One of the most important functions of commercial banks is the collection for their customers of checks and drafts drawn on other institutions. When these documents are received, the accounts of customers who deposited them are credited with the amounts, less a small fee for collection, unless by agreement this service of collection is performed free of charge. The checks are then assorted according to the banks upon which they are drawn and the cities in which those banks are located.
Checks drawn upon home banks are collected either through messengers who present the checks at the counters of the banks upon which they are drawn and secure payment therefor, or through the local clearing house. This is a place where representatives of the banks meet for the exchange of checks. After the representative of each bank has distributed all the checks held by his institution against the others participating in the clearing, and received from them those drawn against his bank, a balance sheet is prepared showing the balance due by or to his bank after the total of the checks distributed has been balanced against the total received. If said balance is adverse, it is paid to the master of the clearing house, and if it is favorable, it is received from him.
The checks received through the clearing house or presented by messengers from other banks and paid, are debited to the accounts of the persons who drew them and returned to such persons as vouchers, the net result of the entire transaction being the same as if all the parties involved had been customers of a single bank, with the exception that some means of paying balances had to be found. Since balances are sometimes paid by checks on some central institution in which credit balances may be obtained by rediscounts of commercial paper, this necessity can be met without the use of any form of currency other than that furnished by banks themselves.
Checks drawn upon out-of-town banks are, in this country, collected through so-called correspondents. Each bank enters into an arrangement with a few other banks, distributed throughout the country and conveniently located for the purpose, by which the correspondent bank agrees to conduct with it a checking account on which it will credit at par or at a stipulated discount the checks sent it for collection and debit checks drawn against such an account. A comparatively small number of such correspondents suffices, since certain banks in the larger cities, by making a business of such collections, conduct checking accounts with a large number of banks, and can thus make collections by mere transfers of credits on their own books or by the use of the local clearing house. The so-called reserve cities in this country constitute clearing centers for the territories contiguous to them, and New York, Chicago, and St. Louis, for the entire country.
Checks received from correspondents and drawn against themselves are debited to the accounts of the customers who drew them and returned as vouchers in the same manner as checks received through the clearing house or paid over their own counters.
Through this interchange of checks between banks and the conduct of checking accounts with each other, intermunicipal and international exchanges are conducted through the bookkeeping processes of commercial banks with the same ease and economy as are exchanges between people living in the same town.
6. Domestic Exchange
The accounts of a bank with its correspondents are a record of the transactions of its customers with the outside world, the checks they receive as a result of sales to outsiders of merchandise, real estate or other property, or as a result of gifts by outsiders to them being credited on such accounts, while the checks they draw or the drafts they purchase in payment for merchandise, real estate or other property purchased of outsiders, or of gifts made to them are debited. When in a given period, say a day or a week, the receipts of the customers of a bank from outsiders, as a result of current or past sales and gifts, exceed the payments made by them as a result of purchases and gifts, its credit balances with its correspondents will increase, and under opposite conditions they will decrease. If the payments should continue in excess for a considerable period, the credit balances of a bank with its correspondents would be exhausted and some means of replenishing them would have to be found, and under the opposite conditions too large a portion of the bank's resources would accumulate with its correspondents and some means of withdrawing funds would have to be found.
When a bank needs to replenish its credit balances with its correspondents, it may ship cash or purchase drafts from other home banks, which it can send to its correspondents for collection like checks deposited in the ordinary course of business. The latter resource will of course be available only when these other banks' balances with their correspondents are not exhausted. Should the balances of all the banks of a town with their out-of-town correspondents be nearly or quite exhausted, shipments of cash to correspondents could not be avoided. If a bank wishes to withdraw funds from its correspondents for home use, it may order cash shipped or it may, perhaps, be able to sell drafts for cash to other home banks.
The expenses involved in shipments of cash, loans, or purchases or sales of drafts for the purpose of replenishing balances with or withdrawing them from out-of-town correspondents, give rise to what is called the rate of exchange. If, in order to make out-of-town payments for its customers, a bank is obliged to pay the expense of shipping cash to its correspondents or to pay a premium on drafts purchased from other banks, the natural method of reimbursement will be a premium charge on drafts sold equal to the amount of the expense incurred. If it wishes to withdraw a balance with its correspondent, since to order cash shipped will involve expense, it will be glad to sell drafts for cash at a discount not to exceed such expense.