There is not space in this chapter to deal exhaustively with the risks of shareholders, but it may be mentioned that, with the exception of the old chartered banks, the members or partners of every joint-stock bank in the United Kingdom were, prior to 1858, liable jointly and severally for the debts of the company. This Act, Statute 1858, c. 91, was not, however, compulsory; and although no bank of unlimited liability has since been formed, it was not until the passing in 1879, after the failure of the City of Glasgow Bank, of the Act 42 & 43 Victoria, c. 76, that all the unlimited banks eventually limited the liabilities of their members. Naturally, a person of considerable wealth would hesitate to risk his fortune by buying shares in an unlimited bank which perhaps returned him only 5 per cent. on his purchase-money; but this objection is not now applicable, though it must not be forgotten that the shareholder is liable for a certain known sum, part of which may be callable and the remainder reserved liability, or all of which may be reserved liability and callable only in the event of the company being wound up. Where notes are issued the members may also be liable for the circulation.

Now that the liability on bank shares is a certain sum that cannot be exceeded the investor is inclined to regard them favourably; and though a rich man, who can afford to take a certain amount of risk, may decide to hold a few bank shares among his other securities on account of their higher yield, this liability, be the risk of a bank coming to grief never so small, makes them a most undesirable investment for those persons the interest upon whose capital is just sufficient to supply their wants. Bank shares, in short, are rich men’s shares; but this fact was brought home to the public so forcibly during the Australian banking crisis of 1893 that it seems unnecessary to dwell upon a point which must be apparent to everybody. Besides, we all know that a man of small means cannot afford to incur a liability on bank shares any more than he can sign an accommodation bill, and it would be as foolish of him to accept the one responsibility as the other. Nor is he the class of shareholder to whom the depositor can look with confidence.

While allowing that the great majority of our banks are prudently managed, it must be granted that banking history is a remarkably stormy one, though it is equally true that the surface of the waters has been but little ruffled during recent years; still, the Baring crisis of 1890 is not yet ancient history; and seeing that the banks are intimately connected with the Stock Exchange, the bill-brokers and the commercial community, a person who predicts that a British bank will never again be in difficulties must be blessed by the Almighty with a most sanguine temperament, for such a prediction is altogether opposed to the weight of evidence adduced by the past, and though its fulfilment is eminently desirable, so peaceful a solution of the banking question seems highly improbable.

In Chapter II, on the choice of a banker, an attempt was made to show why a customer should select a strong institution whose working resources are plentiful, and whose reserve of liquid assets is large enough to enable it to meet a drain of deposits during a run or a panic. The shareholder who guarantees the customers of a bank against loss to a limited extent will naturally take care that he is a partner in a company which maintains an adequate reserve of cash and securities as an insurance fund against those accidents which are quite beyond the control of the most able board of directors. A shareholder, say, holds twenty-five shares in a bank. These shares are for £80 each, and the amount paid up upon each is £20. He, then, receives a dividend upon £500, and incurs a liability of £1,500. But he bought these £20 paid shares at such a price that they only yield him 4½ per cent., and he certainly cannot afford to run any great risk for such a return; so he therefore, before purchasing, took care that the bank held a large accumulation of cash and gilt-edged securities as a reserve fund against those banking risks for which he pledged £1,500 of his fortune. Every prudent man should take the same precaution.

The following illustrations, which are taken from the balance-sheets of two English joint-stock companies that need not be named, will clearly demonstrate that there are banks—and banks.

An English Provincial Bank.

Liabilities to the public upon current, deposit and other accounts are given in the balance-sheet as £4,200,000. The bank’s liquid assets are thus described:—

This bank’s position might be described in one very short word. In the first place, it has neglected to state the amount of its cash in hand and with bankers at call separately, but has mixed it up with its loans at short notice. The only deduction to be made is that the bank possesses so little legal tender that it deems it prudent not to give the figures in its balance-sheet, but to inform the public that it holds £13·8 of cash in hand, at call and at short notice to each £100 of its public indebtedness. The second entry is equally vague. We are quaintly informed that this unique institution, which owes some millions on demand, is in possession of a certain amount of Consols, but the exact sum, and the price at which they are taken, have been left to our imagination, so the bank may be the proud possessor of either £100 or £1,000 of Consols; and goodness only knows what is meant by “other securities.” The second column of our form, however, shows us that this company held £4·1 of “Consols and other securities” to each £100 it owed to its customers. Then, with a touch of true comedy, the auditors tell us that the balance-sheet, in their opinion, exhibits a true and correct view of the state of the bank’s affairs. One’s very soul goes out to those auditors, and a longing seizes hold of one to pat them on the back and shout bravo! No doubt the statement is true and correct, but how strangely incomplete.

Of course there is a serious side to this question. The bank, we can see from the total in our ratio column, held only £17·9 of cash and certain securities in reserve against each £100 it owed to the public. Obviously it is trading on the reputation of its better-prepared rivals, who, should a determined run be made upon it, might feel disposed to save it; but during a crisis, when each company has to take care of itself, such a bank, were its depositors to become nervous, would be compelled to close its doors in a very few hours. Now, would any sane person buy the shares of this bank at a price which returns him about 4½ per cent. on his capital, and incur a liability in excess of the amount of his holding? One would say emphatically not; but it is a remarkable fact that people are to be found who will take this risk with a light heart. Surely they cannot understand the nature of the security they are buying.

