Readings in Money and Banking / Selected and Adapted

by Chester Arthur Phillips

The great value of clearing-house loan certificates lies in the fact that they take the place of money in settlements at the clearing house, and hence save the use of so much actual cash, leaving the amount to be used by the banks in making loans and discounts, and in meeting other obligations. The volume of currency, to all intents and purposes, is expanded by this means to the full amount of the certificates issued.

The loan certificates are taken out by the clearing-house members through loan committees, specially appointed, and are used, as a rule, only in the payment of balances among the associated banks. Thus, when the stringency in the money market seems sufficient to demand it, the clearing-house association meets and appoints a committee called the "loan committee," consisting usually of five bank officers, to act in concurrence with the president of the clearing-house association, who serves ex officio as a member. It is the duty of such committee to meet each morning at the clearing house and examine the collateral offered as security by the banks and issue loan certificates thereon, in such denominations and proportions to collaterals deposited as may be agreed upon. In the past the denominations have varied from 25 cents to $100,000 in the different associations and in proportions varying from $50 to $100 of certificates to $100 of collateral deposited.

These loan certificates bear interest at rates varying from 5 to 10 per cent. per annum, payable by the banks to which they are issued to the banks receiving such certificates in settlement of daily balances. Hence the interest charged against certain banks must exactly equal and offset that credited to certain other banks. The aim is to fix the rates sufficiently high to insure the retirement of the certificates as soon as the emergency which called them forth has passed by. As a rule they are retired by the banks, which take them out as soon as they have obtained sufficient cash to meet their daily obligations. Notice is given by the debtor banks to the committee, calling for such certificates as they wish to retire, and the committee gives notice to the banks holding the same, stating that the interest will cease after a specified date. In due course the holders send the certificates to the clearing house for redemption. Upon the retirement of the certificates the collateral deposited as security is surrendered by the committee in the same proportion to certificates turned in as was required for deposit at the time of issue.

It is by no means the general practice for all the members to take out loan certificates when issues are arranged by the association. Some banks are in such condition as to be able to weather the storm without them, while others are weak and in great need of relief. Some banks regard their use of clearing-house loan certificates as a reflection upon their standing, and hence refuse to apply for them unless driven to it by sheer necessity. Others regard it as in no way prejudicial to their interests, but rather as a patriotic movement in which all the banks should engage, both for the purpose of assisting their fellow-members and for the welfare of the community as a whole.

CLEARING-HOUSE LOAN CERTIFICATES AND THE EQUALIZATION OF RESERVES[129]

Comparison of the course of events during the crisis of 1873 with that in subsequent crises shows a progressively increasing unwillingness or inability among the New York banks to make use of their cash reserves. In 1873 the New York banks at the outset of the crisis held an available reserve of $34,300,000. In the course of four weeks this was reduced to $5,800,000, and the ratio to deposit liabilities was then less than 4.5 per cent.[130] Suspension was not escaped in 1873 but it was of shorter duration than in later crises. The banks at that time were unable to increase their cash resources by any of the means which have been available in later crises. The Government had no surplus of greenbacks, aside from about $12,000,000 which was almost entirely secured and retained by the savings banks. Banknotes could not be issued because the total circulation was at that time limited by law. Finally, additional supplies of gold, secured through imports, were useless for ordinary banking purposes because the business of the country was then carried on by means of an inconvertible and depreciated paper currency. Notwithstanding all these special difficulties, the New York banks, by continuing to use their reserves freely even after payments had been restricted, were able to restore confidence in a comparatively short time, and money began to flow back to them within three weeks after the outbreak of the crisis.

In 1893 the New York banks were in what was for them an unusually strong condition at the beginning of the disturbance, having early in June a cash reserve exceeding 30 per cent. of their net deposits. A succession of banking failures in the West and South led to heavy withdrawals from New York during the latter part of June and the beginning of July. Then followed a lull and money began to be returned to New York. During the third week of July banking failures were renewed in the West and South and the drain was resumed. The positively unfavorable aspects of the situation were altogether similar to those of the previous month with the one further circumstance of a reduced cash reserve in New York. On the other hand, additional means with which to meet the situation were becoming available. At the end of July gold imports in large amount had been arranged. Foreign purchases of our securities were heavy, reflecting increasing confidence in the repeal of the silver purchase law. Arrangements had also been made which would certainly lead to a considerable increase in the issues of bank-notes during August and September. Notwithstanding all these favorable circumstances the New York banks suspended, during the first week of August, when they still held a cash reserve of $79,000,000, more than 20 per cent. of their deposit liabilities.

In 1907 the New York banks restricted payments when they still held a cash reserve of more than $220,000,000 and when the reserve ratio was also above 20 per cent. Both in 1893 and in 1907 suspension was not a measure of last resort taken after the banks had entirely exhausted their reserves and when there was no means of securing additional cash resources. Moreover, after cash payments were restricted the policy of the banks was unlike that adopted in 1873, in that the banks did not make further use of their reserves; they hoarded them and added to their amount, thus unduly prolonging the period of suspension.

Explanation of the failure of the banks in 1893 and 1907 to use their cash resources as completely as in 1873 is simple; but it is of the very greatest significance because it will bring to light the most serious element of weakness in our credit structure. [Written before our banking reform of 1913.]

In 1893 and in 1907 the clearing-house loan certificate was the only device resorted to in order to secure the adoption of a common policy by the banks. In 1873, as on earlier occasions when its use was authorized, provision was also made for the equalization of the reserves of the banks. Thus in 1873 the Clearing House Association in addition to the customary arrangements for the issue of loan certificates adopted the following resolution: