The object of a joint-stock bank is to pay a dividend on its share capital at a rate as high as can be earned consistently with the performance of the main obligations of such a bank, that is, the safeguarding of moneys deposited with it by customers, and of capital subscribed by shareholders.

With regard to moneys deposited, it must be borne in mind that the relation of banker and customer is that of debtor and creditor; and as the bulk of a banker’s liabilities is repayable in cash on demand, without notice of any kind, it behoves him so to conduct his business that he may be in a position to meet any demand, and that without delay or hesitation—or ruin stares him in the face.

We have already seen that before banking—as we understand it—was practised in England, moneys were deposited with the goldsmiths for safe keeping only and that in course of time the goldsmiths realised that they were never called upon, at any one time, to repay the whole amount deposited with them; that an undemanded portion always remained in their hands which they could safely use for their own profit. This principle, indeed, constitutes the foundation of modern banking. But the question of what demand may be made on any particular day, or during any given period, has to be considered and provided for by each banker for himself. Experience teaches that on an average over any lengthened period the payments are met in the aggregate, and more than met, by new deposits. This is evidenced by the steady growth of balances held by the banks.

The receipts for any one particular day, or during any short period, however, may, and frequently do, fall short of the payments. At the end of each week, for example, bankers lose a large amount of cash, which is drawn for wage-paying purposes, and it is not for several days that this cash gradually dribbles back through tradesmen paying in the money they have received from the wage earners. A similar depletion of cash takes place at the end of each month for the payment of salaries. Again, about the middle of each month suburban and provincial banks have their balances depleted owing to retail customers paying the monthly accounts of their wholesale houses. (This latter demand is not for cash, however, but is satisfied from the Bank of England balances, which, of course, has the same ultimate effect as if actual cash were drawn.) At the end of each quarter there is also a disturbance of balances for rents then falling due; and finally, in the summer and autumn months much actual cash is taken temporarily from the banks for harvest and holiday requirements. Thus the banks lose a portion of their cash or bank balance on certain days and at certain seasons of the year. These demands are all known demands, and the banker is prepared accordingly.

It is not sufficient, however, that a banker should be in a position to meet known demands; unforeseen demands may be sprung upon him at any moment, and he must be prepared to meet them immediately they arise. Mr. Bagehot, in his Lombard Street, writes as follows of these unexpected demands:—

“Any sudden event which creates a great demand for actual cash may cause, and will tend to cause, a panic in a country where cash is much economised, and where debts payable on demand are large. In such a country an immense credit rests on a small cash reserve, and an unexpected and large diminution of that reserve may easily break up and shatter very much, if not the whole, of that credit. Such accidental events are of the most various nature: a bad harvest, an apprehension of foreign invasion, the sudden failure of a great firm which everybody trusted, and many other similar events have all caused a sudden demand for cash.”

A banker therefore fortifies himself against any sudden or unexpected call by keeping much more cash in his till than he is ever likely to require in normal times; by maintaining a large balance with the Bank of England—which to all intents and purposes is equivalent to “cash” in the till; and by lending out large amounts to bill-brokers, which advances are fully secured, and are repayable either on demand or at short notice. He is able to arrange the amount advanced in this way from day to day—by lending further sums or calling in loans—according to the circumstances of the moment, so that he can maintain that amount in “cash” or “bank balance” which he considers necessary for his safety.

So we see that “cash” and “balance” at the Bank of England together constitute a banker’s first line of defence—they are, so to speak, his “firing line”—and the money which he lends to the bill-brokers constitutes the “supports” to the “firing line.”

The next defence which a banker maintains against possible pressure is represented by the amount invested in securities. Investments yield on an average a higher return than sums lent at short notice or call; but it must be remembered that securities are not so easily realised, if the necessity should arise.

Of these investments a large portion is represented by Consols, as, in case of need, these can always be sold for cash at very short notice, or in case of great pressure doubtless the Bank of England would be willing to make advances on the security of this stock. Of securities guaranteed by the British Government, other than Consols, there will probably be a large holding, although these securities might not in time of panic be so readily realisable as Consols. Yet it is probable that the Bank of England would, in order to avert disaster, accept such stocks as security against advances. Other high-class securities which yield a somewhat higher return will also probably be held to a large amount. A banker, however, should not rely too much on these securities for purposes of realisation in time of monetary pressure, it being quite possible that at such times there would be no buyers of any class of securities with the probable exception of Consols.

After making due allowance for “cash,” “bank balances,” “call money,” and “investments,” a banker employs the balance of his funds in discounting bills, buying bills from the market, and making advances to customers.

As the dates when bills fall due for payment are fixed, if for any reason a banker deems it prudent to increase his “cash” and “bank balance,” he can readily do so by letting his bills in hand mature, and not taking up new bills in their place. It is open to the banker to sell the bills he holds, that is, to rediscount them, if he choose to do so; but this course is not practised at the present day, except by a few country banks. Moreover, in the event of a panic, probably no one can be found to buy bills, so that they are not in practice realisable before the maturity dates. As an illustration of this, it may be mentioned that on one occasion during the crisis of 1847, it was found to be impossible in the city of London to discount even an Exchequer Bill of the English Government.

