Readings in Money and Banking Part 35

The following discussion of clearing houses is confined mainly to the United States and England. References to the clearing houses of France and Germany, where the introduction of the use of checks and the consequent development of clearing facilities have been tardy, are contained in the chapters devoted to the banking systems of those countries.

I. IN THE UNITED STATES

A CLEARING HOUSE DEFINED

[121]What is a clearing house? The Supreme Court of the State of Pennsylvania has defined it thus:

It is an ingenious device to simplify and facilitate the work of the banks in reaching an adjustment and payment of the daily balances due to and from each other at one time and in one place on each day. In practical operation it is a place where all the representatives of the banks in a given city meet, and, under the supervision of a competent committee or officer selected by the a.s.sociated banks, settle their accounts with each other and make or receive payment of balances and so "clear" the transactions of the day for which the settlement is made.

But we must go farther than this, for though originally designed as a labor-saving device, the clearing house has expanded far beyond those limits, until it has become a medium for united action among the banks in ways that did not exist even in the imagination of those who were instrumental in its inception. A clearing house, therefore, may be defined as a device to simplify and facilitate the daily exchanges of items and settlements of balances among the banks and a medium for united action upon all questions affecting their mutual welfare.

METHODS OF EXCHANGE IN NEW YORK PRIOR TO 1853

[122]During a comparatively short period immediately following 1849 the number of banks in New York increased from 24 to 60. In the daily course of business each bank received checks and other items on each of the other banks, which had to be presented for collection. All such items on hand were a.s.sorted and listed on separate slips at the close of the day, and items coming in through the mail on the following morning were added at that time. To make the daily exchanges each bank sent out a porter with a book of entry, or pa.s.s book, together with the items to be exchanged.

The receiving teller of the first bank visited entered the exchanges brought by the porter on the credit side of his book and the return exchanges on the debit side, who then hurried away to deliver and receive in like manner at the other banks. It often happened that five or six porters would meet at the same bank, thereby r.e.t.a.r.ding one another's progress and causing much delay. Considerable time was consumed in making the circuit. Hence, the entry of the return items in the books of the several banks was delayed until the afternoon, at an hour when the other work of the bank was becoming urgent.

A daily settlement of the balances was not attempted by the banks, owing to the time it would have required, but they informally agreed upon a weekly adjustment, the same to take place after the exchanges on Friday morning. At that time the cashier of each bank drew a check for each of the several balances due it, and sent a porter out to collect them. At the same time the porter carried coin with which to pay balances due by his bank. After the settlement had been made, there was a meeting to adjust differences and bring order out of chaos.

An old bank officer (J. S. Gibbons), in describing the inconveniences and defects of this system, says that some of the more speculative banks took advantage of the weekly method of settlements by carrying a line of discounts to an amount greater than their legitimate resources would allow. Thus, a bank would manage to carry a small debit balance of $2,000 or $3,000 with thirty or more inst.i.tutions, making a total debit balance of, say, $100,000 on which it discounted paper. It was the practice to borrow enough on Thursday to make the settlements on Friday, and the return of the loan on Sat.u.r.day threw it again into the debtor column. Virtually, therefore, the weekly settlements were nominal only, and to show that there was no attempt at economy of time and labor in making them, it is only necessary to say that the cashier drew a check for every balance due him, whereas a draft on one bank in favor of another might have settled two accounts at once.

The banks were at liberty to draw on each other for their credit balances without waiting for the settlements on Friday, and hence, when specie was needed, this was not infrequently done. But so far did many of the banks extend their loans and discounts that a single small draft by one bank on another would induce a general drawing and involve them all in confusion and virtual war on each other. Three o'clock would arrive, with the line of drafts incomplete, thus enabling debtor banks ofttimes to add $50,000 to their specie, whereas creditor banks would find themselves at the close of the day depleted in perhaps twice that sum.

