§ 1. Nature and classes of banks. § 2. Functions of banks. § 3. The essential banking function. § 4. Demand deposits. § 5. Discount and deposit. § 6. Nature of banking reserves. § 7. Time deposits. § 8. Bills of exchange, domestic. § 9. Issue of notes. § 10. Divergent views of typical bank-notes. §11. Banking credit as a medium of trade. § 12. Productive services of banks. § 13. Earnings of banks.

§ 1. Nature and classes of banks. A bank, as one first comes to know it, is a building (or a room in some building) in which there is a fire- and burglar-proof safe. In this room are men receiving and paying out money and acting as bookkeepers. Usually, however, the word bank means, not the building, but the business organization or the enterprise as a whole. Banks perform a variety of useful functions in every modern community. All these functions touch in some way upon the use of money, and banking problems always are related to money problems. It is our purpose now to understand the nature and work of banks in relation to the general business activity of the community.

In the United States there were on June 30, 1920, more than 30,000 banks reported. These may be classified first according to the source from which they derive their charters or authority to do a banking business as: national, state, and private. The last are unchartered and act under the general state laws governing private contracts; in general they are unsupervised.1 Banks may be classified also, according to the two main types of business they perform, as banks for savings and commercial banks. Most banks do mainly a general commercial business; some are distinctly banks for savings; but in truth this dividing line can be less and less sharply drawn between banks as units; rather the distinction must be made between the savings function and the commercial discount function, which are more and more being performed by one and the same bank. The statistical data collected in the United States distinguish only imperfectly between these two. The trust company usually unites these two functions in large degree. This matter will be better understood in connection with the analysis of the functions that banks perform, now to be given.2

1 Opinion favors prohibiting the use of the word bank to any except regularly incorporated organizations, or at least subjecting private banks to the same supervision as the chartered banks.

§ 2. Functions of banks, incidental. Almost every bank performs various functions useful to its customers, but some of which are not essentially bound up with banking, and may be performed by institutions that are not truly banks. Among these are:

(a) Maintaining a safe-deposit vault, where space may be rented by an individual to keep his valuable papers, jewels, etc. The customer does not usually deliver to the bank possession of the valuables, but himself retains the key to the box, which the bank has no right to open. In larger cities this work is often done by separate institutions.

2 Banks in the United States, 1920.

(b)   Acting as money-changer to buy and sell moneys of different nations. This function is of less importance in America than elsewhere because of the great size of our country and of the small portion of our boundaries touching those of other nations using different monetary units. Moreover, the function is in large part performed for Americans by ticket agencies at the ports of embarkation and by the steamship companies en route.

(c)   Selling bonds and other investments to customers. In smaller communities the customers of a bank turn to it as the best source of information for safe investments of personal or trust funds. This opens to it a new possibility of service. Large investments, however, are usually made through the agency of more specialized investment brokers.

(d)   Acting as trustee and business manager for passive investors, and especially as executor and administrator of estates or as guardian of a minor heir. This function was taken up rapidly after about 1890 by trust companies 3 organized under state laws, and after 1918 (as a result of an act of Congress) by many national banks.

(e)   Receiving time deposits at a low rate of interest to lend or invest in securities at a higher rate of interest. Such time deposits are not subject to withdrawal by customer's check, excepting after notice to the bank (if required). Receiving time deposits is the essential function of savings banks (as distinct from commercial banks) and will be more fully discussed in a later chapter.

(f)   Selling its credit, that is, giving its promise to pay at some other place, or at some other time, in return for a payment that yields a profit.

§ 3. The essential banking function. The one essential function of a bank is selling (lending) its credit to its customers in some form that will conveniently serve the same function as money. A bank of this kind is sometimes described as a business whose income is derived from lending its promises. The bank's credit is sold in the form of its promises, the evidences of which are its receipts, depositors' account books, drafts and checks on other banks, and banknotes. The indispensable condition to the exercise of this function by a bank is public confidence in its abilty to fulfil its promise to pay whenever it is due. This confidence is built upon the bank's paid-up capital; its surplus and undivided profits; the further liability of the stockholders to make good any losses up to an amount equal to the capital stock each holds ("stockholder's double liability") ; the financial prestige of the bank's ,officers, directors, and stockholders; the bank's established reputation and "good will" in the community after a period of successful operation; the character of its loans and of the securities which it owns; and, finally, the reliance placed upon the control and inspection by official examiners. The bank then may (in addition to receiving time deposits) sell its credit in any one or in all of the following four ways: (1) by receiving demand deposits; (2) by the method of discount and deposit; (3) by selling exchange of funds to distant points; (4) by issuing banknotes.

3 Not to be confused with a trust in the sense of a monopolistic enterprise, with which it has no connection except by mere verbal accident, through the word trust.

§ 4. Demand deposits. Demand deposits are those payable on demand, the demand in practice being by means of personal checks requesting the bank to pay to (or on the order of) a specified person, or to pay to bearer. A customer's bank account consisting of demand deposits is called a checking account. Since the turn of the century it has become increasingly the practice to pay a low rate of interest (about 2 per cent) on current balances, oftener to large depositors. Banks attract demand deposits mainly by the convenience and economy which they offer to their customers in the guarding of funds from theft and fire and in saving the time, trouble, and expense of carrying money for making payments. A deposit in a bank is to the depositor for most purposes "just as good" as money in the pocket and for many purposes is even better. Thus the banks have become the custodians of a large proportion of the money (or funds) needed for current use by individuals and business corporations. Large amounts of deposits (though only a small proportion of the total) are brought to the banks in the form of bags and rolls of money, or as funds consisting of credit papers, such as checks and drafts, calling for the payment of money. But most deposits are created in another manner now to be described.