When bank notes are given special protection, three objects are kept in view:
1. To Keep The Bank Notes Of A Going Or Suspended Bank At Par.
2. To provide that the noteholder shall be secured against loss, at least ultimately.
3. To Provide For Elasticity Of Issue.
1. Maintaining Parity
The First Of These Objects May Be Attained In Several Ways.
In Canada, for example, the note of a suspended bank begins to bear interest at 5 per cent from the date of suspension until it is redeemed by the central authorities from a special fund kept for the purpose; the result is that notes of suspended banks may be preferred to notes of solvent banks and be held back as investments, while those of the solvent banks are used in payments.
Voluntary or compulsory subscription to a common fund, in proportion to each bank's issues, may be arranged and placed with the government or a trustee who pays from the fund the notes of suspended banks. This is called the "safety fund system."
Again the state may declare the notes legal tender in all or special cases. Such declaration, like any legal-tender law, by clothing the notes with debt-paying power, tends to maintain their circulation at par.
The best and most general method of keeping bank notes at par is to provide means of immediate and constant convertibility. If the holder can at any time, at his will and with little trouble, convert his notes into standard money, they will not go below par. Various devices for achieving immediate convertibility have arisen. The issuing bank must ever according to its promise stand ready to convert over its counter, and if this is done anyone within reasonable distance of the bank might regard its notes as good as gold. To provide for redemptions at distant places and thus give the notes parity over a wide area, a system of local and central redemption agencies may be established, particularly at the chief money centers. Another method of redemption for notes of both active and liquidated banks is immediate redemption by a guarantor. In the United States, national bank notes are redeemed by the federal Treasury upon demand, from a fund contributed by the banks and recouped by sale of pledged securities and other assets, the government, at least by implication, thus guaranteeing redemption. The best means of assuring ability to redeem on demand is to require that the issuing bank keep in its vaults, or with some nearby institution, either a fixed amount of gold or an amount bearing a fixed minimum ratio to the notes issued. The federal reserve banks, for instance, are required to hold gold equal to 40 per cent of the federal reserve notes issued.