named. As an evidence of these claims the bank has in its portfolio bills of exchange and promissory notes of individuals which cover the amount of the loans. These loans may be either on time

or demand.

There is a slight difference between a loan and a discount. In the case of a loan the interest is payable at the expiration of the loan, or, if it be a long-time obligation, at stated intervals annually or semiannually. In the case of a discount, on the other hand, the interest is deducted in advance and the borrower is given, not $1,000, but $1,000 less the interest for the time the loan is to run. Then at the date of maturity he repays to the bank only the face of the loan, $1,000. A discount, then, is merely a loan in which the interest is payable in advance rather than at maturity. In practice nowadays discounting is almost universal, except for call or demand loans.

The item of Bonds, securities, etc., shows that the bank has in its possession various stocks and bonds which it has purchased from time to time. United States bonds to secure circulation indicates the ownership of bonds that are devoted to a specific purpose, that of serving as security for the issue of circulating notes. These bonds are not held in the bank's own vaults, for the law requires that they shall be deposited in the United States Treasury at Washington.' They are nevertheless an asset and the bank receives interest from the government just as it would if the bonds were in its own possession.

The entry Real estate is a statement of the cost value of the bank building, furniture, and fixtures and the ground upon which the bank is located, together with such other real estate as may be necessary to the conduct of the banking business.

Reserve is the statement of the amount of money that the bank has in its till and vaults. It is made up of all the various forms of our currency, except bank notes and minor coins. If a national bank holds in its possession notes of other banks, a separate entry is made. "Notes of other banks" or "Bills of other banks." This is because the law specifies that no national bank shall count bank notes as a part of its specie reserve. A state bank, however, not subject to this provision would not need to make a separate entry for bank notes.

Items closely connected with cash are "Due from other banks" and "Exchanges for clearing-house," or "Checks for clearing," to use another expression. The former indicates that this bank has Under the federal reserve system this item will probably eventually disappear.

deposits with other banks against which it can draw on demand. "Exchanges for clearing-house" means that this bank has checks on other banks to the amount named, which it has cashed or credited to the accounts of its depositors, and in exchange for which it may receive cash from the banks against which the checks were respectively drawn. In practice, however, when presented to the clearinghouse these checks are largely counterbalanced by similar claims against this bank, and only a small net balance, one way or the other, need be paid in cash.

Federal reserve notes are notes issued by the regional (central) institutions. They are to nearly all intents and purposes as good as cash, though they may not be counted as part of the lawful

reserve.

21. DISCOUNT, DEPOSIT, AND ISSUE

BY CHARLES F. DUNBAR

The business of a commercial bank is said to be to lend or discount and to hold deposits. With these two functions may be combined a third, that of issuing bank-notes, or the bank's own promises to pay, for use in general circulation as a substitute for money.

The borrower who procures a loan from a bank does so in order to provide himself with the means either of making some purchase or of paying some debt. He seeks, therefore, to obtain, not necessarily money, but a certain amount of purchasing power in available form, or of whatever may be the usual medium of payment, measured in terms of money. If we suppose him to be a merchant, buying and selling goods upon credit in the regular course of his business, he is likely at any given time to have in his hands a greater or less number of notes, not yet due, signed by the persons to whom he has heretofore made sales; and it is in the form of a loan, made upon the security of one or more of these notes and giving him immediate command of the amount which will become due upon them in the future, that he is likely to procure what he needs from the bank. This loan may be supposed to take the form of what is termed a discount; in which case, in exchange for the note "discounted," the borrower is entitled to receive from the bank the amount promised in the note, less the interest on that amount computed at an agreed rate for the time which the note has still to run. The discounted note becomes

I Adapted from Theory and History of Banking, pp. 9-15. (G. P. Putnam's Sons, 1891.)

the property of the bank, to which the promisor is henceforward bound to make payment at maturity; and this payment when made obviously restores to the bank the amount advanced by it in exchange for the note, together with the interest which was the inducement for making the exchange.

It is now clear, however, that the operation which we have described, although spoken of as a loan by the bank to a borrower, is in fact something more than a loan. The note when given was evidence that its holder owned the right to receive at a fixed date a certain sum of money, and this right the so-called borrower has ceded to the bank. Passing over for the present all question as to what he has received in exchange, his cession of property by sale is as distinct and complete as if he had sold a bale of cotton to another merchant instead of selling to a bank his right to receive money in the future. The note has ceased to be his, and now takes its place among the investments or securities of the bank, although custom may lead to its classification as a "loan or discount."

