Cyclopædia of Political Science, Political Economy, and the Political History of the United States
BANKS, Functions of. In the consideration of the functions of banks and of bankers it will be necessary to assume that the money in use, where the bank is located, is good money and not bad, because all the transactions of banks are stated in terms of money. In the United States the name by which money is designated is dollar; in Great Britain, sovereign; in France, franc; in other countries, other names are used. Each name is the legal definition of a coin containing a certain quantity of gold or silver. It is the metal that gives value; the stamp certifies the weight and purity. Until it is admitted that such coins, and such coins only, are good money, the true function of the bank and of the banker can not be fully comprehended.
—The substitution of what is called inconvertible paper money, the "greenback," for instance; that is to say, the substitution of the deferred promise of a thing for the thing itself, under a statute which forces its acceptance as a legal tender, not only works a fraud upon the people of the country in which such a statute is in force, but it also vitiates all reasoning in regard to money and banks, and perverts the moral sense so as to forbid a clear conception of what is right and just.
—True money must contain its own value in its own substance, and that metal will constitute the best kind of money which retains its value under the most uniform conditions through long generations. The two precious metals, gold and silver, have met these conditions; sometimes varying in their ratio to each other, but either one constituting a more unvarying standard by which to measure the transactions of men than any other substance that has ever been used to serve the purpose of money.
—The great commerce of the world, to which no act of legal tender is or can be applied, is conducted on a gold basis, and the final settlement of the sum due in money on the balance of account is made by a payment of gold coin or its equivalent. This practice would not have become established unless it had been proved by the long experience of the great commercial nations that gold possessed greater stability in its value than silver.
—On the other hand, in all transactions with some countries, China for instance, in which country there is no act of legal tender and no paper money, silver passes by weight and best serves the purpose of money.
—If there were no acts of legal tender in any country and if all contracts were subject to being enforced by the payment in coins of gold or silver according to the kind designated in the specific contract, the metal which proved to be best fitted to the conditions and circumstances of each country would be adopted by it, while the great commerce of the world would remain upon a gold basis, as it now is.
—This statement is made in order to clear the subject of banks and banking from the obscurity that may be caused if the quality of true money is not first defined.
—Banks must exist and must perform their work even when the money by which their transactions are measured is false or bad. For instance, when an inconvertible government note has been made "lawful money" under an act that can only find legal justification as a measure of war, banks must still exist and work under the disadvantage of such a fluctuating and false standard of value.
—What, then, is the function of a bank, and how does it work?
—In general terms, it may be stated that a bank lends and borrows titles to capital measured in terms of money. If the money be good, that is, unvarying in its value, during the term of the loan, the risk of the bank will be in ratio to the solvency of its creditors only, and the rate of interest will be in ratio to the abundance or scarcity of the capital in the titles to which it deals. If the money be bad, that is, varying in its value according to the caprice of legislators or the decisions of executive officers of the government, another element of risk will enter into every transaction, and the rate of interest on loans will of necessity be higher in order that it may cover this element of hazard.
—No borrower wants to borrow money except as an instrument with which to buy the thing he actually needs, and no borrower pays interest upon money. The transaction is stated in terms of money and, in very rare cases, actual money is used, but the thing borrowed is the thing bought and the interest is paid for its service.
—What banks deal in are titles, measured and stated in terms of money, to capital of all kinds, such as gold, silver, copper, lead, iron, cotton, corn, potatoes, etc., etc.
—1. A bank lends its own capital or a title to a part of its own capital; such capital consisting of the coin that has been paid in by its stockholders.
—2. A bank receives from its depositors capital in the form of coined money, or a title to capital in the form of a note, check or draft payable in coin on demand.
—3. A bank lends such part of the capital or title to capital deposited with it, as the conditions of business will permit, to the applicants for loans whom its directors consider safe to trust.
—In the vast majority of transactions no money passes, no money is lent and no money is borrowed. Only a title passes which may be converted into money, but as a rule the money itself remains in the vault of the bank, or in the place of deposit where the bank has put it for safe keeping.
