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Cheque Paying Banks

( Originally Published 1909 )

WE have now considered the various forms of cash money, and the process of the manufacture of the money, or right to draw a cheque, which is dealt in by lenders and borrowers in the money market. And we have seen that the right to draw a cheque in England carries with it the immediate and invariable right to demand gold, and so makes London the monetary centre of the world, since elsewhere this free convertibility of the currency of the country is not to be relied on with the same certainty. The tremendous responsibility undertaken by the London money market is thus apparent, and we have now to examine the various wheels of the great machine by means of which it carries on business.

In our chapter on the manufacture of money we formed a distant acquaintance with the greatest of these wheels, when we saw that the cheque currency of England is manufactured by the banks, largely through the loans and discounts by means of which they create deposits which represent mutual indebtedness between them and their customers.

The provision of currency has thus passed into the hands of the other banks, and the Bank of England's note issue is chiefly used as a basis of the cheque currency which they provide, that is, is held in reserve by them to meet cheques that may be presented for payment in legal tender cash notes or gold. Before we go further, however, we must make sure of what we mean when we talk or write about the banks. I have headed this chapter " Cheque-paying Banks," manufacturing a very ugly phrase in the hope that it may be clear. For it may be said that the essential function of English banking, which differentiates it from other institutions which are very nearly but not quite banks, is this fact that it gives its customers the right to draw cheques against credits arising sometimes from the deposit of cash, more often from advances against security or the discounting of bills, and is prepared to meet these cheques on presentation by paying coin or notes across the counter. The phrase cannot claim the watertight completeness of a logical definition, but it is roughly descriptive.

It includes the country banks, which in their turn bank with the London banks. The cheque-paying banks, in short, for the purposes of this inquiry must be taken to include the native banks of this country, with the exception of the Bank of England, which may be regarded either as the foundation of the banking edifice or as a pinnacle on its summit, but in any case stands by itself. But they do not include the merchant firms and accepting houses, who do a business which is often described as banking, but do not meet cheques drawn on them with legal tender cash, but with a cheque drawn on one of the banks which we classify as cheque paying.

It need not be said that banking groped its way to its present perfection through many difficulties and mistakes. A Royal Commission which inquired into the subject in the early part of the nineteenth century laid bare the fact that in 1793 more than a hundred English county banks failed, and that in 1810 to 1817 six hundred closed their doors. Novelists of earlier generations made effective use of bad banking in the plots of their novels, and actual fact was even more romantic than fiction in the days when the speed of a post-chaise full of bullion might save a bank which was troubled by a run, and difficulties of transport were increased by the highwaymen who infested the roads. In 1793 " a general panic was raging in London ; many bankers failed, some of whom acted for their northern brethren. Fresh London agents had to be appointed and duly advertised in the local papers. This helped to spread alarm. Every holder of a note was anxious to convert it into gold. Scores of country bankers were in London, trying, by any means, to gather the precious metal, with which, when obtained, they immediately posted home, disregarding the perils of robbery on the road. The very bank that had reported ` all quiet and undisturbed' on the 20th had before the close of the month {March) first a clerk and then two partners in London seeking gold, a supply of which they obtained and carried north with all speed.

Mr. Rowland Burdon, partner in the Exchange Bank, Newcastle, was in the metropolis upon the same mission. On the return journey his post-chaise was stopped by footpads, who pinioned the banker and rifled his pockets. The bullion fortunately escaped their notice."

It is recorded in the interesting work just quoted that the great banking family of Backhouse of Darlington were wont, when they found it necessary to replenish their gold store and were anxious to avoid the suspicions that would be aroused if they were known to be doing so, to drive quietly off in a gig as if about to visit a local meeting and to change into a post-chaise and four at Scotch Corner, a noted place on the North Road. The practice throws an interesting light on the extreme care which had to be exercised by bankers in early days in order to do nothing which could possibly excite suspicion. And having mentioned the Backhouse family I cannot avoid the well-known story of the attempt made, according to legend, by Lord Darlington early in the nineteenth century deliberately to break their bank. It is stated that he actually instructed his tenants to pay him their rents in Backhouse notes, meaning when he acquired a sufficient number of them to present them all at once, demand gold, and so make the bank put up its shutters. Jonathan Backhouse was apprised of this intention, and went off to London post-haste for the necessary supply of gold. On his way back one of the fore-wheels came off the chaise, and rather than wait to have the wheel replaced the banker piled the gold at the back part of the chaise, so "balancing the cash" and driving into Darlington upon three wheels. " By this sudden coup the bank was so well provided with specie that when Lord Darlington's agent presented a very large parcel of notes they were all promptly cashed, the Quaker quietly remarking, ` Now tell thy master that if he will sell Raby, I will pay for it with the same metal.' "

