Banking Part 6

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

_5. The Canadian System_

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

The most noteworthy legal provisions pertaining to the banking business in Canada concern note issues and loans and discounts.

Regarding the establishment of branches, the amount, and, with one exception, the composition of the reserves, and many other matters carefully regulated by law in the United States, Canadian bankers are left free to follow their own judgment. Neither is there public examination of banks in Canada. Reports must be regularly made to the Minister of Finance, and he may call for special reports whenever he desires so to do; but neither he nor any other public officer has the right to examine a bank's books or to quiz its officers or directors.

In contrast with banking legislation in the United States, another peculiar feature of Canadian law is the incorporation of the Canadian Bankers' a.s.sociation, an organization resembling in essentials the American Bankers' a.s.sociation, and the a.s.signment to it of important functions connected with the issue of notes and the winding up of the affairs of failed banks.

Regarding note issues, the chief provisions of the Canadian law are as follows: Each bank is permitted at any time to issue circulating notes to the amount of its capital stock, and between October 1 and January 1 an additional amount, equal to fifteen per cent of its combined capital and surplus, may be issued on payment of a tax to be a.s.sessed by the Governor in Council, not to exceed five per cent per annum.

The notes are a first lien on all the a.s.sets of the bank that issued them, and must be redeemed on demand at the head office and at such other places as are designated by a committee of public officials known as the Treasury Board. As such redemption centers, this board has named Toronto, Montreal, Halifax, Winnipeg, Victoria, St. John, and Charlottetown. Each bank must also deposit with the Minister of Finance a sum of money equal to five per cent of its average circulation. The aggregate of the amounts thus deposited by all the banks is known as the "circulation redemption fund," and may be used in the redemption of the notes of a failed bank. In case the fund is so used, and the liquidated a.s.sets of the bank prove to be inadequate for its complete replenishment, a tax sufficient to meet the deficit is levied on the solvent banks in proportion to their circulation.

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

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

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

The general manager is the chief executive and the chief in authority.

While he is subject to the board of directors, on account of his wide experience and knowledge his judgment is usually followed. The other officers are appointed by him with the approval of the board, but, almost without exception, from persons who have served the bank in subordinate capacities. The general manager himself is nearly always a man who has pa.s.sed through the hierarchy of positions from the bottom up, and is therefore thoroughly familiar with every detail of the bank's business and history. The inspector has charge of the examination of the branches, and this work is so carefully and thoroughly done that examination by public officials is not considered necessary, or regarded as desirable by most Canadian bankers.

Regarding this matter, however, there are differences of opinion, and changes in the near future are not improbable. The managers of the branches are in strict subordination to the authority of the general manager, though they are necessarily allowed a large amount of discretionary authority in matters pertaining to the branch over which they preside. Unless prevented by distance, they are in daily communication with the head office or with one of its representatives.

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

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

The notes of the Canadian banks const.i.tute practically all of the hand-to-hand money of the country in denominations above two dollars.

The one and two dollar denominations are supplied by Dominion notes--all but $30,000,000 of which are represented by gold coin or bullion--and the lower denominations by subsidiary silver supplied by the government.

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

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

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

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

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

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

CHAPTER VI

INVESTMENT BANKING

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

_1. Saving and Savings Inst.i.tutions_

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

The need for savings inst.i.tutions varies greatly among the different nations and among different cla.s.ses of people in the same nation.

Among people of great wealth the surplus of income above expenditures is so great that large savings can hardly be avoided, and among all the well-to-do cla.s.ses the margin from which savings are possible is sufficiently large and the desire to save sufficiently great to insure large acc.u.mulations of capital. Among these cla.s.ses there is little or no need for inst.i.tutions designed primarily for the development of the saving instinct. What they need are inst.i.tutions for the safe keeping, acc.u.mulation, and investment of the savings which they are constantly making. The princ.i.p.al work of savings inst.i.tutions, therefore, pertains to the cla.s.ses of people who are not well-to-do and who need encouragement and help in their efforts to improve their material condition, if they are so inclined, and stimulus to make such efforts, if they are not so inclined.

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

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

In a book ent.i.tled, _Savings and Savings Inst.i.tutions_, written by Professor Hamilton of Syracuse University, the following definition is given:[Pages 161 and 162.]

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

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

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

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

Outside of the New England and middle states, savings banks were rare in this country previous to the inauguration of our postal savings bank system in 1911. The explanation of this condition is doubtless to be found chiefly in the wide extension of private, state, and national banks, and trust companies, practically all of which conduct savings departments and solicit the patronage of savers. These inst.i.tutions have coveted this field and have not encouraged the establishment of savings banks. There is reason to believe, however, that they have not worked the field as thoroughly as savings banks would have done and that, on account of the dominance of their other interests, they are not as well fitted as savings banks to work the field thoroughly.

Moreover it is probable that they are not able to pay as high a rate on deposits as well conducted savings banks would be able to pay.

There seems, therefore, to be room, and probably need, here for the development of savings banks of some at least, if not all, of the types above described.

_2. Trust Companies_

Within a comparatively short period of time the trust company has developed into an inst.i.tution of prime importance in the United States. In the beginning of its history it was, as its name implies, simply an inst.i.tution for the administration of trusts of various kinds, such as the execution of wills, the guardianship of minors and other dependent persons, the administration of the estates of persons either unable or unwilling to administer them for themselves, and trusteeship under corporate mortgages, especially those of railroads.

In the latter capacity they became mortgagees in trust for bondholders, registering the bonds, collecting the interest as it became due, paying the bonds at maturity, and in case of default taking the legal steps which were necessary for the protection of the bondholders.

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

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

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

_3. Bond Houses and Investment Companies_

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

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

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