The most serious defect in our banking system in the past has been the scattering of the reserves among twenty-five thousand banks, and the absence of any central reservoir from which these banks could draw cash in times of urgent need. This defect was magnified by the permission given to all national banks, except those located in the three central reserve cities, to keep a part of their legal reserve in other cities. This redepositing of the reserves in the larger cities was in part necessary to allow banks in the smaller cities to provide their customers with exchange on cities where they purchased goods. Banks in reserve cities were willing to pay interest on these bankers' balances because they increased the loanable funds of the bank, no more legal reserve being required than in the case of individual deposits. As a consequence the idle funds of the country and reserve city banks drifted to the central reserve cities, especially New York. Since the New York banks were compelled to stand ready to return these deposits on demand, and since there was no rediscount market where they could convert their discounted paper into cash, these bankers' deposits were employed largely in making call loans to Stock Exchange speculators. Then, when some commercial or financial disturbance occurs and a panic breaks out in New York, "where every panic of the last decade has started," the banks there call their loans and in self-preservation suspend payment. Though the rest of the country may be highly prosperous, banks everywhere follow the lead of New York in suspension, on the theory that they cannot get possession of their reserves in other cities. At such times all banks are further handicapped by the prohibition against lending after their reserves fall below the legal requirement. It should be noted, however, that the failure of the New York banks to return their correspondents' reserves when thus called for "is not due to flagrant disregard of their obligations, but to the defects inherent in the situation, the evils of which they cannot overcome. The reserves are 'fictitious' in that instead of being a cash reserve, as would be indicated by the name, they are paper reserves. That is to say, they have been built up through the deposit of checks, drafts, and other negotiable paper, and as a matter of fact the New York banks have never had, and could not secure, without a complete disorganization of commerce, the cash equivalent of the redeposited reserves of the country banks with them."1

The new reserve plan created by the Federal Reserve Act provides for the gradual shifting of the deposited reserves of national banks from other national banks in reserve and central reserve cities to the twelve Federal reserve banks. All member banks must hold their reserves either in their own vaults or with the Federal reserve bank of which they are members. Instead, therefore, of the concentration of a considerable part of the reserves in New York, and to a lesser degree in the other central reserve cities, where in times of financial disturbance they have proved unavailable, the reserve funds of member banks will be kept in their own district, where they will be held in such form as to be promptly available to meet any emergency that may arise in that district. Provision is made, also, for one region to come to the aid of another when occasion requires. Though still retaining a specific minimum reserve against deposits, the proportion is reduced, and a distinction is drawn for reserve purposes between time deposits and demand deposits. Demand deposits are defined in the Act as those payable within thirty days, and time deposits comprise "all deposits payable after thirty days and all savings accounts and certificates of deposit which are subject to not less than thirty days' notice before payment." The reduction in the proportion of reserves to be held against demand deposits is as follows: country banks, from 15 per cent to 12 per cent; reserve city banks, from 25 per cent to 15 per cent; and central reserve city banks, from 25 per cent to 18 per cent. In the case of time deposits all banks alike are required to keep a 5 per cent reserve. This reduction in reserve ratios is slightly offset by the provision that the five per cent redemption fund held in Washington against outstanding circulation can no longer be counted as part of the reserve.

1 Conway and Patterson: The Operation of the New Bank Act, p. 208.

The Act provides for the gradual withdrawal of reserve funds from existing reserve agents, and after three years, only cash in vaults and balances with Federal reserve banks may be counted as reserves. For a period of twelve months after a Federal reserve bank is officially established, all country bank members must keep two-twelfths and reserve city bank members three-fifteenths of their required reserve on deposit in said Federal reserve bank; for each succeeding six months country banks must deposit an additional twelfth and reserve city banks an additional fifteenth until the total of the former amounts to five-twelfths and of the latter six-fifteenths. Member banks in the central reserve cities must from the outset keep seven-eighteenths of their required reserves with the Federal reserve bank of their district. After the three-year period the distribution of reserves between the member banks and the Federal reserve banks must be as follows: country banks, at least 4/12 in cash in vaults, 5/12 in Federal reserve bank, and 3/12 in either, at the pleasure of the bank; reserve city banks, 6/15 cash in vault, 6/15 in reserve bank, and 3/15 in either; central reserve cities, 6/18 cash in vaults, 7/18 in reserve bank, and 5/18 in either. As will be seen, the transition in reserves will be gradual: for a period of three years member banks may keep a part of their reserves with other banks as heretofore, but though they may continue to keep funds with these correspondents, as they are likely to do until the Federal reserve banks are sufficiently well established to provide equally satisfactory collection and exchange facilities, they cannot after three years count these balances as reserves.

During the three-year period of transition, state banks and trust companies entering the new system are put upon the same basis as national banks by the following provision: "If a State bank or trust company is required by the law of its State to keep its reserve either in its own vaults or with another State bank or trust company, such reserve deposits so kept in such State bank or trust company shall be construed, within the meaning of this section, as if they were reserve deposits in a national bank in a reserve or central reserve city for a period of three years after the Secretary shall have officially announced the establishment of a Federal reserve bank in the district in which such State bank or trust company is situate. Except as thus provided no member bank shall keep on deposit with any nonmember bank a sum in excess of ten per centum of its own paid-up capital and surplus."1

To enable the banks to avoid contraction of their loans, which might otherwise be occasioned by these withdrawals of funds from reserve and central reserve banks and by the payment of subscriptions to the capital stock of the Federal reserve bank, the Act provides that one-half of the required deposit of reserve to be placed in these reserve banks may be received in the form of paper eligible for rediscount.