Finally, I must risk still further the charge of irrelevant anecdotage by telling the story of the man who came down the steps of his bank, the door of which had been closed against him, stumbled under the shock of his ruin into the arms of a friend, and apologized by saying, " The fact is, I had lost my balance."

It would be pleasant to linger over the romance and humours of the primitive days of banking, but it is perhaps still pleasanter, and certainly more profitable, to record that both the comic and tragic side of bank failures, as a common experience, are to the present generation only a matter of tradition.

And yet they are not really a matter of very ancient history, and I have talked with a grey-haired manager of a country bank, now absorbed into a great joint-stock concern, who was behind his counter during a run and asked a customer who came in to draw his balance how he would take it, and was astonished by being asked for the bank's own notes.

The improvement in English banking has been coincident with the development of joint-stock banking, a fact which is the more interesting because it was noted by keen-eyed Adam Smith that the joint-stock system is particularly well suited to banking. His reasons are worth quoting. "Though," he says, " the principles of the banking trade may appear somewhat abstruse, the practice is capable of being reduced to strict rules. To depart upon any occasion from these rules, in consequence of some flattering speculation of extraordinary gain, is almost always extremely dangerous, and frequently fatal to the banking company which attempts it. But the constitution of joint-stock companies renders them in general more tenacious of established rules than any private co-partnery. Such companies, therefore, seem extremely well fitted for this trade."

Apart from this regular working by rule and tradition, joint-stock companies have for some time been subjected to greater publicity than private firms. When there is a large body of shareholders, it is impossible to maintain the same dignified secrecy and reserve concerning the position of a business, which is generally observed by private enterprises : and any bank which has to issue a statement of its position is bound to issue a strong one, or it would at once be the subject of cavil and suspicion, which might have unfortunate results.

Hence it is that publicity has compelled the banks to keep themselves strong, in wholesome fear of the criticism of their rivals and of other members of the monetary body. A good balance-sheet was soon seen to pay those who produced and published it, and the banks found that by giving publicity to their position they gained and maintained public confidence : so much so that nearly all the private banks, though not bound to do so by law, now publish annual or half yearly balance-sheets.

Publicity has thus done much for banking, and its good effects are generally recognized by the most enlightened bankers of to-day, some of whom are strong advocates for its extension. The regular publication of half-yearly balance-sheets was a great step forward. But much may happen between January 1 and June 30, and again between July 1 and New Year's Eve, and the freedom and facility with which the English system of banking works is a temptation to bankers to employ too freely the admirable machinery with which they supply credit and currency to the commercial and financial community, and to build up too big a basis of credit on too small a foundation of cash.. The fact that their doing so facilitates trade and finance and quickens the wheels of commerce all the more efficiently, as long as no untoward result follows, makes it difficult to advocate reform without affecting the interests of a large and powerful multitude, and also necessitates the greatest care in dealing with a very delicate and difficult subject. Nevertheless, it must be remembered that trade and speculation that are based on inflated credit and inadequately secured currency carry with them dangers that are unpleasant to contemplate even in imagination, and it may also be contended that the strength 9f the resistance to the more frequent application of publicity to the position of the banks is in itself a sufficient evidence of the urgent necessity of the reform.

It has long been recognized that it is the duty of currency-creating banks to issue frequent statements of their position. The Bank of England has published a weekly account regularly ever since the Act of 1844.; the Bank of France does the same, and so do all the chief Continental banks of issue.

And in New York, where there is no central bank, there is a weekly statement of the position of the Associated Banks. It may be contended that since the Bank of England makes this weekly statement, and is the keeper of the ultimate reserve of the country, all that is necessary is already done, and that English banking is in this respect quite as subject to publicity as its Continental counterpart. But the conditions in England are wholly different, for, as we have seen, the development of the use of cheques in England has reduced the position of the Bank of England's note issue to one of quite secondary importance as currency, and has made the banks on which the cheques are drawn, the chief creators of currency for this country. The publication of the Bank of England's weekly account shows how much gold it has, and how many notes it has issued against it, but tells us nothing as to how much credit the other banks have built up on the basis of this gold and these notes.

