In April, 1900, the Finance Committee of the United States Senate requested an expression of opinion from Mr. Dawes on a bill then pending before that committee to permit cities with a population of twenty-five thousand to become reserve cities upon application of three-fourths of the national banks located therein. This bill became a law on March 3, 1933.

In commenting upon this proposed amendment to the law, Mr. Dawes stated that there should be a radical modification of the law in regard to reserves, and that greater restrictions should be placed upon the right of a bank to count as a part of its legal reserve so large an amount of credit with a reserve agent. The law as it existed then, he stated, allowed too great a latitude to the banks to use reserve credits for the purpose of increasing their business, thereby increasing too greatly the disproportion between the deposit liabilities of the banks and the aggregate cash resources with which to meet them.

No matter how many reserve cities were created the rate of interest, he contended, or the terms upon which balances could be used, together with the facilities for exchange at the principal moneyed centers, would largely control the selection of correspondents. The demand for New York and Chicago exchange would always necessitate the selection of banks in those cities as correspondents of interior banks. He expressed the belief that the provisions of law then in force in respect to reserve deposits, in their practical effect, were productive of harm to the legitimate business interests of the country, and for that reason he recommended that they should, to some extent, be modified. The disproportion between the deposit credits in the banks and the amount of cash actually held as reserve against them was considerably less than fifteen per cent. of the aggregate deposit liabilities.

Every national bank in the country was presumed by law to be on a conservative basis, so far as its ability to redeem deposits was concerned, when it had on hand in cash, and on deposit with approved reserve agents, twenty-five per cent. of the amount of its total deposits.

In the smaller cities or towns a less proportion of cash and cash resources to total deposits was deemed legally consistent with conservative banking. When the cash and reserve accounts exceeded to any extent the twenty-five per cent. limit, the bank, under the generally accepted rule, could safely loan the excess. In the determination of its ability to loan, a bank did not ordinarily consider the relation of the amount of cash in the vaults to the amount of its credits with reserve agents, for the reason that in usual practice the reserve agent would remit when called upon, or the bank could sell for cash to neighboring banks, exchanges drawn against its balance with the reserve agent. It is the relation of the sum of the cash and reserve balances to deposits which determines whether or not the bank is in a condition to loan.

The fact that national and other banks were allowed to loan on the strength of their deposits in other banks, as well as on account of the cash actually held in their vaults, meant that the actual cash held by them into which checks and drafts were by their terms and by practice concurrently convertible, was much less than twenty-five per cent. of the deposits. This, together with the fact that one bank would credit as a deposit redeemable in cash a check on another bank, meant that the banks added to the purchasing power of the community, or, in other words, created deposit credits for the community.

Mr. Dawes expressed a doubt as to whether, taken as a whole, the handling of large bank deposit balances is profitable to the banks. Bank balances are the most unstable of all deposits, he said, and are the most expensive accounts, not only because of the interest paid on them but because of their extreme activity. Through such accounts the reserve cities were subject to a strain in times of financial stress, which endangered the stability of the entire banking system. A large number of bank deposit accounts swells the totals of a bank's statement, and perhaps serves to attract other business of a more desirable nature, but the advantages of such business are exceedingly doubtful.

Recognizing the instability of such deposits, the banks, Mr. Dawes stated, must loan their money on call, and to secure sufficient call loans, they must go into the speculative exchanges, for it is only by loaning upon speculative securities that the banks are enabled to pay the high rate of interest on bank balances, which is the attraction to the country banks for the deposit of a greater proportion of their funds in New York than is needed for clearances or exchanges.

By way of illustrating the correctness of this reasoning., Mr. Dawes called attention to the fact that during his term as Comptroller there occurred a marked demonstration of the evil effects of the practice referred to upon the legitimate business of the country. At that time there was a material slackening in the demand for money in the interior of the country, and the country banks found it difficult to safely loan their funds. As a result the interest paid by the eastern banks upon deposit balances attracted an immense surplus to New York City and other eastern cities. This redundancy of money in New York and the ease with which loans upon speculative collaterals could be obtained, immediately created a speculative movement in stocks which was carried on with a constantly rising range of prices until the fall of that year. At that time the crop movement in the West and the rising rate of interest in the inerior compelled the banks of those sections to draw upon their balances in New York and to order the remittances of large amounts of currency. At that time the business of the country was in a prosperous condition, with a tendency toward an increase in general prices and the wages of labor.

There was no lack of confidence in the country and nothing which indicated panic conditions, but the demands of the banks of the West for the shipment of currency on deposit with reserve agents resulted in a panic upon the Stock Exchange of New York, which became a grave menace to the business interests of the entire country, by curtailing ordinary credits to legitimate business and commercial enterprises to such an extent as would have resulted in great damage had not the Secretary of the Treasury come to the relief of the money market and checked the rapidly increasing stringency.

While the exchange business of the interior banks always will necessitate large deposit balances in New York and other reserve cities, and higher rates of interest will attract idle funds to the money centers, Mr. Dawes suggested that public policy demanded that the banks of the country should be required to keep a larger proportion of their reserve at home in their own vaults for the protection of the interests of their depositors in times of stress.

By increasing the restrictions upon the right of banks to count deposits with reserve agents as cash, he said, a firmer and safer foundation would be built under the deposit credits of the country, and in times of liquidation the greater strength of the banks would more than compensate for the loss of the small amount of interest on a portion of their bank balances.

Mr. Dawes therefore recommended that the law be so amended as to permit only one-fifth, instead of three-fifths, of the fifteen per cent. reserve then required to be kept by banks not reserve agents, to consist of balances due from reserve agents, and that the provision of law which permitted banks in reserve cities to keep one-half of their lawful money reserve with correspondent banks in central reserve cities be repealed, thus requiring them to keep on hand at all times in their own vaults the twenty-five per cent. reserve then required by law to be maintained.

Mr. Dawes renewed the recommendation that had been so frequently presented by his predecessors for a change in the method of compensating national bank examiners, from a fee basis to a salary allowance. The fee system, he contended, encouraged superficiality in examinations and interfered with a proper apportionment of the examiner's time among the different banks on his list for examination.