from deposits, the interest he receives, so far as it exceeds the interest, if any, paid to the depositors, and a ratable proportion of the expense of carrying; on the business of the bank, is pure gain to him. But a banker may give the loan from his own notes, and in that case his gain is still greater. A bank-note is simply a written promise, by the bank issuing it, to pay to the bearer, on demand, a sum of money—that is, lawful money. The borrower would not accept a loan from a bank in its own notes, unless he believed that it could redeem its promise of paying in coin, and that the public were of the same opinion; for the moment that a suspicion arises that the promise will not be made good, the note will cease to pass from hand to hand as coin, or to perform all the functions that coin performs. But when the loan is accepted in a bank's own notes, it is evident that the interest which the bank draws for the loan of its promises to pay is pure profit, except the proportion—as in the other cases—of the expense of carrying on its business, and the expense of the paper and printing of the notes, and any special taxes resting upon such issues. In other words, a bank which can get people to pay to it interest for the loan of its promises to pay, draws the same income—barring the comparatively trifling expense of manufacturing the written promises—as a bank does which has to provide itself with gold for making its loans. The motive which a bank has to extend its issues on loans is therefore apparent, so long, of course, as it is not compulsory on it to retain unemployed in its coffers as much in gold as it issues in notes.
But it does not follow that when a bank makes a loan in its own notes for a definite period, it will really obtain the benefit of the whole of the interest on it for that period; for the borrower does not apply for the notes that he may keep them lying idle, but that he may pay them out in making a purchase, or in liquidating a debt; and this, most commonly, on the very day he receives them. If the person to whom the notes are thus paid by the borrower has himself no purchase to pay for, or no payment to make, he may, the moment he gets them, return them to the bank that issued them, to lie there on deposit. If the bank pays interest on deposits, as banks often do, then out of the interest drawn by it on the original loan, it will have to pay interest to the depositor of the notes; in other words, the loan is no longer a loan of its notes, but a loan from its deposits. Or, the person receiving the notes from the borrower, may immediately present them to the issuing bank for coin, instead of depositing them. Here, too, therefore, the loan that was made in notes is now converted into a loan of coin that was in reserve from previous deposits, or that was part of the bank's own capital; in which cases, the bank obtains no advantage whatever in having made the loan originally in its notes. It might equally well, so far as profit is concerned, have originally made it in gold from its reserve of deposits or capital. Notes generally find their way back to the bank that issued them through other banks, into which they have been paid as deposits, or for the liquidation of debts due to them. These banks suffer the loss of profit or interest on the amount of the notes thus received by them so long as they keep them; they therefore immediately present them to the issuing bank for gold, to replenish their own reserves, or to lend out.
It will now be apparent to the reader that there are two checks which, under such a system, keep a bank from issuing notes to any extent it pleases. In the first place, there must be a demand for its notes by borrowers. It is only to people in good credit, and likely to make a profitable use of them, that a bank will lend its notes, and such people will not take an increase of loans unless trade is increasing, and new opportunities are presenting themselves for profitably employing the notes borrowed. True, banks, when imprudently conducted, or when deceived in the character of their customers, frequently lend their notes to reckless persons, who overtrade them, and become bankrupt. But banks commit this error, when they do commit it, to a far greater extent by loans of their deposits and capital than by loans of their notes. In the second place, the immediate return of the notes, chiefly through other banks for gold, or for other portions of the reserve of the issuing bank, is a check to its issuing more notes than it has a reserve to meet. This return of notes through banks is called the exchange of notes—the notes issued by a bank being returned to it in exchange for the notes held by it of another bank.
Besides issuing its notes in loans, a bank may issue them in repayment of deposits. In this case, there is the same profit to the bank as in the other case. The bank gets the profit which it makes on the money which was originally deposited or lodged with it, without having to pay interest to the persons who made the deposit or lodgment; the deposit, or money lodged, having now been repaid in its notes. But here, too, these notes are equally liable to be returned to the issuer as when they are issued on loans.
Of all the notes issued, in whatever way, by banks, a certain amount is not returned to them, but is kept in circulation, being what is required by the necessities of the public for use as money, passing from hand to hand. It is of course on this portion that the banks make their profit; and, in consequence of this profit, they are able to afford banking facilities to the public more cheaply than they could otherwise do. The profit is just the interest on the notes in circulation—less the expense of manufacturing the notes, a ratable proportion of the expenses of conducting the banks, and the loss of interest or profit on an unemployed reserve kept from prudence, or by the requirement of law, to meet a return of notes. The interest on the volume of bank-notes in circulation is paid by the persons who originally borrowed these notes from the banks, and who have not repaid them; or if the banks have repaid deposits with the notes, the interest is paid by those to whom they lent what was originally these deposits.
In the foregoing discussion of the nature of banknote issues, it has seemed best to proceed upon the assumption that the issue of notes, and the conditions of the issue, such as the amount of the reserve, lay wholly in the discretion of the banker. This is the so-called ‘free’-banking system, in which the value of the bank-note depends upon its instant redemption in coin, where the whole organization of the system is such that the bank will, in fact, be called upon to redeem its notes frequently. But the issue of bank-notes in modern States is not thus left
