Cities-about fifty of the larger cities of the country; (3) Country Banks-that is, in the remaining cities and towns. Each class has separate reserve requirements as follows:

1. "A bank in a central reserve city shall hold and maintain a reserve equal to eighteen per centum of the aggregate amount of its demand deposits, that is, deposits payable on less than 30 days' notice, and five per centum of its time deposits, in its vaults 6/18 thereof, in the Federal reserve bank 7/18, the balance of said reserve shall be held in its own vaults or in the Federal reserve bank, at its option."

2. "A bank in a reserve city shall hold and maintain reserves equal to fifteen per centum of the aggregate amount of its demand deposits and five per centum of its time deposits." Five-fifteenths of the reserve must be in each bank's own vaults,' 6/15 in the vaults of the Federal reserve bank. The other 4/15 may be held in either place or in both.

3. "A bank not in a reserve or central reserve city shall hold and maintain reserves equal to twelve per centum of the aggregate amount of its demand deposits, and five per centum of its time deposits." Fourtwelfths of the reserve must be in each bank's own vaults, 5/12 in the vault of the Federal reserve bank. The other 3/12 may be held in either place or in both.

The former reserve requirements for national banks were: (a) for banks in central reserve cities 25 per cent; (b) for banks in reserve cities 25 per cent, of which 1/2 might be deposited in central reserve city national banks; (c) for country banks 15 per cent, of which 3/5 might be deposited in reserve city and central reserve city national banks.

"In estimating the reserves required by the Federal Reserve Act, the net balance of amounts due to and from other banks shall be taken as the basis for computation. To this amount should be added the individual demand deposits. Balances in reserve banks due to member banks shall be counted as reserves."

"Whenever any bank has less than the minimum reserve required by law, it shall not increase its liabilities by making any new loans or discounts otherwise than by discounting or purchasing bills of exchange payable at sight, nor make any dividend until the required reserve has been restored. If in thirty days the bank does not make good its reserve in lawful money the Comptroller may, with the concurrence of the Secretary of the Treasury, appoint a receiver to wind up the business of the association."

The Federal Reserve Board is empowered "to suspend for a period not exceeding thirty days, and from time to time to renew such suspension for periods not exceeding fifteen days, any reserve requirements specified in this Act: Provided, That it shall establish a graduated tax upon the amount by which the reserve requirements of this Act may be permitted to fall below the level specified."

"This requirement was omitted by amendment of September 7, 1916. Henceforth all may be held in reserve bank.-EDITOR.

105. REASONS FOR LEGAL REGULATION OF RESERVES1 BY CHARLES A. CONANT

The requirement that a bank shall keep in standard money a certain fixed proportion of its note issues is one of the regulations of banking which has been sanctioned by practical experience. It is a requirement capable of justification upon grounds of public policy. The natural tendency of banking, even where there is no intentional violation of sound principles, is toward the reduction of cash reserves to the lowest limit. This is a natural result of the law of marginal utility and of unrestricted competition. The law of marginal utility leads the community as well as the banker to employ paper as largely as possible as a medium of exchange in preference to coin, because of the economy in the amount of capital required and in transportation and handling. The practical determination of how much coin shall be retained within the country as a basis of security for notes lies with the banker, where there is no restriction upon denominations of notes, because the public will continuously accept notes and rely upon the banker to keep a sufficient metallic reserve. The necessity for regulation is less obvious where the entire volume of notes is issued by a single great bank than in the case of competing banks, because such a bank is not, as a note issuer at least, subject to competition, and its accounts attract more attention.

Where competition enters into the problem between banks otherwise upon equal footing, the bank which runs closest to the danger line in respect to the size of its metallic reserve, without actually impairing public confidence, will make the largest profits. The tendency, therefore, among competing banks will be to reduce their metallic reserves within narrower and narrower limits, until they may fall below the limits of safety. This is the natural result of the effort to render services to patrons for the lowest charges and earn profits for the bank by keeping at the minimum the amount of idle capital invested in reserves. The rectitude of any one banker, or even a combination of bankers, will not guard against the improper reduction of reserves under the stress of competition, unless such a combination is strong enough to discredit the more reckless bankers among depositors and other patrons. The chances will favor the less prudently managed banks, because of their facilities for reducing charges for their services and attracting patrons until the bankers

'Adapted from Principles of Money and Banking, II, 71-73. (Copyright by Harper & Brothers, 1905.)

of greater prudence are driven from business by the fall of their rate of profit below the normal return upon capital.

This process is almost certain to go on in a state of economic freedom, even though there is no conscious abandonment of sound banking principles. The more daring banks, especially if they are younger and smaller than the conservative ones, will keep only the reserve required for meeting ordinary demands, and will rely on the older and more prudent banks to aid them with their stronger reserves in case of unexpected demands. This will be still more the case if the larger banks are in the commercial centers and constitute the natural support of the smaller banks. Where no regulation existed, however, and pre-eminently where no one bank was large enough to feel the responsibility of sustaining the credit of the entire banking system, the tendency would be toward reducing the reserves of even the central banks to the minimum of safety under ordinary conditions. Reserves in such banks would be larger than in country banks, but not adequate to meet unusual demands. This reduction of the reserve to the danger line would, moreover, while there was no marked adverse movement of the precious metals, pass unobserved except by a few students, whose warnings would attract little attention until a serious emergency arose.

