Principles of Political Economy

by Arthur Latham Perry

d. Bank Deposits. We are studying in order the forms of commercial Credits, and we have now come to that one which is central in the operations of Banking, and accordingly this is the place for us to understand clearly what a Bank is, who a Banker is, and what are the motives actuating at once the Banker and his Customers. A Bank is an institution for the Creation, Management, and Extinction of Credits. Money of any kind plays a very subordinate part in the general operations of banks, which live and move and have their being in the sphere of pure Credits. Bankers are buyers and sellers of credits. As merchants are dealers in commodities, so bankers are dealers in credits, buying (1) some credits with other credits, (2) some credits with money, and (3) money also with credits. Before unfolding these three operations of bankers in their motives and profits, a glance backward to the origin of banks would be a help to us in grasping their nature and benefits.

The word "bank" meant originally a mass or pile or ridge of earth, as we still say, a sand-bank, and the banks of a river. When first applied to commercial transactions, the word had a different meaning from what it has at present, although the idea of credit has inhered in it from the first: in 1171, the Republic of Venice, being at war, ordered a forced loan from its citizens, and promised to pay interest on it at 5%; and certificates were issued for the sums paid in, and public commissioners were appointed to manage the payment of the interest and the transfers of the certificates, which were made negotiable. The Italian word applied to such a public loan is monte, but as the Germans were then strong in Italy, the German equivalent word, bank, came to be used alongside of it and instead of it. It meant this common contribution of the citizens to the wants of the State, represented by the mass of the certificates, and came to be applied also to the place where the commissioners paid the interest and transferred the shares. Two other such loans were contracted there afterwards, and an English writer, in 1646, quoted by Macleod, speaks of the "three bankes of Venice," meaning these three public debts, including the evidences of them and the place where they were managed.

The Bank of England also was in its origin in 1694 an incorporation of those persons willing to subscribe to a public loan in time of stress, as "The Governer and Company of the Bank of England." The subscribers to a loan of £1,200,000 became an association, or bank, on the condition that the Government should pay interest to the lenders at 8% annually, and also £4000 a year in addition for the management of the bank, that is, of this debt of £1,200,000 which was the sole capital stock of the new Company, which was authorized to issue an equivalent amount of bank bills to circulate as money. The capital stock was of no use, so far as redeeming these bills was concerned, the stockholders must furnish other money for that purpose besides what they have loaned to the State, but the ownership of so much of the public debt divided among the shareholders, made the Bank respectable, and tended to give public credit to its bills, which at first were paid promptly in coin on demand, and thus the Bank, by increasing the volume of money and by showing confidence in the stability of the State, strengthened the revolutionary position of William and Mary, and consequently the Whigs were the friends and the Jacobites the enemies of the Bank. This function of issuing bills or promissory notes designed to circulate as money, thus begun and still continued by the Bank of England, is much less important in modern banking than the other two functions of receiving Deposits and making Discounts, but it was the function on which the turn began to be made from the older to the newer modes of Banking. All that is needful to be said on this tertiary or money-issuing function of Banks has been already urged under the last head.

The two Banks of the United States in succession, as they were more or less modelled after the Bank of England, gave the same prominence to the function of issuing paper money, under the belief that government bonds afford the best security for the redemption of bank bills, an idea that underlies our present system of National Banks also; and, moreover, those two great banks began to teach the people of the United States something of the mysteries of Deposit-banking, the point that we have now in hand. One-fifth of the capital stock of the first Bank, $2,000,000 out of $10,000,000, was subscribed by the national Government; and besides, the proceeds of the national taxes as they were paid in were passed over to the Bank as Deposits, that is to say, the Bank bought this money of the Government, paying for it with a Credit; and then properly used the money as its own in paying expenses and in discounting paper. Bank deposits do not belong to the depositors, but to the bank; which has thus bought money with credit; and when Andrew Jackson suddenly removed from the second Bank of the United States the national moneys deposited there, and placed them "in the custody," as he expressed it, of certain selected State banks, these amounted at the moment to $10,000,000, and the discount line resting in part on these deposits was at the time over $60,000,000, he removed them under a strong misapprehension of the nature of such deposits; and their removal affected credit, and disarranged business to a remarkable degree, and caused intense excitement all over the Union. Depositing those national moneys with the Bank was a trade between the Government and the Bank for the time being. The Government took in return for the moneys a Right to demand of the Bank in future by cheque or otherwise sums at its convenience to the aggregate of the sums deposited; the moneys became the property of the Bank to be used at its discretion in its ordinary business; the Government took its return-service for the moneys in a Credit, that is, a right to draw out at its convenience in the future corresponding sums; there was a commercial understanding in that case between the Government and the Bank underlying the buying and selling involved in the Deposit, as there always is between depositors and their banks; the banks are always bound to order their business in such a way as to be able to respond to every depositor's call for money, when it comes; but banks in general find practically that a cash reserve of one-third of their Deposits is ample to answer the current demands of their depositors, and the remaining two-thirds may be safely used in discounting short-time commercial paper to their own profit; Deposits, accordingly, are not placed "in the custody" of the banks receiving them; they are really bought by the banks of their customers, who receive in return certain privileges and credits that they prefer to the "custody" of their own moneys; and under these general motives on both sides, there has grown up in all commercial countries an immense line of Bank Deposits so-called, and perhaps we may say that the principal function of banks at present is to buy these deposits with their Credit, and then to handle them in further operations to the convenience of their customers and to their own gain.

