CHAPTER XXII

THE COMMERCIAL BANKING SYSTEM

The commercial bank was studied in chapter xix as a special type of financial institution, and as such it was discussed in isolation, that is, independently of its relations to other banks. We shall find, however, that commercial banks are closely interrelated, each individual institution being in the ordinary course of its business brought into contact with other banks with those in the same city or community, with those in other cities, and even with the institutions of other countries. Taken as a whole, the commercial banks constitute what may be called a commercial banking system. In the present chapter we shall consider the nature of these interrelations and the reasons for their development, together with the origin and nature of the phenomenon of credit currency.

I. CLEARING-HOUSE ASSOCIATIONS

The banks of all the important financial centers of the country have worked out certain of their relations through clearing-house associations. A clearing-house association may be defined as an organization of banks designed to promote in every possible way the mutual interests of the members. The most common of these mutual services and the one that has excited by far the greatest popular interest is that of clearing checks. The practical operation of the clearing-house in this capacity may be readily described.

Let us assume that in a given city there are twenty banks which are members of the clearing-house association. Each day bank No. I receives from its depositors a considerable number of checks which have been drawn against each of the other nineteen banks; and, in turn, each of the other banks receives checks drawn on all the rest. Bank No. 1 credits

to the deposit accounts of its customers the checks as it receives them; and it must then collect these checks from the banks against which they have been drawn. Before the hour set for exchanging the checks at the clearing-house the clerks in bank No. I assemble them in bundles, so that all of those that are payable by each bank will be together. The total amount of the checks to be presented to each bank is also added up on a sheet of paper. At the hour of clearing, messengers from the several banks appear at the clearing-house for the purpose of securing payment of the checks. The process by which these checks are "cleared" is as follows:

Within the clearing-house is a large circular desk, with twenty compartments or stalls. In compartment 1 is a clerk representing bank No. 1; in compartment 2, a clerk representing bank No. 2, etc. The messenger from bank No. 1 deposits in compartment 2 the checks payable by bank No. 2; in compartment 3, the checks payable by bank No. 3; and, in turn, in each of the nineteen compartments. In his turn, the messenger from bank No. 2 deposits in compartment I the checks payable by bank No. 1; in compartment 3 those payable by bank No. 3, and so on around the circle. The messengers from banks Nos. 3, 4, etc., likewise deposit their bundles in the nineteen compartments representing the nineteen banks against which the checks have been drawn. At the conclusion of this presentation of the checks to the proper compartments, each clerk will find in his compartment nineteen bundles of checks, all of which are payable by his bank. These checks are turned over to the messengers, who take them immediately back to their respective banks. Thus the physical transfer of the checks has been accomplished.

Many checks are traded directly between banks. It should be stated, parenthetically, that as a means of relieving the congestion of work in the banks in the larger financial centers a considerable percentage of the checks that are cleared are not actually sent through the clearing-house, although their totals are included in the sums which appear upon the clearing-house records. The reason for this is as follows: The clearing usually

occurs at 10:30 A.M.; and after that hour the bank continues to receive checks from its customers, so that by the end of the day it has assembled a large number of checks payable by other banks. Again at the opening of the bank the following morning a large number of checks is soon received. Now,

if bank No. 1, for instance, did not present any of the checks to the other banks until, say, eleven o'clock, the end of the clearing period, there would then be an enormous rush in assorting them and crediting them to the proper accounts. It facilitates matters very greatly if the checks accumulated after the clearing hour are sent to the banks upon which they are drawn in the afternoon of that day, and if, say, the first hour's collection in the morning is sent over in advance of the 10:30 A.M. clearing hour. Bank No. I therefore sends its accumulated checks drawn on banks Nos. 2, 3, etc., to these banks and trades them for a "batch" of checks drawn against itself, which the other banks have received from their depositors. Each bank can thereupon begin at once the work of debiting the checks to the proper accounts. By having the receipt of the checks spread over the entire day, it is much easier to take care of the enormous amount of routine clerical and accounting work that is necessarily thrust upon the larger institutions.