THE ORIGIN OF THE NEW YORK CLEARING HOUSE

[123]The desirability of a subst.i.tute for such a system had long been realized, but as yet no plausible scheme had been proposed. As early as 1831 a plan had been suggested by Albert Gallatin, which, to a very remarkable degree, coincided with the one ultimately adopted.

But the times were not ripe for the scheme thus proposed. Mr. Gallatin was thinking in advance of the age. In time, however, the question began to be more generally discussed. For nearly a year it was under consideration, and finally it was deemed advisable to call a meeting to take decisive action upon it.

On August 23, 1853, 16 presidents, 1 vice-president, and 21 cashiers, representing 38 banks, a.s.sembled in the directors' room of the Merchants' Bank, and at this meeting a resolution was pa.s.sed providing that "a committee be appointed to procure or hire a suitable room in or near Wall Street, for the purpose of holding meetings of the officers of the city banks; that the said committee be requested to submit a plan, at an adjourned meeting of this body, to simplify the system of making exchanges and settling the daily balances; and that when a room is procured or hired for the above purpose, the presidents or cashiers be requested to meet weekly until a plan is agreed upon." In compliance with this request, the committee presented a plan for the daily settlement of balances, at a meeting held on August 31, 1853, which plan was amended so as to provide "that a room be procured for that purpose, sufficiently large to afford suitable accommodations."

On September 13, 1853, the scheme was adopted and the committee was "clothed with full power to hire a room, appoint a manager and clerks, and make all the necessary arrangements to carry the plan for a clearing house into effect." The date for beginning operations was fixed for October 11. Accordingly, on the appointed day, the representatives of the banks, members of the a.s.sociation, met in a room which had been procured in the bas.e.m.e.nt at No. 14 Wall Street, and made the first exchanges. The total clearings on that day were $22,648,109.87, and the balances were $1,290,572.38. These clearings have since been eclipsed by over $30,000,000 in the totals of a single bank.

The clearing system in America was thus fairly launched, and from that time forth its success exceeded the expectations of even its most ardent projectors. The a.s.sociation consisted at that time of 52 banks, banded together for their common good, which, as they then conceived, consisted solely in the exchange of items and settlement of balances at a uniform time and place. For nearly a year the operations were conducted without a const.i.tution. The adoption of such an instrument was opposed, on the ground that it was not needed and might lead to a dangerous concentration of power in the hands of a few managers, who might use it for personal aggrandizement, or for the exercise of an arbitrary supervision.

MEMBERSHIP AND ADMITTANCE FEES AT NEW YORK

[124]The a.s.sociation at present (1909) consists of 50 members[125] (32 National Banks and 18 State Banks) and the United States subtreasury located at New York. The latter makes its exchanges only at the clearing house, its balances being settled at its own counter. It has no voice in the government of the a.s.sociation, and pays a nominal sum for actual expenses. The privilege which the subtreasury enjoys of making its exchanges through the clearing house is a matter of great accommodation both to the subtreasury and to the banks. The New York post-office clears through one of the members, but renders no compensation to the a.s.sociation for the privilege.

The membership of the a.s.sociation since its organization has been constantly changing, owing to the admission and expulsion of members and voluntary withdrawals, as provided by the const.i.tution.

The a.s.sociation began with 51 members, but by 1858 the list had declined to 46, the lowest number in the history of the clearing house. A membership of 67 was attained in 1895.

On February 28, 1854, the Bank of the Union was expelled and the clearing-house a.s.sociation was authorized to return to it whatever amount was necessary to offset its advances toward the expenses of the clearing house. In the following December the Empire City Bank was expelled and a similar resolution was pa.s.sed but in no case thereafter were any such refunds made....

