The establishment of a safe and uniform bank note system has undoubtedly proved a direct benefit to banking by creating confidence in banking institutions. The National Banking Act stemmed the rising tide of hostile public opinion, which in its most radical phase demanded the suppression of all banks as a penalty and cure for the losses, disturbances, and inconveniences wrought under the then existing system.

Then, too, the banks derive an advantage from the fact that the national bank notes bear the name of the bank and the adjective "national," which serves to advertise the bank among noteholders. An advertising advantage is also realized from having an amount of United States bonds in the bank's statement, since it suggests conservative management and the possession of a reliable secondary reserve. In addition, the ownership of government bonds by the banks and the provision for central redemption of notes open to the banks avenues for cultivating friendly relations with the United States Treasury.

The chief advantage to the banks is sometimes presumed to be the gaining of profits from the note issue privilege. It is commonly alleged that banks make a "double profit" - the interest on the pledged bonds, and the interest on the loans of notes. The extra profit from the interest on the bonds is not large, however, since the rate of interest on most of the bonds bearing the circulation privilege is now only 2 per cent, and this percentage is reduced by several factors. If the bonds sell at a premium, more is paid for a bond than the sum of the notes which may be issued on it, since the notes may not exceed the par value of the bond. Moreover, the bank must maintain a 5 per cent redemption fund with the Treasurer and this may not be regarded as reserve and does not earn interest. In addition, the circulating notes are taxed 1 or 1/2 per cent per year, and the expense of preparing plates, transporting, issuing and redeeming notes, examining the bonds and plates annually, and witnessing the destruction of worn-out notes, must be deducted from the gross profit. Furthermore, if the bonds are bought above par and will be redeemed at par, a sinking fund must be maintained. And, finally, the full volume of notes issued to the bank cannot be kept continuously outstanding by means of loans. After making these many deductions, the net profit from the circulation privilege is small.

The profit is further affected by money rates. In the case of a purchase of bonds at par, the average rate for money does not affect the additional profit derived from taking out circulation, as the amount of notes received is exactly the same as the money invested in the bonds. With bonds purchased at a premium, it is more profitable to take out circulation in a low money market than in a high, since the notes received are less in amount than the price paid for the bonds, and the bank will therefore be able to loan an amount only equal to the par value of the bonds. In a low money market this loss of interest is less than in a high market. Hence, in case of bonds bought at a premium the profits are less in a high money market than in a low money market.

Method of Calculating Profit on Note Circulation

Profit on a national bank's circulation may be thus calculated:

Date of calculation, March 1, 1910.

Issue of bonds purchased, United States registered 2% bonds of 1930.

Price of bonds (101 and interest), $101,000.

Par value of bonds, $100,000.

Money worth on the market, 6%.

Income from bonds per year .........................................................

$2,000

Income from circulation ($100,000 less $5,000 redemption fund) loaned at 6%

5,700

Total gross income ..........................................................

$7,700

Deductions:

Tax on circulation .................................................................

$500

Sinking fund to retire premium, set aside each year....

26

Expenses for plates, expressage, etc. ...................................................

63

589

Net income from circulation................................

$7,111

Net income from loaning $101,000 (net cost of bonds purchased) at 6%.................................................

6,060

Increased income from circulation over loaning cost of bonds direct.................................................................................

1,051

Percentage of increased profit on investment..................

1.04%

C. F. Childs and Company, specialists in government bonds, publish the following table of the profits from the note issue privilege under varying conditions of bonds, money rates, and purchase price:

Table Showing Relative Annual Profit At Different

Prices and Money Rates on a Basis of a Purchase of $100,000 Bonds as of June 1, 1919

Price of Bonds

Money at 8%

Money at 7%

Money at 6%

Money at 5%

Consol 2's at*

101

$ 957

$1,017

$1,076

$1,135

100 3/4

977

1,034

1,092

1,148

100 1/2

997

1,052

1,107

1,160

100 1/4

1,017

1,070

1,122

1,173

100

1.037

1,087

1,137

1,185

99 3/4**

1,057

1,105

1,152

1,198

99 1/2

1,077

1,122

1,167

1,212

99 1/4

1,097

1,140

1,182

I,224

99

1,117

1,157

1,197

1.237

98 3/4

1,137

1,175

1,212

1,250

98 1/2

1,157

1,192

1,227

1,263

98 1/4

1,177

1,210

1,242

1,275

98

1,197

1,227

1,257

1,288

97 3/4

1,217

1,245

1,272

1,300

97 1/2

1,237

1,262

1,288

1,313

97 1/4

1,257

1,280

1,302

1,326

97

1,277

1,297

1,318

1,338

Old 4's At

108 1/2

$ 677

$ 778

$ 878

$ 977

108 1/4

732

832

930

1,028

108

787

885

981

1,078

107 3/4

842

938

1,033

1,128

107 1/2

896

991

1,085

1,179

107 1/4

951

1,044

1,137

1,179

107

1,006

1,098

1,189

I,229

106 3/4

1,060

1,151

1,240

1,329

106 1/2

1,115

1,204

1,292

1,380

106 1/4

1,170

1,257

1,344

1,430

106

1,224

1,311

1,396

1,480

105 3/4

1,279

1,364

1,447

1,530

105 1/2

1,334

I,4I7

1,499

1,581

105 1/4

1,389

1,470

1,551

1,631

105

1,443

1,523

1,551

1,631

104 3/4

1,498

1,576

1,655

1,731

104 1/2

1,552

1,629

1,707

1,782

* Childs and Company's calculation ignores the factor of amortization of premium and accumulation of discount from value at maturity, the term assumed being 100 years.

** During and subsequent to the drafting of the Federal Reserve Act the market value for the 2 per cent bonds has continued. with one brief exception, to be quoted at discount prices. The Secretary of the Tieasury in consequence has ruled that no additional deposit of bonds is necessary or will be called for to offset nominal depreciation in the value of the bond collateral. The 5 per cent redemption fund held at the Treasury Department against all outstanding circulation, coupled with the bank's responsibility and solvency, are regarded as adequate margin to cover any probable depreciation in price of the bonds. The result of this ruling is to make the note issue privilege increasingly profitable as the bonds depreciate below par.

+ ln a 5 per cent money market the net profit from Consol 2's costing 99 1/4 and Old 4's costing 107 is virtually equal.