—Let us consider an example of the first class. A bank lends a part of its own capital. In this case it is a national bank, and its managers desire to issue bank notes; such notes serving the general purpose of money more conveniently than the coin itself, being themselves promises to pay coin. The bank subscribes for a certain amount of bonds of the United States and pays for them with a part of its coin, which coin constitutes the capital loaned, saved, subscribed and paid in by its stockholders. Upon this loan the government pays interest. These bonds are then deposited with the government as security for the payment of bank notes that the bank may issue if payment in coin is demanded.
—These notes being secured by the bonds and being payable in coin by the bank, for which purpose a bank always keeps a reserve in coin on hand, are a good and convenient substitute for money, and for that reason borrowers desire to become possessed of them. The borrower has sold a quantity of merchandise on credit for which the buyer has given a note due at a certain future date. This note is a title to, or promise of money, but payment is deferred. It will not serve the purpose of money as it is not divisible, it is not due on demand, and few persons know whether or not it will be paid. Its owner desires bank notes for use in the purchase of other merchandise to add to his stock in trade. He takes this note, or title to money deferred, to the bank, and, after a discount or deduction of interest, the bank exchanges its notes or titles to money payable on demand for this note or title to money deferred. The interest deducted constitutes the profit of the bank. The whole transaction has consisted in an exchange of titles to money, but no money has been used. Each has rendered a service to the other. The borrower has obtained notes that he can spend, and the bank has been paid interest for the use of its credit. This transaction constitutes the function of a bank organized with a department for the issue of circulating notes.
—The second class of transactions consists in a bank receiving deposits, either of money or of titles to money, in the form of checks, drafts or bills of exchange payable in money on demand.
—A merchant having sold produce for cash, has received, in payment therefor, either bank notes or checks on banks in settlement for the same. These he gathers together and deposits in his own bank. The sum of these deposits, named in dollars, is passed to his credit on the books of the bank, and the bank is liable to have the actual coin demanded, but no money has been used, nothing but a title to money.
—As the sum of all these deposits of many merchants and manufacturers is never wanted at one time, the bank is now ready to enter upon transactions of the third class, that is, to lend a title to a part of the capital of its depositors.
—Another note, being a deferred title to money promised to be paid at a future date, is presented for discount, and the sum of the net proceeds is passed to the credit of the borrower, to be drawn upon by check as he may wish to use it in his daily transactions. In this, again, the transaction consists in an exchange of titles; one is a title to money deferred, the other a title to money on demand.
—Merchandise or commodities on the way from producer to consumer require time for conversion and consumption. During that period of time trust or credit is given by one man to another, and a deferred title to the value of this merchandise takes the form of a note, draft or bill, in which the value of the merchandise is measured in dollars or other coin; that is to say, in true money. These notes, drafts or bills are of limited use, because the credit of the promisors is known to but few. It is the business of bank directors to keep themselves informed and to exchange bank promises to pay money for these deferred promises of persons or firms. Hence it follows that banks are most potent instrumentalities for enabling merchants or dealers to buy the products of farmers and manufacturers. They are as necessary to the quick movement of commodities as railroads, steamboats, carts or wagons.
—The conduct of the business of banks and bankers demands probity, integrity, foresight, and all other qualities that make a true man. All their profits depend upon the services they may render to the community. Hence it ensues that there is no better standard by which to gauge the intelligence and character of the people of any section, state or nation than by their use of banks. The place to choose for the establishment of a branch of industry or business is the one in which banks are numerous and well sustained, and the place to be avoided is the one where banks are subject to jealousy and suspicion. Men who can not trust their banks or bankers are not themselves fit to be trusted by bank or banker.
—The function of a bank is, therefore, to borrow and lend titles to property measured in money, and to keep in reserve a sufficient amount of actual money to meet the occasional demand for coin that may be made upon it. Their use is the measure of the trust reposed in, and deserved by, the merchants and tradesmen by whom they are sustained.
Return to top