The Second National Bank now owns a check signed by John Doe and indorsed by John Robinson directing the Riggs National Bank to pay to the order of John Robinson, one hundred dollars. The Riggs National Bank, therefore, owes the Second National Bank one hundred dollars. During the course of the day the Second National Bank receives other checks drawn on the Riggs National Bank, while the Riggs National Bank receives similar checks drawn upon the Second National Bank. In smaller towns each bank at the close of the day presents its checks to the other for payment and the bank against which the larger amount was drawn pays the difference in money. In the larger places the banks, instead of sending messengers to each bank against which they have checks, send them to a central clearing house, where representatives of all of the banks meet and exchange checks drawn against the respective banks represented settling the differences in money or in acceptable credits.

140. The Bank Draft

John Robinson, let us say, owes one hundred dollars to John Smith, a New York merchant. Instead of sending him his check for the amount, he purchases a bank draft which he sends to him. The draft is an order by the Second National Bank of Washington, for instance, directing a certain New York bank with which it has a deposit to pay to the order of John Smith one hundred dollars. John Smith presents the draft to his bank in New York and receives credit for it. The bank draft, therefore, resembles a check rather than a bank note.

141. The Function Of A Bank

The main function of a bank is to deal in credit. It buys and sells the credit of others, and it exchanges its own credit, which is so generally acceptable in exchange that it does the work of money for some one else's credit which is not generally acceptable in exchange. The two principal operations by means of which a commercial bank performs its function are discount and deposit. In addition to these two operations, certain banks have the right to issue notes.

142. Discount

In our illustration above, John Doe sold Richard Roe's promissory note to the bank. In technical language, the bank discounted the note. The interest on the note may have been deducted at the time of discounting the note or it may be collected when the note is due. John Doe might have presented a note signed by himself to the bank and the bank would have discounted it if it considered that his credit was good enough. Or, in case his credit was not sufficiently good, he might have pledged as collateral or security for the payment of the debt, bonds or stocks or other property.

143. Deposit

John Doe might have received money for the note which was discounted, but he found it more convenient to leave the money on deposit with the bank and to have it paid out on checks as it was needed. The deposit does not consist of actual money but of the right to draw money from the bank. One may secure this right to draw money by leaving money at the bank; the word "deposit" suggests this origin. But as a matter of fact, only a small percentage of deposits originate in this way. For the most part they have their origin in discounts; that is, the depositor secures the right to draw money from the bank in exchange for his own note or for the notes of other persons sold to the bank by him.

144. Note Issue

Since the Civil War certain banking associations known as national banks have had the right to place their notes in general circulation. The right to issue notes was restricted to national banks by levying a prohibitive federal tax on the note circulation of all other banks. The national bank notes were secured by the deposit of United States government bonds which had been purchased by the banks and which were left in the keeping of the Treasury Department as a pledge that the national banks would redeem their own bank notes when they were presented for payment. In addition to the deposit of government bonds the national banks also deposited in cash with the Treasury Department five per cent of the amount of their note circulation.