Sect. II.—: Banks of Deposit and Banks of Issue. Principles on which they are established.

Banks are commonly divided into banks of deposit and banks of issue; that is, banks that take care of other people’s money, and banks that issue money of their own. But there are few banks of issue that are not at the same time banks of deposit; and the latter are farther divisible into two great classes, viz., those who do and those who do not issue the money of their customers. The banking companies established in this country belong to the first class; while the old Bank of Amsterdam did, and the existing Bank of Hamburgh does, belong to the second class.

Instead of keeping money in their own houses, where it would be exposed to various accidents, and to the attacks of thieves and robbers, most people wisely commit it to the care of a banker, and avail themselves of his services in receiving and making payments on their account. They send to their banker such sums of money as they may happen to receive, and all bills and drafts payable to them; and he becomes responsible for their amount, for the regular presentation of the bills for acceptance and payment, and for their proper noting, if not accepted or paid. It is also the practice for parties who have an account at a banker’s, to make all considerable payments by cheques payable by him. As the discharge of these functions involves considerable risk and expense, it is usual for bankers, either to charge a per centage for their trouble, or to stipulate that the parties dealing with them shall keep an average balance of cash in their hands corresponding to the amount of business transacted in their behalf. In this way business is carried on with safety, ease, and despatch; and at much less expense than it would be if individuals kept their own money, and made their own payments.

Of the sums paid into banks, some are intended to meet the cheques and orders drawn against them in the ordinary course of business; while others are sent rather for safe custody, to be retained, till opportunities be found for their investment. The former are generally placed under what are called drawing, and the latter under deposit accounts. But there is no difference between the two, except that the sums in deposit accounts are usually permitted to lie for longer periods, without being operated upon or called up. Such portions of the one or the other as the bankers do not retain in their coffers to meet the usual demands of their customers, they employ in the discount of bills, or in making advances of one sort or other, generally at short dates, to those who require them, and in whom they think they may confide.

This last is one of the most important functions performed by banks of deposit. They become, as it were, receptacles or reservoirs into which the surplus or unemployed capital of the surrounding districts is collected, and from which it is again distributed to those who want it. And it may be proper to observe, that the bankers do not always, nor perhaps even most commonly, confine their advances to those who can give security for their repayment. On the contrary, they are often more influenced in making loans by their knowledge of the conduct, the intelligence, and the pursuits of the parties, than by anything else. And it frequently happens that industrious, frugal, and enterprising young men, who have no guarantee to offer save their character, obtain advances that would be denied to wealthier, but otherwise less trustworthy parties. But without insisting on these considerations, which, however, are not a little important, it is manifest that those who have capital to lend, and those who wish to borrow, are equally indebted to the agency of the bankers, who while they enable these great classes mutually to assist each other, contribute to increase the public wealth by facilitating the flow of capital into the most productive channels.

But, however great, this advantage is not to be exaggerated. Though banks afford valuable assistance in the collection and distribution of capital, it must not be supposed, as is often done, that they have any direct influence over its formation. That is the joint effect of industry and economy—the former in producing convenient and desirable articles, and the latter in saving and preserving them for future use. Credit is neither more nor less than the transfer of money or other valuable produce from one set of individuals called lenders, to another set called borrowers—a transfer which is greatly facilitated by the establishment of banks. And as there can be no reasonable doubt that those who borrow have, in the majority of instances, better means of employing capital with advantage than those by whom it is lent, its transference from the one to the other will, in so far as this presumption is realised, be publicly advantageous. But this is the entire extent of the beneficial influence of what is called credit; and when it happens, as is too often the case, to divert capital into the pockets of knaves and gamblers, it is disadvantageous. No doubt we frequently hear of great undertakings being carried on by means of credit; but such statements are entirely false and misleading. They will, indeed, be uniformly found, when analysed, to mean only that the undertakings are carried on by means of borrowed capital. Credit is impotent to produce anything whatever. It is in fact a mere name for the trust reposed by a lender in a borrower. To call it capital is as much an abuse of language as it would be to call weight colour, or colour weight. It may transfer money or produce from A to B, or from C to D, but that is all that it either does or can do. When credit is said to be high, nothing is really meant save that those who have money or capital to lend have great confidence in the borrowers, and conversely when credit is said to be low.

