Under a system of decentralized reserves about the same possibilities present themselves as were referred to in the case of indirect procedure under centralized reserves. The bank seeking assistance may borrow from or resell investments to selected banks elsewhere, assuming the possibility of its finding such other banks and also its willingness to deal with them in this manner. Or there may be an open market, covering a large part of the country as a whole, where the individual bank may count on reselling its investments to the extent that may be necessary. The result of any of these transactions would involve the virtual transfer of reserves from the lending or the buying banks to the borrowing or selling bank.

In connection with this subject of strengthening reserves, there must, however, be noted the fact that not all of a bank's investments are readily subject to resale or to hypothecation. If we examine a bank statement we learn that, in the main, the bank's investments are made up of loans, of discounts, and of securities - bonds and stocks. The question is, therefore, to what extent may a bank avail itself of these different classes of investments for the purpose of strengthening its own position?

Loans that the bank itself has extended are, in most cases, obviously ill-adapted to further transfer. Loans are usually based on collateral security, and a transfer of the loan itself to some other lender, or the attempt further to borrow on the basis of the obligation involved in the loan, would necessitate the transfer of the underlying collateral. But the lending bank holds such collateral only as a trustee. It may legally dispose of or transfer such collateral only when at the maturity of the loan the lender fails to repay the total amount due or when he fails to provide additional security if this be called for under his contract. Before the maturity of the debt the collateral behind the loan remains the inviolable property of the borrower. Loans on collateral represent, therefore, a comparatively illiquid asset to a bank. Of course a bank may itself borrow by pledging some of its own property, but that is clearly a different matter.

Under decentralized reserves

Investments available for strengthening reserves

Loans

Considering next stocks and bonds, it is apparent that these may be readily sold where there is an open security market. The presence of such a market is, of course, indispensable, and where the organization and methods of the banking system are such as to preclude the possibility of a bank's strengthening its position in any other way, the speculative security markets may become in effect important adjuncts of the banking system, and security speculation may thus attain a degree of importance far beyond what would otherwise be the normal. But for strengthening reserves assurance afforded to a bank by the security markets is, of course, limited to the amount that the bank has invested in stocks and bonds.

Furthermore, it is generally agreed that beyond certain narrow limits stocks and bonds constitute an undesirable investment for a bank with heavy demand liabilities. While such investments may be relatively liquid the risk in carrying them is large. Fluctuations in the prices of securities are too numerous and too extensive to permit anybody except professional speculators to purchase them on any basis other than one of pure investment. As a rule banks will invest in securities only up to the amount of their capital and surplus, because the shareholders in their capacity as owners of the bank have no demand claims against the business. Beyond that, however, the tying up of liquid funds in stocks and bonds is regarded as inadvisable.

Discounts remain therefore as the final dependence. Fortunately, they offer every advantage as a means of strengthening reserves. In the first place they constitute the bank's own property. When a bank discounts a note or buys a bill of exchange or similar instrument, the purchased instrument becomes the bank's property to do with as it sees fit. The bank may hold the discounted paper permanently as an investment, if it so elects, but it is free at any time to resell such paper if it can find a buyer at a satisfactory price. The discounted paper represents a "right to demand" of which the bank made an outright purchase, and, assuming a perfect title, there is involved no question of trusteeship to others which restricts the bank's further selling right.

Securities

Discounts

Furthermore, discounts involving rights to demand specified sums at stated dates have at any time a definitely calculable money value. The value depends upon the length of time that the instruments have to run, and upon the rates of discount or rediscount that prevail in the market concerned. These rates are not, of course, absolutely stable, and the variation in the rates affects the money value of credit instruments, but this variation is not likely to be as frequent or as great as is that of security prices. In discounting, if the rate advances beyond what he originally charged, the banker needs simply to wait until the instrument matures when he collects the total amount due. At the worst there is only the sacrifice of what might otherwise have been extra profit. If the banker must, however, resell or rediscount some of the bills in his portfolio at a higher rate than he originally charged, he can select for the immediate emergency those bills whose term is almost run. Thus about ten days before maturity German bankers often rediscount bills at a higher rate than was charged when the bills were originally purchased. The short period for which the higher rate is charged simply reduces slightly the profit earned at the lower rate for the longer term. The fluctuations in the security market, however, threaten not simply a lessened profit but often a loss in principal as well.

Rediscounting, it may then be assumed, is the most approved method of strengthening a bank's position. The utilization of this expedient depends, however, upon the system of reserves and upon market practice.