After the crisis of 1890, which was faced with most satisfactory equanimity by the English banks the late Lord Goschen urged on the bankers the desirability of a higher proportion of cash reserves, and, doubtless observing that in order to maintain a continually higher standard, more frequent publicity was essential, asked for monthly statements.

His suggestion was immediately adopted by most of the principal London banks. This was some- thing gained, but the partial nature of the reform robbed it of much of its advantage, and attached to it obvious evils and unfairness. None of the private banks followed Lord Goschen's hint, and one of the greatest of them, which has since joint-stocked itself in conjunction with a large number of other private firms, still remains outside the circle of monthly publishers of statements. And none of the country banks, with which the country branches of the London banks are in continual competition in one place or another, considered that Lord Goschen's admonition in any way concerned them.

The bankers who had followed it were thus placed at a disadvantage, if it be a disadvantage to have an incentive applied to them in the direction of prudent banking. And it must be admitted that from the point of view of earning dividends and obliging customers, that banker is temporarily favoured who has least inducement to restrict his credits according to the dimensions of his cash, though ultimately he runs all the greater risk of being a danger to himself and to the rest of the community.

Certainly the banks which do publish monthly statements of their position appear to regard the fact as a handicap to which their competitors are not subjected, and the reluctance of the latter to join the movement is presumptive evidence in favour of the view that they make an unfair use of their comparative freedom from publicity. If this be so, there is clearly all the more reason why publicity should be applied to them.

Moreover, it has become evident that even monthly statements are insufficient if they are to show the position on one day only, the day on which the statement is made out, and are not to give some evidence of the relation between the banks' cash and liabilities throughout the period covered. A periodical "tightness of money," as Lombard Street calls it, towards the end of every month, when the monthly statements of the publishing banks are being prepared, leads irresistibly to the conclusion that some of them call in loans or diminish discounts, and so increase their cash holding in order to make their position stronger on the day of its publication. One of them, the London and County, in order to show that it at least is no party to this system of publishing misleading statements, J. adopted early in 1908 the practice of giving the amount of its daily average cash holding throughout the month, and has thus led the way towards the abolition of a practice which is obviously quite unworthy of the high traditions of English banking.'

It might, perhaps, be unfair to expect all the banks to give a full statement of the daily average position of their cash and deposits, owing to the extra amount of clerical work involved, and an efficient alternative was advocated a few years ago by a distinguished chairman of the Bankers' Institute in the course of a presidential address, in which he suggested that all banks should publish a weekly statement.

The present system by which publicity is applied to banking, once a year in some cases, once a half year in others, and once a month in others, is clearly illogical and unfair, and the fact that obstinate resistance is offered to publicity, especially by certain of the country banks, only shows how necessary is its application.

As will be seen later, the question is intimately connected with the wider problem of the collective gold reserve, and it has been insisted over and over again by practical and distinguished bankers that the proportion of cash to liabilities, in the case especially of some of the country banks, is inadequate, and that periodical publication of their position is an important step towards a remedy for this evil. All that is asked of the banks is that they should show what they are doing, and the reluctance of some of them to do so is not a favourable sign.

The fact that the great majority of the banks do give adequate attention to the relation between their cash and their liabilities rather increases the difficulties of the question, because it brings into being a school of thought which maintains, after the manner of Doctor Pangloss, that all is for the best in the best of all possible banking worlds, and resents any suggestion of improvement as an impertinent intrusion ; but these optimists must remember that, if ever banking trouble should arise in this country, they must not expect the public to discriminate too nicely between the good banks and the less good, so that an indiscretion on the part of a weaker brother might cause serious inconvenience to bankers of the most strait-laced virtue. But the more frequent publication of accounts is a matter which will inevitably be settled, and let us leave it with the hope that the next step will not, like the last, be taken by the banking world as the result of crisis.