The greater part of interbank obligations are canceled. It remains to note how the balances are struck and paid at the clearing-house. We have already seen that bank No. 1 has a record of the total checks which it presents to the other banks. It also receives from each of the other banks, along with the checks, a statement of the total presented by each of the other banks against it. (This includes the totals of the checks that have been traded directly, as well as those actually brought to the clearing-house.) Suppose now that the clerk in compartment I has on his statement $1,000,000, due from the other banks; and that upon footing up the total of the nineteen statements deposited in his compartment he finds that his bank owes to the other banks $1,200,000. Bank No. 1 has therefore an unfavorable balance with the rest of the banks of $200,000.

Suppose the clerk of bank No. 2, in turn, finds that his balance shows $100,000 due from the other banks; the clerk of bank No. 3 finds that $50,000 is due from the other banks; the clerk from bank No. 4 finds that $40,000 is due to other banks, etc. After finding his balance each clerk presents to the clearing-house manager a slip showing the amount due to or from the other banks. And when the manager receives these slips from the twenty different banks, he writes the amounts down in two columns, one showing the sums due to the clearing-house and the other showing the sums due from the clearing-house. Since the checks presented to the clearinghouse by all the banks are the identical checks received through the clearing-house from all the banks, these totals must obviously balance. The clearing-house manager thus has a ready means of "proving" the correctness of the figures presented to him.

There are numerous ways of paying the balances. Various means have in fact been employed in the past in the settlement of these accounts, not all of which are of sufficient importance to require description. The most common method in the larger financial centers, prior to the adoption of the Federal Reserve System, was through the use of clearing-house certificates. Under this method each member of the clearing-house association deposited a portion of its cash resources with the clearing-house and was given in exchange clearing-house certificates. These certificates were commonly of large denominations one, five, and ten thousand dollars. It should be noted that, so far as the bank's balance sheet was concerned, these certificates appeared under the heading of Cash, just as do gold certificates, which are claims against gold in the Treasury Department at Washington.

Now when bank No. I owed to the clearing-house $200,000, as in the foregoing illustration, it would turn over to the clearing-house manager $200,000 in clearing-house certificates. Since bank No. 2 had a balance of $100,000 due from the clearing-house, the clearing-house manager would pay to bank No. 2 $100,000 of the clearing-house certificates which he had received. In a word, the clearing-house manager merely

acted as intermediary in the transfer of these clearing-house certificates from the banks which had unfavorable balances to the banks which had favorable balances.

It will be seen that the use of these clearing-house certificates greatly lessens the risk of transferring funds. For if a messenger carrying them were robbed, no loss would be sustained by the banks, since the clearing-house certificates are acceptable only in the paying of balances between banks.

Clearing-house balances are now settled by book entries at the Federal Reserve bank. Since the establishment of the Federal Reserve System, and the affiliation with that system of all the important state banks and trust companies in the larger financial centers, the process of settling clearing-house balances has been still further simplified. In Chicago, for instance, each bank belonging to the clearing-house association has funds on deposit with the Federal Reserve Bank of Chicago. Accordingly, when the clearing has been completed, the manager of the clearing-house notifies the Federal Reserve Bank that the deposit account of bank No. I should be decreased by $200,000; the account of bank No. 2 increased by $100,000; the account of bank No. 3 increased by $50,000; the account of bank No. 4 decreased by $40,000, etc. Thus by means of simple bookkeeping entries on the books of the Federal Reserve Bank, each bank in the clearing-house association has added to or subtracted from its funds the amounts necessary to settle its account.

The banks of the clearing-house of Milwaukee are also all members of the Federal Reserve Bank of Chicago. And as soon as the clearings have been completed in Milwaukee, the manager of the Milwaukee clearing-house telegraphs to the Federal Reserve Bank of Chicago the amounts which should be debited and credited to the accounts of the different Milwaukee banks.

Not all the banks of a given city are members of the clearinghouse association. The reason for this is that it would complicate too greatly the process of clearing if a large number of institutions were involved. Most banks which are not members