Banks and Banking
From Encyclopediak
Banks and Banking (from Italian banco, German bank, a bench or table for exchanging money), terms used to designate certain financial institutions and their operations. Banks perform three main functions: they are depositories of money, they loan money and they issue circulating notes. The first two functions are performed by practically all banks; the last, only by banks especially authorized by law so to do, and known as banks of issue.
FUNCTIONS. These functions require consideration in further detail. As a depository of funds, the bank has become an indispensable factor in modern business. In this capacity it serves as the custodian of funds, relieving the business man of the danger of loss incident to keeping his money at his own place of business. But more than this, it greatly facilitates the payment of bills and the conduct of transactions. The depositor can draw a check against his account in the bank for the exact amount which lie wishes to pay, and send it by mail to the man who has a claim to be settled. These checks do not even have to be presented by the payee at the bank on which they are drawn, but become negotiable upon endorsement, and may be deposited at any bank, finally reaching their destination through the clearing house. Checks thus serve as money, or as its substitute (See Credit; Money).
The loaning of funds is another important function of the bank. For this purpose not only is the capital available, but likewise the amounts received on deposit, less the legal reserve which must be kept on hand. Banks thus gather up idle money and utilize it in the profitable activities of the community. These loans are secured by the credit of the borrowers, by personal endorsements or by collateral notes, bills or bonds. In state banks, but not in national, money is also loaned on real estate mortgages. The interest on bank loans, usually paid in advance and known as discount, constitutes the bank's chief source of profit. Bank loans are commonly made for short periods of time and for commercial purposes, leaving the long-time loans to be negotiated by other agencies.
Banks also help to provide a currency by issuing circulating notes. Formerly this function was performed by practically all banks, but now the privilege is limited in most countries to specified banks which guarantee their circulation by depositing approved securities with the government or by maintaining an adequate gold and silver reserve, in which coin they agree to redeem their notes on demand. In the United States the issuing of circulatory notes is practically limited to National Banks. By depositing government bonds (in which all National Banks must invest a part of their capital) with the Federal Treasury, these banks may issue circulating notes to the extent of the par value of the bonds, provided this does not exceed the capital stock of the bank. There is a tax of one-half of one per cent on this National Bank circulation; but as the tax on state bank circulation is ten per cent, the latter banks have been forced out of this branch of the business.
The bank also serves, incidentally, as a collection agency, in several different ways. It receives from its customers drafts and bills of exchange for collection, and sends them to its bank correspondents in the cities where the parties live against whom they are drawn, crediting the owners with the proceeds. It likewise receives from its bank correspondents in other cities bills drawn against parties in its own city, presents these for collection and remits the proceeds. In the course of the day's business, there are also deposited in the bank many checks and drafts drawn on other banks, both in the home city and in other cities. These the bank accepts as cash and sends to its corresponding banks for collection.
KINDS OF BANKS IN THE UNITED STATES. Under the subhead History of Banking in the United States in this article will be found some account of the development of banking in this country. Under the present heading the various kinds of banks are described, without reference to their historical origin and relations. There are six kinds of banks in the United States — National Banks, state banks, loan and trust companies or trust companies, saving banks, private banks and postal savings banks.
National Banks are organized under charters secured from the Federal Government. The capital stock must be not less than $50,000, except in towns of 3000 population or less, where it may be $25,000. At least 25 per cent of the capital stock must be invested in United States Government bonds, unless this percentage exceeds $50,000, which is the maximum investment required. National Banks must make five reports each year to the comptroller of the currency at such times as they may be called for, and are subject to inspection by national bank examiners. They must keep reserves on hand to the extent of 15 per cent of their deposits and outstanding notes, but three-fifths of this reserve may be redeposited with national banks in certain specified large cities, known as reserve cities. In the latter, the National Banks must maintain a reserve of 25 per cent, but may redeposit one-half of this with other national banks in New York, Chicago or St. Louis. The stockholders of national banks are legally liable to the amount of their stock. A national bank is not permitted to make loans upon real estate security, nor to own real estate, other than its bank building, unless taken in payment of debts.
State Banks are organized under charters secured from the respective states in which they are located, and are subject to state jurisdiction. In practice they do not issue circulating notes, because of the prohibitive tax. They may loan money on real estate security as well as upon other forms of collateral and upon commercial paper. The laws relating to state banks are reasonably uniform throughout the United States, and these institutions are generally conducted on a sound financial basis.
Loan and Trust Companies, or Trust Companies, are also under state supervision. In general their loans are made upon collateral securities rather than upon commercial paper. They usually pay interest on deposits. While they often do a general banking business, their operations to a considerable extent consist in handling- estates and trust funds, often of large amount.
