I

THE VARIOUS FORMS AND SERVICES

OF BANKING

Introduction

It is impossible to give a precise definition of banking, for the reason that at one time or another the most widely differing economic functions or services have been designated by the term. Even now it includes various forms of financial operations based on substantially different principles. Numerous writers, however, ignoring the popular or business connotations of the word, have attempted to limit the discussion of banking to a particular type of operation, namely, the creation of notes or checks, which are payable on demand, and which thereby furnish media of exchange to supplement the work of money proper in the economic process. While this type of operation is unquestionably of great importance, it is nevertheless only one form of banking, and to treat of it exclusively is to narrow the field to an extent that affords an entirely inadequate understanding of the subject.

It is the purpose of the readings in this chapter, first, to set forth in a very general way the two fundamental types of banking operations the commercial and the investment; second, to enumerate the various forms of banking institutions that have been developed in the carrying out of these fundamental operations; and third, to indicate the great variety of services that are in fact performed by the typical commercial banking institution. All of this is but introductory, however-designed to afford a sort of bird's-eye view of the problem of banking as a whole, and to serve as a point of departure for the detailed study to follow.

It should perhaps be added here that banking (using the term loosely) is one of the oldest of institutions, dating back to a remote antiquity. Archaeologists have discovered, for instance, that Assyria, as early as eight centuries before the Christian era, appears to have had a well-developed system of bills of exchange, promissory notes, and transfer checks, very similar to those of our own day.

Among the Greeks and Romans, also, most of the operations typical of modern banking were common. The Middle Ages, however, was a period of stagnation in banking affairs, as in practically everything else, and it was not until the twelfth century that modern banking history began. In the great commercial cities of Italy and Spain banking developed rapidly between the twelfth and the sixteenth centuries and appears to have been characterized by many of the problems that confront us today. A little later the famous bank of Amsterdam, though of a simple type, was largely responsible for the commercial pre-eminence enjoyed by Holland in the sixteenth and seventeenth centuries. The way in which modern banking originated in England and the general character of the services performed are indicated by the selection on "Goldsmith Bankers in England."

A noteworthy feature of banking in mediaeval Europe was the rise, along with commercial institutions, of numerous great investment bankers or financiers who, through their control of enormous capital resources, were at times almost able to sway the destinies of nations. The Money Trust appears to have been quite as menacing then as now!

I. COMMERCIAL VERSUS INVESTMENT BANKING'

BY WILLIAM A. SCOTT

In order to draw the line between commercial and investment banks, attention must be riveted upon the functions which each performs in the economy of the nation. Commercial banks are essential parts of the machinery by which goods and services are exchanged in the everyday conduct of business. Investment banks are essential parts of the machinery by which the savings of the people are collected and applied to the production and transportation of goods and to the service of such public bodies as the federal, state, county, township, and municipal governments.

In order to comprehend the precise rôle which commercial banks play in the daily exchange of goods and services, we must note certain features of our credit system. To sell and to buy on time are very common practices in modern business. The manufacturer frequently buys raw materials and agrees to pay for them after their transforma

'Adapted from "Investment vs. Commercial Banking," Proceedings of the Second Annual Convention of the Investment Bankers Association of America, 1913, pp. 76-80.

tion into completed products. The jobber frequently buys goods to be paid for after he has sold them. The farmer frequently buys seed, fertilizer, cattle for fattening, etc., to be paid for when the crop has been harvested or the animals sold to the butcher.

The explanation of these practices is to be found in the growing separation of producers and consumers and in the lengthening of the period of production caused by the constant extension of the areas within which goods are marketed and of the use of machinery in manufacturing. Before paying for them consumers like to receive the goods purchased, and middlemen not only to receive them but to sell them again. Manufacturers find advantage in being able to pay for labor and raw products after they have been transformed into completed goods and sold to middlemen or consumers. Hence an interval must elapse between purchase and payment measured by the length of time required for the transportation, selling, and manufacturing processes.

The practice of buying and selling on time results in making practically every business man both a debtor and a creditor, and renders it necessary for each one to meet his debts as they mature by means of the amounts paid by others in settlement of their obligations to him.

