security consists of stocks or bonds greater in value than the amount of the loan and probable interest, which are for the time being deposited with the bank, in the event of failure to pay the loan, the bank secures the satisfaction of its claim by the sale of the securities. In the case of discounts of mercantile paper, the bank relies upon the good faith and general property of the several parties to the note or draft, without having a claim against any specific property.
It is clear that in so far as a bank makes its loans from its capital, it can use for that purpose all that is not needed for running expenses. It should be remarked that commercial banks must have a considerable capital of their own, not only for running expenses, but also as a guaranty to depositors. The larger the capital of the bank, the greater the feeling of security among the depositors that, the personal property of the bankers being embarked in the enterprise, caution and prudence will guide its steps, and that in the event of bad investments, the bank will yet be able to meet its obligations as trustee of their funds. But if a bank can employ all its capital, it is obvious that it cannot employ all deposits in making loans, because occasions are always occurring for removing deposits, as well as making them. Business men, for example, day by day, deposit with their bankers the checks or sums of money which they receive in the course of their business; and, on the other hand, day by day, draw out such sums as they require for the payment of purchases of goods, wages, rent, and other expenditure. A bank, therefore, while continually receiving deposits, is continually repaying deposits; and the amount uncalled for is subject to a daily fluctuation. At one period of the year, or in a certain condition of trade, the amount of deposits may be high; at another, low. As it is a principle at the very root of banking that money deposited shall be returned, either on demand, or punctually at the expiration of a stipulated notice, it follows that banks must always have at hand as much of the money deposited with them as may in any emergency be called for. When business is in its ordinary condition, a bank can, after some experience, approximate pretty nearly to the amount of the greatest demand for a return of deposits throughout the year, and provide accordingly. But sometimes the credit of a bank becomes doubted, either from causes peculiar to itself, or on occasions of a panic or general distrust, when all who own money wish to have it in their own possession. In these cases, there is a run on the bank for repayment of its deposits, and the amount called for may be far beyond the maximum demanded in ordinary times. If the bank has not retained a sufficient amount of deposits to meet the demand, it is said to suspend payment, and, as a general rule, it must wind up its business, the confidence of the public that it will in future restore its deposits on demand being now destroyed. There are two prime rules in safe banking: the one is, that the bank shall lend its deposits only on undoubted and readily reliable securities, however low the profit; and the other that the bank shall retain a sufficient amount of its resources—and this is called the reserve—to meet the possible demands of the depositors even in cases of a run, although there may be no reason to expect one; for when a run comes, it seldom casts its shadow before. But it is evident that the greater the reserve of a bank, the less the amount of deposits which it can lend out and draw interest for; hence the temptation which banks lie under of imprudently lending out a too great proportion of their deposits; and it is their yielding to this temptation that almost always precipitates the failures of banks.
In the practice of private banking, the amount of the reserve is wholly in the discretion of the banker. Chartered banks are frequently subject to legal provisions which determine not only a minimum reserve, but prescribe how it shall be held. Thus, in the national-banking system of the United States, the law requires a minimum reserve of 25 per cent. of the amount of the deposits in large cities named in the law, and 15 per cent. of the deposits in other places. In three of the principal cities, namely, New York, Chicago, and Saint Louis, which are designated as central reserve cities, the whole amount of the reserve must be held in lawful money of the United States. In the remaining cities, one-half of the reserve may consist of deposits in the three central reserve cities named; but at least one-half must be held in lawful money in the bank. In other places, two-fifths of the legal reserve only need be held in the bank in lawful money, and the remainder may be deposited in any of the reserve cities. In practice, the reserve held by the national banks is considerably in excess of the legal requirement.
In England, the practice of banks is somewhat similar. The reserve of the banking department of the Bank of England is always in coin or in notes, against which there is coin lying in what is called the issue department of the bank. Other banks generally hold a portion of their reserve either in Government bonds, which can be readily sold in case of necessity, or as a deposit in the Bank of England. As the Bank of England is the channel through which, directly or indirectly, payments are made and moneys received, by other banks, it is more convenient for them to have their reserve lying as a deposit in it than lying as gold within their own vaults. In the case of a demand on their reserve, the banks will draw out their deposits, in notes, or, if gold be in demand, in gold, from the Bank of England. Whether, therefore, the reserve of a bank is invested in Government securities or is deposited in the Bank of England, or is in Bank of England notes, it is from the coin in that bank that the gold comes in the case of a run. It is apparent from this that it is essential to the stability of all banks in that country, so long as they themselves do not keep a sufficient reserve of coin in their coffers, that the Bank of England shall always be possessed of coin, and ever be able, on demand, to pay its depositors in gold, or to give gold in exchange for all its notes that may be presented to it.
Banks of Issue. We have thus far discussed only banks of deposit and discount, and it is now time to consider the special characteristics of banks of issue. Banks of deposit, as has been mentioned, make loans from their capital and deposits. If from capital, the banker has no greater profit by the transaction than if he had lent out his money in any other way, equally safe, and involving the same amount of trouble. If
