amounts from one another. The coming on of the war and the establishment of special rates designed to facilitate the sale of public bonds tended to make this rate policy still more complex. Since the close of the war the practice has been considerably simplified, and the tendency to-day at most Reserve banks is in the direction of a limitation of the number of rates that are made and toward the classification of paper upon rather broad lines.

CHAPTER XI

RESERVES

I. MEANING OF A RESERVE AND RESERVE POLICY.

In dealing with bank reserves thus far the subject has been spoken of as if the reserve of a bank were more or less a self-regulating factor in its business. In some countries, notably our own, the law regulates the amount of reserve which is required, and in others local custom controls it in a degree which is quite as strict as our legal requirements. It remains true that the reserve of a bank has a very special relationship to the position of the bank itself, while the reserve level or ratio is by many persons taken as an indication of the strength of the institution. Because of this peculiar position of the bank reserve, it is worthy of special study both from the standpoint of theory and from that of practice.

As has already been seen, the reserve of a bank is easily conceived of as the ultimate cash or legal tender which the bank holds for the purpose of meeting its obligations which are presented to it for redemption. In most discussions of banking, therefore, there is quite a distinct implication that a reserve is a fund of cash which is held by the banker for the purpose of making payments on demand. Further study, however, shows that this view of the case, although correct enough when reference is had to an individual bank which has no connection with any other institution, is hardly adequate if the bank under consideration is a member of a system or series of institutions. For example, under the National Bank Act prior to the adoption of the Federal Reserve Act, it was expressly provided that three-fifths of the country bank's reserves might consist not of cash in vault, but of deposit accounts with other

banks. At the present time under the Federal Reserve Act cash in vault is not legally counted as reserve, but only the bank's balance on the books of the Federal Reserve bank. True, the bank which has cash in hand can at once convert it into reserve by depositing it with the Federal Reserve bank, but so long as the cash is held in vault it is not technically reserve. Thus it appears that under certain circumstances the bank's reserve consists not of cash at all, but of credit with other banks.

In the same way it is evident that if a bank possesses claims which are cashable at sight, it is in as strong a position as if it had actual cash. For example, if a bank has on an average one million dollars of checks presented to it through the clearing house and has no offsetting claims with which to meet them, it must expect to see its reserve reduced by one million dollars. If, however, it has claims on other banks of equal amount, the cashing of these checks has no effect upon its reserves, which remain the same. Here is another application of the thought that interbank credit is frequently a satisfactory form of bank reserve. How this idea is developed in the actual computation of member bank reserves has been elsewhere explained in connection with government regulation and need not be enlarged upon here.

One further development of the reserve idea needs, however, to be noted before leaving this phase of the subject. A bank may have in its possession paper made by solvent institutions, firms, or individuals, which is not payable at sight or on demand, but which under central bank arrangements is convertible into a reserve credit through the process of rediscounting. In that event-assuming that the reserve institution stands ready to rediscount such eligible paper practically in any quantity desired-the bank may be warranted in regarding its holding of such paper as in effect equivalent to reserve. This fact is expressed in the familiar term which refers to the secondary reserve of a bank, meaning thereby items of assets which can quickly be converted into means of payment. Summing up, we may say that in modern banking the bank reserve includes all

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those parts of the bank's assets which are available for meeting demand obligations. They may be actual cash in hand, or cash with another bank, or rediscount credit on the books of another bank, or unquestionably eligible items ready for rediscount.

With this understanding or definition of the term "reserve," the analysis of it becomes considerably easier. 'By a bank's reserve policy is meant the policy of the bank in dividing its assets between quick and long-term obligations A bank's reserve is low when the bulk of its funds are in obligations which cannot be realized for some time to come. It is high when the proportion of its assets in immediately available form is large. The reserve ratio which is often spoken of with reference to banks is obtained by dividing the quantity of actual cash or available bank credit which the institution owns by the amount of its demand liabilities. Thus, for instance, if bank A has on its books $100,000 of demand deposits and has outstanding $50,000 of notes, it may evidently be called upon at any time to pay $150,000. Now, if this bank has in its vaults $75,000 in cash, it has a reserve of 50 per cent. If, under the Federal Reserve system, it has $75,000 credited to it by its Reserve bank, it has a reserve of 50 per cent. In the case of the Reserve bank itself, only the cash on hand is figured in estimating reserves.

In order to keep a bank solvent it must evidently maintain in available or liquid form such a part of its assets as will under any probable conditions enable it to meet the demands that may be presented to it. These may be notes offered for cashing, or checks drawn upon it by depositors and presented by other banks. Exactly how large a proportion of such demands will be presented at any time is a matter which can be determined only by experience. The Federal Reserve Act requires central reserve city banks to keep a reserve of 13 per cent against their demand deposits with Federal Reserve banks, but it is assumed that the former will maintain in their portfolios a considerable additional amount of eligible paper which may be rediscounted at any time. Before the Federal Reserve Act

was adopted, such banks were required to keep in their own vaults a cash reserve of 25 per cent. In the central banks of Europe, prior to the outbreak of the war, it was not infrequent to carry reserves ranging from 60 to 70 per cent of demand liability. Yet in England the joint-stock banks frequently allowed their reserves of cash in vault to run below 5 per cent of demand liabilities, trusting to replenish them, if necessary, through credit obtained through the Bank of England. From all this it is clear that there is great variation between different banks in regard to the amount of reserve needed or called for, and that the amount thus required depends a great deal upon the character of the bank's business and the attitude of its clientele at any time. Maintenance of a proper amount of reserves is thus the outcome of knowledge on the part of the banker concerning the needs of his community, and in no small measure the result of experience and observation of local) habits and customs. A much larger reserve, for example, must be carried in a factory town where large numbers of employees are paid off on Saturday night, than is necessary in a neighboring residential suburb where there is little demand for cash and where payments are largely made by check.

II. MAINTENANCE OF RESERVE.

Supposing, however, that a banker has, through experience guided by legislative requirements, determined the approximate amount of reserve which he needs to carry in ordinary circumstances, it will be a matter of constant watchfulness on his part to see that he is able to maintain the proper balance between quick and slow assets. If, for example, a number of his customers are obliged to ask for extensions of credit, he does not receive payments either in the form of checks on other banks or cash or of reduction of his own outstanding liabilities that he may have counted upon. He thus finds that his liabilities are larger than he had expected in proportion to his quick assets. On the other hand, if he is too conservative he may find that he misses much good business by holding his cus