Normal time variations may be taken care of by bank without external aid

Extraordinary increases of demand require outside aid

Time variations and centralized reserves

Even under decentralized reserves, however, considerable mobility is attainable. A variety of expedients may contribute to this end.

In the first place there may be a broad loan and discount market, in which borrowing and lending and the buying and selling of discounts is on so large a scale and over so wide an area that banks as well as individuals may confidently rely on finding in it lenders of funds or purchasers of good paper. The development of such a market depends upon the existence of large quantities of widely acceptable securities or credit instruments, and upon the possession by those in need of funds of adequate supplies of such securities and instruments. In the United States there has developed a commercial paper market through which the paper of large, well-known firms is widely distributed among the banks of the country. While this is of advantage to the firms concerned, it is of no great benefit to banks when the necessity for strengthening reserves presents itself.

Other expedients also may be relied upon. There may be, for example, fairly wide voluntary bank affiliations which make possible mutual assistance in times of pressure. Again, special forms of investment may be employed to build up a secondary reserve. Stock exchange securities and call loans based on such securities have been extensively employed by banks in the United States. Moreover, special expedients may be initiated when circumstances demand it. Thus resort to the issue of "clearing-house loan certificates" which are accepted as a substitute for cash in settling clearing-house debit balances, has been frequent and widespread in the United States. In essence the issue of such certificates is a means of locally centralizing reserves and of supplying to the banks a place where loans and rediscounts can be arranged.

Mobility under decentralized reserves

Facilities afforded by a broad loan and discount market

Bank affiliations, etc.

In the absence of these or similar expedients, or where the available expedients are but irregularly resorted to, anticipated stress may lead to unnecessary hoarding just at a time when credit facilities should be freely extended. The only alternative to such hoarding is a regularly maintained high average of reserves, which is uneconomical and which would probably also not be high enough for serious emergencies.

The strengthening of reserves by individual banks to meet an increased demand for their facilities is possible only when they can get more cash or when, as already indicated, relatively excessive reserves elsewhere are accessible to them. Attention may now be directed to the question of procedure in both of these cases.

At a given moment the only source of additional cash for reserve purposes for banks is that which is in general circulation. But drawing cash from circulation offers but an uncertain reliance in this direction. In times of stress deposits of cash with banks are not increased. Indeed they are frequently diminished, and the banks may even lose cash through withdrawals by some of their more timid depositors or noteholders. Hence an increase in a bank's cash holding through withdrawals of money from circulation is not to be seriously counted on as a means of strengthening reserves.

Relatively excessive reserves elsewhere must, therefore, be relied upon. The question then arises, under what conditions and by what methods will these reserves be made accessible?

Absence of proper expedients means high average reserve

Strengthening of reserves requires more cash or mobility of reserves

Cash from circulatior an uncertain reliance

Under what conditions are reserves made accessible?

Under centralized reserves it is first of all necessary that the individual bank's deposit with the reserve-holding bank be regarded as equivalent to a cash reserve in its own vaults. Were this not so, the individual banks would, to the extent that reserves were necessary, have to carry their reserves in their own vaults. That would imply the opposite of centralization. Under a system of centralized reserves, therefore, the question of strengthening reserves is, for individual banks, in the main, simply a question of strengthening balances with the central, reserve-holding agency.

A bank may strengthen its balance with the reserve bank either directly or indirectly. It may proceed directly by dealing with the reserve bank itself. It may, first of all, obtain a loan from the reserve bank, with or without collateral, and the loan so obtained may be added to its balance. Or it may sell to the reserve bank some of its investments, if these be of satisfactory character, and the purchase price may then be added to its balance.

A local bank may proceed indirectly by dealing with other banks like itself rather than with the reserve bank. It might, for example, arrange for a loan from other banks. The proceeds of such a loan would presumably be paid over by the lending banks in the form of checks drawn on the reserve bank, which checks would then be deposited by the borrowing bank to its own credit at the reserve bank. Or, instead of borrowing from other banks, the bank concerned might sell to them some of its own investments, obtaining from them, as in the case of the loan, checks drawn on the reserve bank. Lastly, the bank of our example might sell in the open market, if there were such, some of its investments available for open-market operations. Stocks and bonds or discounted paper might be offered for resale, and the proceeds obtained could then be used to strengthen balances at the reserve bank.

Requirements under centralized reserves

The strengthening of balances with reserve banks

Dealings with other banks