By these are meant securities which mature in a short time, the chief representatives of which are the bills of exchange and other forms of paper which come into existence as a result of the operation of the credit system. These have already been referred to as the chief objects of bank investment, and for this purpose their superiority to other forms of securities, such as bonds or stocks, has already been pointed out. We will here indicate the circumstances and the forms of legislation which tend to constrain banks to confine their investments chiefly to this sort of paper, and thus to prevent overstraining their credit.
Among these, of first importance are the actual needs of business men for coin and other forms of legal-tender money. Inasmuch as the greater part of the money of all kinds which is received in the ordinary course of business is deposited with banks, these needs show themselves in the form of demands upon the banks for cash. How are these demands to be met? One of the means is the new deposits which are daily made. A considerable portion of the cash which a bank pays out one day will return to it in the form of deposits in a comparatively short period of time. Exclusive reliance upon this means, however, is quite out of the question. In the first place, a margin over and above what is absolutely called for each day must be kept in order to ensure safety; and in the second place, it is evident that no bank can absolutely rely upon a return to it of all the cash which it pays out. Deposits are quite as apt to take the form of checks on other banks as that of cash, and the proportion of these elements in deposits is liable to vary from day to day. Moreover, cash once paid out may find a permanent lodgment in the pockets of the people; some of it may be lost; and a third portion may travel outside of the community to some other section. The latter fact must be taken into consideration especially by banks in large centres which have extensive connections in other cities and in rural districts. Demands for cash in such instances may come from out-of-town places and must be provided for. For instance, during the autumn New York City banks are obliged to meet large demands for currency made upon them by institutions in the western part of the country. They cannot count upon the return of this cash before the lapse of several months, and in the mean time they must provide themselves with means for meeting local and regular demands. In these cases the chief reliance must be placed upon bills of exchange and promissory notes running for short periods of time. A bank which invests a considerable portion of its funds in this class of securities may so arrange its investments that a fair percentage of its securities will fall due each succeeding day, thus ensuring the payment into the treasury of the bank either of actual cash or of the means of securing it from other institutions or the government. In times of exigency securities of this sort may also be rediscounted and thus turned into cash even before their maturity.
While in general the self-interest of banks may be relied upon to secure the investment of an adequate amount off their funds in liquid securities, it has been found desirable in some countries to ensure this condition of things by legal enactment. In the United States the National Banking Act indirectly secures this end by prohibiting banks from investing in real estate except to the extent necessary for the accommodation of their business or to protect themselves against losses occasioned by the failure of their creditors to pay their debts on maturity. The laws regulating the banking business in Germany secure this end by providing that two-thirds of the authorized circulation of every bank of issue shall be covered by bills of exchange maturing in not more than three months and bearing not less than two solvent names.
The desirability of some sort of legislation to prevent investments in unsound and unwieldy securities is beyond question. Bankers are not so unlike other men that they can always be relied upon to resist the temptations offered by enterprise promoters and friends in financial straits. However, the various laws which have been described are efficient in this direction in very different degrees.
Another method of accomplishing the same end is through the statutory regulation of the cash reserves. According to the laws of the United States national banks are grouped into two classes, and the requirement is made that the one class shall keep a cash reserve equal to twenty-five per cent, and the other one equal to fifteen per cent, of their deposits. In the former class are placed banks in the so-called reserve cities, which have a capital of at least $200,000 and are permitted to receive on deposit a portion of the cash reserves of other banks. This requirement is rendered efficient by the regulation that if a run or some other unforeseen event should reduce the cash reserve temporarily below this limit, the bank must stop discounting until it is restored.
Commendable as is the purpose of this legislation, it is open to serious objections. In the first place, it is difficult to classify banks according to their needs for cash. Different localities make very different demands upon their banking institutions, much depending in this respect upon the nature of the business carried on and something upon the customs of the region. Hence, when all banks are placed in two classes, one of two results is quite certain to follow. Either the limit set by law will be so low as to afford no real protection, or it will be in some cases so high as to seriously interfere with the accommodation which the banks ought to be able to render to the business of the community. The weight of this objection becomes more apparent when we consider the effects of the clause requiring banks to stop discounting as soon as their cash reserves fall below the legal limit. This regulation makes these reserves practically useless at the time when they are most needed. Cash reserves are most apt to be infringed upon in times of incipient or actual crisis, and it is precisely on such occasions that banks should be able to accommodate business men to the greatest extent possible, that they should be able indeed to discount first-class securities in even greater amounts than in ordinary times. The provision in question, however, absolutely prevents this, and thus is apt to exaggerate the conditions which characterize such periods of industrial unrest. When it is remembered that the note circulation of our national banks is incapable of expansion to meet such an exigency, it will be seen that this regulation renders their currency absolutely inelastic in times of crisis, and thus tends to throw an undue portion of the burden of such times upon the state and private banks.