A system of centralized reserves and of monopolistic note issue must make both reserves and bank notes available to its constituent local banks. In this connection it may be noted that in the Federal Reserve System the deposit balances of the member banks in the federal reserve banks may, as already indicated, be counted as reserves by the member banks. This is, of course, a necessary corollary of centralized reserves. These deposits may be checked against by the member banks or be simply drawn down in reserve notes or in lawful money. The important consideration for the member banks is, therefore, the maintenance of adequate balances with their several federal reserve banks.

Deposits in reserve banks lawful reserves for member banks

This is made possible by the provisions for rediscount-ing. ' With the indorsement of a member bank, the federal reserve banks may discount for such member bank, notes, drafts, and bills of exchange arising out of actual commercial transactions. The law imposes on the Reserve Board the responsibility of determining the character of such paper, but it specifically declares ineligible notes and bills covered by, or put out for carrying, stocks and investment securities, except notes and bonds of the United States government. On the other hand, it provides that paper secured by agricultural products or other goods and merchandise shall not be declared ineligible. The obvious purpose of the discrimination against investment and similar paper is to discourage security speculation. Bills acceptable for rediscount may not run longer than ninety days, exclusive of days of grace. Here too an exception is made in favor of the rural borrower, in that bills issued for agricultural purposes and those based on live-stock may have a six months' maturity. The amount of these longtime bills, however, must be limited to such a percentage of the assets of the reserve bank acquiring them as may be determined by the Federal Reserve Board. In order to control the utilization of the advantages of the Federal Reserve System by banks which are unwilling to assume corresponding obligations, it is provided that, in applying for or receiving discounts, a member bank can act for a non-member only with the express permission of the Federal Reserve Board. Lastly, it may be mentioned that, according to an amendment adopted in August, 1916, a reserve bank may make advances to member banks on their promissory notes, for periods not exceeding fifteen days at rates established by the reserve banks but approved by the Reserve Board, provided that these notes are secured by "such notes, drafts, bills of exchange, or bankers' acceptances" as are eligible for rediscount or for purchase by the reserve banks, or provided that they are secured by the deposit of bonds or notes of the United States. In other words, if a member bank has on hand eligible paper that it prefers to keep rather than to rediscount, or if it holds or can obtain government bonds or notes, it can offer either or both as collateral for a direct loan.

Redis-counting

Paper eligible

On the whole, therefore, it may be concluded that the question of obtaining till-money or that of strengthening reserves is simply one of having on hand an adequate supply of bills acceptable for rediscounting, or of bonds or paper that can be used as collateral for a direct loan.

In connection with rediscounting, however, one important question remains. This relates to the provision made for one reserve district to get the advantage of possibly redundant reserves in other districts. Nothing is as effective in bringing about a free flow of funds as an open discount market. With such a market each bank buys or sells according to its own needs. If the paper available be of the proper character, and if the interbanking relations be such as to inspire the necessary confidence, this free flow of funds may not only characterize the nation as a whole, but may also enter as an important possibility in international operations.

Understanding the advantage of an open discount market, the framers of the law endeavored to provide at least some of the facilities necessary to its creation. Provision was made for the creation of bankers' acceptances. As the law now stands, member banks may accept drafts and bills of exchange growing out of exports and imports up to one-half of their paid-up and unimpaired capital, or with the permission of the Federal Reserve Board, up to the full amount of such capital. Moreover, they can accept bills growing out of domestic transactions but not in excess of one-half of their paid-up capital and Surplus, provided that shipping documents conveying or securing title are attached to the bills at the time of acceptance, or provided that the bills are secured by warehouse receipts, etc., conveying or securing such title. The transaction covered must involve readily marketable staples. The amount of acceptances for one individual firm, etc., is limited to 10% of the bank's paid-up and unimpaired capital and surplus unless the bank is secured either by attached documents or by some other actual security growing out of the same transaction as the acceptance. For bills with strong banks as acceptors there ought to be a wide demand. Such bills ought to flow wherever the rate of discount is lowest. To facilitate this dispersion, the law permits the federal reserve banks to discount these acceptances when they have the indorsement of at least one member bank. Moreover, as a further important factor in helping the free flow of funds, the law permits the reserve banks to buy and sell in the open market acceptances and bills of exchange eligible for rediscounting, and the open market purchases need not have the indorsement of a member bank. Finally, should it be impossible to build up an open market, or should the possibilities of such a market prove at any time inadequate, there is the provision that the Federal Reserve Board may permit, and, on vote of five members may compel, the reserve banks to rediscount for each other at rates fixed by the Board itself.

Inter-district flow of funds

Basis of an open discount market