The banker is a broker between two principals, but he differs in one important detail from an ordinary broker. In Mincing Lane the broker finds a buyer for the tea merchant; there his action ends. He charges a commission for the service he has rendered, and withdraws. Not so the banker: he does one thing more, and it leads to extensive consequences. He guarantees the solvency of the borrower whom he finds for the depositor, He chooses the man who shall buy in the stead of the farmer, and does not even declare his name. The deposit of purchasing power passes wholly into his own hands, but on one most serious condition, that he shall return it to the depositor on demand. He has lent means to the tea merchant which belong to the farmer, and the farmer may ask for them back at any time. This fact presents a grave difficulty. It is impossible that a tea merchant, still less a manufacturer, should purchase tea or cotton with funds that he may be required to repay at any moment. On such a condition, banking, so far as it lends means to traders, would be impracticable: a banker would be reduced to the necessity of investing the farmer's purchasing power in buying Exchequer bills, or Government bonds, capable of being resold at any time without any probable loss. But experience teaches him that he is under no such necessity. He discovers that in ordinary times, with a large number of depositors, demands for immediate repayment of deposits are subject to a general law of average on which he may safely rely, and that average falls far short of his receipts. If one depositor suddenly . runs his account down very close, other depositors are found to be coming in, without any probability of early cheques for repayment being drawn by them. On this fact, revealed by experience, the banker is entitled to place the same confidence as a Life Assurance Company has to build on tables of the average rate of mortality; and he further establishes an understanding with his depositors that they shall generally leave a fair balance in his hands.
This fluctuation in the cheques drawn upon him by his depositors exposes the banker at all times to pay on a given day more than he receives, and thus compels him to provide a certain amount of cash ready in hand to provide for such a contingency. He is consequently unable to lend all that he receives. He cannot authorise borrowers to draw cheques on him to the full amount of those he has to collect; the difference will reach him in cash; that cash he keeps as a reserve against sudden demands. That reserve furnishes him with protection against the risk of committing an act of insolvency by being unable to obtain back his loans as fast as his depositors demand repayment. It might be, indeed almost always is, a question of time. He has lent on terms more or less long. The bills he has discounted may be perfectly sound, but they are not yet due. He may possess much wealth, but it is not accessible at the moment, or the man to whom he has made a loan may not be ready to repay. Security against this danger, inherent in modern banking, is the object of the reserve.
The magnitude of the reserve, which prudence counsel every banker to provide, is a question of great practical importance. The reserve entails a diminution of the banker's profits; it is coin and banknotes not used, but kept in store; hence, he has a strong motive of interest to make that reserve as small as possible. Still safety is the paramount consideration. How large a reserve then ought a banker to keep? That will vary with the particular circumstances of each bank. A bank in a quiet agricultural district, fed by rich landowners and steady farmers, whose habits are regular and well-known, will be safe with an exceedingly small reserve. A bank in London or New York, whose depositors are engaged in wide commercial operations, liable to heavy and sudden losses, dealing with distant markets, and are exposed to unexpected contingences, such a bank will require a reserve of much larger dimensions, relatively to the amount of the business which it transacts. Thus there is no fixed rule for the size of a reserve; it is a matter for the intelligence and judgment of each banker. But in every case - and this is the supreme point - safety, protection against being found actually without the cash imperatively demanded by depositors, is the one sole reason for the existence, the one sole law for the management of the reserve. No other reason can be assigned that will bear a moment's consideration. Everything which is urged in support of a reserve, which pleads some other law of the reserve, resolves itself ultimately into the absurdity of the Mercantile Theory, that it is a good thing for a country to import gold into a country for the gold's sake, to be kept like jewels locked up in a wardrobe and never worn, - bought at a large cost, and sentenced to utter useless-ness, so far as it is in excess of the demand for small change which society requires, and of the need of reserves of reasonable amount.
In a nation whose trade is spread over the whole world, such as England, and must necessarily encounter the varying circumstances of many countries, bad harvests, wars diminishing industry, foreign commotions striking down the supply of a chief material of industry, such as cotton, trade must fluctuate, and along with trade the funds at the disposal of banks. Thus the equilibrium between receipts and lendings becomes a matter demanding high intelligence and skill from every banker. His reserve must vary, at times enormously. It is natural that he should watch it with a jealous eye. His reserve is composed of gold and notes; and when he finds them diminishing, what more natural than that he should believe that there are too few notes and too little gold in circulation? Give England more gold, cry her bankers, and her reserves will be strong: get more gold and notes into circulation, exclaim trembling merchants in England and America, and bankers will have more to lend us and on cheaper terms. That is, in fact, to say - operate on three parts in a hundred of the resources of banks, and there will be plenty to lend and discount will be easy, even though banking may carry out its transactions, without money, in a single city to the extent of one hundred millions of pounds a week. Such a doctrine is an absurdity on the face of it. Anxious banking and high rates of discount are shown by facts to accompany often large reserves and an expanded circulation. The gold in the bank cannot be lent, and is not lent, the urgent needs of traders notwithstanding. The fact is clear for one who understands the nature of currency. Coin and notes are wanted for those transactions which are effected by their agency; and these are insignificant trifles compared with the transactions carried out by the agency of banking. The transactions in both cases are exchanges of goods; and it is in what is happening to goods, to property, and not in what is happening to the tools that move their ownership, be they metal or cheques, that we must seek for the causes of these anxious times and elevated discount. More gold from Australia, more notes issued, beyond what there is a specific demand for to be used, go into the vaults and tills; they cannot be issued, and are not, whatever may be the pressure in the money market. But this is a fact which banking oracles steadily refuse to perceive. It is perfectly possible - and it has happened over and over again - that a very tight money market with a severe rate of discount, or that an easy money market with a very low rate, should co-exist with the same amount either of circulation or of cash reserve. The gold flowed in or out, as the balance of trade or the payment on debts due by foreign countries required, or as the miners chanced to send it to England in scarcity or abundance; but these same causes may and do go along with pressure or ease in the City.