Chapter XX Banking
Imagine that you are a druggist in a small town. Suppose that a woman comes in to buy two ounces of camphor and in exchange gives you three eggs. In a few moments, perhaps, a man enters to buy a safety razor and brings with him wheat enough to pay the bill. Another, again, wishes to trade a turkey for a fountain pen. You can readily see the inconvenience to which you would be put in such exchange of actual commodities; yet this was the method used in primitive times, a method called barter.
To overcome the inconvenience of barter, as civilization advanced, it became necessary to establish a common medium of exchange, which could be accepted for anything one had to sell and with which one could buy anything he wished. This is what we call money. To meet the requirements, money must not be bulky, must be durable, and must not readily change in value. In civilized countries gold and silver are the bases of exchange.
But gold and silver are heavy and inconvenient to carry about in large, or for that matter in small, quantities, and for convenience the following kinds of paper money have been established:
1. Gold Certificates are issued with the government’s guarantee that there is gold deposited in the Treasury equal to the amount of the face of the bill. At any time the one holding such a bill may demand of the Treasury that he receive gold for it.
2. Silver Certificates are similar to gold certificates, except that silver is deposited in the Treasury instead of gold.
3. United States Treasury Notes are promissory notes of the government to pay the sum indicated. They are not payable on demand.
4. National Bank Notes are promissory notes issued by the national banks and are payable on demand of the bearer. Before a national bank may issue such notes, it must own United States government bonds of at least the amount for which it issues notes. These bonds are held by the Treasurer of the United States as security that the bank will pay its notes. According to the Owen Glass Bill, passed in December of 1913, national bank notes may at the option of the banks be gradually withdrawn from circulation.
Credit
Credit is a promise to pay at some future time for a thing which you receive now. Its use is probably as old as the practice of exchange and quite as important. The simplest and most extensive form of credit is “book” credit, such as you get at the grocer’s or butcher’s or at the department store. To explain a little more complex kind of credit: Suppose you owe Smith one hundred dollars. At the same time Smith owes Jones one hundred dollars. Because you owe Smith, he may give Jones an order to collect the money from you. With this order Jones may pay his lawyer, let us say. Perhaps the lawyer has bought a bill of goods from you. He pays you with the same order. You destroy the “note,” and thus four actual transactions have been taken care of without the use of any money. The business institution which deals especially with credits is the bank.
Banks
A bank which fulfills every banking function must have these three departments: (1) the commercial department, (2) the savings department, (3) the trust department. Some institutions specialize in one department more than in either of the others, and thus, taking the name from their principal function, banks are known as follows: (i) commercial banks or banks of deposit, (2) savings banks, (3) trust companies.
Banks of Deposit
Banks of deposit or commercial banks are business men’s banks. Their two principal functions are (1) receiving money for safe-keeping on deposit, and (2) loaning money to business men at interest. The deposit function is based on confidence and credit. The business man takes his money to the bank not only because it is convenient for him to do so, but also because he has confidence that the money will be more carefully protected than if he kept it in his own possession. In depositing his money in the bank, the business man uses a deposit slip such as the one illustrated here. The teller puts down the amount in the bank book of the depositor, who is credited with that amount on the bank’s books. He is entitled to draw just that much actual cash or that much credit in the form of checks. (See page 339.) Most firms do not deposit a sum of money and then promptly draw it out again in the form of checks to pay current liabilities, but maintain a fairly steady balance in the bank. On large average monthly balances most banks allow interest, varying from one per cent on balances of one thousand dollars to three per cent on balances of ten thousand dollars or more.
Discount
Because a large bank has many depositors, the aggregate of all the balances makes a considerable sum of money. Bankers have learned by experience just what proportion of their deposits they can depend on to remain steadily on deposit as a balance, and thus they know what proportion of their deposits it is safe to use for the purpose of discount. The simplest case of the discount function is the discount of a promissory note. In the note shown in the illustration after ninety days John H. Blodgett will receive from Lucius Thomas five hundred dollars with interest. But perhaps Blodgett cannot wait ninety days for his money. In this case, he takes the note to his banker, who will pay him the five hundred dollars less a certain percentage or discount, which is the bank’s profit on the transaction. The bank then collects the note when it becomes due.
Collateral
Instead of cashing a note held by one of its customers, the bank may itself loan money at interest for a short period of thirty, sixty, or ninety days, taking the note of the business man to whom the money is loaned. In most cases, however, unless the bank knows the business man well, a certain amount of collateral is demanded as an assurance that the borrower will pay the loan when it becomes due. The amount of collateral deposited with the bank is usually 10% to 25% in excess of the amount loaned, and it may take the form of stocks or bonds; mortgages on real estate; liens on stock, fixtures, or personal property; or warehouse receipts. When the amount borrowed is paid, the collateral is returned; if it is not paid within a reasonable time, the collateral is sold, and the amount loaned, with interest to date, is taken from the proceeds.