Of the various investments of a banker, “advances to customers” are the most difficult to realise in time of pressure, as the wherewithal for the customers to repay their advances is then wanting, and in their efforts to obtain necessary funds the danger would only be aggravated. In such times, indeed, the commercial world requires extra assistance to avert an actual crash.

“Premises” is an item appearing among the assets in balance sheets of joint-stock banks. It is probable that in many cases the value of the premises largely exceeds the figure at which they are put in the accounts, and hence they constitute a hidden reserve; but the investment, by its nature, is one that cannot readily be made available to meet sudden demands.

We see, therefore, that a banker’s assets usually consist of the following six classes of investments:—

The first three of these classes constitute what is known as a banker’s “liquid assets.”

Table Showing, in the case of Nine Representative Joint-Stock Banks, the Percentages of the Various Classes of Assets respectively to the Amount of Liabilities to the Public.

The averages of these percentages[2] respectively are as follows:—15·3, 12·6, 21·3, 49·2, 61·6, and 111.

On examining this table it will be noted that the proportions of funds invested in “liquid assets” do not vary materially with the different banks. When we examine, however, the separate classes of investments making up the total of “liquid assets,” we see that the case is different, and a wide divergence is shown. This is especially so in “call and short money,” where the proportions vary from 5·4 per cent, to 25 per cent, and in “investments,” where they vary from 11 per cent to 31·5 per cent.

The figures given are those of one particular day, and that a day on which, according to popular belief, some of the banks indulge in what has been called by the Press “window dressing”—that is, adjusting to a greater or less extent the amounts held in the respective classes of securities, with a view to the presentation of more impressive figures in the balance sheet to be published as at that day. Had we the actual daily records of the various banks at our disposal, it is not improbable that a greater variation would be shown in the items of “cash” and “call money”; but these figures are not available. It is true that most of the banks now publish monthly statements as to their position, and it is a noticeable fact that while some banks issue these monthly statements as on the close of business of the last day of each month, others vary the day on which the statements are made up; and it is open to conjecture that this variation of date is with the object of making a better showing.

It must not, however, be inferred that such a course as this (“window dressing”) is the usual one adopted by our banks; but it is a method of business which is possible, and which rumour has it is pursued in certain cases. This explains such remarks in the money articles as, “Money was in request to-day, owing to a large amount being called off the market by the banks for window-dressing purposes.”

As regards “call and short” money, it is possible that in time of actual panic a considerable portion of it would not be repaid when “called,” especially as regards the “short” money. It is generally believed, though not stated in any balance sheet, that a large part of this “short” money is not lent to the bill-brokers, but to the Stock Exchange—that is, to stock-brokers. Loans to the Stock Exchange are fixed from one account to the next (about a fortnight ahead), and are then supposed to be paid off if required. In time of difficulty, however, would—or rather could—this money be repaid by the various brokers to whom it is lent? Supposing a broker had a loan of £100,000 secured on American railroad shares, and a crisis suddenly developed, from where could the broker obtain the money to repay the advance if it were called in? He would not be able to sell the shares without serious loss, if at all; and he would have great difficulty at such a time to induce another banker to make him a fresh loan. In all probability the loan would not be repaid, however much the lending banker was desirous, or in need of regaining possession of his money.

Therefore such loans to the Stock Exchange (excepting, perhaps, amounts secured on Consols or such like) cannot fairly be entered under the heading of “call and short” money in a balance sheet. It is desirable, for these reasons, that balance sheets should give more explicit information than is usually the case; and more particularly they should specify separately the amounts lent to the bill-brokers at “call” and “notice,” and the amount lent to the Stock Exchange from account to account.

Turning to the question of “investments,” it may be noted in our table that those banks which show only a small proportion of “call” money, in most cases show a large proportion of “investments”; while, on the other hand, those which show a large amount at “call” hold only a small amount in “investments.”

The table exhibits a wide divergence in the proportions of “investments” held. These proportions vary from 11 per cent, to 31·5 per cent. The actual proportion of investments held, however, is not of so much concern as the nature of the securities which compose the investments; that is, whether or not they are readily realisable in case of need. The classes of investments are fairly shown in most bank balance sheets, and from a study of these some useful information can be gained. As an illustration of this, bank E in the table on page 94 shows in its balance sheet approximately the same holding in Consols as bank I, but the latter bank has deposits from its customers of twice the amount shown by the former. Now if bank E were to reduce its Consols by one-half (giving the same proportion as I), and put the proceeds in “cash” and “call money,” its position would appear thus (using the actual figures of Consols shown by the balance sheets of the two banks)—

This somewhat reduces the wide disparity at present shown in the respective figures, and it is quite possible that this difference could be still further reduced if we knew the actual amount held by each of these banks in securities, other than Consols, guaranteed by the British Government, and made the same assumptions with regard to these as in the case of Consols. As a matter of fact, considerably more than half of the 26·6 per cent. of investments held by bank E appears in the balance sheet of the bank as being composed of such securities, and these might prove a more valuable asset in time of trouble than so much money nominally at “call” or “short notice.”

