60. Banking credit.-Banking credit is the power of a bank to secure advances of funds in exchange for its promises to pay. As noted in the foregoing discussion, banking credit is intimately connected with all other forms of credit, particularly with commercial credit. Under modern conditions bank credit is the life blood of the whole commercial organism. The modern commercial bank has aptly been defined as "a manufactory of credit." On the other hand, it is commercial credit that creates the vast amount of credit instruments the handling of which constitutes the bulk of the commercial banking business. Commercial banks are commonly known as banks of "discount and deposit," a designation which suggests their most important functions. Formerly a third function, that of issuing circulating notes, was of primary importance, but in recent years this function has been of lesser consequence. That a bank creates credit and that banking and commercial credit are closely interwoven can readily be seen in the everyday discount and deposit operations of the bank. Banks have learned by long experience that in ordinary times the depositors will not all call for their money at the same time and that only a small proportion of the total deposits need be kept on hand to meet daily demands. The banks are able, therefore, to use a considerable part of these deposits for granting credit to business men who have evidences of property in the form of commercial paper, book accounts, or warehouse receipts which they are willing to pledge or sell to the bank in exchange for the right to use the bank's credit. Ordinarily when a business man secures a loan at his bank he does not want cash, but rather a credit against which he can draw checks to meet his obligations. Thus, because banks enjoy the confidence of the business community to such an extent as to retain possession not only of deposits but also of the funds loaned, they are able to create several times the amount of credit transactions that could have been created in the hands of individual depositors.1

1 Hagerty, p. 42,

Banking credit is generally accorded the highest rank in the field of credit. To be successful a bank must have the fullest confidence of the public, and must always be ready to meet its note and deposit liabilities on demand. In personal or mercantile credit, debtors who are unable to meet their payments when due may get an extension of time without seriously impairing their credit standing, but a bank must meet its credit obligations promptly as they mature, or close its doors. The most imperative obligations of a bank are the calls for money by its depositors. To meet these demands banks must keep a cash reserve, the minimum amount or proportion of which is fixed by law in this country, though in most other countries it is left to the discretion of the banks. Since, however, the bank's chief business is loaning or exchanging its credit for short periods, and since its credit obligations are usually several times the amount of money available in the bank to redeem them, it is important that its loans shall be of such a nature that a fair share of them can be quickly converted into cash. To have at all times that quick control over its assets that is indispensable to its solvency, a commercial bank must largely confine the investment of its funds to short-time loans based on mercantile transactions. Until the enactment of the Federal Reserve Act in 1913, national banks were not permitted to make loans on real estate, and even under the terms of that act such loans are carefully restricted. Real estate has not been regarded as a liquid asset, that is, one that can quickly be turned into money. The function of the commercial bank is not to supply industry with permanent capital, but rather to loan its credit temporarily to business men, the nature of whose business is such that they can confidently count on repaying what they have borrowed within a comparatively short time. This takes the form mainly of the purchase of "business paper" consisting of promissory notes and bills of exchange running from thirty days to four months, which from the viewpoint of the bank become "loans and discounts.

Another important service of banking credit is to supply a medium of exchange by the issue of circulating notes or by means of deposit accounts which circulate in the form of checks and drafts. Both are used in making advances to customers or in exchange for commercial credit in the form of promissory notes or bills of exchange. Both bank notes and deposits are demand obligations of the bank and as a medium of exchange they discharge substantially the same functions in the business world. Bank notes are used as hand-to-hand money because they are payable to bearer, are issued in fixed denominations, and pass freely everywhere, even among strangers. In country districts where banking facilities are not so general or convenient, the bank note rather than the check must be used as a means of payment. Checks, representing deposits, are more serviceable to the business man since they can be drawn for any amount and can be transferred from one person to another by indorsement; they are more convenient and safe than coin or notes for sending through the mail; if a check is lost a duplicate can be issued and payment of the original stopped at the bank; and, of not least importance, a cancelled check constitutes a voucher or receipt showing that the obligation for which it was drawn has been paid. Because of these and other advantages, deposit currency in the form of checks finds steadily increasing use as an instrument of credit.

61. Instruments of banking credit. The chief instruments of banking credit, other than bank notes, are checks, bank drafts, bank acceptances, and letters of credit. A check is a written order on a bank for money drawn by one who has a deposit there. Checks are usually made payable to someone's "order," and must then be indorsed by the payee before they can be negotiated further or cashed. A check drawn to "bearer" is payable to any person who holds it. Technically, a check is only an order on the bank, but legally it is an implied promise to pay on the part of the drawer of the check, and any person "giving a check upon a bank in which he has no deposit account is liable to prose

cution for obtaining money under false pretences. A depositor, wishing to make a payment at a distance where he is not known, or being required to present unquestionable evidence of his financial ability to fulfill his agreement in some contract, or bid for bonds, or the like, may request his bank to certify his check. The cashier writes or stamps across the face of the check the word "certified" or "good when properly indorsed," followed by his signature. The check then becomes the bank's promise to pay or guarantee and the depositor's account is at once debited as if the check had been paid. Where a bank does not make a practice of certifying checks, it may instead issue a bank draft or a cashier's check payable to the order of the depositor, or to the person whom he designates.

A bank draft is an order drawn by one bank on another bank. Practically all banks keep funds on deposit with banks in other cities, especially in the large financial centers, in order that they may be able to meet the demands of their customers for a form of payment which will be accepted without question. The banks draw upon these accounts and sell their drafts to their customers, making a small profit on the charge for "exchange." Bank drafts pass as cash practically anywhere in the country and constitute an important method of making remittances from one part of the country to another. Drafts on New York,

commonly known as "New York Exchange," are acceptable all over the country, owing to the fact that New York is the commercial and financial center of the country and that business men everywhere have dealings with that city.

A bank or banker's acceptance is a bill of exchange drawn upon and accepted by a bank or a financial firm engaged in the business of granting acceptance credits. It is a device by which a bank permits the use of its own credit by its client for a consideration. The following transaction will illustrate the use of the bank acceptance: A in Chicago buys a bill of goods from B in Philadelphia and arranges with his bank to accept on presentation the draft of B with bills of lading or other documents for the goods attached. Upon receipt of the draft and documents the bank accepts the draft, thereby assuming responsibility for its payment at maturity. The instrument has thus become a bank acceptance and may be sold, rediscounted, or held as an investment. A agrees to furnish his bank with funds to pay the acceptance at maturity, and the bank turns over to him the documents which entitle him to the goods. The bank advances no money; it merely extends the use of its credit to its customer, for which service it charges him a commission agreed upon in advance. Another form of bank acceptance, known as a commercial credit bill, is created when a customer draws his own draft directly on the bank and the bank accepts it for payment at a future date. Such acceptances or bills may be secured by some form of collateral or by the general credit of the customer. The bank acceptance has long been employed in Europe, and is slowly making its way in this country. Prime bank acceptances backed by well-known banks are readily rediscounted and constitute one of the most liquid of all forms of bank investments. Originally the Federal Reserve Act permitted member banks to accept only such drafts as represented operations in the exporting and importing of goods, but by an amendment passed in 1916 domestic acceptances also were permitted.1 To encourage the use of these double1 For further discussion of bank acceptances, see pp. 321, 392.