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CHAPTER VIII

THE CREATION OF CREDIT BY BANKS

91. Banks must have deposits. A young man asked an experienced southern banker how he could tell whether it was advisable to organize a bank in a certain town. "Can you get deposits?" the banker asked. "Do not profits depend on loans?" the young man queried. "Yes, but profits from loans depend on deposits" was the reply. If a bank gets deposits, they can be loaned. If a man borrows $5,000 and his account is credited, the loan has increased deposits. As the borrower checks against his loan the total deposits decrease, unless another customer deposits these checks, or new deposits are gained. The less the drain on deposits, the more possible are further loans, and the greater the profit. Bank loans of the United States amount roughly to about five times as much as the banks' own funds represented by capital and surplus. 92. Banks lend their own funds. -Banks lend money and credit. What is the source of the money they lend? Every bank receives its first money from the stockholders. A bank may be formed by the sale of stock all paid up at 15% above par. If its capital is $200,000, it has a surplus to begin with of $30,000. Whatever portion of these funds is not used for building, fixtures, supplies, or reserve; is available for loans.

93. A bank's credit attracts the funds of others which can be loaned. - People who have surplus funds need a place to put them. Because of the confidence created by their capital and reliability banks have become recognized

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as the proper place to make deposits either for safe-keeping or temporary investment. In fact banks have created such confidence in themselves that many prefer banks as a permanent place for their savings. A bank with $50,000 capital may attract $250,000 of other people's money for deposit. All depositors do not want all of their money at the same time. Although most deposits may be payable on demand, a bank's experience soon shows what proportion of the total is sufficient to have in vault in order to meet all the ordinary demands of depositors. Five per cent may be enough. Enough more, 7%, 10%, 12%, or 15% (see 127 and 231), will be kept where it can be made immediately available in case of an unusual demand. The remainder may be loaned safely. The creation of confidence by banks has enabled them to lend a large portion of the funds of others which they have attracted. Because the depositor can get his money any time he wants it, he doesn't want it except when he needs it. Whenever he gets money he takes it to a bank. Credit on the books of a bank, the ability to call for money when needed, has become a more desirable possession than money actually in pocket.

When a bank pays money to a depositor who spends it, the one who gets it either again spends it, or returns it to a bank. A banker at Christmas time was asked about the drain on his deposits by people who were spending. He laughed and said "the merchants bring it back to us." In the case of a single bank it would make a difference whether the merchants did enough business with it to enable it to recover the deposits which were being withdrawn. Otherwise loans might have to be restricted.

Business men have surplus funds at certain seasons which enable them to have good bank balances. Then the bank can lend to other business men who at that season are in need of loans. In a few months the situation is reversed.

Funds accumulate in one section of the United States in one season and the surplus is shifted to centers where borrowing is active. Funds flow to the cotton belt to move the crop in the autumn and later the excess goes back to centers where food, clothing, equipment, and articles of luxury are manufactured. The actual operation is somewhat as follows: At the height of the time of large deposits by cotton growers in their banks, the bankers place deposits and loans in other centers. As the farmer calls for his deposits in order to make payments, the banker withdraws his deposits or loans from the eastern banks.

Banks are the avenues through which the demand and supply of funds reach an equilibrium.

94. Banks create a preference for credit. A bank not only accepts money for deposit, but it accepts checks and similar credit instruments as cash, and itself goes to the trouble of collecting them. Since people take money to the bank for deposit and a bank accepts checks as money, people had just as soon have checks as money. In large amounts they prefer checks. Because creditors are willing to accept checks, debtors prefer to give them on account of the numerous advantages of checks (see 51). There is no longer any need for money to pay anything except petty accounts and items such as traveling expenses. It is not merely the credit instrument that is preferred, it is the deposit credit on the books of the bank that is preferred. The holder of money or a credit instrument takes it to the bank and gets credit. He issues his own checks to others who do the same thing. The bank transfers deposits from one account to the other, or pays them to, and receives them from other banks. In most cases whoever has a claim against a bank lets his bank collect it, and he himself is satisfied with the credit for the amount on the books of his own bank (see 53).

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Banks lead people to prefer other credit instruments when checks are not satisfactory. A personal check may be used to pay running accounts all over the United States but for occasional payments a substitute is better. Bank drafts are extensively used, especially by banks in paying by mail claims against themselves. The traveler can use travelers' checks, or letters of credit (see 164-5). Except for small transactions and change there is always some kind of substitute for money in the form of bank credit. For cases where money is absolutely necessary bank notes have been devised. To the person on the street and in the market bank notes are money; to the bank which issues them they are a credit which is used when all other credit-substitutes for money are lacking. They serve every need except that of small change and foreign transactions. In the United States state banks can not issue their own notes, but if they belong to the Federal reserve system, they as well as national banks can rediscount their customers' paper or borrow on their own 15-day (or less time) paper and receive in return Federal reserve notes (see 243). Bank notes are payable on demand but, because they are, people prefer not to demand payment unless necessary and a large proportion of them circulate until they are worn out and then new ones are issued. The life of paper money varies from 1 to 6 years. One, two, and five dollar bills do not last long.

If the banks of a city have average daily clearings of $5,000,000, they have circulating that much credit, which is greater than the total of all the outstanding notes of these banks would be.

95. Banks lend their own credit. A bank lends not money but credit when it makes a loan handing over the counter its own notes, payable on demand. If these are returned by any one and money demanded, it is given; but for most purposes the notes are satisfactory. Usually

they appear in deposits and are again paid out. In a similar way, but not to so great an extent, a bank lends its credit when borrowers, as most of them do, ask not for money, but for credit for their loans - deposits against which they can write checks. Checks may not be written immediately for the entire amount, but the bank is earning interest every day. Some people's accounts are such hand-to-mouth affairs that they write checks as quickly as or before loans are made, but many borrowers anticipate their needs. The writer this moment knows of a loan for $5,000 made six weeks ago which has not yet been used. That is exceptional. It is possible for loans on the average not to require complete withdrawals of cash for several days. If 90-day loans of credit subject to check remain uncalled for an average of 9 days, ten per cent of them may rest entirely on credit, no money being needed.

Sometimes a borrower gives his check to a customer of the same bank who deposits it to his credit, and delays its use still longer. As long as checks are written and redeposited the bank makes transfers of book credit and does not need to make payments. The check of a borrower from Bank A may be to a depositor of Bank B. Bank B receives the check for deposit and presents it to Bank A. If at the time, Bank A has also received a check for such an amount drawn on Bank B, the two are cleared and no payment between banks is necessary. To the extent that some portions of a bank's loans result in such transfer the bank is lending credit. Its customers are using deposit-currency. Checks take the place of money. The bank's credit is circulating. If there were only one bank in the United States and all people did business with it, and there were no foreign transactions, it might happen that as long as people trusted this bank, nearly all loans could be of credit. As it is, a bank well

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