There are, of course, other functions of banks of deposit practised quite generally by all banks, and these will be explained later. The functions just described, however, distinguish banks of deposit in a general way from the other two classes.
Savings Banks
A savings bank accepts from its depositors small amounts of money which are not subject to withdrawal by check, but on which it pays a low rate of interest. As a general rule, an account may be opened with one dollar; and when the initial deposit is made, the depositor is furnished with a pass book, similar to the bank book, in which further deposits, interest credits, and withdrawals are recorded. Interest is compounded every four or six months, and money must, as a general rule, remain on deposit until an interest payment date before the depositor receives any interest on it. The usual rate of interest is three per cent, although four is often paid. Frequently, before banks allow deposits to be withdrawn, they demand a certain number of days’ notice, usually thirty. It is well to investigate the conditions under which the depositor places his money in the safe-keeping of the bank, because the withdrawal requirements are often stringent. Because of the stability of this class of deposit, banks are always anxious to increase their savings accounts, as a large proportion of the funds may be used for loans.
A form of the savings bank established in the United States in 1911 is the postal savings bank, in which the post-office is made the depository for savings. The post-office in the town deposits its funds in the local national or state bank, which, as security for safe-keeping, must deposit with the Treasurer of the United States bonds at least equal in value to the amount of savings deposited in the bank. Postal savings banks are practically absolutely safe, because, if the bank which takes care of the funds should fail, the bonds may be sold, so that the savers will receive their money. From deposits made in the postal savings bank, the return to the depositor is only two per cent, whereas the return from deposits made in the bank’s own savings department is three, three and a half, and sometimes four per cent.
Trust Companies
The Richards’ Baby Stocking Fund
A miner named Richards was killed in an accident in an Alaska mine. Among his possessions were found a number of letters and a baby stocking containing a little gold dust. The letters told that Richards had a little six-year-old daughter, who was now left destitute. The rough miners made up a fund of $2,500 in gold dust, depositing it with the United States Commissioner of the Territory of Alaska, to be held by him until the proper disposition of it could be made. A committee was appointed, who agreed that one hundred dollars a year for ten years should be used to give the child a common school education, and then five hundred dollars each year to give her a college education. A legal guardian was appointed, and the Kansas City Trust Company asked to act as co-guardian to invest the money and make the required remittances. The funds were first deposited by the commissioner in a bank in Portland, which sent them to the Kansas City Trust Company. Correspondence was of course carried on at the same time, the Kansas City Trust Company agreeing to accept the trust without remuneration. They have invested the money in five per cent bonds, thus increasing the fund yearly.
This is called a trust because the money is entrusted for safe-keeping and investment to the bank, which is called the trustee. A bank may also become the trustee for property left at the death of a person, both when there is a will and when there is none. When there is no will and the bank takes charge of the affairs of the deceased, the bank is called the administrator; when there is a will, the executor. Another important function of the trust company is acting as receiver for a company which has failed; that is, adjusting the company’s affairs in the way fairest both to the stockholders and to the company’s creditors. The trust company often acts, also, as agent for its clients’ property, performing the same duties as a real estate agent.
Form of Remittance
Banks as a class are distinguished one from the other according as they specialize in one or more of the functions described above. However, there are certain services that all banks perform and certain facilities that they all offer in connection with the payment of money from one person to another. These concern the forms of remittance.
If you have studied business arithmetic or bookkeeping, you very likely know the definite forms that are used. At all events, you know that currency should never go through the mails. The following is a brief review of the more important forms that may be used. Study the illustrations carefully, noticing particularly the similarity of form in all. Uniformity in such matters is desirable because it saves time as well as misunderstandings. The forms we shall consider are:
1. The check
a. Personal
b. Certified
2. The money order
a. Express
b. Postal
3. The bank draft
4. The time draft
5. The sight draft
Check.—A check is a written order on a bank, signed by a depositor, directing the bank to pay a certain person a certain sum of money. When the bank pays the order, it deducts the amount from the depositor’s account. The one who signs the check is called the drawer or maker; the person to whom or to whose order a check is made payable is called the payee; the bank on which a check is drawn is called the drawee.
Of course, before you could write a check for one hundred dollars, you must have deposited at least one hundred dollars in the bank on which the check is drawn. The bank supplies you with a check book, consisting of blank checks, each attached to a stub. When you write a check, you put the same information on the stub to be kept for reference. Then you tear off the check through the perforated line, using it to pay for whatever you may have purchased.
Certified Check.—Suppose, however, that you are writing this check to pay a debt to a stranger who lives in another city. He may hesitate to accept it as money. That he may have no cause to doubt your ability to pay the check, you take it to your bank to have the cashier investigate your account. If he finds that you have sufficient funds, he writes or stamps Accepted or Certified on the check and signs his name. At the same time the amount of the check is deducted from your account. Such a check is accepted without question when the holder is properly identified.