Under our present national banking system the Government is still a depositor of public moneys in some of the banks designated as "depositaries." At the close of the fiscal year, 1888, there were 290 of such depositary national banks, and the Treasurer held United States bonds of the face value of $56,128,000 and the market value of $68,668,182 in trust for these banks to secure public moneys lodged with them. This system of national deposit with the banks began in 1864. The total held by the banks June 30, 1888, was $58,712,511, an increase during the year of $35,395,633.

But our concern is especially with the Bank Deposits of individuals, with their motives in making these, and with the motives and the methods of the bankers in handling them. In order to draw the confidence of the people in its locality, a bank must not only be, but also seem to be, well-to-do and prosperous. Most bankers find it to their account to become known owners of public stocks; and in many cases, as in the present national banks of this country, are required by law to own such stocks, and this gives them a kind of credit and public standing scarcely to be reached by the ownership of ordinary property. Thus the Bank of England held at the outset £1,200,000, and now holds £15,000,000 of securities, mostly of the public debt of England. As merchants begin by laying in stocks of goods of the kinds they purpose to deal in and offering them for sale, so bankers begin by bringing together money and credits of their own in order to attract to themselves in the way of buying and selling the money and credits of other people. In order to deal successfully in credits the banker must have credit, that is, he must have the reputation of having property of his own, and of being an honest and careful manager of his own affairs and of the affairs of others so far as they are intrusted to him. Each of our present national banks, now (1890) 3150 in number, must have by law a paid-up capital of not less than $100,000, and in cities of 50,000 people their capital must not be less than $200,000 each, except that in places having less than 6000 inhabitants banks with not less than $50,000 capital may be organized at the discretion of the Secretary of the Treasury. The main purpose of all this is to secure strong financial organizations fitted to draw the confidence of the communities in which they are placed, and in this manner and by means also of constant national supervision to attract the Deposits of the people to the banks.

Now, as was said a little while ago, perhaps the central function in banking is for the banker to receive his customer's money and also his credits falling due, and to render to him in return for these a credit, that is, a right to demand from himself an equal sum at a future time or times. The evidence of this right is entered on the banker's books, and usually too on the customer's passbook, and thus becomes what is called a Deposit. The ownership of the money and of the credits deposited passes over completely from the customer to the banker. It is a complete case of buying and selling to the mutual profit of the parties. The banker has the right to do just what he pleases with his deposits, and the customer has a right to draw cheques on his credit as and when he pleases; only the banker's entry of the transaction on his books is a virtual and a legal promise to pay that amount to his customer, and therefore he must be ready to respond to his customer's call, whenever the latter demands, not his own money, but so much of his banker's money. A deposit, accordingly, is not the very thing deposited, but a credit. It is the banker's promise and the depositor's property. It is in this way that a banker buys ready money with a credit.

The motive, then, that leads the depositor to intrust his money to the banker is the desire, not to have that specific money kept safely for him, for he lost possession of it absolutely when it passed the counter, he sold it and took his pay in something else, but rather to have the unquestioned right to call on the banker for such sums (not to exceed the deposit in the aggregate) and at such times as may suit his own convenience. He has such confidence in the integrity and solvency of the banker, finds it so practically convenient to have dealings with him, and comes to have certain minor privileges at the bank in other relations over non-depositors, that he quite prefers a credit on the banker to the possession of the money itself.

The corresponding motive of the banker to receive his customer's funds on these terms is that he finds by experience (his own and others'), that he can safely use a large portion of these moneys deposited in other operations in credit profitable to himself, and at the same time be practically sure of meeting all his customer's calls for money as they are made. Every good banker finds out, that many of his customers wish always to leave a balance in his hands; that while some of them are constantly drawing cheques on him for cash, others of them are as constantly depositing with him in cash; and that consequently he can properly and safely use a large part of the money he has purchased with his credit to purchase other credits with. Deposit-banking, therefore, is not only convenient and profitable for the depositor, but also excellent and profitable for the banker.

Besides these two parties benefited, there is a gain, too, for the community at large in deposit-banking; inasmuch as a new capital as such has been thereby created, a series of new values, which would not otherwise have existed at all. Were there no deposit-bank in that locality, every man now a customer of it would of course keep his own reserves for himself for prospective contingencies: now, all these little reserves are aggregated in the bank, the convenience of them for each customer's contingencies is just as great as if he kept his own in his own safe or wallet, but the banker finds that he can use, say two-thirds of the whole, and still answer each customer's call. Here is a new capital. Here are scattered valuables brought together to be loaned out to a profit, which were otherwise barren and useless for the time being. Industry is quickened in a wide circle, products are created and brought to market, wages are paid and profits are gained, in direct consequence of bringing together under favorable auspices for safe loaning the little hoards and driblets of many individuals, which were practically useless in isolated hands.