From this example we can see that in examining the balance sheet of any bank, particular attention must be paid to the composition of the investments, whether they are of such a character that one may fairly rely on being able in time of stress to realise them immediately, or, in the alternative, borrow from the Bank of England on their security. We may repeat, as the matter is of importance, that the actual amount of securities held, or the proportion which they bear to the total balances, is not of such importance in the case of a bank, as the nature of the securities which form the investments. One London bank’s investments simply consist of a large holding of Consols; and though times might conceivably come when it would be impossible to realise even such a holding at short notice, yet such an investment forms a backbone and reserve which cannot be overestimated.

Having considered the securities which constitute the “liquid assets ” of bankers, we will now briefly turn our attention to the manner in which the remainder of bankers’ funds are usually utilised. As we have already seen, this remainder is used mainly in discount operations and advances to customers, while a certain amount is generally sunk in premises, etc. These three items have been classified together in our table, as the necessary information is not given in some of the published balance sheets to enable us to specify them separately. As regards “premises,” it may be repeated that though they form a valuable asset, yet they are not an available one, and would, generally speaking, only be realised in the event of a winding-up.

The bills held under discount comprise bills which are discounted for the customers in the ordinary course of business, and also bills bought from bill-brokers; and they constitute a fairly available asset.

The “Advances” to customers is a security of a very fixed nature. In times of trouble it is the asset most difficult of realisation, and it is the rock on which the majority of banks which have come to grief have struck.

No information respecting this asset is vouchsafed in any balance sheet beyond the bare total. It is a known fact that banks are lenders on practically any kind of security which has a fairly steady value, and in which there is a “market”; stocks, shares, produce, houses, lands—all are offered as security, and all are accepted under various conditions. But it is of the utmost importance that bankers should closely watch and scrutinise the aggregate of advances which they may make upon any one kind of security, so as to keep the amount within due limits. If too large a sum is advanced on one kind of security, and that security should become much depressed in value, the banker may be caught between two fires: on the one hand, the customers who have deposited this security will, from its fall in value, have become financially weakened, and perhaps not be in a position to repay the advances; and on the other hand, if the banker wish to repay himself by realising the securities, he may find that the margin of value has run off, and what can be obtained by selling the securities in the market will not cover the advances, or possibly, for the time being, they will prove to be unsaleable. Thus he will be left in the dangerous position of having a considerable proportion of his assets indefinitely locked up, and a certain number of his customers in a weak and reduced condition financially.

Neglect of the precaution of spreading advances over different suitable classes of investment has brought many banks to ruin in the past, and under similar conditions would do so in the future. This danger is not now so pressing as in former times. Owing to the present custom of establishing branches, and to amalgamations, the operations of banks are now frequently spread over wide areas, and therefore automatically their advances tend to spread over many more industries and securities than was formerly the case. When banks were more local, their prosperity rose or fell with the industry and conditions of their particular district.

We see then there is danger in locking up too large amounts in advances on any one class of security. But there is an equal danger in advancing too large sums to a few customers. A firm may be of very good standing and report, and keep a first-class and highly remunerative account with its banker. From time to time it has advances from its banker, which he is very glad to make, and which are regularly repaid. But a time may come when an advance may not be repaid when due; instead, a further advance is asked for. This is made without question, and probably further advances, always increasing and never reducing. After a time the banker may become a little fidgety, and cautiously suggest a reduction, but will probably be told that ample funds will come to hand shortly. When this time comes the funds may not have been received, and the customer may insist that he must have further help, or he will not be able to meet his obligations. The banker should require ample cover before advancing further sums; but if he is weak and yields to pressure, matters will go from bad to worse, until the customer may practically rule and command the bank, the two concerns will be involved together, and when the customer “goes” the banker will go too, or at the best suffer a big and weakening loss—not only loss of money, but loss of credit, which will affect him seriously in the future, and may ultimately cause his fall.

This danger is not a hypothetical one. It is unfortunately founded on fact. It was this cause which led to the disastrous and all-reaching failure of the City of Glasgow Bank. When the position of that bank was examined it was found to have lent as much as six million pounds among four customers. Gilbart says: “Almost every bank that has failed can point to some one, two, or three large accounts to which it mainly attributes its failure.”

On looking at the last column of our table we see that all the banks hold assets in excess of liabilities to the public; the excess is in respect of the capital and reserve fund. As an additional security for the depositors, each bank has only a part of its subscribed capital paid up. The remainder, the uncalled capital, constitutes an extra reserve for the benefit of the depositors.

The profits made by joint-stock banks are high, the majority of dividends varying between 10 and 20 per cent.; and notwithstanding such satisfactory dividends, large reserve funds have been accumulated from undivided profits. These reserve funds in some cases equal, and even exceed, the total of the paid-up capital. It may be added that many of the banks are popularly credited with holding other reserves which do not appear in their balance sheets.