Hongkong branches, as furnished by the officials of those banks, are as follows:

A circulation of over $11,000,000 among 300,000 people is an average per capita of about 36 pesos, or about $18 in gold. This is in addition to the circulation of silver dollars and subsidiary silver coin. This is in striking contrast with the paper circulation of the SpanishFilipino Bank, which amounts to about $8 Mexican or $4 gold, even if the circulation were confined within the city of Manila, and which it is proposed to reduce to less than $3 in gold. It is no doubt to be considered that many of the notes issued in Hongkong circulate in Canton and the surrounding country, but it is also a fact that the notes of the Spanish-Filipino Bank circulate throughout the Philippine Archipelago, and some even reach foreign countries in the processes of international trade. This comparison would seem to make clear the pressing need of providing some substitute for the notes of the Spanish-Filipino Bank as their volume is reduced, and for further issues of paper currency as business increases in the Philippine Islands. There exists a strong desire among Americans in the islands that the new issues shall be afforded by American banks.

NECESSITY OF LIBERAL PROVISIONS FOR NOTE ISSUES.

Ability to obtain a larger volume of paper currency is not only vital to the prosperity of the Philippines, but the privilege of issuing notes upon a profitable basis is one of the most effective weapons of competition with the foreign banks which can be put into the hands of American banks doing business in the islands. This weapon will not be supplied by the power to issue notes under the provisions of the present national banking law, requiring the deposit in the Treasury of United States bonds for the full face value of the notes issued. This privilege would certainly not be availed of sufficiently to supply the paper circulation urgently needed in the Philippine Islands. The reason why it would not be availed of is found in the relatively small profit obtained upon circulation when thus secured, with the various restric

tions which govern it, when compared with the profit obtained by the direct loan of the capital without the formalities attending its investment in bonds.

Circulating notes will not be issued by any bank under conditions which afford no profit. The contraction of the bank currency which went on for many years, even in the United States, because of the high price of bonds, is a slight indication of the influences which would operate on an American bank doing business in a country where a much higher rate of return can be earned by capital than under present conditions at home. The obstacles to issuing notes in the Philippines based upon United States bonds would be greater than in the United States, because of the absence of a local bond market, the necessity of obtaining bonds from long distances at high prices, and the delay which would occur in reducing circulation and getting possession of the bonds when market conditions suggested it. It is not an unreasonable assertion that American banks, clothed only with the power of issuing notes under the conditions of the present national banking law, would, because of these obstacles, entirely refrain from issuing notes and would leave the islands without any increase in this class of paper currency.

It is recommended that different and more liberal provisions be made in respect to note issue, holding out sufficient prospect of profit to induce national banks established in the Philippines to supply the pressing need for currency. There can be no question of the safety of such issues in the case of banks with the large capital which has been suggested in this report, with their profits and losses diffused over different sections and different countries through the system of branches. The colonial and foreign banks having their head offices in London issue notes upon their general assets in various countries of the Orient, Africa, and South America without depositing special pledges with the British Government or with the local government where they are established for the security of these notes. The reputation and resources of the bank are in many cases superior to any reputation for security which they would derive from having deposited any part of their assets as pledges with the local governments.

The deposit of the assets of a bank in a government office or in any place out of its own custody deprives the bank of that quick command of its resources which is one of the fundamental principles of safe commercial banking. Even where the English law sometimes requires banks to hold certain classes of assets against their issues of notes, these assets are held in most cases in the bank itself, and the bank is not required to part with control over its resources. The same is true of all the great banking institutions of the European continent. The special securities required for the protection of circulation are held by the bank itself, and are not segregated in the public treasury

from its banking resources. Whatever distinction may be drawn between the business of these banks, because of their size and the importance of their transactions, and the business of local banks in the United States will not lie against the class of banks to be established in the Philippine Islands if the recommendations of this report are adopted, because such banks will conform more closely to the great banks of issue in Europe than to the isolated banks of modest capital in the small towns and cities of the United States.

A circulating note is only another form of certified check put into a form which permits its ready transfer from hand to hand without indorsement. As an obligation of the bank it differs in no essential respect from the obligation to a depositor, except where its character is strengthened by making it a preferred lien upon all the assets. Both the deposit obligation and the note obligation are liabilities payable on demand. If there is any distinction, it is in favor of the note obligation, because a note circulates through many hands and is less likely than a deposit obligation to be a subject of frequent demands upon the bank. The power to issue notes instead of issuing obligations in the form of deposit receipts is important in an undeveloped country, because the people of such a country are less accustomed than in a fully developed country to the use of other forms of credit. To deprive them of that form of credit is to discriminate against those sections which desire notes and in favor of those sections which make use chiefly of deposit accounts and checks. There is no reason by which this discrimination can be justified unless it is required by public security and convenience. Upon these grounds it is only necessary to provide that the power to issue notes shall be safeguarded in a manner which will insure the redemption of the notes in full in case of the failure or liquidation of the bank by which they are issued.

SAFEGUARDS SUGGESTED FOR NOTE ISSUES.