Banks, when not conducted by men of probity, skill, and caution, are very apt to excite and inflame a spirit of speculation and gambling. They do this by furnishing speculators with loans and discounts, by means of which they are not enabled merely, but tempted to engage in hazardous enterprises. And for a time, or while the process is going on, everything wears an air of prosperity; and those old-fashioned houses, as they are called, that carry on a legitimate business on capital of their own, are frequently undersold and driven from the market by the competition of adventurers, trading on the funds of others, ready to encounter any risk, and living in the greatest splendour. But at length the thing is overdone, the bubble bursts, the worthless machinery of fictitious bills, rediscounts, and so forth, is exposed, and the tragi-comedy is wound up by the offer of a composition of some 1s. or 2s. per pound. Bankers and money dealers who employ the money entrusted to their care in so reckless a manner, are fitter for Newgate than for the situations they so unworthily fill. It would be a great stretch of charity to suppose that advances of the kind now alluded to can be wholly the result of imprudence. Bankers have peculiar means at their disposal by which to become acquainted with the character, position, and capabilities of those who apply to them for advances. And it is their duty to avail themselves of these means to distinguish between the careful and the improvident or reckless trader—between the man who may and the man who may not be trusted. It is difficult to believe, provided they make the necessary inquiries, that they should be often or greatly deceived in their judgment of individuals; and, provided they act with due caution, they will never so far commit themselves, even with the most respectable firms, as to endanger their own establishment in the event of the failure of the latter. Bankers may risk their private fortunes, if they have any, as they please, but they are not entitled to risk the money of their constituents by making advances to equivocal parties, and especially to those who are notoriously overtrading. It is impossible, perhaps, to bring an abuse of this sort within the meshes of the penal law, but it cannot be too strongly condemned in the opinion of the public. There is nothing about which people should be so cautious as the employment of bankers; and high character, experience, and reputation for prudent management, ought always to have the preference over fair promises and prospectuses, even when the latter are backed by offers of high interest.

The private bankers of London have not been, until recently, in the habit of allowing interest on deposits, though in special cases it was sometimes done. But in Scotland, and also in many parts of England, it has been long the practice to pay an interest on deposits of from one to two per cent. less than the market rate at the time. And the joint-stock banks set on foot in the metropolis since 1826, having introduced the practice of giving interest on deposits, provided a certain notice (generally from three to eight days) be given before they are withdrawn, very large sums have been, especially during the last ten years, deposited in these establishments. Most private banks have been compelled, in order to maintain their position, to adopt in a greater or less degree the same system. There can, indeed, be little doubt that it will, in no very lengthened period, become universal, and that the amount of deposits will be progressively and largely augmented.

By bringing, as it were, the advantages of savings’ banks, without any of their limitations, within reach of all classes, of the middle and upper as well as of the lower, this system is, in many respects, highly advantageous. It may, indeed, be doubted whether any means could be devised more likely to generate and diffuse a spirit of economy. Unhappily, however, its advantages are alloyed by the formidable disadvantage of its involving a great amount of insecurity and hazard.

Banks that give interest on deposits must employ the balance at their disposal so as to realise that interest, plus a profit to themselves. Investment is not optional with them, it is indispensable; and they cannot, in seeking investments, look to security only. Profit must be in their estimation as great, or even a greater consideration. But profit and risk are inseparable, and are always directly proportioned to each other; and hence it is, that in periods of discredit, or when a revulsion occurs, suspicions may be expected to arise in regard to the solidity of deposit banks, especially of those that pay high rates of interest on the sums committed to their custody. These suspicions may frequently, no doubt, be very ill-founded; but if they be entertained, the result will be nearly the same. This was exemplified by what took place the other day in Glasgow. There a run, partly for payment of notes, but more for deposits, compelled two great joint-stock banks to suspend payments, of whose solvency, notwithstanding their gross mismanagement, no reasonable doubt could be entertained; and led to a crisis that has had the most serious consequences.