The const.i.tution is very explicit in its terms governing the admission and conduct of members. Applicants are first considered by the clearing-house committee and referred hence to the committee on admissions. The latter committee, if, in its opinion, after a careful examination, the applicants are qualified for membership, refers them to the a.s.sociation for final action, a three-fourths vote of those present being necessary for admission. Banks may be elected to membership at any meeting of the a.s.sociation, but before being considered by the clearing-house committee each applicant must be shown to have an unimpaired capital or an unimpaired capital and surplus of at least $500,000. Each new member is required to signify its a.s.sent to the const.i.tution, in the same manner as the original members, and pay an admission fee, according to capital, as follows: A bank the capital of which does not exceed $5,000,000 must pay $5,000; a bank the capital of which exceeds $5,000,000 must pay $7,500. Any member increasing its capital is required to pay in accordance with those rates.

[126]METHODS OF SETTLING BALANCES

There are no less than five different methods of settling balances, in whole or in part, without the use of money at the clearing house. They are (1) by manager's check on debtor banks given to creditor banks; (2) by borrowing and loaning balances without interest; (3) by borrowing and loaning balances with interest; (4) by the use of one or more of four forms of certificates, viz., gold and currency depository certificates, United States a.s.sistant treasurer certificates, and clearing-house loan certificates; and (5) by draft on another city.

When money is not used in the adjustment of balances at the clearing house, one of the most common methods of settlement is by manager's check on debtor banks in favor of creditor banks. In such cases the creditor banks send clerks to the clearing house to receive the manager's checks, which may be cashed by the debtor banks, exchanged for cashier's checks or exchange on another city, or sent through the clearings on another day.

There is one important advantage of the manager's check over settlements in cash at the clearing house: By its use only one transfer of cash is necessary in making settlements, and thus the risk is greatly diminished.

The second mode of settlement, other than on a cash basis, is by borrowing and loaning balances without interest. At Chicago and Pittsburg this method is practised as a matter of convenience to the several members. After the exchanges have been made and the balances determined, a certain length of time is devoted to this transfer.

The third method is that of borrowing and loaning balances upon interest, as practised in Boston.

The fourth method is that of employing some form of certificate. Many of the large clearing houses provide for a depository to receive in special trust such United States gold coin as any of the banks belonging to the a.s.sociation may voluntarily deposit with it for safekeeping, upon which certificates may be issued, to be used in the settlement of clearing-house balances. Such certificates are usually issued in denominations of $5,000 and $10,000, and are negotiable only among the a.s.sociated banks. Many of the clearing houses impose a fine for their transfer to any other party than a member of the a.s.sociation.

Coin certificates were devised by F. W. Edmunds of New York, and came into use about 1857. The Bank of America first acted as a depository, but after the beginning of the greenback epoch the a.s.sociated banks chose the United States subtreasury as such depository for both gold and currency. When the new clearing house in Cedar Street was occupied, the gold deposits were transferred to the magnificent vaults with which it is provided, and these at the present time hold a very heavy deposit of gold, as well as a very large amount of currency, against which have been issued clearing-house certificates as before mentioned. The a.s.sociations in practically all of the large cities of the United States now use these gold depository certificates in the settlement of clearing-house balances.

Clearing-house loan certificates are issued only in emergencies. The period during which balances are settled by such instruments lasts usually only three or four months, or until the financial disturbance which called them forth has subsided.

The fifth method is by draft on some other city. In some places the option is given of settling in cash or by draft, as at Austin, Tex.; Charleston, S. C.; Frederick, Md.; Jacksonville, Fla.; Kansas City, Mo.; New Orleans, La.; Rochester, N. Y.; and Saginaw, Mich. In others settlements are made exclusively by drafts on another city. Among these are Syracuse, N. Y.; Worcester, Ma.s.s.; Fall River, Ma.s.s.; Fremont, Ohio; Hartford, Conn.; Holyoke and Lowell, Ma.s.s.; and Binghamton, N. Y.

Sometimes foreign drafts are used in payments of equal thousands only, as at Wilmington, Del., and Chester, Pa.

Generally speaking, about 40 per cent. of the clearing houses of the United States use drafts on other cities in paying their balances. About 30 per cent. settle by manager's check, and about 25 per cent. settle by cash alone, the remaining 5 per cent. settling by a combination of two or more of the foregoing methods.