The safeguards recommended in regard to the issue of circulating notes by banks in the Philippine Islands are:

1. That notes shall not be issued except by banks with a capital of $500,000 or more.

2. That notes shall be a first lien upon all the assets of the issuing bank.

3. That notes shall not be issued beyond the amount of 50 per cent of the paid-up capital of the bank.

4. That a reserve shall be kept in cash or in cash obligations equal to 25 per cent of the amount of the circulation outstanding.

5. That banks issuing notes shall continue to make the deposit of $50,000 in United States bonds required from national banks with a capital of $200,000 or more as a preliminary to beginning business, and that such bonds shall constitute a part of the security for note issues.

6. That a tax at the rate of one-half of 1 per cent per annum shall be paid upon the circulation actually outstanding, whose proceeds shall constitute a safety fund to be used, if necessary, for the redemption of notes of failed banks beyond the amount provided by the first lien upon their assets.

7. That bank notes shall not be issued below the denomination of 5 pesos, or $2.50.

These safeguards are abundantly sufficient, judged by the history of banks of issue during the last century in the United States and in other countries, to insure the redemption of the notes of failed banks in full in all cases. The effects of limiting the issue of notes to large banks have already been pointed out.

The provision that the notes shall be a first lien upon the assets would in itself provide for the payment of the notes in full in almost every case, without permanent drafts upon the guaranty fund. The average dividends paid by national banks in the United States which have been placed in the hands of receivers have been about 75 per cent. The assets have rarely fallen below the amount required to pay the full value of the circulating notes. If this is the experience with several thousands of isolated banks, some of them of very slender resources and conducted by persons with limited banking experience, a much better showing would obviously be made by strong banks with widely diffused resources and such a limited power of issue as is proposed for the Philippine Islands.

The limitation of the amount of notes issued to 50 per cent of the capital of the bank is a precaution which goes beyond that of the banking law of Canada, where the system has been most effectively worked out of issuing notes upon the general credit of the banks. Banks are there permitted to issue notes to the full amount of their capital and are not required to deposit any pledges in the custody of the Dominion Government, except the bank-note guaranty fund, which is constituted from the proceeds of the tax upon circulation. In the few cases of failure which have occurred since the creation of the guaranty fund, the notes of the Canadian banks have remained constantly at par and have been redeemed promptly from the fund without seriously reducing its amount. The Government has been able in nearly every case to recover from the assets of the bank on behalf of the fund a sufficient amount to cover all the amounts disbursed for the redemption of the notes.

SUSTAINING THE GUARANTY FUND BY TAXATION.

The sufficiency of the rate of taxation provided for maintaining the guaranty fund may be judged from the history of the national banking system of the United States. The rate of taxation there levied upon circulation from the beginning of the national system until very

recently has been 1 per cent per annum. The proceeds of this tax have been about $90,000,000. The total circulation of failed national banks at the time of failure has been about $22,000,000. If the notes represented by this circulation had not been secured by United States bonds, but had been a claim upon the general assets of the issuing banks, 75 per cent of this amount, or about $16,500,000, would have been provided for from the general assets. This would have left $5,500,000 to fall upon the guaranty fund, if such a fund had been constituted from the proceeds of taxation. As this fund would have been $90,000,000, the demands upon it would have been less than onefifteenth of this amount, and the fund would have scarcely felt the effect of paying these losses. It is obviously safe, therefore, to make the tax one-half the rate which has been collected upon the circulation of national banks in the United States, or one-half of 1 per cent. Such a tax would have raised upon the circulation of the national banks up to a recent date $45,000,000, or about nine times the demands which would have been made upon the guaranty fund if the notes of failed national banks had not been secured by United States bonds.

Additional safeguards are provided for the circulation proposed for the Philippines in the provisions for a specific cash reserve against circulation and for the continuance of the system of minimum bond deposits by banks entering upon business. A bank having a capital of $500,000 would be permitted to issue only $250,000 in the class of notes recommended in this report. These notes would be covered at the outset to the amount of 20 per cent by the bond deposit which is required as a preliminary to beginning business under the national banking law. The further requirement that banks should hold a reserve of 25 per cent of their circulation, or an amount of $62,500, if they issued circulation to their full legal limit, would add another safeguard, raising the total proportion of the circulation fully covered by special security to 45 per cent. There would be still another small amount in the custody of the Government to make up the 5 per cent fund for the current redemption of notes. If this fund and the other two resources mentioned remained unimpaired, the notes would be covered by actual cash or bonded security to the amount of 50 per cent of their face value. It is possible that in case of failure the cash reserve required against circulation would be found to be somewhat impaired, but frequent reports of the state of this reserve and of the other resources of the bank would enable the bank examiners and officials to note any weakness in bank management, and to take prompt steps to correct it or close the bank before its resources became further impaired. Deliberate fraud in making returns might conceal a depleted reserve between the dates of two inspections, but all banking experience demonstrates that such fraud is rare and is extremely difficult in the case of a large bank having many agents and high-salaried officials of supposed good standing and responsibility.