It is difficult to know how to ward off such contingencies; but it nevertheless seems to be indispensable that something should be done in that view, otherwise we may be said to be always exposed to the most tremendous risks. It may not be practicable to form an accurate estimate of the amount now held as deposits by bankers and money-dealers in Great Britain only; but if we take the entire sum at about two hundred millions, we shall probably be within and not beyond the mark. And of this vast sum more than a half is payable “at call,” and more than three-fourths within ten days. But everybody knows that such payments are practically impossible. And hence it is plain, that in the event, which may any day occur, of a bank with a large amount of deposits getting into difficulties, or of any circumstance occurring that should occasion a distrust of the system and a general panic, the whole fabric would fall to pieces, and we should have an universal smash.

This appears to be as unsatisfactory a state of things as can well be imagined. But de republica nil desperandum. Though formidable, the evil is not insuperable; and the dangers referred to are so great and imminent, that no time should be lost in adopting measures by which they may be either obviated or mitigated. Explosions of the credit system are, in the commercial and financial, what explosions of gunpowder are in the physical world. And it would seem to be quite as necessary to endeavour to lessen the frequency and violence of the former as of the latter. Hence we think it would be good policy to enact, that all sums bearing interest, in the hands of bankers, discount-brokers, and money-dealers generally, should not be legally demandable without a month or six weeks’ notice. A regulation of this sort would not interfere with anything that is valuable in the existing system, while it would confer on it some portion of that solidity of which it is at present so miserably deficient. It would protect all classes against the effects of sudden and unreasonable fears and panics. It would give time to the borrowers to collect their resources; and to the depositors calmly to inquire into the character and situation of those to whom they had entrusted their money. This may not be enough; but some such measure as this appears to be indispensable for the security and protection of the public.

It has sometimes been contended that the notes and monies deposited in banks by private parties continue to be their property, and are as really a portion of their money as the notes or sovereigns which they retain in their tills or their pockets. The place where it is kept is different; but, except in this respect, the money which they have lodged in and that which they have out of banks, is said to be, to all intents and purposes, identical. But though specious, this statement is entirely fallacious. The money which depositors lodge in banks forms a part of the money of the country; but after its lodgment in them it ceases to belong to, or to make a part of the property or money of the depositors. They have consigned it to banking establishments, and acquired credits in its stead; that is, they have acquired the right to draw upon and receive equal sums of money from these establishments. But everybody knows that the right to a thing is not the thing itself, but something altogether different. A banker who owes a million or other sum to depositors, might regard himself as being in a sufficiently secure state, if, according to circumstances, he had a third, a fourth, or a fifth part of that sum in notes and gold in his till to answer the demands of the depositors, while he employed the reserve in advances to others. Hence it is plain that bank credit and money have nothing in common. Those who confound things that are so very different can have no clear apprehension either of the one or the other.

It is on the distinction between money and deposits or credits, that the business of banking really depends. It is a business by which a small amount of money is made to supply a large amount of credit, the profits of the bankers arising from the use of the money so economised. The Bank of England, for example, often holds more than twenty millions of public and private deposits, while she is considered to be in a perfectly safe and sound position if she have in the till of her banking department five millions, or even less, in notes and coins.

It is hardly necessary, after these statements, to observe that the profit made by bankers in employing part of the money committed to their custody is extrinsic to, and independent of, any profits which they may realise on capital of their own. “Such banks,” to use the words of Mr Ricardo, “would never be established if they obtained no other profits than those derived from the employment of their own capital. Their real advantage commences only when they begin to employ the capital of others.”—(Economical and Secure Currency, p. 87.)

But we are not thence to conclude that it is indifferent whether such banks have or have not independent capitals of their own. That would be the greatest of errors. Unless it have a command of capital proportioned in some degree to the extent of its business, those who deposit their money in a bank have but slender security for its payment. For if bankers make improvident or injudicious advances, if the securities in their possession be discredited, or difficulties of any kind arise in the conduct of their business, those who have no capital, or but little of their own, may be obliged to stop payment, when more opulent firms may be but little affected by the like circumstances. Much, no doubt, must always depend on the character and knowledge of the parties. But no amount of skill or caution can ever fully compensate for the want of adequate capital. It is the sheet-anchor of security, the only real and substantial guarantee to which the ordinary creditors of a bank have to look. When such capital has been accumulated by the bank, it shows that its affairs have been well managed, and raises a strong presumption in its favour; and when it has devolved on the partners by inheritance, or been bequeathed to them in legacies, the fair inference would seem to be, that they will not (unless they be mere fools, unworthy of any kind of confidence) rashly compromise its security by engaging in questionable proceedings.

