What Functions do Banks Perform?—Banks are established and maintained to satisfy certain needs which arise wherever men carry on extensive trade with one another. |1. As institutions of deposit.]| In the first place when money is accumulated by people in the course of their business some safe place is needed to keep it. Banks, therefore, serve as institutions of deposit. |2. As agencies for loaning money.| In the second place, as business develops, it becomes necessary for people to borrow money. Banks facilitate this borrowing. Their two primary functions are to receive deposits and to make loans. But in order that they may perform these two primary functions to the best advantage the banks have assumed other subsidiary functions as well. |3. Sometimes also as issuers of paper money.| Frequently they issue bank notes, or the bank’s own promises to pay, for use in general circulation. |4. To transfer funds from one place to another.| They sell drafts or bills of exchange, thus enabling people to transfer funds from one city or country to another without the trouble and risk of sending the actual money. As a rule they provide safe-deposit vaults in which customers, on payment of a small sum, are permitted to keep their valuables. These vaults are fire-proof and burglar-proof. Banks also collect money which may be due to a customer from someone elsewhere. They help the national and state governments to sell their bonds. Frequently they act as trustees, holding property for children until they grow up or for other persons who are unable to look after the property for themselves. Without banks it would be difficult, if not impossible, to carry on the operations of modern business.
The Early American Banking System.—The national constitution contains no mention of banks or banking. Hence it was assumed that the power to charter banks would rest with the states. The states assumed this authority but the national government desired to exercise it also, and during the first thirty years of its existence established two great banks, both of which became unpopular and ultimately went out of existence. The first Bank of the United States, established in 1791, ceased to do business in 1811; the second bank, chartered in 1816, incurred the wrath of President Andrew Jackson and went to the wall in 1836.[[203]] From this date to the Civil War the state banks, of which a large number were established in all parts of the country, had the field to themselves.
The National Banking Act of 1863.—During the Civil War, however, the national government encountered great difficulty in raising funds. When it issued bonds the people would not buy them readily. The state banks showed very little interest in marketing them. So Congress, in this emergency, decided to establish a system of national banks in order to facilitate the sale of war bonds. The National Banking Act, passed in that year, laid a heavy tax upon the paper money of all state banks, with intent to drive this currency out of circulation. It then provided that any bank chartered by the national government might issue untaxed paper money provided it bought United States bonds to a designated amount and deposited these bonds in Washington as security. In other words the Act of 1863 aimed to provide a uniform system of bank notes throughout the country, these notes to be backed by government bonds. The plan worked well and its main provisions have been retained to this day.
Present organization of the national banks.
National banks are owned by private individuals who subscribe the capital stock. These stockholders, or shareholders, elect the bank’s officers, who in turn manage the business. The profits go to the shareholders in the form of annual dividends. Each national bank must buy a designated amount of United States bonds and these bonds are deposited in Washington. In return the bank receives an equal amount of paper notes, with its own name engraved thereon, and these notes the bank pays out over its counters, thus putting them in general circulation. If the bank should become insolvent, the government would redeem the notes since it holds the bonds as security. |Their functions.| The national banks receive money on deposit, make loans, and perform the various other banking functions. They are strictly regulated by national law; they must make periodic reports and are frequently inspected by officials from Washington. |Their reserves.| One requirement is that they shall always maintain a certain “reserve” so that they may be in a position to make all payments which may be called for by their customers. The supervision of the national banks is in the hands of an official known as the Comptroller of the Currency, who is appointed by the President.
State banks and trust companies.
In addition to the national banks there are state banks and trust companies throughout the country operating under state charters. These institutions do not issue paper money but perform all the other banking functions.[[204]] Their business is regulated by the laws of the state in which they are located and they are supervised by state officials. The laws relating to state banks and trust companies differ considerably from state to state.
Defects of the national banking system due to the concentration of reserves and lack of flexibility.
The Federal Reserve Banks.—Although the national banking system worked pretty well for fifty years after its establishment, certain defects came to be recognized. One of these defects, in actual practice, was the necessity of always keeping available a “reserve” amounting to a certain percentage of each bank’s total deposits. It was not necessary to keep this reserve in the bank’s own vaults; a part of it might be placed upon deposit in larger banks where it would draw interest. As matters turned out, a considerable portion of the reserves was usually deposited with large banks in New York City. In times when business was good and money plentiful, this arrangement worked very well, but when periods of business depression arrived and money became scarce every small bank naturally drew upon its reserve deposits in the larger banks, which found difficulty in paying them all at the same time. Moreover, it was found from experience that during times of business prosperity the country needed a large increase in paper money while the national banking system, as established in 1863, proved too rigid to meet the business needs of the country.
How the Federal Reserve system remedies these defects.