Banking

by William Amasa Scott

(b) Loan Operations.—In making loans, a typical method of procedure for a business man is to arrange with a bank for what is technically called a "line," that is, the maximum amount he may expect to be able to borrow under normal conditions. This "line" determined, he borrows from time to time according to his needs, giving as security his personal note, payable in one, two, three, four, or six months. Sometimes an indorser is required, and sometimes the deposit of collateral, mortgages on real estate, bonds, stocks, and warehouse receipts being the most commonly used securities employed in such cases. Ordinarily, when a note falls due, he expects the bank to renew it, if its payment at the time is not convenient, the agreement on a "line of credit" ordinarily carrying with it that implication, though not legally, probably not morally, binding the bank so to do. Indeed, the customer ordinarily counts the amount of his "line" as a part of his working capital and expects to keep it in use a large part, if not all, of the time.

In the determination of the amount of these "lines of credit," the judgment of some one or more bank officers, assisted by a discount committee and sometimes, though not as a rule, by a specially organized credit department, rules. In forming these judgments, the bankers of the United States as a class are not guided by any universally recognized and well established principles. The best ones require from their customers carefully prepared statements showing the nature and volume of the business they transact, and a careful classification of their assets and liabilities. Others, and these are a large majority, rely upon the knowledge they already possess, gained by general observation, and supplemented by verbal inquiries made from time to time and by the voluntary statements of the customers themselves.

The significance of the distinction between commercial and investment operations in the business of banking is not generally understood, and is consequently little regarded. The dominant question in the mind of the average banker, both in determining the amount of a customer's line and in making loans to him after the line is fixed, is how much he is "good for," and on this point the total net worth, rather than the nature of the business operations, of the customer is likely to be decisive. Of course, the banker is also influenced by the customer's reputation for both integrity and business ability.

This method of procedure has the advantage of rendering access of people to the banks easy and of promoting their extensive use, but it has the grave disadvantage of opening the doors wide to inflation of credit. The majority of our bankers do not know whether more or less than their savings deposits and their capital and surplus, the only funds which can safely be invested in fixed forms, is so invested. The promissory notes of their customers, which constitute the major part of their assets, give no information on this point, and they have not made the investigations necessary to determine with certainty the destination of the funds they have loaned. They are satisfied with the knowledge or the conviction that their loans can be collected, not at maturity—they know very well that many, probably most, of them can not—but ultimately. The result is that unconsciously and gradually the banks create their demand obligations in the form of balances on checking accounts against fixed investments in machinery, buildings, lands, mines, etc., and, when the payment of these obligations is demanded, the reserves fall below the danger point and they are forced to require payment at maturity of paper which the maker had counted upon having renewed indefinitely, and the payment of which is only possible by the forced sale of the property in which the borrowed funds were invested, or of some other property in his possession. If only a single bank or a comparatively few banks find themselves in this condition, relief may be found in the rediscount of paper with other banks, in direct loans, or in the sale of securities on the exchanges; but, if the condition is general, relief by these means is impossible, and widespread forced liquidation becomes necessary. An aggravated situation of this kind causes panic and results in a commercial crisis.

(c) Treasury Operations.—The operation of our independent treasury system produces arbitrary fluctuations in the reserves of the banks and prevents that degree of prevision which is essential to the most economical and the safest practices. The funds needed for current purposes are withdrawn from the banks and kept under lock and key in the treasury vaults, thus diminishing reserves to the extent of their amount. Surplus funds likewise accumulate in the vaults with the same result, until the Secretary of the Treasury sees fit to deposit, and the banks find it possible to receive them. Even then the depository banks alone are directly benefited, and no one of these knows long in advance how much it is going to receive or when funds left on deposit will be withdrawn.

Since the volume of the business of the government is very large, the effects produced by the movement of its funds are of such magnitude as to give them national importance, the ability of banks to loan and to meet obligations already incurred being profoundly affected by them. Among these effects must also be noted the inability of the banks to calculate these movements in advance, as they to a degree can those produced by the operations of their commercial customers, and the relation between them and the Secretary of the Treasury, which results. The relation between the receipts and the disbursements of the government vary greatly from month to month and year to year, so that, on the basis of past experience, it is impossible to predict when the banks will gain from or lose to the treasury. The action of the Secretary of the Treasury regarding deposits of surplus funds is equally uncertain and unpredictable. No fixed policy regarding this matter has yet been established by precedent or determined by law. Each secretary follows his own judgment and is influenced by current events and conditions.

The uncertainty which results creates a speculative atmosphere about the money market and renders the banks dependent upon the secretary and the secretary influential on the money market in a manner which is unfortunate for both. Since they cannot be indifferent to the operations of the treasury, and cannot predict them, banks are obliged to speculate regarding them, and, if they err, they are likely either to over-extend their credit operations or unduly to contract them. The former will result when they expect an increase in their reserves from treasury sources and do not get it, and the latter when contemplated withdrawals of funds do not occur.

The Secretary of the Treasury is not in a position properly to exercise the power conferred upon him. He is outside the channels of commerce and industry, and must, therefore, secure at second hand the information necessary for intelligent action. Such sources of information are frequently unreliable and inaccurate and their use subjects him to the charge of favoritism and to the danger of acting in the interest of special groups or special localities.

(d) Operation of the Reserve System.—Each national bank now keeps locked up in its vaults money to the amount of at least six to twenty-five per cent of its deposits and a balance with banks in reserve and central reserve cities sufficient to bring the total to at least fifteen per cent of deposits in the case of country banks, and twenty-five per cent of deposits in the case of reserve city banks. In addition, it is customary for most banks to carry as a secondary reserve high-grade bonds which can be readily sold in case of need. The practice of state banks is practically the same as that of national, and that of trust companies differs only in the amount of reserves carried and in the proportion between the different items.

This system has many disadvantages. Among them the most obvious, perhaps, is the withdrawal of enormous sums from the current use of the agriculture, industry, and commerce of the country. That portion of these reserve funds which is required to be kept under lock and key in the vaults, amounting in the aggregate to a billion and a half of dollars or more, is not available for use in ordinary times, and is practically useless even in times of stringency, since according to present law, when the reserves fall to the minimum prescribed by law, banks must stop discounting, under penalty of being put in the hands of a receiver. The other portions of these funds, namely, those deposited with banks in reserve cities and those invested in bonds, are likewise withdrawn from the uses of current commerce, since a large part of the former is only available for use on the New York Stock Exchange, and the latter are invested in railroads, mines, factories, land, etc.