As a preface to the remarks on this department, the following simple and concise statement is taken, by permission, from that excellent book, "Money and Banking," by Mr. Horace White. (Book II, Chapter I, page 235, Edition of 1895.)

"FUNCTION OF A BANK"

"A bank is a manufactory of credit and a machine of exchange. Mr. H. D. McLeod's analysis of the mechanism of banking is substantially this: A man has $5,000.00 of his own money. He starts a bank. His neighbors deposit $45,000.00 with him. This money becomes the absolute property of the banker. The depositors have simply a right to withdraw an equal amount whenever they like, which right can be enforced by law. The banker owns the money and the depositor has a claim, or right of action, against him for an equal sum. But the depositors will not draw the money out immediately; if they had intended to do so, they would not have deposited it at all. The banker finds by experience that some of his customers will deposit as much money as others draw out, so that $50,000.00 is on hand all the time. He concludes that if his own $5,000.00 in connection with his good reputation, is considered by the public a guarantee for $45,000.00, then the whole $50,000.00 will serve as a guarantee for at least $200,000.00. When he begins, his balance sheet reads in this way:

"He now begins to discount the commercial paper of his customers running say ninety days at 6%. When he discounts a bill of exchange for $1,000.00, he deducts the interest for ninety days ($15.00) and credits the customer the remainder ($985.00) on his books. This $985.00 is called a deposit, because the customer has the right to draw it out by his check exactly as he could draw out an equal sum of gold deposited by him in the same bank. In the eye of the banker, and of the customer, and of the law, it is a deposit. In ordinary times it is like any other deposit. That is, the proportion remaining uncalled for at any time will be about the same as the proportion of actual money deposited. Yet it is nothing but a bank credit. Hence the word deposit, when thus used, is clearly a misnomer, since, by derivation and common understanding, a deposit means a thing laid away, or given in charge of somebody. It must be borne in mind, therefore, that bank deposits consist of two different things, namely, (1) money, (2) bank credits, and that the latter may be four or five times as large as the former.

"The process continues till the banker has $200,000.00 of discounted bills in his portfolio. Then his accounts stand thus—

"This is Mr. McLeod's exposition and it is the correct one. It follows that the banker has manufactured something which serves as a medium of exchange to the extent of nearly $200,000.00. This something is credit. Goods can be bought and sold with it as readily as with money, since the checks drawn against these deposits are universally accepted. The whole $200,000.00 of bills are not discounted in a lump, but gradually, so that some are always maturing and bringing money in to meet the checks of customers, in an endless chain of deposits and discounts. It is found in practice that $200,000.00 of loans and discounts may be easily carried on $50,000.00 of cash. Thus, the loans of all the National banks in the United States in October, 1894, were $2,000,000,000.00, and their cash (including silver certificates and silver dollars) was a trifle less than $400,000,000.00, or only one-fifth of the amount of the loans. The other four-fifths was credit, and perfectly sound credit too, for it had passed through one of the severest panics in our history."

The foregoing quotation is an unanswerable argument for the need of banks as manufacturers of credit in every community. The greater the banking capital in any section, the easier it will be for the people of that section to carry on and enlarge their business.

The Loan Department is not only the most important, but it is the money-making end of the bank. If it makes no loans it will pay no dividends. If, on the other hand, it makes bad loans, it will go out of existence.

It can be understood readily that the successful bank officer, whose duty it is to accept or reject loans, must be a person of large experience and wide knowledge of men and affairs. He must be an excellent judge of human nature. Not too conservative, nor yet too venturesome. He must be a constant student of financial conditions; and must expand or contract his loans as the sea of finance is placid or stormy. His responsibility is great. He must lend, but he must lend judiciously, millions of other people's money. He can not allow feelings of personal friendship to warp his judgment. He must be thoroughly familiar with the laws concerning the making and the collection of notes.

In an address to the National Banks in 1863, the Hon. Hugh McCulloch, the first Comptroller of the Currency, gave this sound advice:

"Do nothing to foster and encourage speculation. Give facilities only to prudent and legitimate transactions. Distribute your loans rather than concentrate them in a few hands. Pursue a straightforward, upright, legitimate banking business. Treat your customers liberally, bearing in mind that a bank prospers as its customers prosper."

