Banking

by William Amasa Scott

The regulation of reserves has become a subject of legislation in this country only. Our national banking act classifies national banks into three groups, called country, reserve city, and central reserve city banks, and requires those in the first mentioned group to keep cash in their vaults to the amount of at least six per cent of their deposits, and balances in approved reserve city banks sufficient to bring the total amount up to fifteen per cent of their deposits.

Banks in reserve cities are required to keep in their vaults cash to the amount of at least twelve and one-half per cent of their deposits, and balances in central reserve cities sufficient to bring the total up to twenty-five per cent of their deposits. Banks in central reserve cities are required to keep at least twenty-five per cent of their deposits in cash in their vaults. When the reserves of a bank fall to the prescribed minimum, all discounting must cease. Regulations essentially similar are found in the banking laws of most of our states.

The purpose of these regulations is to set a limit to the extent to which banks may expand the volume of their loans and discounts, in the belief, apparently, that, if at least the prescribed proportion of cash is all the time kept on hand, the banks will be able to meet their obligations. As in the case of the regulations concerning investments, the authors of these failed to recognize the significance, from the point of view of the cash demands likely to be made upon banks, of the kind of paper admitted to discount. If discounts be confined to commercial paper, the demand obligations they create will be met for the most part by transfers of credits on the banks' books or by the return of the notes issued, and, as foreign experience has demonstrated, the adjustment of cash resources to needs can safely be left to the judgment of the bankers themselves, who, through variations in the discount rate, rediscounts, and other means, can regulate it with ease. If investment paper is admitted to discount, reserves less than one hundred per cent of the demand obligations thereby created are unsafe, since a less amount is likely to force liquidation on the banks' customers, with the results above indicated.

The most elaborate regulations for the prevention of inflation have been developed in connection with legislation concerning note issues. The reason for this is the fact that commercial banking was at its origin and for a long time thereafter carried on almost exclusively through note issues, the conduct of checking accounts being a comparatively recent development. The phenomenon of inflation was, therefore, first observed in connection with note issues and associated with them. Even now the essential similarity of note issues and checking accounts as banking instrumentalities is not universally recognized.

The means of safeguarding note issues which have been incorporated into legislative enactments are the prior lien on assets, the safety fund, the requirement and sometimes the mortgaging of special assets, and the limitation of the total issues. By the prior lien is meant the provision that in case of failure the note holders shall be paid in full before any of the assets are distributed among other creditors. By the safety fund is meant a required contribution from each bank, usually a percentage of the amount of notes issued, placed in the hands of some public official and kept for the redemption, in case of failure, of such of the notes of failed banks as cannot be redeemed out of the assets of the banks themselves. Additional contributions from the solvent banks are required for the replenishment of the fund when it has been depleted.

The practice of different countries regarding the requirement of special assets to be held against note issues, as well as regarding the mortgaging of such assets, is not the same. Germany and France, for example, require their banks to cover their note issues by designated proportions of commercial paper and coin, while the United States requires its banks of issue to cover their notes by government bonds and to contribute a five per cent redemption fund in addition, and England requires the Bank of England to cover a designated amount of its issues by government and other securities and the remainder by coin. Unlike the others, the United States mortgages to the note holders the securities, that is, the government bonds, required to be held against the notes, by providing that in case of failure these securities shall be sold and the proceeds used for the settlement of their claims.

In all of these provisions, the protection of note holders against loss in case of failure has been an influential consideration, and in the cases of the prior lien and the safety fund, the only one. The prevention of inflation may have entered into consideration in the other cases, but among the states mentioned the regulations of France and Germany alone are efficient in this direction, since they alone prohibit note issues against investment securities. The above mentioned regulations of England and the United States tend rather to promote, than to prevent, inflation, since they require the holding of investment securities against note issues.

The limitation of the aggregate amount of notes that may be issued is a common legislative regulation. In the United States the limit set is the amount of the capital stock, and in France it is an arbitrary figure from time to time changed as the needs of the bank seem to require. As a safeguard against inflation, the value of such limitation depends upon the basis of the issues. If it is investment securities, as in the case of the United States, limitation to a low figure, not in any case to exceed the capital stock, is desirable, since such limitation keeps the inflation within such bounds that the banks themselves may be able to withstand the effects of it by selling upon foreign markets, without great and perhaps without any loss, the securities in which their capital and surplus funds are invested. If the basis of issues be commercial paper, such limitation is unnecessary, since inflation in such a case is improbable, and pernicious, unless it be placed above the point which the volume of issues is likely in ordinary cases to reach.

(c) Other Means of Safeguarding the Interests of the Public.—Experience has shown that publicity is a valuable safeguard against bad bank practices, and legislation has, therefore, provided for it by the requirement that statements of banking operations shall be published from time to time. The national banking act of the United States and many of our state banking acts, for example, provide for the publication five times a year of bank balance sheets, drawn up according to prescribed forms.

The inspection of banks by public examiners and the requirement of detailed reports to public officials are also provided for in our federal and state legislation. Canada requires the reports but not the inspection by public officials, on the ground that the latter cannot be thorough and efficient, and is, therefore, likely to mislead the public and cause it to be less vigilant than it otherwise would be in the use of other means of safeguarding its interests.