Readings in Money and Banking Part 41

Since the banks have branches in agricultural and mining communities, often distant from the railroad by several days' journey, and these branches are accepting the notes of other banks and giving credit for them as if they were gold itself, it is evidently important that each banker should have all possible information with regard to the status and business of his compet.i.tors. As a result one finds among the bankers of Canada a surprisingly intimate knowledge of each other's affairs.

TWO NEGATIVE QUALITIES

The two negative qualities of the Canadian bank note--its lack of a legal-tender quality and of a government guaranty--at first sight may seem to readers in the United States a source of weakness. Yet Canadian bankers would doubtless all agree that nothing would be gained by making bank notes legal tender for any kind of payment or by making the Government in any measure liable for their ultimate redemption. Such measures would probably be rejected as likely to prove harmful. It would be like hampering a flying machine with unnecessary bars of steel. Bank notes, like bank checks, are mere promises to pay money and are more convenient than money because they can be created as need for a medium of exchange arises. When either has done the work that called it into existence, it should disappear from circulation and be redeemed. If it is made a legal tender like money itself, or if its redemption is guaranteed by a strong government, there is always the danger that ignorant cla.s.ses of people will regard it as money itself and withdraw it from circulation.

The Canadian Government has nothing to do with the daily redemption of bank notes and does not guarantee that they shall be redeemed. It is custodian of the 5 per cent. redemption fund and is under obligation to redeem the notes of failed banks out of this fund, but if a series of bank failures should exhaust it the note holder has no guaranty that government funds will be used for his relief.

The possession by the note holder of a first lien upon the a.s.sets of a bank, including the funds that may be collected from shareholders on account of their double liability, gives rise to such general confidence in the ultimate convertibility of a bank note that the notes of a failed bank, on account of the interest they bear, sometimes command a premium.

As a rule, the notes of such a bank are collected by the other banks and held until the date of redemption has been named by the Minister of Finance.

CANADIAN BANKERS' a.s.sOCIATION

The Canadian Bankers' a.s.sociation is an incorporated body with powers and duties prescribed in an amendment to the Bank Act pa.s.sed in 1900.

Each chartered bank is represented in the membership and has one vote.

The a.s.sociation is required by law to supervise the issue of bank notes and to report to the Government all over-issues, to look after the destruction of worn and mutilated notes, and to take charge of suspended banks. Its headquarters are in Ottawa. The expenses of the a.s.sociation are apportioned among the banks and do not apparently const.i.tute a very heavy burden, for the secretary has an exceedingly small staff. All expenses incurred by the a.s.sociation on account of a suspended bank are, of course, a charge against the a.s.sets of the bank.

When the notes of a bank are so worn or mutilated that it wishes to replace them with new notes, notice is sent to the secretary of the a.s.sociation, a date is fixed, and in the presence of the secretary the old notes are duly counted and taken to a furnace, where they are consumed in the presence of the secretary and other witnesses. After this solemn operation has been performed and the signatures of all parties observing it have been duly attested, new notes are issued by the a.s.sociation to replace those that have been destroyed.

The clearing houses in the Dominion are subject to regulation by the a.s.sociation. It also has the power to establish sub-sections and to do educational work by providing for lectures, compet.i.tive papers, examinations, etc. The _Journal of the Canadian Bankers' a.s.sociation_, a quarterly publication of excellent quality, is edited by the secretary and is at present the only educational force at work among bank employees.

ELASTICITY OF THE CIRCULATION

While the amount of notes that the chartered banks may issue is limited by the Bank Act to the amount of their paid-up capital, experience has proved that this legal limitation is only nominal and that the real and effective limit is imposed unconsciously and automatically by their customers and themselves. Each constantly seeks to increase its issue of notes to the legal limit, yet the combined efforts of all are never able to force into circulation more notes than the people need.