It has been sometimes proposed to allow banks to be constituted with limited liability. But that is in every case a vicious principle, lessening the natural responsibility under which every man ought to act, and tempting parties to engage in all manner of desperate adventures. In banking, such a principle would be especially mischievous; for it is a business that requires great caution and prudence—the very virtues with which the principle of limited liability is most at variance. It may, indeed, be said that the numerous instances of mismanagement and embezzlement that now prevail, show that even the principle of indefinite liability is not enough to make joint-stock banks be conducted prudently and honestly. But, however defective, still it is the only principle on which any stress can be safely laid, and the instances referred to, bear, after all, but a small proportion to those of an opposite description. The great majority of banks are discreetly and faithfully managed. And if knavery and folly be sometimes found to prevail where every partner is deeply interested in their prevention, and is liable to the last farthing he possesses for the consequences, the fair presumption is, that they would be ten times more prevalent were the partners liable only for the amount of their shares in the bank. To suppose the contrary would be a contradiction; it would be equivalent to supposing that a man is to be as much interested in the safety of £10 or £100, as of £1000 or £10,000, or of his entire fortune, however great it may be.

Whatever else may be the effect of the late disclosures of mismanagement, fraud, and robbery, on the part of the directors and secretaries of joint-stock banks, it can hardly fail to make the partners in those associations more alive to the dangers of their situation, and to convince them, that if they would provide for their own safety, they must be more cautious than hitherto in regard to the persons they elect to fill these situations, and less disposed to take their statements for granted. Such, however, is the carelessness of most people, even in regard to those matters which most nearly concern them, that these anticipations, though reasonable, may not be fully realised. But, in the case of banks with limited liability, they must be sanguine indeed, who look for any improvement. The partners in these associations have no sufficient interest in their prosperity to make them take any unusual trouble about the way in which they are conducted, and they neither fear ruin, nor even any considerable inconvenience, from their failure. The chances, consequently, are ten to one that their managers will be left without let or hindrance to pursue their own schemes; and, when such is the case, what but abuse can be expected to be the result?

But it is argued, that whatever may be the influence of the present system on the partners in the existing banks, were companies with limited liability established, the depositors would be on their guard, and would not trust them with their money, unless they were well assured of their solidity. But, in truth and reality, they never can have any assurance of the sort on which it would be safe to rely. A bank with limited liability might have, or pretend to have, a large capital. And supposing it really had such a capital in the current year, that may not be the case in the next, or in any subsequent year. And yet as the public can know nothing certain of the bank’s losses, its credit may not be impaired, and deposits may be pressed upon it after it is really insolvent. In such cases the public is helpless; and if the indefinite responsibility of the partners in banks be not enough to make them look to their proper management, it would be worse than idle to depend in any degree on the fears or interests of the depositors. This is not a matter about which there needs be any speculation. The experience of the United States is decisive of the question. In the Union, the banks are all, or nearly all, established under a system of limited liability, and, notwithstanding their insecurity, and their perpetually recurring insolvency, they always hold large sums in deposit. Promises, professions, the bait of high interest, and the confidence placed by every one in his superior sagacity and good fortune, fill the coffers even of the establishments least worthy of credit. And such, no doubt, would be the case in England, were a like system established amongst us. But what, under such circumstances, would be the situation even of a well managed bank, were any suspicions to be entertained of its credit? The rush would be tremendous; for every body would reasonably conclude, that if he did not succeed by pressing forward with “hot haste” in getting payment of his deposit, the chances were ten to one he would get little or nothing. He has no proprietary body to which to look for payment of his claims; and if the doors were once shut against him, he could hardly expect more than some miserable dividend at some distant term.

