To more clearly illustrate the operation of the old law in this respect let it be assumed that a country bank having net deposits of $1,000,000 was required to maintain a reserve in lawful money of fifteen per cent. - $150,000. Two-fifths of this amount, $60,000, was required to consist of cash in bank, and the remaining three-fifths, $90,000, might consist of balances due from approved reserve agents in reserve cities.
Now this country bank had on hand $90,000 of its own notes, or the notes of other national banks, which could not be counted as reserve. In order to make these notes available for reserve purposes the bank sent them to its reserve agent and received credit for a like amount as lawful money reserve.
The reserve city bank from which this credit was due was required to carry a reserve against this deposit of twenty-five per cent., or $22,500. One-half of this amount, or $11,250, might consist of a balance due from its reserve agent located in a cen-tral reserve city. The bank could not count any part of the $90,000 of national bank notes received from the country bank as reserve so it sent the entire amount to its central reserve city agent, received credit therefor, and counted $11,250 of such credit as part of the lawful money reserve required to be held against the $90,000 deposit of the country bank.
The central reserve city bank was required to carry a reserve in lawful money of twenty-five per cent., all of which was required to be held in its own vaults. No part of the national bank notes received from its reserve city correspondent could be counted as reserve, so the whole amount was shipped to Washington for redemption and the bank received in exchange therefor an equal amount of legal-tender notes.
The $90,000 notes of the country bank were redeemed and charged by the Treasurer of the United States to the bank's five per cent. redemption fund and such of the notes as were fit for use were returned to the country bank and new notes were issued in place of those destroyed as unfit for circulation. Then the process above described was renewed in an endless chain operation.
Now how much lawful money reserve was actually held against this $1,000,000 of deposits in the country bank? As has been stated, the amount required by law was $150,000.
The country bank held six per cent., or......
The reserve city bank held twelve and one-half per cent., or.........................
And the central reserve city bank held twenty-five per cent., or.....................
Instead, therefore, of a reserve of $150,000 being held against the $1,000,000 of deposits, only $93,750 was actually held, or a fraction over nine per cent. instead of fifteen per cent., as the law required.
There is still another feature of this law which was misleading in its operation and created a fiction in bookkeeping.
The original $150,000 reserve required to be carried by the country bank against the million dollars of deposits was shown on the books and in the reports and published statements of the three classes of banks at a total of $180,000, as follows:
The country bank reported:
Due from reserve agent........................
The reserve city bank reported:
Due to country bank.......................
Due from central reserve city bank
The central reserve city bank reported Due to reserve city bank........
The payment of interest by city banks on balances due country banks in excess of exchange requirements was, therefore, not the only incentive to the concentration of bank deposits in the city banks.
The reports of condition of national banks for August 22, 1907, the date of the last call previous to the panic of 1907, show that on that date the amount due to banks and bankers from national banks in New York City alone aggregated over $465,000,000 and in addition thereto over $145,000,000 was due country banks, which had been placed in New York City banks to be loaned for account of the former.
Some authorities and writers on banking and currency strongly advocated the concentration of funds at the principal financial center of the country, and predicted that New York City would eventually become the financial center of the world, but the panic of 1907, and other financial disturbances, demonstrated in a very practical manner the evil results of such concentration under the then existing system of currency.
No commercial bank should pay interest on deposits subject to check or withdrawal on demand, either to banks or individuals, but competition with trust companies and other banking institutions operating under State authority has forced national banking institutions into many undertakings not authorized or con-templated by the National Bank Act and foreign to the legitimate functions of commercial banks.
The payment of liberal and, in many cases, excessive rates of interest by trust companies and State banks has compelled many competing national associations operating in the same place or locality to offer like inducements for deposits and, in order to find profitable employment for such surplus funds, to make loans or investments of a more or less hazardous or speculative character.
The policy of allowing interest on deposits subject to check and payable on demand is foreign to the spirit of sound commercial banking and the tendency of such a practice is not to materially increase the earning power of the bank, but to greatly en-danger the safety of the funds of depositors.