Security important in loans

Obtaining deposits with discounts and loans purely a credit transaction

Although, as was stated above, a bank finds no profit in the mere acceptance of cash, checks, etc., for deposit, every bank is, nevertheless, extremely desirous of getting the greatest possible amount of such deposits. The reason is, as will now be shown, that these greatly increase the bank's "lending" power, or its power profitably to sell present rights to demand for future rights to demand.

The bank learns by experience that depositors will exercise from day to day only a fraction of their rights to demand represented by their deposits. Those who deposit cash itself certainly do not immediately want cash, for if they did the task of making the deposit would constitute a useless expenditure of energy. Depositors of cash may want some money in hand from day to day, but in this case they are confident that it can be obtained, and hence they call for it only in so far as an actual need is felt. All the cash that the bank has to keep on hand for this purpose is, therefore, the proportion of the cash deposits that is likely to be withdrawn from day to day. Such cash constitutes the "reserve" held against deposit liabilities based on cash itself. The remainder of the cash can then be used as a basis for discounting or for lending purposes.

It is important at this point to note that the great majority of those who have paper discounted or who borrow from the bank do not want actual cash. They, like the depositor of cash, may experience an occasional need for money in hand, but normally they want simply a deposit on the books of the bank, which deposit gives them a right to demand cash should they need it, and which they can split up and transfer as a whole or in part, by means of checks, to whomsoever they may have payments to make. This is of tremendous importance to the bank because it requires the bank to hold in actual cash as a reserve only a fraction of the total obligations represented by the additional deposit liabilities growing out of loans and discounts. A given addition to the available cash reserve will, therefore, permit a much wider extension of deposit liabilities than the sum represented by the cash itself. Just how wide this extension may safely go is a matter that experience alone can determine, and its determination constitutes one of the most important problems that the practical banker has to solve.

Cash deposits important to bank

Depositors seldom exercise their rights to demand cash

Small cash reserve adequate

All depositors alike in this respect

To a given bank the depositing of checks drawn on or of "notes" issued by other banks is almost as satisfactory as the depositing of cash. These checks and notes confer on the lawful holder, as was seen above, the right to demand cash. When they are surrendered to a bank as a deposit the bank may exercise this right or it may simply use the right as an offset to similar claims against itself which, as deposits, may have come into the possession of such other banks. In both cases the net result is the same. Had the bank elected to demand the cash it would have had to meet with cash the claims presented by other banks. The gain of cash on the one hand would have been offset by the loss of cash on the other. It greatly simplifies matters directly to offset the respective claims as far as that is possible. Where the notes of one bank may be used by other banks as a part of their lawful reserve, as is the case with the notes of the large central banks of Europe, the notes, as long as they are good, have, to the banks receiving them, all the advantages of cash itself. In general, then, it may be said that where there are adequate collection or "clearing" facilities checks and bank notes are for the practical purpose of obtaining deposits equivalent to cash itself.

The "clearing system," which involves the mutual cancellation of claims by banks and the payment in cash of differences only, strengthens greatly the bank's lending power. In almost every community in the United States where there are more than two or three banks one can find a "clearing house."1 A "clearing house" is ordinarily a place where the representatives of the associated banks gather from day to day to present to each other the checks and other items which, under the rules of the association, may be presented for collection through the clearing house. Each bank is ordinarily represented by two clerks. The duty of one is to receive and to record the claims presented for payment by all the other banks. The duty of the other is to present in regular order the claims of his bank against all the other banks. The amounts are fully reported to an officer of the clearing house who makes the proper entry on the day's clearing sheet and who then calculates for each bank its debit or credit balance as the case may be. It is this balance alone which is paid in cash. On the New York Clearing House, where the exchanges run from $300,000,000 to $1,000,000,000 per day, the average percentage of cash required to pay the balances is barely five. This obviously permits a large economy in the use of cash. If a bank had to keep on hand each day enough cash to meet all the checks that are presented to it for payment its cash reserve would needs be much larger than it is under the clearing system. But since under the checking and clearing system a bank can count on receiving as deposits from its own depositors checks on other banks aggregating an amount approximately equal to the amount withdrawn by check from day to day, and since in the clearings the amounts withdrawn may be balanced against the amounts paid in, it is only for the possible debit balance at the clearing house that cash provision has to be made. The gain to the bank in lending power is apparent.

Checks or notes on other banks as good as cash to given bank