Savings Banks were originally organized as benevolent institutions, established in order that the thrifty man of limited income might have an opportunity to make investments in small amounts from time to time. They are of comparatively recent origin, dating from the latter part of the 18th century. The first one established in the United States was the Philadelphia Saving Fund Society, chartered in 1819. Others were soon established in New England, and then they spread rapidly to other parts of the United States. They are under the control of state laws, which are fairly uniform in the various states and are designed to safeguard the depositors in every possible way. Their development and influence have been remarkable. In 1920 the $6,536,470,000 deposited in savings banks in the United States was owned by 11,427,556 depositors, with an average account of $615 each. The average rate of interest paid by savings banks is about three and one-half per cent.
Private Banks are established by individuals and companies for the purpose of loaning money and receiving deposits. There is little state regulation and their reliability depends upon their capital, their honor and the conservatism with which their business may be conducted.
Postal Savings Banks paying two per cent interest have been established under the auspices and guaranty of the Post Office Department of the United States Government, to encourage thrift by providing a safe place of deposit for small savings.
The Banking power of the United States in June, 1920, is given as $50,981, 900,000. The banking power of the United States alone is over three and a half times as great as the banking power of the world in 1890, when estimates placed it at $15,985,000,000, and the banking power of the United States is now more than nine times greater than in 1890, when it was estimated as $5,150,000,000.
BANK OF ENGLAND. The Bank of England, the most important bank established in the world, was chartered in 1694 as a joint-stock association, with a capital of i 1,200,000, all of which it loaned to the government. In return it was made the banking agency of the government, with the right to issue notes and establish branch banks. Its charter has been renewed and amended from time to time, the last renewal being in 1844, when the issue department of the bank was separated from the general banking department. The notes issued by the Bank of England are in denominations of £S and upward, and are based on bullion and approved securities, most of the latter being government bonds. The bills are convertible at any time into gold. The bank has the management of the public debt and aids in financing the government. For 160 years it has occupied its great one-story stone building in Threadneedle Street, which covers about three and one-half acres. In addition to the Bank of England there are also many private and joint-stock banks in England. These do a general banking business, but their right of issue has been so restricted as to leave that function almost wholly to the Bank of England.
CONTINENTAL BANKS. On the Continent of Europe there are both governmental and private banks. The Bank of France is a private corporation, second only to the Bank of England in reputation. It was founded in 1800 and has the sole right ' to issue bank notes in France. It is the regulator of the commercial credit of France, has often rendered service to the government by loans, and at times has given outside assistance, as during the embarrassment of the London money market in 1890. Its holdings of gold exceed those of any other institution in the world except the United States Treasury. There are also large and important banks in the other countries of Europe.
EARLY HISTORY OF BANKING. Banking has been in existence since remote antiquity, but with this difference: the modern banker deals in credit, while the banker in ancient times was primarily a custodian of other people's money and a buyer and seller of foreign moneys. Evidences have been discovered of the existence of banks in Assyria several thousand years before Christ. In ancient Athens and Rome, also, banking operations were conducted. Modern banking, however, had a somewhat independent origin in Italy in the Middle Ages, the earliest public bank, that of Venice, being established in 1171. But this was at first a bank of deposit only, and it was still several centuries before the introduction of banking in the modern sense, involving the loaning of money left on deposit, the issuing of bills as currency, and the use of transferable checks. Public banking in this sense began with the establishment of the Banco di Rialto at Venice in 1587. The bank note was invented and first issued by the Bank of Sweden in 1661. It was not until the 18th century that banks took the further step of issuing notes not secured by coin, and of loaning money on the credit of the borrower.
HISTORY OF BANKING IN THE UNITED STATES. At the birth of the United States as a nation, one of the most serious problems was that of financing the war and meeting the expenses of government. A new financial system had to be created in the midst of the struggle for independence. The first attempt was made by issuing paper currency known as continental money (See Continental Money). The collapse of this currency led to the chartering by Congress of the Bank of North America in 1781, which was expected to supply an adequate circulating medium for the country by its issue of notes. Through this bank Robert Morris loaned large sums of money to the government and did much to restore credit. The Bank of New York and the Bank of Massachusetts (at Boston) were organized in 1784. The different states continued to issue paper money until 1789, when this was prohibited by the new Constitution. But during the subsequent period the states still chartered banks that issued currency; the circulation of which, however, was largely local and often depreciated below face value.
The Bank of the United States. On Feb. 25, 1791, Congress chartered the Bank of the United States, as an essential part of the financial system inaugurated by Alexander Hamilton, the first secretary of the treasury. This is sometimes called the Central Bank. It had a capital of $10,000,000, one-fifth of which was subscribed by the government. In addition to doing a general banking business, the bank furnished a sound circulating currency, aided in financing the government and was the depository of the national treasury. It was located at Philadelphia, but established branches in other cities through which it facilitated exchange between the different parts of the country. Its charter was limited to 20 years. When this expired, so much opposition had developed to a centralized bank, especially on the part of the state and private banks, that a renewal was denied by Congress. The institution wound up its affairs, and was converted into a state bank.
