The essential banking function.

1. A bank is a business whose income is derived chiefly from lending its promises to pay. Banks have passed through many changes in the past three centuries. Originating on the street corner for exchange of money, they have evolved into great institutions of many forms, and performing many functions. The definition seems paradoxical, but it expresses what in modern thought is the essential feature of a bank: the lending of its credit. A reserve of money is needed by the man of business. But for the banks each man would have to keep his reserve in his own till. Except the small sum needed for current uses, a bank can keep this reserve more economically than individuals can. It has the advantages of large production similar to those of a large factory. The process of lending credit is called deposit and discount. It grew out of the deposit of actual money for safe keeping and the loaning to borrowers by the method of discounting their notes. The term now has a somewhat different meaning, for a merchant may obtain a deposit today without putting any money in the bank. He gets the bank to discount his notes or collateral security, and to enter the sum to his credit as a deposit. He becomes a depositor by borrowing, not by lending to the bank. The sum is under the borrower's control; he can check it out when he wishes; but he usually keeps a certain balance to his credit. The bank's gain is larger than ordinary interest, because it gets a discount on the large sums left in its possession. The bank increases its funds also by attracting deposits from those who do not care to borrow.

2. Functions not essential to banking are ordinary money-lending, money-changing, exchange to distant points, safe deposit, and issue of bank-notes. Banks often lend in the ordinary way, allowing borrowers to draw the money out at once, but this is not the business they prefer. Many individuals and corporations, such as endowed charities, colleges, insurance companies, lend great sums of their own money without thereby partaking in any degree of the peculiar character of banking. Money-changing (the exchange of coins of different countries) is done by banks, but likewise by many other agencies not sharing the essential banking character. Foreign and domestic exchange is the issue and cashing of "drafts" for money payments between distant places. Most banks are well fitted to perform this function, but some banks do not undertake it, and it is performed also by some business houses that are not banks. Safe deposit is the keeping of things to be returned in identical form, as silverware, notes, and papers. By banks in small towns this is sometimes done freely, sometimes for a slight charge; but in large cities safe-deposit vaults are generally quite unconnected with banks. Even bank-note issue is not essential to banking; most banks in the United States issue no notes, others issue very few. All these functions may be united under one management, but the essential banking function is deposit and discount.

Other functions usually performed.

3. The income of banks is derived from discounts, interest on their own capital, charges for exchange and collection, rents on investments, and profit from, the loan of their banknotes. The income of banks is drawn from different sources, according to the size of the community, and the nature of the banks. While in the villages and smaller cities they perform a number of functions, in the larger cities they usually specialize in a far greater degree. Like every other enterprise, a bank must start in business with some paid-up capital as a guarantee of credit. Further security is afforded by the limited liability of shareholders for losses, in proportion to their capital stock. The same amount of money could be loaned with less trouble and more cheaply without starting a bank, but used as a banking capital a part of it can be loaned while still serving to attract money deposits. Charges to smaller customers for exchange are a source of income to some banks, but in many cases this service is freely performed for regular customers and becomes a considerable expense. Banks make few investments in real estate or other physical property; it is, in fact, their duty to keep out of ordinary enterprises, but they are forced sometimes to take for unpaid debts things that have been held as security. Profits on bank-notes have at times been the main, possibly the sole, motive for starting banks; but that is not the case today when the right of issue is so strictly limited.

Sources of the income of banks.

Productive services of banks.

4. Banks are productive economic agents performing important industrial services. False ideas have long been entertained about the magic power of banks to produce wealth from nothing. To many, banks are a mystery much like paper money. Their opponents sometimes have pictured them as vampires fattening on the blood of industry. That they have shown abuses at times is undeniable, but, like other economic agents, they are to be judged by their net efficiency. The bank is a tool performing services similar to those of money. For some purposes money is an awkward and costly agent in comparison with banks. For remitting payments from New York to San Francisco or Hong Kong, money is a medieval device. Money can more safely be entrusted to a bank than to a strong chest in one's own house. The man who refused to make use of banks in this day would isolate himself economically, and would soon find himself out of any but the smallest business. He could no more get along without the banks than without the post, the telegraph, or the telephone.

The gathering of loanable funds by the banks, making them available at once, reduces hoarding, makes money move more rapidly, and creates a central market between borrowers and lenders for the sale of credit. While not creating more physical wealth directly, it adds to the efficiency of wealth; it oils the bearings of the industrial machine. To abolish banks would be to destroy labor-saving machinery. Banks perform incidentally a further service in developing better business methods in the community. In supplying credit to active business, banks are constantly passing judgment on the collateral security presented to them and on the solidity of the enterprises that are seeking support. They enforce promptness and exactitude in business dealings.

Because in their public nature banks are very analogous to money, they have always been looked upon as properly subject to more supervision than most private business, and government has always exercised a considerable measure of control over them, sometimes for good, sometimes for evil.

The bank as a labor-saving device.