In 1913, accordingly, Congress made provision for the establishment of a Federal Reserve system which does not displace but supplements the operations of the national banks. By an act passed in that year provision was made for the establishment of twelve federal reserve districts, with a federal reserve bank in each. The capital stock of each federal reserve bank is contributed by national or state banks within the districts, these contributors being then known as “member banks”. The national government also subscribes a part of the capital stock when necessary. |The Federal Reserve Board.| Each federal reserve bank is controlled by officials, some of whom are elected by the member banks and some appointed by the national government through a body known as the Federal Reserve Board. This board is composed of the Secretary of the Treasury, the Comptroller of the Currency, and five other members appointed by the President.
Functions of the Federal Reserve Banks.
These federal reserve institutions are bankers’ banks. They do business with banks only, not with individuals. They receive deposits from banks and lend money to banks. The member banks now keep with them a portion of their reserves. In this way the reserves are mobilized at twelve different financial centers where they can be readily drawn upon.[[205]] The Federal Reserve Board has authority to increase or decrease the percentage of reserves which the member banks are required to maintain, thus giving the reserve system a large degree of flexibility. Whenever a member bank needs additional paper money for circulation it goes to the federal reserve bank of its district and deposits any sound “collateral”, that is to say, any acceptable security, and receives federal reserve notes of like value in return. This collateral may be in the form of government bonds or it may be, and more often is, “commercial paper”. |How they give flexibility to the whole banking system of the country.| By commercial paper is meant the notes or other obligations of corporations and individuals which have been given to the member banks in return for loans made to such corporations and individuals. The federal reserve banks are authorized to issue federal reserve notes, to an unlimited extent on the security of this collateral provided they also keep a gold reserve amounting to forty per cent of the total notes issued. In addition they are empowered to issue federal reserve bank notes secured by United States bonds in the same way as national bank notes are secured. It is expected that in time the national bank notes will go out of existence altogether, their place being taken by these federal reserve bank notes.
Value of the Federal Reserve system.
Since their establishment in 1913 the work of these federal reserve banks has been of great value. They have enabled the banking operations of the country to expand and contract in accordance with changes in business conditions, thus obviating serious danger of financial panics. In helping the government to float the various Liberty Loans they rendered great service. There is no doubt that the system has improved and strengthened the banking facilities of the country.[[206]] This will appear more clearly when the relations of banking and credit are discussed a few pages further on.
Commercial and savings banks distinguished.
The Practical Operations of Banking.—There are some elementary things connected with the practical operations of banking which everyone ought to know. Generally speaking, there are two kinds of banks, commercial banks and savings banks; or, in some cases the same bank may have two departments, a commercial department and a savings department. Both commercial and savings banks receive deposits; the former may or may not pay interest according to the amount of the deposit and the length of time it is left in the bank; the latter always pay interest if money is left on deposit a prescribed length of time. When money is deposited in a commercial bank the depositor is said to have an “account” and he may issue checks up to the amount of his deposit. |Bank checks.| A check is an order, addressed to the bank, and calling for the payment of a designated sum. This check may be cashed at the bank on which it is drawn, or the person who receives it may have it cashed at the bank where he has his account. Banks cash checks for their own customers no matter what bank the checks happen to be drawn upon.
One result of this is that every bank at the close of each day’s business will have on hand a large number of checks drawn against other banks. |The clearing house system.| It receives payment on these checks through the medium of the “clearing house”, an institution which is maintained by the banks in every large city. To the nearest clearing house a clerk takes each morning all the checks on other banks that have come in during the previous day. These are sorted out and exchanged for checks drawn on the bank itself which are held by other banks. Whatever difference there happens to be is paid in cash.
How bank loans are made.
When any person desires to borrow money from a bank he gives his note, which is a promise to repay the bank at a designated time. The bank may ask the borrower to obtain an endorsement upon his note, that is, to have some responsible person put his name on the back of it, which means that the endorser assumes liability for the amount of the note if it is not paid by the maker on time. Or the bank may ask the borrower to deposit “collateral” as security for the payment of the note. This collateral may be in the form of bonds, stocks, mortgages, or any other intangible property that has sufficient value. The bank holds this collateral until the loan is repaid.