In his earlier reports Mr. Hulburd devoted a good deal of attention to the practice which prevailed to some extent among the banks at that time of paying interest on bank balances. He criticised and condemned this practice in severe terms, and quoted the Chancellor of the Exchequer of England as declaring in his comments on the causes which led to the crisis of 1857, as "one eminently liable to abuse, and containing within it the elements of danger."
Notwithstanding the criticisms of Mr. Hulburd, however, this practice, which he so strongly condemned in 1867, steadily increased with the growth of the national system until it became almost a universal custom among the banks, the evil effects of which, as he predicted, were shown in some of the panics of later years.
The contention of Mr. Hulburd was that country banks should keep deposits with city banks only for the purpose of facilitating exchanges in carrying on their own legitimate business, and that the funds so placed should not be allowed to exceed the amount actually necessary for the current demands of their business. He contended that -
The payment of high rates of interest on bank balances attracts all the spare capital from the country to the commercial centers. It is drawn away from the country where it is needed to the business centers where the rate of interest is higher. The cities then come in competition with the country and compel borrowers in the country to pay higher rates for loans.
He quoted M. Pereire, the President of the Credit Mobilier of France, as saying that "Banks are instituted only to lower the rate of interest and they fail in their mission when they do not fulfill that character." Mr. Hulburd said:
The city banks by the payment of interest offer a premium for deposits, the volume of which should he regulated only by the ebb and flow of trade. An artificial stimulant is applied, in order to accumulate funds in excess of the natural demand. So long as the country banks can employ their means more profitably at home, they will do so, but when their own trade is dull they will send their money to the business centers. And it so happens that the city banks will secure the greatest abundance of means exactly at the time when they have the least use for them. But, as they pay interest for such deposits, they must be used. The city banker becomes a broker, seeking after investments. He must get more interest than he pays, or he will lose money. He must loan it on call, for it is payable on demand, and it always will be demanded when he wants it the most. Deposits are the reserve of the country, and the deposits of the country banks at the centers of trade are their reserves for all demand liabilities. Banks were required by law to keep a reserve of fifteen per cent. of their deposits, three-fifths of which may consist of balances due from the city banks. Forbidden to use their reserve in their own business, they remit it to New York, where it is not held in reserve, but is loaned to stockbrokers and speculators. Receiving interest on the amount under the name of a deposit, they really loan it on call to the city banks, which in turn loan it at a higher rate of interest.
A bank may know the character of its individual deposits, and may be able to judge with some degree of accuracy of the extent to which it would be safe to use them. But of the deposits of another bank and of the causes that may create a demand by its customers, no reliable estimate can be formed further than that such deposits reach their maximum at the dullest season of the year, and their minimum at the season of the greatest activity in business. Bank balances are working balances, not surplus capital seeking investment. They ought not greatly to exceed the amount necessary for the convenient transaction of business. The city banks are equally interested with the country banks in preserving healthy and natural relations between the centers of trade and their tributaries. Any influence that interferes with such relations cannot be beneficial, and the allowance of interest is an unnecessary interference, the termination of which would promote the interest of both parties to the arrangement and secure greater safety to the public whose reserve funds are at stake under the practice alluded to.
Mr. Hulburd, therefore, was of the opinion that the funds required by law at that time to be held in reserve by country banks for the protection of depositors should not be loaned to the city banks on interest. But the practice that he complained of to 1867 continued and prevailed to a far greater extent in later years. Country banks deposited their surplus funds with city hanks, not for the purpose of facilitating exchange in carrying on their legitimate business, but largely, if not wholly, for the greater interest rates they derived therefrom.