The amount of reserve required can be determined only by experience. In ordinary times it depends chiefly upon the habits of the community in which the bank is located regarding the use of hand-to-hand money as distinguished from checks and upon the character of its customers. These habits differ widely in different nations, and considerably in the different sections and classes of the same nation. In most European and Oriental countries, for example, checks are little used by the masses of the people, while in the United States and England they are widely used. In these latter countries, however, they are less widely used by people in the country than in the cities, and by the laboring than the other classes in the cities. Within the same city one bank may need to keep larger reserves than another on account of the peculiarities of the lines of business carried on by its customers and the classes of people with whom it deals.
In times of crisis and other periods of extraordinary demand, bank reserves must be much larger than in ordinary times. Hoarding, unusually large shipments of money to foreign countries and between different sections of the same country, and payments of unusual magnitude, increase the demands for cash made upon banks at such times.
The manner in which clearing and other balances between banks are met also has an influence on the amount of reserves required. If such balances are paid daily and always in cash, the amount needed for this purpose is much larger than if they are paid in checks on some one or a few institutions and at longer intervals.
The note issue privileges of a bank also affect its reserve requirements. Since, if not prohibited by law, notes may be issued in all denominations needed for hand-to-hand circulation within a nation, and since for all purposes except small change such notes are as convenient as any other form of currency, a bank with unrestricted issue privileges can supply all the demands of its customers for currency for domestic use, except those for small change, without resort to outside sources of supply. In this case, however, it needs to keep a reserve in order to meet demands for the redemption of notes. Such demands arise on account of the need of coin for small change or for shipment abroad or of means for meeting domestic clearing and other bank balances. The aggregate needed for the supply of such demands, however, is much less than would be required if the privilege of issuing notes did not exist.
In the maintenance of reserves the chief reliance of commercial banks is the circulation of standard coin within a nation and the importation of such coin. The coin within the borders of a nation passes regularly into the vaults of banks by the process of deposit, and on account of the credit balances they carry with foreign institutions, the loans they are able to secure from them, the commercial paper they hold which is discountable in foreign markets, and the bonds and stocks sometimes in their possession which are salable there, they are able to import large quantities in case of need. Since the standard coin in existence in the world adjusts itself to the need for it in substantially the same manner that the supply of any other instrument or commodity adjusts itself to the demand, banks ordinarily have no difficulty in supplying their needs, and under extraordinary circumstances, though difficulties along this line sometimes arise, means of overcoming them are available which will be discussed in the proper place.
If, as is the case in the United States, certain forms of government notes are available as bank reserves, these find their way into the banks' vaults by the process of deposit in the same manner as coin. The possession of such notes by a bank enables it, to the extent of their amount, to throw the responsibility for the supply of standard coin upon the government, and in the circulation of the country such notes take the place of an equivalent amount of standard coin. Whether or not a government ought to assume such a responsibility is a question which will be discussed in a subsequent chapter.
For the nation as a whole, the balances in other banks and the discountable commercial paper and bonds which a bank may count as a part of its reserves are not reserves except to the extent that they may be employed as a means of importing gold. They are only means through which real reserves of standard coin are distributed. The payment in cash of a balance with another bank or the discount of commercial paper with another domestic bank or the sale of bonds on domestic stock exchanges do not add to the sum total of the cash resources of the banks of a nation. Their only effect is to increase the cash resources of one bank at the expense of another.
Adequate facilities for the distribution of the reserve funds of a country, however, are second in importance only to the existence of adequate supplies of standard coin. If such facilities are lacking, existing reserves can be only partially and uneconomically used, with the result that much larger aggregate reserves are required than would otherwise be necessary and that the entire credit system is much less stable than it otherwise would be.
2. The Selection of Loans and Discounts
The problem of the reserves is vitally connected with that of the selection of loans and discounts. As was shown in the preceding chapter, the chief business of a commercial bank is to conduct exchanges by a process of bookkeeping between individuals, banks, communities, and nations. This process consists primarily in the converting of commercial bills and notes into credit balances and bank notes, in the transfer of such balances and notes between individuals and banks, and in the final extinguishment of such balances and the return of such notes at the maturity of the commercial bills and notes in which the process originated.