We have now to consider what it is that the bank gives in exchange for the right to demand and receive money at a future time, acquired by it under these circumstances. The proceeds of the discounted note, or its nominal amount less the interest for the time for which it is to run, are in the first instance placed to the credit of the merchant, to be drawn out by him at once or at different times, as convenience or necessity may dictate. In thus crediting him with the proceeds, the bank plainly gives to him simply the right to call upon it at pleasure for that sum of money. Whether this right is exercised at once by demanding and receiving the money, or whether the exercise of it is postponed as regards the whole or a part of the amount, in either case the right to demand, or to "draw," is the equivalent received by the merchant in exchange for the right, sold by him to the bank, of which the note discounted was the evidence. The sum which he is thus entitled to call for is said, so long as it stands to his credit, to be deposited in the bank, or to be a deposit standing in his name, so that the transaction is seen to be, both in form and in substance, an exchange of rights.

But a deposit may owe its origin to a different operation from that which has just been examined. It happens every day that the merchant, having cash in hand, prefers not to hold it in his possession until it is required for use, but to "deposit" it with the bank where he usually transacts his business until he needs to use it. In this

case, when he makes his deposit, the property in the money or substitutes for money actually handed in by him passes to the bank, and he receives in exchange the right to demand and receive at pleasure, not that which he paid in, but an equivalent amount. Here, then, as in the former case, the transaction is in effect a sale, although the use of the word "deposit" seems at first to suggest an entirely different idea of its character.

The other leading operations of banks, when analyzed, can also be resolved into cases of the exchange of rights against rights, or of rights against money; as, for example, when the bank, for the convenience of its customer or depositor, undertakes to collect a note due to him by some third party, in which case the amount paid to the bank in money by the promisor is passed to the credit of the promisee as a deposit. Here the bank has received money for the account of the depositor, and has given to him in exchange a right to draw at pleasure for the amount or any part thereof, the property in the money actually paid having passed absolutely to the bank in exchange for the right to draw. And again, when the bank buys from a merchant a bill of exchange, or when it sells a bill of exchange drawn by itself on some correspondent, it effects an exchange of money against a right, or of a right against money, strongly resembling those already considered.

A little consideration of the manner in which notes are issued by banks will show that in the bank note we have only another form of liability, differing in appearance, but not in substance, from the liability for deposits. The bank note is the duly certified promise of the bank to pay on demand, adapted for circulation as a convenient substitute for the money which it promises. It is issued by the bank, and can be issued only to such persons as are willing to receive the engagement of the bank in this form instead of receiving money, or instead of being credited with a deposit. Thus the so-called borrower, who in the first instance has been credited with a deposit and to whom the bank is therefore to this extent liable, may prefer to draw the amount in notes of the bank and to use them in making his payments. But, in this case, it is plain that the liability of the bank is changed only in form; it is still a liability to pay a certain sum of money on demand. And so if the depositor pays in money and receives notes, or receives notes in satisfaction of a demand of any kind against the bank, he, in fact, foregoes the use of the money itself and consents to receive in its stead a promise to pay upon

demand and to receive the evidence of that promise in the form of notes. The question in which form he shall hold his right of demand against the bank is one to be decided by the nature of his business or by his present convenience, but plainly the decision of this question in no way alters the relation between himself or any transferee of his right, on the one hand, and the bank on the other. The notes issued by a bank are thus a liability distinguishable in form only from its liability for deposits, and the functions of deposit and issue, instead of being distinct, as is often assumed, are one in substance.

22.

THE ONE UNDERLYING FUNCTION OF A BANK'

BY H. PARKER WILLIS

What is banking? Many writers define a bank as an institution which exercises the functions of discount, deposit, and issue, a classification which yields very little insight because of the fact that such a grouping of functions is merely a way of describing banking as an operation from different points of view. What the bank does is the same under each of these heads; there is no difference in its essential performance. Reduced to its lowest terms, this essential function is that of guaranteeing the credit of individuals. The basic banking transaction may be described as follows:

A has purchased goods from B and has given B a document or "note," in which he promises to pay B the sum of $1,000 with interest at the end of ninety days. We may assume that this payment is absolutely certain, and that there is no risk of loss. B, however, wishes to get means of payment immediately in order to meet his own obligations. In order to do this, he resorts to someone who has immediate funds and asks him to extend "accommodation." The banker takes the note from B, and B gets in exchange the right to draw upon the bank at sight up to an amount agreed upon. This process is called discount, and the difference between the amount that B can draw at sight and the face of the note is the discount for this transaction. The banker seldom, if ever, enters into such a transaction without having B's endorsement or guarantee on the note, but it is plain that what has been done is to substitute the credit of the bank for the credit of A and B. The banker counts upon not being asked to pay money for the drafts drawn on him by B. That is to say, he expects that not everyone to whom B gives a draft or

I

Adapted from The Federal Reserve, pp. 5-9. (Doubleday, Page & Co., 1915.)