It has already been stated that the great improvement in English banking, which has changed the picturesquely exciting system illustrated at the beginning of this chapter for one of monotonous solidity, has coincided with the development of banking by joint-stock companies. And it is interesting to note that the law of the land, as far as it could, presented an insuperable obstacle to this development. It gave a monopoly of joint-stock banking in London to the Bank of England, but it defined banking, as banking was when this monopoly was given, as the right to issue notes. But when the nature of banking changed, and it became the business of a banker not to give a customer a credit and let him take out notes, but to give a customer a credit and let him draw cheques, it was perceived that the Bank of England's monopoly did not prevent the establishment of joint-stock banks in London ; and so the law, in spite of its manifest intention, was practically annulled by a change in banking practice which its framers could not possibly have been expected to foresee. It was in 1834 that this discovery bore fruit in the foundation of the London and Westminster Bank, and since then it may be said that English banking has passed into the hands of the joint-stock banks by their rapid development, by the readiness with which they absorbed the old private banking firms, and finally by the action of a large number of the latter, which were amalgamated in 1896 into a great joint-stock bank, named Barclay and Company, after the principal firm among its components.

The distinguishing feature of the new banking which has thus grown up is the system of banking by branches. In former days each bank stood by itself with its customers all in one neighbourhood, and if it had branches they were quite few and confined within a comparatively small area. The new banking opens branches all over the country, or buys the interests of other banks, and seems to seek to diffuse its business as widely as possible.

The consequence is that English banking, instead of consisting of a large number of small firms or companies providing monetary facilities each for its little band of customers, has been systematized into a compact army, composed of a few well-regulated and strongly equipped regiments, each of which has its companies and outposts scattered up and down a big area, but worked from a common centre, and with excellently organized arrangements by which the needs of each district can be watched over and provided for.

This development has great advantages, the most obvious of which is the imposing magnitude of the gigantic modern banks as compared with the pigmy firms of the old system of separate entities.

Since the banker trades on public confidence, and size is the most impressive quality for striking the public imagination, the process of amalgamation and branch building has certainly strengthened banking in a most important respect. And it need hardly be said that it has also done a great work in regulating the ebb and flow of monetary facilities and providing a number of channels, all connected with the central reservoir, by which the process of financial irrigation can be most easily and cheaply conducted, and the supply can most readily be applied to any part that may happen to be suffering from drought. As long as all goes well in the world of banking the present system will readily be acknowledged to be a great improvement on its predecessor.

At the same time, it must not be forgotten that this multiplication of bank branches has also multiplied the number of points at which the banking body is vulnerable, and that, if it should so happen that all did not go quite well in the banking world, and every branch open became a sucker instead of a feeder, the magnitude of the defenders task would be greatly increased by the diversity of the outlets for the banks' life-blood. A cash reserve which would be adequate enough for an institution which keeps all its liabilities under one roof may easily be meagre for one which has smaller liabilities scattered over different points in a score of counties.

From this point of view the size of a bank, which is so striking an indication of solidity in the eyes of the uninstructed, presents a different aspect on closer examination. For it is usual to measure the size of a bank by its deposits, in other words by its liabilities, and by the number of its branches. And when the liabilities are not only great but wide spread, they become still more misleading as a test of greatness. In estimating the wealth of an individual we should hardly begin by enumerating the number of millions that he owed, and the number of places in which he owed them. We should admire the magnitude of his credit operations, but in assessing his solidity we should most of all want to know how liquid were the assets which he held against this mass of debt. And so with banks. The bigger they are, and the more widely scattered their places of business, the greater is their need for prudence and foresight. It need not be said that these platitudes are fully recognized by those in charge of the many-branched banks.

We have seen that the banks, by creating the cheque currency with which English commerce and finance is now conducted, play a supremely important and responsible part in the domestic economy of the London money market. But this is only one side of their importance. They also, in normal times, that is, at times in which it is not necessary for the Bank of England to intervene and control the position, regulate the price of money in London as indicated by the rate for day-today loans and short fixtures, and the discount rates for bills of all dates. To a certain very limited extent, it is true, they are controlled or affected at all times or at nearly all times by the Bank of England's official rate, because the allowance that they make to depositors for the use of their money is generally though not invariably 1 1/2 per cent. below Bank rate. But, besides the funds which they hold on deposit, they also have very large sums left with them on current account, on which they in most cases pay no interest at all, so that it often happens that they can and do lend in the money market at a lower rate than they pay to depositors.

