Banking Part 3

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

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

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

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

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

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

_5. Adequacy and Economy of Service_

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

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

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

The system of branch banking, almost universally employed elsewhere, is strong where our system is weak, but it has weaknesses of its own.

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

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

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

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

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

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

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

CHAPTER IV

COMMERCIAL BANKING IN THE UNITED STATES

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

_1. State Banks_

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

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

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

_2. National Banks_

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

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

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

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

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

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

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

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

_3. The Independent Treasury System_

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

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

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

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

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

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

_4. The Interrelations of These Inst.i.tutions_

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

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

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

The center of the entire system is in New York City. The clearing house a.s.sociation of that city, consisting of over fifty national and state banks and trust companies, includes the banks the vaults of which const.i.tute the central money reservoir of the country and which const.i.tute the center of the country's clearing system. Through the New York subtreasury pa.s.s the greater part of the receipts and disburs.e.m.e.nts of the government, and the chief a.s.say office in the country is located there. The New York stock exchange is our only stock and bond market of national scope, and consequently the investment center of the country.