CHAPTER III

THE CURRENCY OF CUSTOM

A simple illustration has been given of how we entrust our money with a bank and how a bank employs it. Let us in our next step analyse a typical balance sheet of a big bank, for it will help us to get a clearer notion of the functions of a bank and of the character and complexity of the money market.

_Dr._

£ _s._ _d._ £ _s._ _d._

TO CAPITAL AUTHORISED 30,000,000 0 0 To Capital ISSUED 3,000,000 0 0 To Reserve Fund 1,125,000 0 0 To Amount due by the bank on Current, Deposit, and other Accounts 37,583,237 8 11 To Acceptances on account of customers 3,153,328 7 11 To Rebate of Interest on Bills discounted, not yet due, carried to new account 53,807 1 3 To Amount of Nett Profit 225,676 10 1 --------------------- £45,141,049 8 2 =====================

_Cr._ £ _s._ _d._ £ _s._ _d._

By Cash in Hand and at the Bank of England 5,996,667 14 8

By Money at Call and Short Notice 5,674,476 5 1 ----------------- 11,671,143 19 9

By INVESTMENTS--

Consols and other Securities of, or guaranteed by, the British Government, of which £35,000 (Stock) is lodged with public bodies 2,488,966 12 6

By Indian, Colonial Government and other Securities 3,771,738 10 11 ----------------- 6,260,705 3 5

By Bills Discounted 6,811,870 13 8

By Loans, Advances, other Accounts and Securities 16,218,748 12 6

By Liabilities of Customers for Acceptances as per contra 3,153,328 7 11

By Freehold and Leasehold Premises 1,025,252 10 11 ------------------- £45,141,049 8 2 ===================

On the liability side the capital issued is the amount paid up by shareholders, capital which the bank has employed in the ordinary course of its business. It represents a contingent liability to these shareholders, who have invested their capital for the sake of the return in the shape of dividends. The large sum of thirty-seven and a half millions is the most important item. This is the real working capital of the bank. It is apparently the aggregate amount deposited by the public with the bank.

This is what the bank owes to its clientele.

But the deposits are not solely money actually placed with the bank. This huge sum includes the loans the bank has made to other customers, to its borrowers. Every loan makes an additional deposit. The man who borrows a sum of money from the bank is credited with that sum and the credit appears in the current accounts. The bank has security for this loan, and, as already pointed out, this security is liquefied into bank currency. Cheques can at once be drawn against it so long as the loan runs and cheques are the country’s currency. Securities, therefore, have been converted into national currency and indirectly into legal tender.

The more, therefore, a bank lends the more do its deposit and current accounts grow.

The reserve fund speaks for itself. It is generally a fund accumulated annually out of profits and invested in the best securities. The larger the reserve in proportion to the capital and business the stronger is the bank’s position. It is a provision against future contingencies and is not touched except for these contingencies. One purpose is to meet depreciation in investments or other losses. The money being invested in the highest securities these can be sold for cash whenever the need for it arises.

The acceptances on behalf of customers are also practically covered by securities deposited by customers, until they lodge the funds to meet the bank’s liabilities in this direction. The net profit is the fund due to the shareholders of the bank, who receive their dividends therefrom.

On the asset side, the cash in hand and at the Bank of England consists of coin and notes. A portion of this is in the tills and safes of the bank in order to meet the ordinary daily needs, the incomings and outgoings, while the rest is money deposited with the Bank of England in precisely the same way as an individual deposits money with a joint stock bank. It serves two purposes. It composes an additional reserve there in legal tender, and facilitates the clearings between the various banks, debits and credits being daily adjusted in the books of the Bank of England.

It is contended by many that the banks do not keep reserves large enough in proportion to their liabilities--reserves, that is to say, in actual legal tender. It is contended that they trade on too slight a margin of gold, or legal tender; but this question must be threshed out when the way has been cleared for it.

The next item is the money at call and short notice. This is practically the money lent by the banks to money brokers, stock brokers, and discount houses. Money at call practically means that the bulk of it is lent from day to day and that banks can demand its repayment at a moment’s notice. The money is also borrowed on security, so that while the banks owe the money to the borrowers and the borrowers owe the money to the banks, the banks have the securities. These securities thereby become currency. They can also become currency if the public will accept them as currency, but the public prefers cheques to securities. The greater convenience of cheques need not, of course, be emphasized.