And the price at which they lend in the money market makes the market rate for loans, except on quite rare occasions.

It seems to be impossible to go straight forward in this inquiry, and now we must pause and explain the meaning of this phrase, the market rate for loans.

If I may be allowed to express it with a view to clearness and simplicity rather than fulness and precision, it means the rate at which the banks are prepared to lend money or the right to draw a cheque to the bill-brokers. The bill-brokers ought to be explained too, but they must wait for the next chapter, and in the meantime can be described roughly as specialists who devote themselves to discounting bills, or acting as intermediaries in the discounting of bills. If you look at the aggregate bank balance-sheet drawn up to illustrate our chapter on the manufacture of money, you will see on the right-hand side among The only banks which at present separate current from deposit accounts in their balance-sheets are The Union of London and Smith's Bank, Messrs. Glyn, Mills, Currie & Co., and Messrs. Hoare, On June 30, 1908, the Union owed L24,204,000 on current account, and 11,812,000 on deposit account, the former being thus rather more than double the latter. At the same date Glyn's current accounts were L10,009,738, and their deposit accounts 4,289,486. On July 6, Messrs, Hoare showed current accounts L41,885,819, and deposit accounts 561,519. the assets first the cash in hand and at the Bank of England, the bank's first line of defence, and then " loans at call or short notice." These loans are made day by day by the banks to the bill-brokers, money lent to whom is regarded by bankers as a second line of defence, since it is habitually placed either " at call " from day to day or for periods which do not usually exceed a week ; and can thus, in theory at least, be called in readily. The phrase also, in some cases, covers loans from banks to stockbrokers ; but when the rate for money is quoted in the City, it usually means the rate between banks and bill brokers. And any one who reads the opening paragraph of a newspaper money article and is puzzled to find that there was very little demand for money, and day-to-day loans were easily to be had for some apparently absurdly unremunerative rate, need not therefore infer as sometimes happens that a great revolution has been effected in human nature, and that money is no longer an object of man's ambition. The phrase generally misleads those who are not used to City jargon, and I once heard an indignant gentleman in a railway carriage vehemently asserting that the newspapers talked infernal nonsense, because he had apparently strayed by some mistake into the money article of the one that he had been reading, and had learnt from it that money was " unuseable," and that balances had been offered in vain at 1 per cent. It appeared that he had spent the previous day in a fruitless endeavour to induce his bank to allow him an overdraft on the security of certain pictures, apparently his own works, and of quite problematical value ; he had offered to give up to 10 per cent. for the accommodation, and was so deeply stirred by the statement that there was no demand for money at x per cent. that he roundly dismissed all City journalists as unfit even to be art critics, which appeared to be the extreme limit of condemnation in his opinion.

It is very important that the meaning of the word " money " as used in the City should be clearly grasped, for we shall find that the rate for this money and the facilities for getting it are most important wheels in the machine, and it is essential to keep a tight hold of the correct significance of the phrase.

Money, then, has a special sense when spoken of by the chief dealers in it, thus presenting yet another example of the confusing inconsistencies of economic nomenclature. In this sense it is usually a loan granted by a banker to a bill-broker for a day or for a period not exceeding a week. The rate for this class of accommodation thus represents the price of the right to draw a cheque given to a borrower of the highest possible credit against securities of the highest possible class, and for the shortest possible period. And it is thus quite misleading to draw any inference from it concerning the rate that ought to be paid under different conditions.

This rate is, in normal times, practically decided by the cheque-paying banks. Other lenders, such as the Indian Government's representatives, or the finance houses or merchants, sometimes have large balances employed among the bill-brokers, but the deciding voice concerning the value of the rate for short loans is ultimately that of the banks. And it is in the extreme elasticity of this rate that we begin to detect the great difficulties that have to be coped with by those who control the London money market. I must be allowed for the moment to beg the question that the London money market has to be controlled, and to add that many of the difficulties of London's position arise from the fact that many members of the money market do not adequately recognize that it has to be controlled, and that even those who do waver constantly between the horns of a dilemma which is ever present, one being their own immediate interest, and the other that of the market as a whole and in the future.