The war with England brought about a suspension of specie payments by the state banks in 1814, and so demoralized the currency that Congress was glad to recharter the Bank of the United States in 1816, with a capital of $35,000,000. Of this, the government again subscribed one-fifth, and made the bank, with its branches, the depository of the public funds. The state banks were forced to resume specie payments, and business again prospered. When the charter expired in 1836, it was not renewed, largely because of the opposition of President Jackson, and the bank was forced to go out of business in 1841, with the loss of its entire capital, although it succeeded in paying all of its debts. Under President Van Buren the United States treasury and subtreasury system was established for the care of the national funds (See TREASURY DEPARTMENT), and the state banks were given full swing for a quarter of a century.
State Banks. State banks are banks that are chartered by the Legislatures in the several states. They existed from the first as strong rivals of the Bank of the United States; and between the first and second charters of that bank, 1811-1816, they greatly increased in number and importance. They have also existed side by side with the national banks since 1864. During the period from 1836 to 1864, however, they constituted the distinctive feature of the nation's financial history. These banks were without Federal supervision, and the banking laws differed greatly in the various states. As a result, the currency fluctuated in value, and it was dangerous to accept a bank note without first investigating the bank. The panics of 1837 and 1857 were caused by wild speculation, which was directly encouraged, to say the least, by overissues of unsecured bank notes.
In response to the public demand for greater security, New England adopted a system known as the "Suffolk System," which required the prompt redemption of the banks' notes at par, by means of deposits kept for that purpose with the Suffolk Bank in Boston. New York State in 1829 devised the "safety fund system," which required the cooperating banks to pay dues into a common fund for the assistance of any contributing bank in case of need; but this fund was exhausted in the panics of 1837 and 1857. In 1838 New York adopted the "free banking system," which required banks to secure their issues of currency by means of various classes of public bonds to be deposited with the banking department of the state. This plan was imitated in several other states, and formed the basis of the later national bank system. The formation of clearing houses, beginning in New York in 1853, further aided in securing stability. Many of the state banks were converted into national banks in 1864 and the rest continued to transact a general deposit and loan business.
National. Banks. The vast expenditures of the Civil War forced the government to adopt a new financial system. The state banks had suspended specie payments in 1861, and there was no central bank through which the government could borrow funds. In this crisis Salmon P. Chase, secretary of the treasury, devised the national bank system as a means for securing Federal loans by granting special privileges to banks that would advance the money. This was accomplished by the national bank law of Feb. 25, 1863, supplemented by that of June 3, 1864. Any national bank might be organized under a Federal charter, with a capital of not less than $50,000, provided it invested at least one-third of its capital in United States bonds. Large numbers of national banks were at once organized, and by the new system the government secured both a market for its bonds and a uniform national bank currency, guaranteed by these bonds, to supplant the old local state bank currency which had become wholly inadequate to meet the needs of the commercial world. In later Congressional acts, notably the Gold Standard Act of 1900, the provisions of the national bank law were modified in the direction of greater liberality.
Regional Reserve Banks. On Dec. 23, 1913, the act providing for regional reserve banks became a law. This act created a Federal Reserve Board consisting of the secretary of the treasury, comptroller of the currency, and five other members appointed by the president. An organization committee consisting of the secretary of the treasury, the secretary of agriculture and the comptroller of the currency was also provided. This committee divided the country into 12 districts and located the regional banks at New York, Chicago, Minneapolis, St. Louis, Kansas City, Cleveland, Dallas, San Francisco, Boston, Philadelphia, Atlanta and Richmond, Va. All national banks are required to become members of the regional bank in the district by subscribing for stock in the regional bank. State banks may become members by complying with the same requirements as the national banks. Regional banks deal only with member banks except in special cases. Funds deposited in regional banks may be loaned to member banks on such commercial paper as is approved under the law.
The government is authorized to issue new treasury notes of a distinctive style for each regional reserve bank. When such a bank is under the necessity of paying out more money than its cash resources permit, it can place a portion of its commercial paper purchased from member banks in the hands of the Federal reserve agent and receive therefor its new currency. Each reserve bank, however, is required to keep a reserve of 35 per cent of its deposits and a 40 per cent gold reserve as a guarantee of the redemption of this currency. Its redemption is also guaranteed by the government. One regional bank cannot pay out the notes of another except under penalty of a heavy tax. These special notes are to be retired as soon as the emergency calling for their issue has passed.
The Federal Reserve Board exercises general control over the entire system, and can compel one regional bank to loan to another in time of need.
