div>
<p>Along with the discussion of the currency has gone, since 1896, a
vigorous discussion of the banking system. The two problems are so
closely related that a change in the one suggests readjustment of the
other. One extreme plan is to<span class="pagenum"><SPAN name="Page_470" id="Page_470">[Pg 470]</SPAN></span> abolish bank-notes entirely and to
replace them with additional issues of greenbacks; the other extreme
plan is to authorize the issue of almost typical bank-notes. A
modification of the Canadian banking system, which has great merits, is
held up for imitation. Bills have been repeatedly before Congress
authorizing the maintenance of a general guarantee fund with which the
notes of failed banks could be redeemed, and at the same time
authorizing branch banks such as those in Canada. Public sentiment has
never strongly favored this plan, however, and there is more likelihood
of the passage of a bill providing for emergency notes in time of
financial stress, after the plan followed in Germany.</p>
<div class="sidenote">Bank regulation a protective measure</div>
<p>That the control of banking is an important duty of government is the
conclusion of the practical world. The various banking systems of the
leading countries embody different plans for the one purpose of the
adequate control of banking in the public interest. Government control
of bank-notes is felt to be of the same nature as factory inspection,
that is, to be a protective measure. When public interests are at stake
and private interests conflict with them, government acts to forbid one
citizen from doing harm, and to protect other citizens from injury.</p>
<hr class="chap" />
<p><span class="pagenum"><SPAN name="Page_471" id="Page_471">[Pg 471]</SPAN></span></p>
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