For example, any given banker at any given moment may most reasonably consider that the rate at which he lends money to the bill-brokers is a question which merely concerns himself and his duty to his shareholders. He has so much cash, so much invested in securities, so much advanced to customers, and a further proportion which he can, according to the rules by which he regulates his business, lend to the bill-brokers at call or short notice. Any rate for this is better than none, and, if the bill-brokers only bid him xi per cent for it, why should he not take it rather than lose the profit to be made by the creation of so much credit ? If he does not, he will very probably cause the bill-brokers to go across the street and bid a rival bank x per cent., and the only result of his abstinence will be to swell the profits of a competitor. From the point of view of the individual banker these arguments are irrefutable.

And yet it is much to be desired that some system could be devised of more harmonious agreement among bankers as a whole, by which the rate for money, in the City sense of the word, could be made less mercurial, and especially could be prevented from falling to a merely nominal level, and so, as we shall see, unduly depressing discount rates, encouraging all kinds of kite-flying and the production of finance paper, turning the foreign exchanges against London, and increasing the difficulties of those responsible for the maintenance of the gold reserve.

We have seen that the banks supply English commerce and finance with most of its currency, and also regulate the price of money in the money market. But we have not nearly exhausted their important functions. They also, in normal times, are chiefly responsible for regulating the discount rate in London, that is, the rate at which bills of exchange drawn, as described in a previous chapter, for payment at a future date, can be turned into immediate cash. This market rate of discount is an even more momentous matter than the market rate for money, because it has a very important bearing on the foreign exchanges, another of the complicated questions which have to be dealt with later on. The importance, in fact, of the market rate for money arises largely out of its effect on the market rate of discount; if the bill-brokers are supplied freely with money at low rates, and think that they see a probability of the -continuance of this free and cheap supply of credit, they are naturally encouraged to discount bills at low rates, so that the banks which regulate the money rate thus exercise a strong and direct influence on the discount rate.

But they also exercise a still stronger and more direct one by being themselves large discounters of bills, so much so that many bill-brokers contend that it is the bankers who directly determine the market rate of discount. And this is probably true, for most of the bill-brokers are chiefly intermediaries, and only discount bills with the object and intention of promptly rediscounting the greater number of them ; and the bankers are the chief buyers with whom they can most regularly count on placing the bills that they take; consequently, when it is known that two or three of the chief banks are not taking bills below, for example, 3 per cent., this fact has a marked effect on the market rate of discount, that is, the rate quoted by the bill-brokers. And as the market rate of discount is an important factor in influencing the foreign exchanges, which in turn are an important factor in influencing the inward and outward movements of gold, we come round once more to the great importance of the policy pursued by the banks with regard to discounting bills.

Still more important and delicate do their duties become when there arises any question of dis- criminating between the classes of bills that will be taken, whether the objection be to bills of a certain kind, or to bills drawn on a certain house. By merely intimating to the bill brokers that he does not want many " house bills," or many bills drawn on a certain name, or that he is not taking paper which is too obviously of the kite-flying order, a bank manager can at any time profoundly affect the inner working of the financial machine. The exercise of such a power has to be handled with the nicest discretion, for any such intimation, especially when the paper of any particular accepting house is objected to, generally produces a good deal of gossip and conjecture, and is certain to have some effect on the credit of the firm that is indicated as having been accepting more heavily than its resources are considered to warrant.

And this part of the bankers' duty in watching over the volume of acceptances, and seeing that the accepting houses do not overstep the bounds of prudence, is complicated by the fact that the banks have themselves lately taken up the business of acceptance to a greatly increased extent. But this feature in their business will be more fitly discussed when we come to consider the position and function of the accepting houses as such.

Finally, the bankers fulfil a highly important function by providing credit facilities for Stock Exchange speculation. This they do both directly and indirectly. Directly by making loans to their customers on the security of stocks and shares which the latter buy, not as investments, but because they think they will rise in price, or will return a higher rate of interest than the rate which the banker will charge for the loan ; and indirectly by making loans to members of the Stock Exchange which the latter employ in financing the speculative commitments of the public. The rates earned by bankers for this kind of accommodation are generally profitable, and the most strait-laced moralist would hardly question their right to provide credit for this purpose. In fact, in the case of direct loans to his ordinary customers, the banker need not necessarily know that the transaction is intended for speculation. Let us suppose that you arrange with your banker for an advance against a line of Argentine bonds, which you want to buy because you think you see a chance of reselling them at a profit, or because you can buy them to pay you 5 per cent., and you can get a loan from your banker at 3 per cent., and pocket the difference of 2 per cent. In such a case, as far as your banker knows, you may want the credit in order to buy a house, or to engage in some productive commercial operation. Nevertheless, in most cases he is probably in a position to make a fairly accurate guess, and when he is lending directly to members of the Stock Exchange, he knows well that in nine cases out of ten he is financing the purchase of securities by those who for one reason or another are not in a position to pay for them, and so is facilitating the speculative holding of stocks as opposed to the real possession of them by investors who have paid for them out of savings.

