The previous chapter has traced the organization of a commercial bank and has touched upon its administration by explaining the duties of the officers Continuing the general survey of the commercial bank, the next step is to analyze the actual working of its various departments. These operations could be examined to advantage from the viewpoint of the banker himself, but it is the purpose of this book to present the subject rather from the position of the depositor. Therefore, the following study of bank operation will be external rather than internal in treatment, and will present only those features of technical practice which are essential to an understanding of the principles underlying commercial banking.

As we have already seen, the central function of a commercial bank is to substitute its own credit, which has general acceptance in the business community, for the individual's credit, which has only limited acceptability. How this single function is exercised in actual practice may readily be understood by viewing the relation between a bank and a depositor. Let us assume that A of New York City has sold a bill of goods worth $100 to B of Boston. The latter may settle with A by giving him cash, a check, or a promissory note. If payment be made in cash, A generally uses this money to build up his account at his bank, and so he brings it to the receiving teller, who adds the amount of the deposit to his credit with the bank. A now possesses $100 of bank credit which he may withdraw at any time. If he wishes to transfer this sum to one of his creditors, he will draw a check in favor of the latter, who may present the instrument for payment directly to the paying teller of the drawee bank.

The transaction thus described has involved only the receiving and the paying of a deposit of cash. But modern business is not generally conducted on a mere cash basis, and its financial aspects cannot be understood by so simple an illustration. As mentioned above, B may also reimburse A by means of a check drawn in this instance on a bank located in Boston. A now holds a claim on Boston funds which naturally he prefers to have available for his use in New York. One way to secure this purpose would be to sell his claim of $100 to some one who owes a similar amount to a creditor in Boston. However, an easier method is merely to deposit the check with his New York bank, which is continually engaged in offsetting such claims with institutions in other financial centers. Thus, without any further trouble to A, his bank accepts the deposit of the check, credits his account, and then allows him to draw against the sum. This service by which banks secure payment of claims on one another is the operation of exchange.

Another aspect of banking practice is illustrated by the third method of payment, by which B gives his creditor a note promising to pay $100 within a certain number of days after date. A thus holds a claim on future funds, but this will be of little value if he must meet immediate obligations of his own creditors. A thereupon takes the promissory note to his bank, which first tests the financial responsibility of both parties. If satisfied, the bank credits the account of A and thus permits him to make withdrawals for the payment of his debts. The bank has thus substituted its own credit for that of B, and has given A the right to immediate funds in place of his claim to future funds. This is the process of "discounting."

In this illustration the bank has discounted the note by simply adding the sum to A's deposit account. If the bank is chartered under the national law, it may extend credit to A not only by increasing his deposit, but also by giving him its notes, which circulate throughout the community. This issue power of national banks has declined in importance since the inauguration of the Federal Reserve system, which has provided for the eventual elimination of national-bank notes and the circulation of a new form of currency. Thus the three operations of deposit, exchange, and discount alone have a significance in banking practice. The following sections of this chapter will deal with a bank's departments and subdivisions which carry out these several processes.