A bank which is caught short of cash during a crisis must apply for assistance to the Bank of England, and the Bank, which at so critical a time is the only market for securities in existence, would, before making it an advance, demand to see its securities. This bank, we know, possesses a list of “Consols and other securities” which it values at £172,170; but if the Bank advanced £100,000 against them, which is highly improbable, how could it pay off even £500,000 of its deposits? It seems to me that it must go under. The usual fate of these weak provincial banks is amalgamation with the better managed and more powerful companies, but the danger is that a storm may sweep them out of existence before they drift into one or another of these havens of rest. Fortunately, the state of the bank in question is exceptional rather than representative, but it is unwise to jump to the conclusion that the shares of every English bank are a desirable investment.

Our second illustration deals with the balance-sheet of one of the large joint-stock banks whose liabilities on current, deposit and other accounts amounts to £26,652,300. The liquid assets held in reserve against this sum are:—

Ambiguity is not the dominant note in this balance-sheet. We can see at a glance that the bank is well prepared to pay off a large proportion of its indebtedness on demand, for it holds £15 in cash against every £100 it owes. Money at call and notice (short loans to the bill-brokers and stockbrokers), which is much less liquid than cash, is stated separately, and its list of investments consists entirely of British Government securities. Moreover, we are told at what price they have been taken. The balance-sheet, though not perfect, is clear and informing; but a company that holds £4,000,000 of Consols at 90 would not be so foolish as to hide its financial light under a bushel; so when a bank modestly refers to “Consols and other securities” we may be quite sure that its holding of Consols is either remarkably small or else that its directors are exceedingly stupid. It is more probable, however, that they are astute gentlemen who reason that the luminosity of a farthing dip might call forth smiles of wonder and amazement were it allowed to shed its radiance and waste its fragrance outside the bushel.

The bank we are discussing, then, held £56·2 of cash, call money and gilt-edged securities in reserve against each £100 of its liabilities to the public; and such a bank, it need not be said, is splendidly prepared to protect the balances of its depositors and the interests of its members. As a matter of fact, the real interests of both are identical; for if a bank neglects to keep an adequate reserve of cash and securities it exposes its customers to the risk of loss and inconvenience through its stoppage during a run or a panic; as, should the bank suspend payment, the customers must either suspend too, or find another banker, while its shareholders might lose all their capital and also be called upon to make good any deficit. Obviously, then, the bank which holds £56 in liquid assets to each £100 it owes is the one with which to do business. The shares of this bank return about 4½ per cent. at the present market price; and seeing that the company has minimized the risks of its members its shares will be chosen in preference to those of the institution which has accumulated a somewhat doubtful reserve of liquid assets which works out at a ratio per cent. to its liabilities of only £17·9.

We next come to a banking company’s profits, which are a source of great annoyance and wonderment to certain people, who cannot understand how dividends of from 10 to 20 per cent. can be earned in the worst of times when everybody else is feeling the depression in trade acutely. The mystery is not very profound, for a banker’s business, of course, is only profitable so long as he can trade with the money of his depositors, and, as his own capital is usually small when compared with his deposits, it follows that a very small percentage on his working resources will return a high rate of interest upon his capital. Upon a certain amount of his deposits he allows a rate which is regulated by the Bank rate; and he charges a rate upon his loans and advances, the said rate being also more or less influenced by the Bank rate, the difference between the two rates representing his margin of gross profit. He regulates this margin by changing his deposit rate at each alteration of the Bank rate, but he also obtains money upon which he does not pay interest, and as that sum earns considerably more when the Bank rate is at 4 than when it is at 2½, it follows that his “free” money is largely responsible for the fluctuations of his dividends.

But a banker cannot trade with all his deposits. He has to keep a certain sum lying idle in his safes and tills, and with his London agents or the Bank of England. He further requires a good list of securities which can be either converted or pledged with the Bank of England should occasion arise, and such a list will not return him much more than 3 per cent. upon the sum devoted to that purpose. Then he employs a portion of his funds in the short-loan market, so he has only about 60 or 70 per cent. of his deposits to advance in the shape of loans, overdrafts and discounts to customers. In other words, a well-managed bank has to devote a large proportion of its resources to insuring its business.

Take the bank in our second illustration. Its paid-up capital amounts to £2,800,000, and its reserve fund to £1,600,000, so the shareholders’ funds come to £4,400,000. Deposits and other accounts are £26,652,300, making its total working resources £31,052,300. Now the net profit earned during the half-year was £207,869, so the bank cleared ·669 of a pound upon each £100 with which it was trading; and seeing that the trader expects to make 10 per cent. on his turn-over, it is pretty evident that bankers’ profits shrink into insignificance when compared with his. But the bank’s paid-up capital is only £2,800,000; and as £14,000 will pay 1 per cent. per annum for the half-year on that, this profit of £207,869 enables the bank to declare a dividend at the rate of 14 per cent. per annum, and to carry a large amount forward to the profit-and-loss account of the next half-year; yet it can hardly be said that its earnings on £31,000,000 are enormous; still, they look it when metamorphosed into a rate of 14 per cent. But this is only another illustration of how easily the crowd can be deceived by statistics.

It would be absurd to attempt in a short chapter to discuss the price of bank shares; but as the banking companies, unless they enjoy an exceptionally sheltered position, earn less during those periods of depression which from time to time overtake the trade of the country, it follows that their dividends, like their deposit rates, rise and fall with the Bank of England rate. Bank shares, therefore, can be bought cheaply when trade is bad and loanable capital cheap. As the so-called gilt-edged securities, during normal times, should then be dear, it often pays to sell out of the latter, invest in bank shares, and wait for the turning of the tide.