It will be seen that a bank’s “investments” are a large sum. They include the reserve fund, and the bank’s annual income is, of course, swollen by the interest it receives on these investments, in the same way as an individual’s income is increased. These investments are of the very highest class and strengthen the assets the bank possesses against its liabilities on deposits. It is presumed, of course, that they can be readily sold for cash should the need for the conversion arise.

Bills discounted reveal the character of another source of income. They represent investments in another high-class security. A few bills may be discounted directly on behalf of customers, but the bulk are bills re-discounted from the discount houses. Bill brokers discount bills at a certain price and the banks re-discount them at a lower price, and both, therefore, make a good aggregate profit out of the business. Bill brokers are practically the middlemen between merchants and the banks.

These bills of discount being an investment and a sound security are thereby liquefied into ordinary currency and ordinary capital, capital which the merchant is able to use in the ordinary course of his business, while the nation at large benefits from the increased capital employed and the greater production and consumption that are the immediate fruits of it.

The largest item on the asset side is the composite one of “loans, advances, other accounts and securities.” These include customers’ overdrafts and advances to customers on all kinds of security and estate, and may, perhaps, be regarded as the least liquid or the least readily realizable assets a bank has. In this item are its chief risks, and, perhaps, the soundness of banking is best judged by the size of this account. The larger the size the greater, presumably, are the risks; the smaller the size the less are the risks.

But the aggregate forms a portion of the wealth of the community. A customer gives some kind of security when he overdraws his account. But all this composite wealth, of whatever class its component elements may be, is, by the machinery of the bank, converted into currency. These loans amount to nearly half the liabilities on deposit and current accounts, therefore additional currency to this amount can be placed in circulation. If no banks lent on such wealth there would be less potential capital in circulation; the capital would be as stationary and as unfruitful as hoarded coin. While, therefore, the bank owes this sum to the borrowers, giving them power to draw cheques against it or to take out the whole sum in cash, the borrowers owe the money to the bank; for the loans interest has, of course, to be paid according to the class of security lodged. This interest is one of the chief sources of a bank’s income.

The liabilities of customers for acceptances has been explained. They offset the item on the liability side. They may be regarded as a moderate source of a bank’s income, and this class of business has to be done with great care. As for the bank’s premises, this is its own property in which it must do its business, and it is self-explanatory.

Having analysed a typical bank balance sheet, we are able to see the kind of business a bank conducts and the valuable functions it performs on behalf of the community. A bank is in reality a manufacturer of currency--not of legal tender currency, but the currency of custom. The Government does not provide this necessary machinery, so the banks provide it, and we can imagine what would happen to the country if the machinery broke down, or if it were compulsorily stopped.

This custom currency has become so much an integral part of the economic and financial structure of the country, that even our tax-gatherers will accept a cheque as readily as sovereigns. Our currency is to all intents and purposes a paper currency, the soundness of which is rarely questioned. It is not legal tender currency, but it is as vital to the well-being of the nation as legal tender currency.

The other paper currency is Bank of England notes and, since the war, Treasury £1 and 10_s._ notes. Even though the whole of these notes may not be convertible into cash, they are legal tender simply and solely because the legislature has enacted that they shall be legal tender. This is, of course, something outside custom. If the legislature were pleased to do so, it could enact that cheques on certain specified banks should be legal tender, just as it arbitrarily enacted that the new Treasury notes, issued without any gold backing at first, should be legal tender, equal to the amount of their face value in gold.

I wish to emphasize the distinction, therefore, between the currency of custom--something that has grown up out of the needs of the community, something essential to its welfare and progress, the product of an advanced stage of economics and of civilization--and the currency called legal tender. Though debts are paid and are payable in custom currency, the power of this currency to redeem debt could be destroyed in certain circumstances, the circumstances of a panic. They may be remote circumstances, but, remote as they are, they raise deep problems which to this day are discussed with energy and heat.

Ought the Government to provide machinery more adequate than that it does provide to meet the currency needs of the nation? This is one aspect of the problem. Some say it ought to provide it, some say this does not come within its province. It is left to the banks to provide that currency as best they may and quite apart from their methods of providing it, it is indisputable that they administer to a vital economic need. If, therefore, they administer to that need, should the Government come to their assistance in those circumstances which cause a collapse of their machinery?

This question has been answered in part by the Government since the outbreak of the war. It helped the machinery to work, and provided against a possible collapse by issuing “emergency” currency notes. The Government having acknowledged an emergency and established a precedent, the problem is now much simplified.