The most familiar type of relationship between banks is that of clearing, and for purposes of convenience it is customary that banks should be united in what is called a clearing house. A clearing house is usually an unincorporated local association of banks formed for the purpose of conducting interbank relationships. There are clearing houses in all of the principal financial centers of the world, and in the United States there are upward of 200 such organizations. Some of them are very small and their business is conducted upon an extremely simple and elementary basis. Others are highly organized and have their own buildings and elaborate organization. Some have in years past undertaken the task of examining their members and of reporting to a clearing-house committee whenever bad financial practices showed themselves. Still others have in various ways performed mutual service for the banking community. In all, however, the central function of the clearing house has been that of offsetting claims against one another. The technic of clearing has been fully treated in many authoritative works on the subject. Only the underlying thought or idea of the process will be referred to here. Suppose the existence of only two banks which have constituted themselves a clearing house. Bank A has in the course of its business received checks drawn on bank B in the amount of $10,000. Bank B has received a like amount in checks drawn upon A. Of course, in receiving these checks each bank has credited them to the depositors. A's books therefore show a liability of $10,000 to depositors, while on the asset side it has accumulated an item called "exchanges for clearing house," which consists of the total of checks on other banks thus deposited. A like situation exists in bank B. Representatives of the two banks now meet and each hands the other the bundle of checks drawn upon it. Bank A has thus eliminated its "exchanges for clearing house" from its assets. In return it has received a bundle of checks drawn upon it by its own depositors. It now charges these checks to the account of the depositors who originally drew them. The same step is taken by bank B. Now the situation is the same as it would have been if the checks had in the first place been directly deposited in the banks upon which they were drawn. The effect of the clearing has been nothing more than to offset the claims against one another. There is evidently no source of income in this process, and, on the other hand, no loss. The clearing house probably requires the use of an office or room and perhaps a little clerical assistance, so that it involves some expense which may be divided pro rata between the two banks. At all events, the clearance has resulted in avoiding payments of coin, and has in effect extended the bookkeeping process of each bank so as to include the checks which are not directly deposited with it. It is thus a labor-saving device and also a great economizer of money.

If a third bank, C, now enters the clearing group, the process becomes somewhat more complicated. A presents bundles of checks to B and C, B to A and C, and C to B and A. It is always possible that there will be what is called a perfect clearance - that is to say, that the total amount which each bank has against the other two is equal to the aggregate which they present to it. This, however, is a rather unlikely contingency. The chances are that some one of the three banks will either owe the others or be a creditor of the others, and this remains true even as the number of banks included is enlarged. Now if A owes C, let us say, $500, while B owes a like amount to A, and C owes $500 to B, it is evident that each member owes $500 and is due $500. The payments may thus be allowed to cancel. If, on the other hand, the debts are not exactly equal in amount the clearing house may direct A to settle with C, while B is released from paying A, and A is released from paying C. In this way the number of payments to be made can be reduced. Another way of meeting the same situation is that of requiring each bank to keep a certain balance with the clearing house. Then debtor banks draw checks in favor of the clearing house, while creditor banks are paid by it. The result is to settle the whole series of transactions with a minimum of actual payments.

Another complicating element may come into the situation if the clearing house permits its members to present checks drawn upon banks which are not represented in the clearing house but which have requested certain members to clear for them. In such cases the different members may be merely representatives of a string of banks whose transactions pass through them, and are cleared on its books. Again the question may arise whether such clearances for nonmembers arc made in behalf of banks which are situated in the same city or outside of it. There is no reason why a member of the New York clearing house should not undertake to clear the checks of a bank located in San Francisco if it wishes to do so, and the question whether it could afford to do such work, and if so at what charge, would then have to be settled between the New York clearing member and the San Francisco bank. Ordinarily, however, the checks for out-of-town banks which are brought to the clearing house by members are segregated and are put through a separate division of the organization, which is known as the country clearing house. Of this more will be said at a later point. It is enough to remark here that, in general, clearings in the proper sense of the term are made on an instantaneous basis - that is to say, they represent items which are immediately cashable.

As has already been noted, banks instead of clearing their items might simply deposit them with the other banks on which they are drawn, leaving them on deposit there. This, in fact, is the way in which many checks are disposed of when they are deposited with banks which are located elsewhere than the institutions on which they are drawn. For example, bank A in New York City may have received, say, $10,000 of checks drawn upon banks in various small towns in California. At the end of the day's work these checks are carefully sorted and massed together with others. The bank will then send the whole $10,000 to a correspondent in San Francisco. This San Francisco bank will give bank A a credit for the $10,000, and it will then proceed to collect the checks. Perhaps it may send some of them direct to the banks on which they were drawn. For example, suppose that one of the checks was for $500, and was drawn on a Fresno bank. The San Francisco bank may transmit it to the Fresno institution, or perhaps to another bank in Fresno, for credit. Or it may happen that the Fresno bank has an account with the San Francisco bank, in which case the San Francisco bank, having been previously authorized to do so, charges the $500 off against the Fresno bank's account on its books. In this case it has simply-given credit to the New York bank for $500 and reduced the Fresno bank's credit by $500. Suppose now that in the course of its regular business the San Francisco bank receives a check drawn on bank A in New York City, which originally sent it the $10,000 for deposit. It may charge this $500 check off against the credit on its own books in favor of bank A, thereupon remitting the check as a paid item to the New York bank. Or it may be that in all these cases the bank on which the check is drawn has stipulated that it wants to see and approve the signatures on checks before they are paid, and in that case they may simply be sent to it, and when found to be correct the transmitting bank will be directed to mark them off against the account. This process is usually referred to as collection, as distinct from clearing. The difference between the two is that, whereas clearing is an instantaneous process in which only balances are settled, collection is a continuous process in which the proceeds of items are remitted. It may easily be that in collection not a single cent of money is ever passed. Bank A, for example, may in the course of a year send $1,000,000, at one time or another, in checks to bank B and get credit for them, while bank B may in the course of the same time send a like amount to A, the two accounts "washing out" at the end of the period and neither bank owing the other anything. In such cases the payments are sometimes said to have been "cleared on the books," but the process is not clearing because it has involved time. It is a process of collection and settlement by means of credit.