Among the many proposals submitted to the consideration of the Bank Committee of 1857, perhaps the most extraordinary was that which assumed that something was wrong with the currency whenever any difficulty was experienced in the discounting of bills originating in real transactions, and that means should be found, in some way or other, to compel the discount of such bills. It may excite surprise that such a proposal should have been seriously made, and still more, that it should have been listened to and published. Luckily it cannot be called “perilous nonsense,” its folly being so very obvious, that it can impose on none. The discount of bills is an advance or loan of capital equivalent to their value till they become due. That advance is now usually made in paper; but as that paper is really equivalent to gold, it might, were it not for the greater convenience of the present practice, be as well made in coin or in commodities. The amount of the currency has, in truth, nothing whatever to do with the greater or less facility of discounting. That depends entirely on the amount of capital applicable to such purpose, compared with the amount of bills offered for discount. The settlement of such transactions is, if anything can be, a matter to be left to the free and uncontrolled arbitrament of the parties. Whether a bill be discounted at five or ten per cent, or not discounted at all, is, in a public point of view, of no importance. When a capitalist declines to make an advance, whether on a bill or anything else, the presumption is that he has good reasons for his refusal. But, whether good or bad, the public has no right to interfere in the matter; and any attempt it might make to interfere would be attended with ruinous results. Those who suppose that the facility of discounting depends on the magnitude of the issues of paper, would do well to recollect that in Holland, which for a lengthened period had a very extensive commerce, and where paper was unknown, the rate of discount was always very low. And while such was the case in Holland, every body knows that in the United States, which have some 1300 banks for the issue of notes, the rate of discount is usually very high, and sometimes exorbitantly so.

The business of banking was not introduced into London till the seventeenth century. It was at first conducted by the goldsmiths, who lent the money lodged in their hands for security to government and individuals. In the course of time the business came to be conducted by houses who confined themselves to it only, and nearly in the mode in which we now find it. From 1708, as already stated, down to 1826, with the exception of the Bank of England, no company with more than six partners could be established, either in London or anywhere else in England and Wales, for conducting banking business; and a very large portion of that business is still conducted in the metropolis by firms with a small number of partners, or by what are called private banks.

In 1775, the London, or rather the “city” bankers, established the “clearing-house.” This is a house to which each banker who deals with it is in the habit of daily sending a clerk, who carries with him the various bills and cheques in the possession of his house that are drawn upon other bankers; the practice formerly being to exchange them for the bills and cheques in the possession of those others that were drawn upon his constituents, and to pay the balance on the one side or the other in cash or Bank of England notes. By this means the bankers connected with the clearing-house were enabled to settle transactions to the extent of several millions a day, by the employment of not more, at an average, than from £200,000 to £500,000 in cash or Bank of England notes.

Latterly, however, the arrangements connected with the clearing-house have been so much simplified and improved, that neither notes nor coins are any longer required in settling the largest transactions. The clearing-house itself and the various banking firms connected with it, have accounts at the Bank of England; and the balances that were formerly settled by a money payment are at present settled by transfers from one account to another. The saving of money in the adjustment of large transactions occasioned by this and other contrivances, accounts for the fact, that the proportion of notes of £20 and upwards issued by the bank has considerably declined of late years, while that of £5 and £10 notes, which are used in ordinary dealings, has been materially increased.

The security afforded by a bank of deposit is a matter as to which there must always be more or less of doubt. When, indeed, a banking company confines itself to its proper business, and does not embark in speculations of unusual hazard, or from which its funds cannot be easily withdrawn, it can seldom fail, except in periods of panic or general distrust, of being in a situation to meet its engagements; whilst the large private fortunes that frequently belong to the partners afford those who deal with it an additional guarantee. Much, however, depends on the character of the parties, on their living within or beyond their incomes, and on a variety of circumstances with respect to which the public can never be correctly informed; so that though there can be no doubt that the security afforded by many banks of deposit is of the most unexceptionable description, this may not be the case with others.