In lending, the bank should encourage the business interests of its community and should discourage speculation.

If every one, before asking a loan, would put this question to himself, "Would I take this risk," his banker would be saved much embarrassment. On the other hand, if you know your security is good, there is no reason why you should feel any degree of awe or nervousness in offering your own or your customer's notes. That is what the bank is in business for, and your proposition, if not made for purposes of reckless speculation, is welcomed in ordinary times.

Bear in mind, however, that your banker may, at times, have to refuse your paper, because he has seen clouds on the financial horizon of which the average person is ignorant, and he is endeavoring to protect, not only his stockholders, but his patrons, from the storms that are imminent. It is advisable for you to consider his views carefully, and probably to curtail business expansion.

Your average balance on the bank's books has a great deal to do with the amount of the loans, no matter how well secured, that you can ask reasonably.

Every bank has a number of customers who expect to be taken care of in the loan department. But, if all the bank's patrons are borrowers, it soon will have loaned out all of its funds. The bank must have depositors also. While some depositors do not ask for loans, experience has shown that the proportion of a customer's balance to his loans must be sustained in order to keep the bank adjusted. In New York the banks generally require a regular customer to keep an average balance of not less than twenty per cent. of the loans made him. Most interior banks consider ten per cent. about the right proportion. For example, in the interior cities, if your account shows an average balance of $200.00, you can reasonably request loans, properly secured, of $2,000.00. An average balance of $1,000.00 should entitle the depositor to loans of $10,000.00 and so on. Experience proves that if the banker does not keep this important point in mind, his machinery will be "out of gear."

Speaking generally, it will pay any concern to borrow money, if necessary, to show a fair balance to its credit. Bankers are only human, and all business is selfish. Every bank will be disposed to take care of its best paying customers first in times of financial storms. Every merchant looks out for his best customers first. Why not a banker? When a firm attempts to hold its bank down to the last cent of profit, keeps no balance to speak of, and subjects the bank to endless expense in the collection of its checks and drafts, it can not reasonably expect as liberal treatment in "squally times" as the concern which pursues the broader policy of "live and let live."

Some firms, if they would figure it out, could see plainly that the bank was handling their account at a loss; yet, they think they are conferring a great favor in placing their business with any bank.

A large concern was pursuing this narrow policy. Among other things it made a practice of borrowing large sums in other cities at four or five per cent. when the local rate was six. The recent panic came on. Money advanced to fifty, to one hundred per cent. in New York. The local banks were having all they could do to take care of their own good customers. The result was that this firm came to the verge of an assignment. And, if it had not happened that the banks of its city did generously come to its rescue, it would have collapsed.

It is well to remember, that, while the rates of interest in New York are temptingly low at times, they fluctuate violently and often without warning; also that the bankers in a strange city have no personal interest or local pride in your success or failure.

Money is only a commodity, and rates of interest are governed by supply and demand. Now the supply of money in the New York banks varies tremendously, by millions of dollars in fact. This variation comes from many causes. On the other hand, the demand for money in New York is constantly changing. The reasons for this are manifold. But in the smaller cities, both the supply and demand are much more uniform and steady. Hence the rates of interest, outside of New York, are much less liable to change. Therefore, unless the demands of your business exceed the banking facilities of your town, it is very advisable for you to confine your loans to the local banks.

The loan department is restricted by certain laws, just as the other departments. State and Savings Banks, and Trust Companies must obey the laws of their particular State, but any bank having the word "National" as part of its name, or the letters "N. A." (National Association), or the letters "N. B. A." (National Banking Association) following its name, must adhere strictly to the provisions of the National Bank Act. The Congress of the United States has forbidden the use of the word "National" as part of the name of any Bank or Trust Company which does not comply with all of the sections of the National Bank Act.

As the statutes differ in each of the separate States, only the laws governing National Banks will be considered here.