The reason why an excessive issue of bank notes in Canada is impossible is found in the two following facts:

1. Every bank must redeem its notes on demand in seven commercial centres in different parts of the Dominion.

2. The monetary circulation of Canada, exclusive of $1 and $2 bills, and "change" consists entirely of bank notes.

The redemption system is an automatic and effectual check against inflation. It is easier to get notes redeemed in Canada than it is to secure payment of checks in the United States, for the notes are redeemable at different points throughout the Dominion and no exchange is ever charged. If a country merchant acc.u.mulates more currency than he desires to keep on hand, he deposits it, together with his checks and drafts, in the local branch of his bank. This branch immediately sorts out the notes of other banks and treats them as it does checks and drafts upon other banks, either sending them to the nearest redemption agency or using them as an offset in the local clearing house if the issuing banks have branches in the locality. The branches of a bank are not obliged to redeem the notes of the parent bank, but must accept them at par in the payment of all dues. Thus each bank is doing its utmost to bring about the redemption of the notes of other banks. At the same time it is paying out its own notes to all customers who ask for cash, seeking to bring its circulation up to the limit. As a result of these operations, two powerful forces are constantly at work, one putting notes into circulation, the other retiring them, and the people of Canada always have on hand just the amount of currency they need and no more. It is the people, not the banks, who determine how much the circulation of the banks shall be.

BANK NOTES HAVE NO COMPEt.i.tION

The fact that the bank note has exclusive possession of the monetary field in Canada is most important. His ignorance of this fact is one reason why the average banker or business man in the United States has been unable to get a practical understanding of the Canadian system. Its significance is easily seen. If Canada, like the United States, had in circulation a lot of government notes in denominations of $5, $10, $20, the Canadian banks would be able to increase their issues of bank notes almost without limit, for their new notes would simply take the place of the government notes, the latter going into bank reserves. The people of Canada in making deposits would not discriminate against bank notes, but would deposit the government paper quite as freely as the bank paper. As a result, the amount of the government paper in circulation would gradually decrease and the amount of bank notes would increase. The volume of Dominion notes in the vaults of the banks would expand, and as these notes are redeemable in gold the banks would feel justified in larger extension of their credit, so that an increase in deposits and current loans would ensue. Under such circ.u.mstances such freedom of issue as is enjoyed by the Canadian banks would doubtless result in inflation.

But such conditions do not exist in Canada. All the paper currency in the hands of the people, excepting $1 and $2 bills, is in the form of bank notes. There is no chance to subst.i.tute bank notes for government notes. Hence, if at any time business relaxes and the need for money among the people grows less, an increasing tide of bank notes flows into the banks. The people who bring these notes do not ask for money in exchange, for to them the notes are money. They take bank notes to the banks just as people in the United States take greenbacks and silver certificates--to be exchanged for a deposit credit or account.

NO LIMIT OF ISSUE REALLY NECESSARY

Theoretically there is no reason why any limit should be fixed upon the amount of notes which a bank may issue. Even though a bank has a monopoly of issue in a country--like the Bank of France--it nevertheless is unable to expand its circulation beyond the people's needs. Such a bank, unless it should adopt a reckless policy of lending which would bring ruin quickly upon itself, can exercise very little influence upon the amount of currency in circulation. In a country like Canada, where several banks are issuing currency, no single inst.i.tution can enlarge its issue of notes beyond the needs of its own customers. If it should endeavor to do this by lending freely to customers who promised to use its notes in different parts of the country, the effort would be futile.

The notes would quickly find their way into the branches of other banks and be sent in for redemption.

Like most other countries, however, Canada has placed a limit on the note-issuing privilege, fixing it at the amount of a bank's paid-up capital. While there is no scientific necessity that such a limit be fixed in order to prevent the over-issue of notes, nevertheless there are other considerations which justify it. It is an indirect method of compelling banks to increase their capitalization _pari pa.s.su_ with the growth of their business. Inasmuch as the capital of a bank is the stockholder's contribution toward its a.s.sets, it is exceedingly desirable that this contribution be made as large as possible, for, other things being equal, the strength of a bank varies with the amount of its capital. It is not unreasonable, therefore, to require that banks in return for the useful note-issuing privilege should be required to keep their capital resources large.