The danger of such gradual impairment of the reserves would be much greater when there was no minimum limit prescribed by law or custom than if such limit existed. The awakening to the fact that metallic reserves were inadequate to sustain business and credit would finally come at a time when country banks had reduced their reserves to the form of deposits in commercial centers and the banks in the commercial centers had reduced their reserves to a point which permitted the extension of little aid to their country correspondents. At such a moment the failure of a few country banks might carry with it the collapse of the whole banking structure, as one institution. after another discovered that it was leaning upon a broken reed in relying upon other banks, and the banking and business community suddenly had revealed to them in a flash the slender foundation upon which credit rested.

106. RESTRICTIONS ON LOANS

a) It shall be lawful for any such [banking] association to purchase, hold, and convey real estate as follows:

First. Such as shall be necessary for its immediate accommodation in the transaction of its business.

Second. Such as shall be mortgaged to it in good faith by way of security for debts previously contracted.

Third. Such as shall be conveyed to it in satisfaction of debts previously contracted in the course of its dealings.

Fourth. Such as it shall purchase at sales under judgments, decrees, or mortgages held by such association, or shall purchase to secure debts due to said association. (National Bank Act, June 3, 1864.)

Such associations shall not hold the possession of any real estate under mortgage, or hold the title and possession of any real estate purchased to secure any debts due to it for a longer period than five years. (National Bank Act, June 3, 1864.)

"Any national banking association not situated in a central reserve city may make loans secured by improved and unencumbered farm land, situated within its Federal reserve district, but no such loan shall be made for a longer time than five years, nor for an amount exceeding fifty per centum of the actual value of the property offered as security. Any such association may make such loans in an aggregate sum equal to twenty-five per centum of its capital and surplus or to one-third of its time deposits, and such banks may continue hereafter as heretofore to receive time deposits and to pay interest on the same." (Federal Reserve Act, December 23, 1913.)

The Federal Reserve Board shall have power from time to time to add to the list of cities in which national banks shall not be permitted to make loans secured upon real estate in the manner described in this section. (Federal Reserve Act, December 23, 1913.)

b) To one person or corporation: The total liabilities to any association, of any person, or of any company, corporation, or firm for money borrowed, including, in the liabilities of a company or firm, the liabilities of the several members thereof, shall at no time exceed one-tenth part of the amount of the capital stock of such association actually paid in and unimpaired and one-tenth part of the unimpaired surplus fund, provided that the total of such liabilities shall in no event exceed thirty per centum of the capital stock of the association. But the discount of bills of exchange drawn in good faith against actually existing values, and the discount of commercial or business paper actually owned by the person negotiating the same, shall not be considered as money borrowed. (National Bank Act, as amended June 22, 1906.)

c) On security of own stock: No association shall make any loan or discount on the security of the shares of its own capital stock, nor be the purchaser or holder of any such shares, unless such security or purchase shall be necessary to prevent loss upon a debt previously contracted in good faith; and stock so purchased or acquired shall, within six months from the time of its purchase, be sold or disposed of at public or private sale; or, in default thereof, a receiver may be appointed to close up the business. (National Bank Act, June 3, 1864.)

107. OBJECTIONS TO LOANS ON REAL ESTATE1

The prohibition against loans on real estate is a feature of the National Banking Law which has been much criticized in some quarters; and as evidence that this restriction upon the powers of the national banks is unreasonable and unnecessary, it is urged that real estate is the best kind of security; that savings banks, trust companies, and insurance companies are authorized to make such loans; and why, therefore, should not the national banks be permitted to do the same? But, by the great majority of bankers, the restriction is deemed wise and salutary. The objection to real estate security is not to its sufficiency, but to the kind. As the obligations of the banks are largely payable on demand, it is necessary that the securities it holds should be readily convertible into money; and while a mortgage upon real estate may be good security, it cannot be made immediately available, in case of an emergency. Personal securities of the kind usually taken by banks can be quickly assigned and promptly realized upon; but the transfer of any interest in real estate is always attended with more or less delay. It has not infrequently been the case that banks have been compelled to suspend when their assets were more than sufficient to pay their debts simply because a large portion of the assets were real estate securities, upon which it was impossible to realize at the proper time. In the case of insurance companies, trust companies, savings banks, and similar corporations there is not the same necessity for having the assets in a convertible form, but it is rather desirable that a large portion of the investments shall be of a more or less permanent character; and, therefore, real estate loans are well adapted to their purpose.

108. ARGUMENT FOR LOANS ON REAL ESTATE

By O. M. W. SPRAGUE

For banks all of whose obligations are payable upon demand the real estate loan, quite regardless of its safety, is wisely considered unsuitable. Such loans are commonly wanted by borrowers for a considerable period of time, and therefore they cannot readily be

' Adapted from Digest of National Banking Laws, p. 28. (A. S. Pratt & Sons, 1908).

* Adapted from "Proposals for Strengthening the National Banking System," Quarterly Journal of Economics, XXIV (1909-10), 204-5.