43. NATIONAL BANKS AND TRUST COMPANIES1

BY O. M. W. SPRAGUE

In times of moderate strain the clearing-house banks of New York were often enabled by means of the trust companies to make a better showing in the weekly bank statements than would otherwise have been the case. As the business of the trust companies was chiefly local they were not subject to seasonal withdrawals of cash, and their lending power was, therefore, more nearly the same throughout the year. An increase in rates for loans in New York was usually followed by a shifting of loans from banks to trust companies. By this means the deposit liabilities of the clearing-house banks were reduced, thus enabling them to preserve the cherished 25 per cent reserve ratio. The resort to this device was, of course, greatly simplified through the close affiliations between some of the large banks and trust companies, and it was so much in evidence during the years before the crisis of 1907 that the surplus reserve became quite as much an object of mirth as of confidence.

44. INTERDEPENDENCE OF BANK RESERVES

BY VICTOR MORAWETZ

The character and sufficiency of bank reserves must be considered with regard to the banking situation as a whole as well as with regard to the affairs of each separate bank.

Thus a deposit claim of one bank against another bank-that is to say, its right to call upon such other bank for the payment on demand of a sum of money-may be treated as a reserve, if we leave out of consideration the position of the banks collectively and the general banking situation. But obviously the liability of a bank to pay money to another bank would not increase the collective ability of all the banks to pay all their depositors and would not in the least strengthen the general financial situation. When a particular bank strengthens its own reserve by drawing upon its deposit with another bank, it weakens to the same extent the reserve of the bank upon which it draws.

I

Adapted from Crises under the National Banking System, pp. 227-28. (National Monetary Commission, 1910.)

2

Adapted from The Banking and Currency Problem in the United States, pp. 16-19. (North American Review Publishing Co., 1909.)

Similarly, bank-notes may be treated as a reserve if the position of the bank holding such notes be considered without regard to the general banking situation; but, having regard to the situation of all the banks, it is clear that such notes are not good as a reserve. A bank note is merely a promissory note payable in money on demand. Bank "A" holding notes of bank "B" may consider such notes as good as money so long as bank "B" is solvent and pays its obligations on demand; but it is obvious that when bank "A" obtains money from bank "B" by requiring it to redeem its notes, the reserves of bank "B" will be diminished exactly as much as the reserves of bank "A" are increased. That, having regard to the entire banking situation, bank notes are not a good reserve becomes apparent upon considering the case of several banks exchanging their notes, and each bank calling upon the others to pay their notes in lawful money.

As long as financial conditions are normal, call loans may be regarded as a good reserve, because a bank can obtain cash promptly by calling such loans; but call loans do not strengthen the general banking situation, and, therefore, when there is a severe money stringency, they are not good as a reserve. When a bank calls a loan, the borrower either must borrow the same sum from some other bank, although required to pay a very high rate of interest, or he must obtain the required sum by selling property, and in that event the purchaser usually must draw the money from the banks. Therefore when a bank strengthens its reserve by calling a loan, the practical effect is to draw the money from other banks and pro tanto to weaken their reserves.

For similar reasons, as long as financial conditions generally are not strained, bonds or other securities that have a ready market may serve as a reserve, because by selling such bonds or securities a bank can obtain money; but reserves of that character do not strengthen the general credit situation and are not available when most needed by the banks that hold them. When a bank sells securities in order to obtain lawful money to pay its depositors, the purchaser usually must draw the purchase price from the banks. The selling bank thus would obtain lawful money by drawing indirectly from the reserves of other banks. Therefore when there is a general money stringency, bonds or other salable securities are not good reserves. During the recent panic many of the banks and trust companies, including some of those which failed, owned large amounts

of high-class securities, but this did not help them or relieve the general situation, as the combined lawful money reserves of the banks and trust companies were inadequate.

Deposits by banks in other banks, bank notes, call loans, and bonds or other securities are not, properly speaking, bank reserves at all. They are only the means of obtaining reserve money for particular banks by drawing this money from the reserves of other banks. In considering the general financial situation, deposits of banks, bank notes, call loans, and securities held by the banks should be disregarded. For the ultimate payment of bank-deposit liabilities the only true reserve is legal-tender money.

45. EARLY SETTLEMENT OF BALANCES BETWEEN BANKS1 BY JAMES G. CANNON

Prior to the establishment of the New York Clearing-House in 1853 the method of settling balances between banks was a very costly and cumbersome process. 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 assorted 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 a porter with a book of entry, or passbook, 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 retarding 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

Adapted from Clearing-Houses, pp. 127-31. (National Monetary Commission, 1910.)

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, 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 institutions, 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 Saturday 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 the 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.

46. LOANS OF NEW YORK BANKS AND CLEARING-HOUSE BALANCES

Each bank in New York attempts to keep at all times a close adjustment of loans and reserves, that is, to prevent a decided fluctuation in the ratio. This is accomplished through an expansion or contraction of call loans, and the banks of the metropolis even go so far as to anticipate the balances resulting from the daily settlements at the clearing-house. Call loans are made in two ways: at each bank as a lending institution, and at the "money post" on the floor of the Stock Exchange, where the representatives of the banks

meet with the stock-exchange brokers each business day at 11 o'clock. By that time each bank has heard the returns from the clearing-house settlement and knows whether its reserve for the day has increased or decreased. It can, therefore, calculate whether it can expand its loans or whether it must "call" some of its demand loans in order to replenish its reserve. Each broker also usually knows at that hour whether he has a surplus or needs to borrow. For about an hour, therefore, banking operations are active on the stock exchange.

About two o'clock there is usually another bustle of activity in consequence of unexpected inflows and outflows of bank funds. Thus an almost constant adjustment is effected, in so far as the conditions of the market as a whole permit.

(2) CLEARING-HOUSES

47. THE ORIGIN OF CLEARING-HOUSES IN THE UNITED STATES I

BY JAMES G. CANNON

On August 23, 1853, 16 presidents, 1 vice-president, and 21 cashiers, representing 38 banks, assembled in the directors' room of the Merchants' Bank, New York, and appointed a committee with instructions to prepare a plan "to simplify the system of making exchanges and settling the daily balances." On September 13 the plan proposed was adopted, to become effective on October 11. Accordingly, on the appointed day, the representatives of the banks, members of the association, met in a room which had been procured in the basement 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 association 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 constitution. The adoption of such an instrument was opposed, on the ground that it was not Adapted from Clearing-Houses, pp. 133-35; 263-65. (National Monetary Commission, 1910.)