The whole spirit of the National Bank Act in relation to loans is to prevent the advancing of money on anything but "quick assets." In other words, loans must not be made on any security, that can not be turned into money quickly. For this reason a National Bank can not lend on real estate as a security. Also it should not accept notes having longer than ninety days or four months to run. The fundamental principle of the law is the guarding of the depositors' money; to have it ready for them at all times. But the whole fabric and theory of banking is founded on the fact, demonstrated by centuries of experience, that at no one time do all the depositors want to draw all their money from all the banks. Also that every day some loans are due and can be converted into cash if necessary.

Payment of demand, or "call," loans can be demanded any day. On time loans, payment can not be asked for until the maturity of the note, the day agreed upon by the bank and the borrower.

On demand, or "call," loans the interest must be paid at the end of every three months, or when the loan is paid. On time loans, the interest, or discount, is paid in advance.

Notes reading one, two, three, or four months after date are due, of course, one, two, three or four months after the date of the notes. But thirty, sixty, or ninety-day paper is not due in one, two, or three months. This is a common error. The exact number of days must be calculated. The following table for determining the maturity, or "due date," of thirty, sixty, or ninety-day paper is herewith given:

TABLE FOR FINDING MATURITY OF NOTES AND DRAFTS

At 30, 60, and 90 Days

National Banks can lend only a certain proportion of their deposits.

In New York, Chicago, and St. Louis, called Central Reserve Cities, National Banks must keep on hand, in lawful money, a reserve of twenty-five per cent. of their deposits.

In Albany, Baltimore, Boston, Cincinnati, Cleveland, Detroit, Louisville, Milwaukee, New Orleans, Philadelphia, Pittsburg, San Francisco and Washington, called Reserve Cities, the National Banks must have the same reserve of twenty-five per cent. of their deposits. But the National Banks in these last-named thirteen cities can keep one-half of their reserve in National Banks located in any of the three Central Reserve Cities, viz.: New York, Chicago and St. Louis.

In all other cities or towns the National Banks must have a reserve of fifteen per cent. of their deposits, but nine per cent. of their reserve can be kept in National Banks located in any of the thirteen "Reserve Cities"; or in National Banks in the three Central Reserve Cities.

"Approved Reserve Agents" are the banks of the larger cities, selected by the banks of smaller cities or towns, in which to carry part of their reserve. These selections must be approved by the Comptroller of the Currency, the executive head of the National Banking System.

A National Bank is forbidden to lend more than ten per cent. of its combined capital and surplus to any one firm or individual. "But the discount of bills of exchange drawn in good faith against actually existing values, and the discount of commercial or business paper actually owned by the person negotiating the same, shall not be considered as money borrowed." Also no National Bank can lend on its own stock as security.

The Comptroller of the Currency can have an examination made, as often as he may deem proper, of the condition of any National Bank. The visits of the National Bank Examiners are never announced in advance. They come suddenly and without warning. Their duties are not only to balance the books and count the cash, but also critically to examine each loan and its security; and to give especial attention to loans to any director or officer, and to any concerns in which they may be financially interested.

If the bank is overloaned, that is, has loaned more than the law allows, the examiner immediately reports it, and the Comptroller of the Currency orders that bank to cease lending, and to require payment of enough of its loans to make good the reserve required by law. And if the bank does not court disaster and the closing of its doors, it hastens to obey orders and to "get in line."

The supervision of the National Banks is not perfunctory or careless. It is very strict.

The inquisitorial powers of the National Bank Examiners are practically unlimited. They have a legal right to put any bank officer on oath in questioning the affairs of the bank. They look into every department in the most searching way, and any disobedience of the law is reported promptly to the Comptroller. These Examiners are appointed by the United States Government; and if they want to hold their positions, they must be strictly impartial in their reports to the authorities.

The provisions of the National Bank Act have been so rigidly enforced, that in forty-four years, or since the Act was passed by Congress, the average annual loss to depositors in National Banks, has been only thirty-seven one thousandths part of one per cent. of their deposits. Practically no loss at all.

Isn't that a tribute to the wisdom of that law; to the strict supervision of the Government; and to the honesty and integrity of the officers of National Banks; past and present? It has happened, of course, that some spoilers have occasionally obtained control of a National Bank, and have dishonestly used the depositors' money in risky ventures for their own profit. But the officials of the Treasury Department have soon sized them up, and such men shortly find the banking business not to their liking, especially with "Uncle Sam" as a supervisor.