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check on him will want to cash it, or, if such cashing should be demanded, that other checks and drafts will come into his possession sufficient to offset those which he is thus asked to make good.

This hope is founded upon the fact that the banker accepts the funds on deposit. He allows persons who want to have their money safely kept to leave it with him, and this affords them a convenience because they can now pay by means of checks. When he makes a discount he may, and usually does, in the United States, make it merely by crediting the person to whom it is granted with a fixed sum, allowing that person to draw on it to the amount indicated. It is clear that this "deposit" function is the same as the discount function, except in so far as the deposits with the banker consist of money. Where they are created simply through crediting a customer with a specified amount, the deposit function is merely another aspect of the discount function. Neither function could be carried on without the other.

It may be that the customer of the bank would rather not receive the credit on the books of the institution because the persons with whom he deals do not understand the check system or have no facilities for cashing checks. Should that be true, the customer will probably ask to receive his discount in currency. If the banker is allowed to exercise the issue function, he will then merely hand the person to whom he has granted the discount a quantity of "bank notes." They are notes which he agrees to pay at sight if presented. In this phase of the operation the banker has merely taken the note from B and given in exchange a quantity of his (the banker's own) notes in small denominations. The banker now has A's note endorsed by B for $1,000 for ninety days, while B, having paid, say, $10 for the service, has, say, ninety-nine of the banker's notes of ten-dollar denomination payable to bearer. The question may be asked why B did not simply issue his own notes, numbering one hundred, of denominations. of $10, and pay them to anyone who desired him to settle his obligation. There is no reason why he might not have done so except that the banker's credit is better known than his, and that the banker specifically undertakes to pay his own notes in money when they are presented. It is quite true that in most cases the holder of such a note will not present it for payment; but one principal reason why he does not do so is that he knows he can, if he chooses, liquidate in that way at any time. Performance of the operation just referred to over and over again, and proper protection of the

bank's notes and deposits issued or granted so that the holder may get cash at sight, is commercial banking. The banker may modify the plan of his business by entering into an agreement with his customers to pay them, not at sight, but on time; and in that case he is able to use such funds as come to him for long-time investments. The basic idea is the same in the one case as in the other, but the method of procedure is different.

23. RATIO OF NOTES TO DEPOSITS IN DIFFERENT CLASSES OF BANKS1

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1,477.2 423.5 2,754.9 658.1 5,012.1

From Statistics of Banks and Banking in the United States, 1867-1909. (National Monetary Commission, 1910.)

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25. THE FUNCTION OF A CASH RESERVE1

BY IRVING FISHER

It cannot be too strongly emphasized that, in any balance sheet, the value of the liabilities rests on that of the assets. The deposits of a bank are no exception. We must not be misled by the fact that the cash assets may be less than the deposits. When the uninitiated first learn that the number of dollars which note-holders and depositors have the right to draw out of a bank exceeds the number of dollars in the bank, they are apt to jump to the conclusion that there is nothing behind the notes or deposit liabilities. Yet behind all these obligations there is always, in the case of a solvent bank, full value; if not actual dollars, at any rate dollars' worth of property. By no jugglery can the liabilities exceed the assets except in insolvency, and even in that case only nominally, for the true value of the liabilities ("bad debts") will only equal the true value of the assets behind them.

These assets are largely the notes of merchants, although, so far as the theory of banking is concerned, they might be any property whatever. If they consisted in the ownership of real estate or other wealth in "fee simple," so that the tangible wealth which property always represents were clearly evident, all mystery would disappear. But the effect would not be different. Instead of taking grain, machines, or steel ingots on deposit, in exchange for the sums lent, banks prefer to take interest-bearing notes of corporations and individuals who own, directly or indirectly, grain, machines, and steel ingots; and by the banking laws the banks are even compelled to take the notes instead of the ingots. The bank finds itself with liabilities which exceed its cash assets; but in either case the excess of liabilities is balanced by the possession of other assets than cash. These other assets of the bank are usually liabilities of business men. These liabilities are in turn supported by the assets of the business men. If we continue to follow up the ultimate basis of the bank's liabilities we shall find it in the visible tangible wealth of the world.

We have seen that the assets must be adequate to meet the liabilities. We now wish to point out that the form of the assets must be such as will insure meeting the liabilities promptly. Since the business of a bank is to furnish quickly available property (cash

Adapted from The Purchasing Power of Money, pp. 40-46. (The Macmillan Co., 1913.)

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or credit) in place of the "slower" property of its depositors, it fails of its purpose when it is caught with insufficient cash. Yet it "makes money" partly by tying up its quick property, i.e., lending it out where it is less accessible. Its problem in policy is to tie up enough to increase its property, but not to tie up so much as to get tied up itself. So far as anything has yet been said to the contrary, a bank might increase indefinitely its loans in relation to its cash or in relation to its capital. If this were so, deposit currency could be indefinitely inflated.

There are limits, however, imposed by prudence and sound economic policy on both these processes. Insolvency and insufficiency of cash must both be avoided. Insolvency is that condition which threatens when loans are extended with insufficient capital. Insufficiency of cash is that condition which threatens when loans are extended unduly relatively to cash. Insolvency is reached when assets no longer cover liabilities (to others than stockholders), so that the bank is unable to pay its debts. Insufficiency of cash is reached when, although the bank's total assets are fully equal to its liabilities, the actual cash on hand is insufficient to meet the needs of the instant, and the bank is unable to pay its debts on demand.

The less the ratio of the value of the stockholders' interests to the value of liabilities to others the greater is the risk of insolvency; the risk of insufficiency of cash is the greater the less the ratio of the cash to the demand liabilities. In other words, the leading safeguard against insolvency lies in a large capital and surplus, but the leading safeguard against insufficiency of cash lies in a large cash reserve. Insolvency proper may befall any business enterprise; insufficiency of cash relates especially to banks in their function of redeeming notes and deposits.

Since, then, insufficiency of cash is so troublesome a conditionso difficult to escape when it has arrived, and so difficult to forestall when it begins to approach-a bank must so regulate its loans and note issues as to keep on hand a sufficient cash reserve, and thus prevent insufficiency of cash from even threatening. It can regulate the reserve by alternately selling securities for cash and loaning cash on securities. The more the loans in proportion to the cash on hand the greater the profits, but the greater the danger also. In the long run a bank maintains its necessary reserve by means of adjusting the interest rate charged for loans. If it has few loans and a reserve large enough to support loans of much greater volume, it will endeavor

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