They release capital tied up

In fixed forms of wealth

In the same way banks may restore control of wealth which has been released on credit to others. This is the essence of discounting. A manufacturer, for example, sells a bill of goods to a wholesaler. The wholesaler does not pay cash but offers instead a ninety-days' acceptance. The goods which the wholesaler receives represent a part of the manufacturer's personal fund of capital invested in his business. For the time being the manufacturer surrenders control of this part of his capital, and if he himself holds the acceptance until maturity it means that, in the interim, if he is to maintain his output on the same scale as before, he must draw more heavily on his own resources. If he has not such resources to fall back on the sale of goods on credit would cripple him as a producer. The possibility of discounting his customer's paper, however, saves the manufacturer from this embarrassment. Through the bank discount the claim to liquid funds maturing at a future time is transformed into liquid funds immediately available. With liquid funds so secured the manufacturer can immediately buy more raw material, etc., and his productive efforts are not in the least impaired. The purchase by the banks of bills of exchange, promissory notes, etc., constitutes thus in essence the reëstablishment of the producer in the control of his personal capital, of which he has in the course of his business surrendered particular embodiments to others. The gain to society is in the maintenance of a given tempo of wealth production - the entrepreneur is not forced to slacken his pace because of a surrender of a part of his capital.1

In advances of goods to others

1 The sale of goods on credit is here assumed simply as a fact. Yet it might be argued that were there no sales of goods on credit

Correlated with this function of releasing to the entrepreneur capital tied up is another of equal significance, namely that of supplying the capable entrepreneur with capital that he would otherwise not obtain. Some business men who have proved themselves honest, capable, and far-seeing can oftentimes get advances from bankers on no security other than their personal notes. These cases are, of course, exceptional, because the risk involved for the banker is great, but instances are found in sufficient number to make the type worthy of notice. Indeed we have examples on an important scale in the system of "cash credits" in Scotland, and in the daily practices of the Canadian banking system. Furthermore in the cooperative credit systems of Europe, the idea of banking on personal integrity and capacity with joint responsibility has grown to a system of huge proportions.

The banks which make advances on purely personal security are thus really coining into a medium of exchange, honesty, skill, and ambition, - they are in other words transforming into "liquid" capital productive capacity itself. The gain to the individual is of course apparent. His increased credit is equivalent to an addition to his own possessions; his operations are extended and his returns are multiplied. Society too makes a considerable gain. Individual capacity is more fully utilized and wealth is produced that would otherwise not be produced. Indirect consequences often result that are of even greater significance. The system of cash credits is given as the explanation of Scotch prosperity,1 and in Europe it is shown that the cooperative credit societies have in numerous cases improved not only the economic situation of the peasants but their moral and spiritual condition as well.1 It is to society's interest to have every producer capable of making a substantial contribution to the sum-total of wealth supplied with the capital necessary to his effort.

They coin ability and integrity there would be no necessity for the service of the bank in releasing or restoring capital surrendered to others. But it could easily be shown that the extension of credit in the sale of goods has economic advantages in variety of choice, promptness of utilization, etc. The cost of such credit must, of course, be finally covered in selling price, but large scale production, involving large volume of output, yet ultimate unit distribution of product, would hardly be possible without wide extension of credit.

1 See, for example, H. D. MacLeod, Theory and Practice of Banking.

There remains a final point to be discussed in connection with the economic services of banks. Social interest is best subserved when the price charged by the banks for advances of funds is as low and as uniform as possible throughout the domestic market.

This price charged by the banks is found in their discount and loan rates. Repeated reference has been made in the previous discussion to the widespread use of credit in modern production. There are relatively few business firms that are not more or less constantly dependent on the banks for discounts and advances, and the prices that business men receive for their goods and services must be high enough to cover the expense of banking accommodation as well as the other expenses that arise in the conduct of business. In other words the discount rate for "money" enters as one of the regular costs of production that must be covered in the selling price if business men are to remain in the field and make their contribution to the supply of their respective commodities. If cost of production be low then price to the consumer tends to be low because of the effect on supply in competitive production. Hence a reduction in one of the important elements in cost, or the maintenance of such an element on a relatively low basis, tends to redound to society's interest through a lowering of final selling price. In short men have to give less of themselves to get their needed or desired wealth than they would otherwise be obliged to give.

