The special functions of central banks may be grouped under three heads: they serve as fiscal agents of government; they have large powers of control over the currency through the more or less complete monopoly of note issue; and, finally, since they hold a large part of the reserve of the other banks, they are directly responsible for the foundation of the entire structure of credit. This last is by far the most important function of central banks. Indeed, in a general but very true sense, central banks may be said to have but this single function, - to insure the maintenance and smooth working of the systems of credit, of which they are the most important, though not necessarily the most considerable members. It is a duty which rests upon central banks because the other banks, which hold a little or no cash reserves, rely upon their deposits at the central bank and upon the expectation of being able to borrow from it through rediscounts or direct loans.1 The centralization of bank reserves was not one of the objects in view when the first central banks were established. Historically,it is probable that it came about in large measure as an unintended result of the monopoly of note issue and of the government business handled by them. Such is quite certainly the case with the Bank of England, the earliest central bank in date and the model for all others of its kind. Through its government business other banks were inevitably brought into daily contact with it, and the convenience of an account upon its books became readily apparent. Again, the partial monopoly of the right of note issue, in a period when banking methods were undeveloped, was an advantage which, along with its government business, gave the Bank of England a position of unquestioned superiority, both in size and in prestige. From keeping a balance to keeping their entire reserve in the central bank required no essential change in the every-day methods of business of the other banks. This stage had been reached in England before the close of the eighteenth century, and for generations English bankers have held in their own vaults only such amounts of money as are required for every-day purposes, - till money, as the English are wont to designate it. This custom was still further strengthened in 1854, when the plan was adopted, in the settlement of clearing balances, of simple transfers upon the bo"oks of the central institution. In other countries, virtually the same situation has been reached. Although the other banks may hold slightly greater amounts of cash, they carry balances, larger or smaller, with the central bank, and are quite as dependent upon it to meet extraordinary requirements.

1 For some account of these crises see Ch. XI below.

1 The London banks do not ordinarily borrow directly from the Bank of England. They withdraw money lent to bill brokers, who in turn are obliged to borrow from the Bank. The difference is one of form rather than of substance.

In the exercise of their function in relation to the reserve the possession of government balances is of much advantage, and the privilege of note issue is in most countries indispensable. Government balances are indeed at times so small as to be of little service, and in the case of the Bank of England the right of issue is of little practical importance since the Bank of England note is virtually nothing more than a gold certificate. In Continental countries where there is slight use of checks the right of issue by a central bank would seem to be indispensable and it is a power which in any country adds greatly to the strength of a central bank. Owing to the general preference of people for paper money, as the stock of gold in a country increases much of it will be secured by a central bank in exchange for its notes. The great strength of the Bank of France is mainly a result of this process. The stock of money in circulation has increased and this gold instead of going directly into circulation has been taken to the Bank of France to be exchanged for bank notes.

The activities of a central bank in normal times are of a comparatively simple and even routine nature, not very different from those of the other banks about it. In some countries on account of statutory requirements, and in all countries from motives of sound policy the loans and other investments of central banks are confined to those which are deemed of the highest quality, a decided preference being given the trade bill over the collateral loan, The high quality of the assets is not, however, insisted upon with the intention of converting them into money in times of emergency. A central bank is then the refuge of last resort for the other banks. Any attempt to call in loans or realize on securities would be directly opposed to the working principles of a central reserve banking system. It invariably happens at such times that the loans of central banks are largely increased.1

The good quality of the assets in general is important because it gives that prestige which is half the battle for a central bank. A reputation for conservative, sound judgment is absolutely essential to the maintenance of universal faith in the strength of the central institution. For this reason, and even more in order to be able to meet the responsibilities of its position, it is equally essential that a central bank should hold a very large reserve against its credit liabilities. There is, of course, no precise proportion of reserve which is everywhere adequate amid varying circumstances. The general character of the economic activities of the country, its financial position, and the size of its entire credit structure must be the determining considerations for each central bank. In all countries with such institutions there has been a distinct tendency to maintain a larger reserve than was formerly thought necessary. This seems to be due to a more clear recognition of their responsibilities, and because these responsibilities have increased with the growth of other banks and the more intimate relations between the money markets of the world. After the Baring crisis in 1890 it was generally felt that the reserve of the Bank of England was too small. The proportion to deposit liabilities which, in normal times, had been in the neighborhood of 40 per cent., was therefore increased to rather more than 45 per cent. The Bank of Germany holds about the same proportion of reserve to demand liabilities as does the Bank of England, and the reserve of the Bank of France, for many years, has been notably greater than that of any other country.