Endorsement.—If A gives you his check for twenty-five dollars, you could not receive the money until you had endorsed the check; that is, put your name on the back, which is, in effect, giving a receipt for the money. You may do this in various ways. You may endorse:
1. In blank; that is, merely write your name across the back.
2. In full, by saying, “Pay to the order of ——” and signing your name.
3. By restricting the payment to a particular person; as, “Pay to ——” This check cannot now be cashed by anyone except the one named in the endorsement.
Express Money Order.—An express money order is much like a check, except that it is drawn on an express company instead of on a bank and reads, for example: Continental Express Company agrees to transmit and pay to the order of —— (the one to whom you are sending the money) —— (the amount). The order is signed by the treasurer of the company and countersigned by the agent who sells it. You can buy such an order at any express office. It may be endorsed like a check.
Postal Money Order.—The other form of money order, the postal, is an agreement signed by the postmaster of one city that the postmaster of another city will pay the amount of money named in the order to the person named in the order.
Bank Draft.—A bank draft is very much like a check, except that instead of two individuals dealing with each other two banks conduct the transaction, their places of business being in different cities or villages. A bank draft is sometimes called a bank check, because in the case of both a draft and a check one party draws upon another with whom the first has funds deposited. As a general rule, banks and business houses require that remittances be sent to them by drafts drawn on New York or Chicago banks, as there is a charge called exchange made in the collection of checks drawn on local banks.
In the draft that follows, the State Bank of Utah, of which Henry T. McEwan is Assistant Cashier, makes out the draft. The bank which is ordered to pay the money is the National Park Bank of New York. The money is to be paid to Henry L. Fowler. The State Bank of Utah is called the drawer; the National Park Bank of New York, on whom the draft is drawn, is the drawee; Henry L. Fowler is the payee.
The payment indicated above was probably made without actually sending the money from Salt Lake City to New York. It was done in this way:
Henry L. Fowler of Salt Lake City owes one hundred dollars to a man living in an Eastern city, let us say Charles Emery of Rochester, N. Y. Mr. Fowler goes to the State Bank of Utah in Salt Lake City and “buys a draft on New York,” made payable to himself. The bank makes out the above, charging Mr. Fowler one hundred dollars plus a fraction of one per cent for its trouble. Mr. Fowler endorses it in full to Mr. Emery of Rochester and sends the draft to the latter. He has the draft made payable to himself so that the endorsement will constitute a full record of the transaction. Mr. Emery takes the draft to his own bank in Rochester, endorses it in blank, and receives the one hundred dollars. Thus Mr. Fowler has paid out the money and Mr. Emery has received it.
The way the banks conduct the transaction is as follows: There are certain big money centers in the country; e.g., New York, Chicago, St. Louis, San Francisco. Important banks in other places have money on deposit in at least one bank in each of these centers. The banks which thus deal with one another are called correspondents. The National Park Bank is the correspondent of the State Bank of Utah. When Mr. Emery cashes the draft at his Rochester bank, the latter sends it to its New York correspondent, and at the same time charges the correspondent one hundred dollars. The correspondent presents the draft to the National Park Bank, which pays the money and charges the same amount to the State Bank of Utah. Explain how this settles the transaction.
Time Draft.—A time draft is much like a bank draft, in that two banks conduct the principal part of the transaction for two individuals, but no money is actually paid at the time the draft is drawn. The details of a transaction of this kind are explained on the following page.
Horace Prang of 1008 Elm Street, Columbus, Ohio, owes Loetzer & Co. five hundred dollars, due August 27, 1915. Loetzer & Co. make out the draft above and deposit it in the Bank of Buffalo. The latter sends the draft to its correspondent in Columbus, which presents the draft to Horace Prang. If he is willing to pay the note when it falls due, he writes across the face of it, “Accepted” adds the date, and signs his name. It is now returned to the Bank of Buffalo. The Bank of Buffalo will then discount the draft for Loetzer & Co.
Sight Draft.—A sight draft is much like a time draft, except that the amount is paid by the person on whom it is drawn as soon as it is presented, instead of after a stipulated length of time.
Suppose the Empire Elevator Co. of Buffalo has sold $420 worth of grain to the Smith Milling Co. of Springfield, Mass. When the grain is loaded on the cars, the railroad company gives the Empire Elevator Co. a bill of lading. Now, the Smith Milling Co. must possess this bill of lading before it can take the grain from the cars at Springfield. The Empire Elevator Co. deposits the bill of lading with the above draft in the Marine National Bank of Buffalo. This bank sends both to its correspondent in Springfield. The Springfield bank presents the draft to the Smith Milling Co., who may take the grain from the cars on payment of the draft. In case of non-payment, both draft and bill of lading are returned to the Marine National Bank of Buffalo, and the Empire Elevator Co. must make arrangements for the return or the disposal of the grain.