Not only is a generally low discount rate socially advantageous in an active and progressive economic society, but it is also desirable to have the rate as uniform as possible throughout the domestic market. The competitive organization of industry rests on the assumption that in the long run the most efficient producers will supplant the less efficient. But the efficiency here involved is the all-around inherent capacity of the individual himself. With respect to all the circumstances beyond the individual competitor's control it is desirable to have as close an approximation to uniformity as possible. Any purely fortuitous advantage enjoyed by a limited number of competitors gives them a handicap in the race. Railroad rebates furnish a case in point. Discriminatory rates, when extended, go usually to the large and powerful shipper and not by any means necessarily to the most efficient shipper. A large part of the success in this country of some of the big monopolistic combinations in their competition with smaller rivals has indisputably been due not to superior productive efficiency, but in many cases to special advantages of one kind or another. The special advantage may, ac-cording to its scope and nature, be a cloak for inefficiency and weakness, and it is desirable, therefore, in the social interest to eliminate all special advantages. There can hardly be any question that differences in the rates paid by competitors for bank accommodation may give rise to such a special advantage in favor of him who pays the lower rate. One important element in his costs is made lower for him than the corresponding element in the costs of his competitors. Of course this very discrimination in rates may itself be simply an indication of differences in efficiency. The firm getting the lower rate may have established an enviable reputation for honesty and promptness in meeting its obligations. On the other hand it may simply be operating in a market where money rates rule lower than they do elsewhere and in this case the lower discount rate gives such a firm a discriminatory competitive advantage. In general then it may be said that in so far as discrimination in discount rates arises as a result of circumstances bevond the control of borrowers of bank funds it is desirable from the social point of view to eliminate such discrimination.

Their services greatest when their rates are low

Uniform rates also desirable

1 H. W. Wolfe, People's Banks (1910).

Summing up the several points that have been advanced in this chapter it may be said that by stimulating saving, by economizing in the use of capital set aside for the purpose of facilitating exchanges, by promoting the productive investment of saved wealth, by facilitating the rapid utilization of available capital implements, by releasing to the entrepreneur capital tied up and by supplying to the capable entrepreneur capital not otherwise obtainable, banks not only promote the most economical use of capital but they also afford a stimulus to the whole productive process and enlarge the opportunity of individuals with capacity, assuring to society at the same time a fuller utilization of that capacity. Indeed, it might almost be said that modern large-scale production with its necessarily round-about method, with its sale of goods on credit, and with its large dealings would be practically impossible without banks. The dynamic influence of bank credit in a system characterized by rapid flux and readjustment can hardly be exaggerated. The social gain from banks will be at a maximum, however, when, with other things equal, the banking system is so organized as to permit a uniform as well as a low discount rate throughout the domestic market.

The responsibility of the modern banker is heavy. Through the decisions that he makes in extending credit he controls to a considerable extent the flow of the community 's capital. His ability to understand and to measure human nature may mean the fulfilment or the destruction of the hopes of the individual, and upon his temperament and his judgment may hang the prosperity of the whole community. If he acquit himself well of the responsibility that is laid upon him he deserves a high reward, but if he be negligent, irresponsible, and self-seeking, his removal from the field of banking should be as prompt as circumstances will permit.

Summary

Selected References

C. A. Conant, Principles of Money and Banking (1905), Book IV, Chapter VI (Domestic Clearings And Exchange); Book V, Chapter III (The Economic Services Of Banks).

J. Laurence Laughlin, Editor, Banking Reform (1912), Chapters XVI-XVIII inclusive.

H. Parker Willis, American Banking (1916), Chapter I (The Bank'S Operations).