When a Canadian bank has reached the limit of its note issue--which has rarely happened--it begins at once to treat the notes of other banks very much as if they were its own. Instead of going to the expense of sending them in for redemption, it uses them as counter money, paying them out to depositors in response to their calls for cash. If all the banks in Canada should issue notes up to the limit, as some of them did during the exciting months of 1907, and if the current rate of interest did not warrant the issue of the taxed notes provided for by the amendment of 1908, the note circulation would immediately lose its elasticity. As further expansion would be impossible, the banks would have to meet any increasing demand for currency by paying out gold and Dominion notes, thus depleting their reserves. Such a situation would doubtless lead to a sharp advance in the discount rate and to the importation of gold.

THE PRACTICAL LIMIT UNDER THE LEGAL

It should be noted that the practical limit of note issue is about 10 per cent. below the legal limit. The manager of a bank having a paid-up capital of $1,000,000 begins to get nervous when his circulation equals $900,000. His office may be in Montreal and his bank may have branches in the far East and in the far West and in the mining wilderness of the North. Some of these branches he can not reach by telegraph and some are distant a week by mail. He immediately sends warning to all the branches and cautions them against any large out-giving of notes and against entering into transactions which will be likely to lead to unusual demands for currency. On account of this situation, even in times of greatest pressure, the total issue of the banks is usually 10 per cent.

below the authorized limit.

DEPOSITS

The liabilities of Canadian banks, like those of commercial banks in Great Britain and the United States, furnish a fairly correct index to the expansion of the country's credit. Since the Canadians, like other Anglo-Saxons, make free use of the check book in the settlement of both business and private accounts, any increase of bank loans and discounts is usually attended by a corresponding increase in deposits. When a Canadian business man discounts his note at his bank he almost invariably leaves the proceeds on deposit with the bank. As he makes his payments by check his own deposit account declines, but the bank accounts of his creditors increase, so that the net result of borrowing in Canada is an increase in the total of bank deposits. Consequently, in good times, when the banks are freely extending credit, the deposits grow, and in periods of dullness and liquidation they decline. A growth of deposits, therefore, is commonly accepted as an indication of business and industrial activity.

If a business man in Canada has temporarily a large balance in his bank and realizes that he will not need the money for several months, he will either arrange for its entry as a time or savings bank account, or for the payment of interest on his balance as a current account. Of course, the bankers do not encourage this practice, nor can it be indulged in by a depositor who is also a borrower. Depositors of the cla.s.s who are paid a small rate of interest--usually 2 per cent.--by national and state banks in the United States, usually have savings department accounts in Canada and get 3 per cent.

SAVINGS DEPOSITS ALWAYS PAID ON DEMAND

On account of the fact that the time or savings bank deposits contain such a large proportion of money likely to be needed in business at any time, the banks regard both cla.s.ses of deposit as being essentially the same form of liability. Practically all the deposit liabilities of a Canadian bank are payable on demand, although payment on two-thirds of them at the present time can not legally be demanded until after notice.

Custom has made it imperative that a Canadian bank shall pay any and all of its depositors on demand. For any bank to refuse to let a depositor have his money when he calls for it would be regarded by the public as an acknowledgment of weakness. Certainly no Canadian bank would take the risk of making the experiment.

Canadian bankers feel that 3 per cent. is too high a rate of interest to pay depositors. This rate is a matter of tacit agreement among the banks and no single bank can afford to lower it, for such action would cause it a loss of business. On the other hand, if any bank, hoping to increase its deposits, should offer to pay 3-1/2 per cent. or 4 per cent., its conduct would be looked upon with grave disapproval by its compet.i.tors. Some of the new banks in recent years have obtained business in this manner and have been severely criticised by the managers of the older inst.i.tutions.

