The invest ment banker The char- The commercial bank The investment banker on the other hand is a middleman pure and simple. Those having new enterprises to finance come to him for aid. He studies the situation and decides on what basis the financing can best be done. He may make some advances of his own to meet immediate needs, but, in the main, he expects to raise the necessary capital by interesting his clients. When the organization of the new enterprise is complete and when the issue of securities, etc., has been arranged, the effort is made directly or indirectly to interest those with funds to invest. The banker may appeal to his own clients or he may through listing of securities on stock-exchanges endeavor to attract the general, investing public. Whatever the method of procedure, however, his activities are limited by the amounts that he can so gather together. The investor himself is one whose main object is to increase future income through a profitable investment of his savings. While he ordinarily prefers to have his investment in a readily saleable form the return of his principal in cash is not of primary importance. Certainly the investment banker, after once having sold securities to his client, or having obtained them for him, accepts no responsibility for the return of the sums involved. If the investor wants his money back he has to take his chances in the market, while the making of the investment in first instance comes under the general rule of caveat emptor. Hence it may be said that the function of the investment banker is to mobilize investment funds, and to assist in the apportionment of these funds to productive uses. The projects that he takes up, and the recommendations that he makes, are, of course, of far-reaching importance to economic development, but he is limited in his activities by the amount of actual investment funds of which he can obtain control. The economic function of the commercial or credit bank is more fully discussed in a subsequent chapter. It is this type of banking with which this book is concerned. Here it may be said that the commercial or credit bank is an institution sui generis. It is not merely a middleman, but is a highly creative, dynamic agency that goes farther in its control of capital than the money actually intrusted to it would indicate. On the money actually in its possession it builds a structure of credit, and this credit as a claim to value is even more important than money itself in the process of exchange. Without anticipating the analysis in the subsequent chapters it may be said that the credit extended by the commercial bank takes the form of deposits and of notes. In so far as these forms of credit serve to obtain control of a part of the community's saved wealth, the bank extending the credit virtually controls the use of such wealth. As the notes and deposits constitute liabilities payable on demand, from the depositors' and from the noteholders' point of view they represent temporary surpluses instantly available in liquid form. To preserve the liquid character of its credit the commercial bank cannot, of course, consent to the utilization of its funds for long-time investment purpose. This credit can be employed only in short-time productive operations where the original investment is quickly followed by sale and return of principal. Hence through the creation of credit payable on demand the commercial or "credit" bank may be said to mobilize and to apply to productive use that portion of the wealth of the community which is in a relatively liquid form, and which must be preserved in that form. It is the purpose of this book to explain how the commercial bank carries out this function, and to set forth what principles must be borne in mind in the organization of such banks into a nation-wide system, if they are to be permitted to render the maximum economic service of which they are capable. SELECTED REFERENCES CHARLES F. DUNBAR, Chapters on the Theory and History of Banking (1906), Chapter I. H. G. MOULTON, Principles of Money and Banking (1916), Part II, Sections I and II. CHAPTER I THE BANK'S OPERATIONS Nature of a depositsimply a book entry The term bank is ordinarily applied to an institution Definition which receives deposits of money or of credit and which of a bank seeks profit through the extension or sale of its own credit. It is sometimes said that a bank lends "money," but actual money enters only occasionally into the transactions of a bank. All bank transactions are, however, expressed in terms of money, and if money itself be not employed only that which is equally acceptable will suffice as a substitute. What is a deposit? "Why," says the depositor, "that is an amount of money standing to my credit on the bank's ledger and against which I can draw my check." Is it a specific sum of money actually stored in the bank's vault? Most decidedly not. It is simply an entry that is made on the books of the bank in order to indicate that the depositor, under whose name the entry is made, has a right to demand from the bank a certain sum of money. To only a small extent does the depositor actually exercise his right to demand money. In most cases all his purposes can be served simply by transferring his right, as a whole or in part, by means of a check, to whomsoever he desires to make a payment. The result is that the bank finds it necessary to hold in actual cash against its deposits only a fraction of the total liability represented by the sum of all the deposits. The cash so held is called the "reserve." The general nature and purpose of the reserve will be more fully discussed later on. "If a deposit is not cash," it may be asked "what is it?" It is simply that elusive something to which we give the name "credit." From the viewpoint of the depositor Only a per- cash Bank deposits are simply credit Deposits preferred to cash because of safety and convenience himself the deposit is equivalent to cash because it is a right to demand cash from a thoroughly responsible agency. From the viewpoint of the bank the deposit is simply a liability, an obligation to pay cash, which in all probability will not have to be met for some time to come. That is to say, in place of the cash itself which the depositor has a right to demand he is satisfied with the naked obligation of the bank to pay. As long, therefore, as the deposit is allowed to stand it represents simply "credit" based on the confidence that the bank has been able to inspire in the depositor. Why, it may be asked, should a person desire to have a mere right to demand cash from a bank when he might just as freely have the cash itself? This is another way of asking the question: why should a person prefer to deposit money in a bank rather than keep it at home? There are of course several excellent reasons. In the first place a bank deposit is much safer than money in hand or at home. The risk of loss, theft or destruction of a sum of money in the pocket or stored in a place of uncertain security at home is normally ever so much greater than is the risk of failure to meet its obligations on the part of a well established bank. Of course, a good many worthy people have a profound distrust of all banks and bankers, preferring to sacrifice possible earnings of interest and to run the risk involved in hiding the money at home rather than to intrust it to the safekeeping of others. But while in earlier years this distrust often had ample justification, today there is less and less reason for it, and it tends to survive only among the very ignorant. In the second place a bank deposit offers a more convenient method of payment than actual money affords. This is especially true where the amounts involved are large. It is a relatively simple matter to write out a check for a large amount, but the counting out of a large sum of cash in coins or in bills is tedious and time-consuming. Not only is the writing of a check simpler than counting |