It is rarely possible, however, for a business man to make the maturities of the debts due him and the debts due by him to others exactly correspond, and he therefore finds himself under the necessity of transforming into means of payment the obligations of other people due in the future. This service the commercial bank performs for him, and in this consists its unique function in the national economy.

The means by which this service is performed is the discount of the evidences of indebtedness of others to him, or of his own personal notes, and this in the vast majority of cases is accomplished in this country by exchanging these credit documents for balances on a checking account, which balances can be transferred at will to other people at home, in other cities, or in other countries or transformed into hand-to-hand money.

The service rendered by the investment bank differs greatly from that of the commercial. It acts as an intermediary between the person who has accumulated capital and those who are in a position to invest it in fixed forms. Two processes are here involved: the accumulation of the savings of the community on the one hand, the development of natural resources and the construction and management of

manufacturing and transportation agencies on the other. The transfer of capital to public bodies, such as central governments, states, municipalities, and other political divisions, for unproductive consumption is a process also carried on by investment banks similar to the other in its nature, but having peculiarities which place it in a class by itself.

It is the business of the investment banking institutions of a country to see that this work of directing the savings of the country into its various enterprises is economically and efficiently done. It is their business to stimulate saving and to provide facilities by which every person who saves can readily put his accumulated funds to productive use. It is their business to search out opportunities for investment, to see to it that the natural and human resources of the nation are used to the best possible advantage in the promotion of its economic interests. This is a great work, as important and essential to the well-being of the nation as that which commercial banks or institutions of any other kind perform.

2.

A CLASSIFICATION OF BANKS AND TYPES OF BANKING OPERATIONS

Banks are commonly classified either according to the type of business in which they specialize, or according to the legal authority under which they conduct their business. Under the first classification we find the following: commercial banks, investment banks or bond houses, savings institutions, and trust companies. However, there is often a far from complete specialization in the work performed by these various institutions; indeed, "commercial" banks and trust companies as a general rule now perform nearly every kind of banking operation.

Under the second classification we have: national and state banks and private banks-the classification indicating the source of, or the absence of, specific authority to conduct a banking business. The term "state bank," however, has numerous connotations. Most commonly the term is used in connection with state institutions which engage in commercial operations. From this standpoint-the character of business carried on-savings banks and trust companies cannot be called state banks, even though incorporated under state law. Again, private unincorporated banks have also been classified as state banks where they are subject to regulation by the state. For our present purpose, however, the distinguishing feature is the chartering

by state governments. Trust companies, savings banks, bond houses where incorporated, and commercial institutions are all state banks in this classification.

Private banks are of various kinds: (1) small concerns which engage in a general banking business (largely savings), without any specific grant of authority; they may or may not be under the supervision of the state banking department; (2) various co-operative credit or loaning associations; (3) unincorporated investment banks, or bond houses.

But while banks may be classified into several different kinds of institutions, and while, from the standpoint of services performed, they offer a wide variety of advantages in the way of affording a place for the safe-keeping of money, transferring funds at small expense for the benefit of customers, providing a convenient and uniform system of currency, etc., there are nevertheless but two fundamental types of banking operations. In the last analysis all banking may be classified as either commercial or investment business.

3. THE VARIOUS SERVICES OF BANKS1

BY JAMES W. GILBART

Banks are useful as places of security for the deposit of money. The circumstance which gave rise to the business of banking in this country was a desire on the part of the merchants in London to obtain a place where they might lodge their money in security. Everyone who has had the care of large sums of money knows the anxiety which attends their custody. A person in this case must either take care of his money himself or trust it to his servants. If he takes care of it himself he will often be put to inconvenience, and will have to deny himself holidays and comforts, of which a man who is possessed of much money would not like to be deprived. If he entrusts it to others, he must depend upon their honesty and ability. Besides, in both these cases the money is lodged under the owner's own roof and is subject to thieves, to fire, and to other contingencies, against which it is not always easy to guard. All these evils are obviated by means of banking.

The bankers allow interest for money placed in their hands on deposit. By means of banking the various small sums of money

I

Adapted from The History, Principles, and Practice of Banking, 1837. Michie's revision (1882), pp. 213-22. (G. Bell & Sons.)