Clearing houses located in New England settle, as a rule, with drafts on Boston or New York, or both. Clearing houses in the vicinity of Philadelphia usually settle with drafts on that city or on New York, and those located in that part of the country lying east of the Mississippi River settle more or less by draft on New York or Chicago. Settlement is also sometimes made by draft on some of the larger cities, such as Baltimore, Washington, Savannah, Kansas City, Detroit, Omaha, and San Francisco.

[127]RATIO OF BALANCES TO CLEARINGS

The ratio of balances to clearings depends partly upon the number of banks, but much more upon the amount and character of their business and upon their relations one to another. This is ill.u.s.trated by figures which have just been collected, covering the transactions for the year 1908. At Pittsburg, with 20 members and 128 non-members clearing through members, the balances were 16.5 per cent. of the clearings; at Buffalo, with 11 members and 7 non-members, 12 per cent.; at Chicago, with 20 members and 40 non-members clearing through members, 7.5 per cent.; at Philadelphia, with 31 members and 1 non-member, 11.5 per cent.; at St.

Louis, with 17 members and 35 non-members, 9.3 per cent.; while in New York, during the fifty-four years of its existence, the percentage of balances to clearings has been only 4.64 per cent., notwithstanding the operation of the United States a.s.sistant treasurer, who almost always has a heavy debit balance.

The more nearly the banks stand on an equality with one another, the more nearly will their transactions approach a complete offset, which, of course, would leave no balance to settle.

[128]THE NATURE OF CLEARING-HOUSE LOAN CERTIFICATES

Clearing-house certificates are of two kinds--those issued upon the deposit of gold coin (and in New York City and Boston on gold and silver certificates and legal-tender notes) and those issued upon the deposit of collateral securities. The former are employed in ordinary times solely as a method of economizing time and labor and reducing risk in handling large sums of money. The latter are employed in times of financial disturbance or panic, and although both are intended for use solely in the settlement of balances at the clearing house, the circ.u.mstances that call them forth, the results effected by their use, and the part they play in banking economy have little or nothing in common. The certificates issued upon the deposit of gold, etc., are termed "Clearing-house certificates," and those issued upon the deposit of collateral security are very properly termed "Clearing-house loan certificates," with which latter only are we here concerned.

Clearing-house loan certificates may be defined as temporary loans made by the banks a.s.sociated together as a clearing-house a.s.sociation, to the members thereof, for the purpose of settling clearing-house balances.

Such certificates are negotiable, as a rule, only among the members of the a.s.sociation, and are not in any sense to be regarded as currency.

They are not even seen by the business community, and do not pa.s.s from bank to bank except in payment of clearing-house balances.

To obtain an intelligent understanding of the real character and purpose of such certificates it will be well to treat somewhat of the circ.u.mstances under which they are issued. In the course of the present century the United States has undergone periodical derangements of business affairs, when confidence was displaced by mistrust, when the payment of debts became difficult, when property values declined, and business houses failed; when industry and trade were paralyzed, and general stagnation ensued in all lines of enterprise. In such times depositors in banks, stricken with fear and sometimes pressed by need, draw out their deposits, in many cases to such an extent as to render it difficult or even impossible for the banks to contract their loans sufficiently to meet the demands thus made upon them. Under our currency system no adequate method is [was] provided for expanding the money volume as occasion demands, whereby the banks can continue their usual loans and discounts, and thus prevent a panic with all its evil consequences. Hence it is left in a large measure to the financiers of each community to work out their own remedy, supplemented by such mutual a.s.sistance as a courteous regard for each other may dictate or as business relations may demand.

Quick to see the defects in our currency system, and the desirability of in some way supplying it, the bankers of New York, nearly fifty years ago, devised the scheme of issuing clearing-house loan certificates as a method of relief from temporary stringencies. Subsequently, nearly all the clearing houses in the great centres adopted the same device, and by their heroic resort to the measure they have at different times relieved the business community of untold disaster, for which invaluable service they have justly received the grateful recognition of the entire country.