The matter of protection of bank credit has been the bone of contention between two schools of banking thought - those who believe in the "currency" principle and those who adhere to the "banking" principle. The former believe that bank notes by entering the currency displace so much gold, which is driven abroad, that such an issue of notes might completely expel the gold and force the country to an inconvertible depreciated basis, and that therefore the state, to protect itself and its citizens, must so regulate bank note issues as to prevent such results. The adherents of this theory would make the bank notes practically gold certificates with 100 per cent gold reserve, or if that were impossible, would minimize the uncovered issue.

It is evident that this theory emphasizes the safety of the currency but makes its volume constant and inelastic, neither of which is desirable. The volume of bank notes should expand and contract freely with the needs of business; if it does not the price level must vary inversely as business activity, or else the elasticity must be provided by deposit currency.

The adherents of the banking principle, on the other hand, hold that the right of note issue should be full and unlimited at the discretion of the banker who for business reasons, they assert, will find proper protection and reserves for noteholders and depositors, and who, so long as he keeps notes convertible, can bring neither the bank itself nor the business community into any danger. Should the notes become inconvertible, this theory holds that a redundant depreciated circulation would result, but if the notes are kept convertible the bank can only put a definite quantity into circulation, any excess being returned to it for redemption and for the liquidation of old loans.

This principle is sound except that there is no safeguard against imprudent and reckless banking. With conservative bankers the maintenance of convertibility would be unquestioned, but if bankers should become reckless and give loans on easy terms the note issue would readily expand until the possibility of converting upon demand would cease, provided demand were at all general. To curb the reckless banker and protect creditors against his extravagances is the aim of modern bank regulation.