SAVINGS DEPOSITORS NOT PROPERLY REWARDED

To an outsider it would seem that the savings bank depositor in Canada is not generously treated. In the United States he gets 4 per cent. on his savings even in the large cities. In Canada, a country where real estate mortgages yield from 7 to 9 per cent. and the bonds of new corporations are selling at prices giving the investor a higher return than he can get in the United States, it is certain that a real savings bank could well afford to pay depositors 4 per cent. It is doubtless true that 4 per cent. is a higher rate of interest than most of the savings depositors in the chartered banks have a right to expect. A large part of these deposits are not savings deposits at all.

Nevertheless it is doubtful if the banks would be justified in a reduction of the rate.

The right solution of the problem seems to lie in another direction, namely, in the making of a sharper distinction between demand and savings deposits. The funds received from both cla.s.ses of depositors should not be treated alike. The money of savings bank depositors should be invested in bonds and mortgages and then could be made to yield a net return of over 5 per cent. If the depositors were not allowed to check upon their accounts they would be a source of such little expense to a bank that it could easily afford to pay them interest at the rate of 4 per cent. At the present time the banks are paying 3 per cent. interest on money which they are lending to commercial borrowers and for the care of which they are maintaining an expensive force of clerks. Depositors who have checking accounts might be allowed 2 per cent. on large balances, but out-and-out savings depositors, people who make no use of the check book, are certainly ent.i.tled to a 4-per-cent. rate in a country where investment capital is as fruitful as it is in Canada.

Strictly speaking, the savings departments of the chartered banks are not savings banks, for they do not pretend to devote their time funds to long-time investments. The amount of securities held by the banks is never equal to the amount of time deposits.

A thorough reorganization of the savings departments of the chartered banks, to equip them for the real business of a savings bank, would not be possible without an amendment to the Bank Act, which now prohibits them from loaning money upon real estate or upon the security of real-estate mortgages. It is generally believed that this prohibition is commonly evaded by the banks through the acceptance of such mortgages as "additional security" after loans have been made. A savings bank, of course, must have the legal right to accept such security.

NO BANKERS' BANK

The indebtedness of banks to banks is not large in Canada. The branch system makes it unnecessary for banks to carry balances in other inst.i.tutions located in the financial centres. Nearly every bank has a branch in either Montreal or Toronto and in these branches carries the major proportion of its cash reserve, so that branches in the far West or in the maritime Provinces are always able to sell exchange on Montreal or Toronto. Canada has no bankers' bank. The Bank of Montreal, which is the largest bank in the Dominion, its a.s.sets being equal to about 25 per cent. of the total, is often spoken of as the government bank because it is the largest government depositary, yet it holds a very small amount of funds belonging to other banks.

AMOUNT OF THE RESERVE FIXED BY EACH BANK

It must not be supposed that the Canadian banks do not carry adequate reserves. On the contrary, every bank manager gives to this subject daily and most conscientious thought. To the Canadian banker the word "reserve" means a fund immediately available for the liquidation of liabilities. How much this fund ought to be depends altogether upon the amount and character of the liabilities to be protected.

A Canadian bank manager, having before him the amount of time deposits and demand deposits, respectively, knowing the probable future needs of the various depositors, being in constant touch with branch managers both by wire and by letter, and having back of him information born of many years' experience, easily determines how much his bank's reserve ought to be in order to a.s.sure its safety. The law neither helps nor hinders him; it simply requires that the bank shall satisfy the demands of depositors in accordance with the terms of the contract and that it shall redeem its notes on demand. The public by force of custom expects a bank to do a little more than the law requires, for its credit is bound to suffer if it take advantage of its legal privilege to delay payment upon time deposits. The manager is a hired man, sworn to do his utmost to protect the credit of the bank, trained for many years in its service, familiar with its history and its policy, anxious to guard his own reputation and character against criticism. Under these circ.u.mstances it would be remarkable if he did not fix the amount of his bank's reserve nearer the ideal figure--if an ideal banking reserve is possible--than could possibly be done by a body of lawmakers or of any other men outside the bank.

COMPEt.i.tION IS NOT LACKING