All joint-stock banks, or banks having more than six partners, whether for deposit and issue, or for deposit merely, are ordered, by the Act 3 and 4 Will. IV. cap. 83, to send quarterly returns of the number and names of their partners to the stamp-office. But there was no good reason why similar returns should not, and several why they should, be required from all banks; and this having been done by the Act 7 and 8 Vict. c. 32, which also provides for their publication, little if any farther interference would seem to be required with banks not issuing notes. There is in this respect a wide difference between them and banks of issue. It is the duty of government to take care that the value of the currency shall be as invariable as possible; but it has never been pretended that it is any part of its duty to inquire into the security given by the borrowers to the lenders of money, any more than into the security given by the borrowers to the lenders of any thing else. Government obliges a goldsmith to have his goods stamped, this being a security to the public that they shall not be imposed on in buying articles of the quality of which they are generally ignorant; but it does not require that the persons to whom the goldsmith sells or lends his goods should give him a guarantee for their payment. This is a matter as to which individuals are fully competent to judge for themselves; and there is no good reason why a lender or depositor of bullion or notes should be more protected than a lender or depositor of timber, coal, or sugar. Gold being the standard or measure of value, government is bound to take effectual precautions that the currency shall truly correspond in the whole and in all its parts with that standard; that every pound note shall be worth a sovereign; and that the amount and value of the aggregate notes in circulation shall vary exactly as a gold currency would do were it substituted in their stead. But if A trust a sum of money in the hands of B, it is their affair, and concerns none else. Provided the money afloat correspond with the standard, it is of no importance, in a public point of view, into whose hands it may come. The bankruptcy of a deposit bank, like that of a private gentleman who has borrowed largely, may be productive of much loss or inconvenience to its creditors. But if the paper in circulation be equivalent to gold, such bankruptcies cannot affect either the quantity or value of money, and are, therefore, directly injurious only to the parties concerned.

But though such be the direct effects of the bankruptcies of deposit banks, their indirect effect, by propagating panics and runs on other banks, may be most disastrous. And to prevent their mischievous influence in this respect, it would be good policy, as already seen, to require a month’s or six weeks’ notice to make deposits bearing interest legally demandable.

The other description of banks of deposit, or those which do not employ the funds in their hands, or engage in any sort of business, are established without any view to profit, that they may secure the money, and facilitate the transactions of those who deal with them. The latter obtain bank credits or bank money, equivalent to the sums they deposit in the bank; and as the principal traders in towns where such a bank is established belong to it, each has a bank credit, and their payments are made without the intervention of money, by writing off so much from the credit or account of one to the credit or account of another. It is only in the event of a person having to pay money to a stranger that he has any motive to withdraw any portion of his deposit from the bank. An institution of this sort is, to those who deal with it, what the clearing-house is to the London bankers. Its expenses are usually defrayed either by a small fee charged on every transfer of bank credit from one individual to another, or by a charge on the coin or bullion deposited, or both.

A bank of this sort can never, unless its agents act dishonestly, be involved in debt, or in any kind of difficulty. The constitution of the Bank of Amsterdam was in so far vicious that it was not managed by parties interested in its welfare; that is, by agents chosen by the depositors. On the contrary, it was managed in the most secret manner by those who happened to be magistrates of the city, whether they were or were not depositors. And they, in violation of their oaths, privately lent to others a large portion of the funds deposited in the bank. But a proceeding of this sort is hardly possible in the case of a properly constituted deposit bank, like that established in Hamburgh. For in the latter the managers are appointed for short periods by the depositors, who, of course, endeavour to select the most trustworthy persons. And though it be necessary that the strictest secrecy should be kept in regard to the accounts of individuals in the bank, its affairs are otherwise transacted with sufficient publicity, while the deposits in its coffers may be withdrawn at any moment.

The trade or business of a banker has probably existed in all civilised countries in all ages. The bankers of Greece (τϱὰπςζιται) and Rome (argentarii, mensarii, nummularii) exercised nearly the same functions as those of the present day, except that they do not appear to have issued notes. They received money on deposit, to be repaid on demands made by cheques or orders, or at some stipulated period, sometimes paying interest for it, and sometimes not. Their profits arose from their lending the balance at their disposal, at higher rates of interest than they allowed the depositors. They were also extensively employed in valuing and exchanging foreign monies for those of Athens, Corinth, Rome, &c., and in negociating bills of exchange. In general they were highly esteemed, and great confidence was placed in their integrity. The rate of interest charged by the bankers was sometimes very high, but that was not a consequence, as has been alleged, of their rapacity, but of the defective state of the law, which, as it gave every facility to debtors disposed to evade payment of their debts, obliged the bankers to guarantee themselves by charging a proportionally high rate of interest. In modern times the business of banking and exchange was, for a while, almost entirely engrossed by the Jews and the Lombards of Italy.