BANKS LEND THEIR OWN CREDIT 123

situated as to the business of its locality and the nation with a favorable assortment of depositors gets its share, whatever that may be, of the new deposits resulting from the credit created by the banking system as a whole.

What is meant by assortment of depositors inter-related in a business way is shown by the following illustration: During the Liberty Loan drives to obtain funds for the prosecution of the Great War, the effect on the banks was frequently discussed. Thousands of depositors in a town would make payments to the U. S. Government. To help out in the situation the United States became a depositor in local banks to the amount of such payments. So far there was no drain of these deposits. When the Government bought food, equipment, or clothing, paid soldiers, or made other payments to the extent of its deposits (loans), there was, due to governmental operations, no drain upon bank deposits at all, if the folks who got U. S. checks spent them with merchants, manufacturers, and others who did business with these same banks. The situation would have been similar where the Government used deposits in one section to pay manufacturers many miles away, if those merchants at the same time were paying for purchases of raw material in the first section. In either case a savings bank whose depositors made subscriptions, which did not have merchants and manufacturers as depositors to whom these payments might return, would have a drain not to be replenished until its own depositors made savings from payments for salaries and wages received from merchants, manufacturers, and contractors, who did receive the payments from the government.

A bank's lending strength is far greater when it has a variety of customers whose business is so inter-related that loans may be made without a complete drain. A

bank in a city suburb had the accounts of many work

men, a few salaried men, a few retailers, no wholesalers, and one manufacturer. Most of the people traded in the heart of the city and there was little reciprocal business. Clearings were always against this bank. Every time a loan was made checks were written and actual payment was made. No loan or payments of money seemed to bring any additional deposits to this bank. Whatever stimulation to business resulted from lending the savings of its customers, made deposits for other banks, and in return this bank received no new deposits from the loans and payments of other banks. The attempt to get sufficient savings accounts to make the bank succeed failed and it never succeeded in paying dividends until it moved uptown and secured in addition the business of a different group of depositors.

96. Banks guarantee individual credit. A different type of bank credit is illustrated by the bank acceptance (see 158). The borrower pays his bank a commission for accepting his draft payable in 60 days. With the bank guarantee on it he can then sell the draft to some individual, or bank, for a much better price than he would have received from a straight loan and thus he recovers the amount of the commission. In this case the bank has guaranteed the credit of the borrower; the bank will pay whether the borrower does or does not give it the funds with which to pay the draft when it comes due. If according to arrangement the borrower on the day before the acceptance is due. gives the bank the funds with which to pay the acceptance, the bank has made a loan of credit only.

Professor H. Parker Willis of Columbia University has emphasized on many occasions that the main function of banks is to guarantee individual credit and make it immediately available. In the case of the bank acceptance the

1 See H. Parker Willis and George W. Edwards, Banking and Business, p. 22, (Harper and Brothers, New York, 1921.)

RELATION OF LOANS TO DEPOSITS

125

bank guarantees the credit and obligates itself to pay at the maturity of the acceptance. In the case of loans the bank agrees to pay on demand up to the amount of the loan the checks of the borrower. The borrower's notes would not have been universally accepted, but his checks

are.

97. A bank cannot lend several times its deposits. Since people prefer to have bank notes, or checks in payment, and when they get them, they prefer to deposit them rather than have the money, banks as a system can make loans and be called upon to pay only a portion of them in money. If several million dollars of new gold comes into the country, banks can expand their loans to several times the amount of the gold. On account of this fact a great many people have the idea that a balance of theirs of $1,000 enables a bank to lend several times that amount. The idea is a mistaken one. The thing is impossible. Most deposits today have originated in credit and in the aggregate a bank can lend only the actual balance of the depositor, less whatever reserve it is necessary to maintain against his balance.

2

In addition to lending deposits a bank can lend upon any paper that can be rediscounted. Its ability to rediscount and its judgment as to the wisdom of expanding rediscounts affects its willingness to lend (see 125 and 127).

98. Adjustment between loans and deposits. Deposits originate in two ways-credit from loans and actual deposit of funds. The former kind of deposit is checked out. Banks strive to secure as many deposits of the latter kind as possible. Total deposits are being checked against

2 The principle that what is true of a system of banks may not be true of an individual bank is shown by Spurgeon Bell in Profit in National Bank Notes, American Economic Review, March 1912. It is shown and worked out in detail as to bank loans by C. A. Phillips in Bank Credit, chapter 3. (Macmillan Co., New York,

but the deposits that count for the bank are the credit balances day by day, the difference between total deposits and checks, the net deposits. As these increase the excess over the amount required for vault cash and lawful reserve can be used for new loans. If cash withdrawals cause net deposits to decline the bank must call in some of its loans, sell some of its investments, rediscount some of its loans, or borrow, to maintain its reserve. As funds are accumulated in a bank to pay off loans, deposits rise, but unless new loans are made both deposits and loans decline when the checks with which loans are paid are honored. Whenever the loans of a bank equal its excess deposits the payment of old loans by checks on itself results only in freeing its reserve. If old loans are canceled by funds from elsewhere the entire amount can be used for new loans. Because loans are paid by checks against bank balances, and when first made are used to increase the bank balances of borrowers or creditors, the bank loans of a nation rise and fall with the bank deposits which are subject to check.

CHAPTER IX

SECURITY FOR LOANS

99. Kinds of security. No one can borrow unless he can offer assurance that he will repay. That assurance springs from the capital of the borrower, his capacity for succeeding, and his character. If property is pledged to the payment of a debt, the security is "collateral." This may consist of real estate, bonds, stocks, notes; securities based on goods, such as warehouse certificates, pipe-line certificates, and order bills of lading; and merchandise, or other tangible, or intangible, property. "Personal" security is that which is existent without any special pledge of property from the capital, ability, and integrity of the maker, or makers, acceptors, or indorsers.

The Comptroller of the Currency of the United States in his annual report presents statistics as to the nature of the security upon which the loans of all kinds of banks are issued. The total amounts of loans in each class vary sharply from year to year. An approximate idea of the loans may be given. Fifty to 60 per cent are based upon personal and unclassified security, 10 to 20 per cent are secured by real estate, and 25 to 35 per cent are secured by bonds, stocks, or other collateral. National banks are commercial banks. Fifty to sixty per cent of their loans are on personal security, and 35 to 45 per cent are secured by the deposit of bonds, stocks, and other securities. Only a small portion are loans on real estate. Of the loans on personal security a large proportion are loans on singlename paper without any collateral. In many towns and cities the majority of the loans that are made are on