By performing this function, within due limits, the banker is carrying out a perfectly legitimate side of his business, and assisting operations which are beneficial to the community as a whole. The majority of speculators probably lose more money than they make, but if they choose to indulge in this expensive form of amusement, it is not their banker's business to interfere with it, and during the course of the process they are unconsciously rendering a financial service by promoting the freedom of markets and facilitating dealings in securities.

Nevertheless, the readiness with which bankers can place credit at the disposal of speculators sometimes has bad effects, which have to be watched for carefully by those who regulate the supply of it.

For example, there can be no doubt that it was an important cause, among others, of the abnor- mally high level to which the prices of well-secured stocks were forced in the period of exceptionally cheap money in 1896-97, when Consols touched and " gilt-edged " securities could with difficulty be found to yield the buyer 21 per cent. This state of things was a great hardship to the real investor, and was undoubtedly brought about to some extent by the number of enterprising folk who borrowed from their banks at 1 per cent. or so against gilt-edged securities yielding 2i per cent., and pocketed the difference accruing from the yield on the stock and the profit arising from the advance in its price, which continued merrily up to a point. The demoralization of the gilt-edged market, dating from that golden period, and quickened by subsequent wars and other causes, is still being painfully lived down. But this is a point which perhaps does not directly concern the banker, as such, though as a large holder of securities he is affected by any tendencies which warp the true course of markets. Still, he is quite justified in arguing that he is not to blame if his customers, by the use that they make of the credit that he gives them, produce abnormal effects on prices.

More to the purpose is the fact that Stock Exchange securities are only to a limited extent liquid, that is to say, realizable at a moment's notice, and that the more a banker wanted to call in credit granted against them the less liquid they would be. It was once gravely contended by a gentleman who was opposed in principle to the existence of Government debts, that if every holder of Consols wanted to sell at once, and there were no buyers, the price would be nil. Which is one of those absurd truisms which contain their own refutation in their very truthfulness, but nevertheless are only caricatures, so grotesque as to be unrecognizable, of a very real fact. In this case the fact is the less exciting platitude that the more people there are who want to sell stock, and the fewer who want to buy it, the lower its price will be, and the less easy it will be to sell it at all. It is boasted that the market in Consols is so free that they can be sold on Sunday. And there are other securities enjoying the advantage of an international market, that is, of being freely dealt in in Paris and on the other Continental Bourses, which can really be disposed of at any time, at a price. But they are not many, and in times of difficulty or crisis, the possibility of which can never be wholly absent from the mind of a prudent banker, it is quite conceivable that securities, quoted officially at substantial prices, could not be turned into cash on any terms, and that the lending banker might find the credit that he had granted used to draw away his cash, without being able either to compel his customer to repay him or to convert the collateral and so replenish his resources.

From this it must not be inferred that bankers commit any indiscretion in conducting this class of business. All these matters are questions of degree, and if due attention be given to the class of security advanced against, and the extent to which these transactions are entertained, nothing can be said against them by a reasonably minded critic. As we have seen in a previous chapter, the finest class of security for a banker to hold or to finance is the bill of exchange drawn against real produce of universal consumption which is moving into the hands of those who will consume it, and so will pay for itself in due coursed. ln all other securities the existence of a buyer to meet the views of the seller is more or less problematical. However intense the panic, the human race must be fed and clothed, but the extent to which it will take securities from those who want to sell them will vary in an inverse ratio to the severity of the panic.

And though it would be absurd to argue from this ground that bankers ought to hold nothing but produce bills, it is quite relevant that the limits to the negotiability of some other securities should be constantly kept in view.

This chapter has grown to a portentous length, which must be excused owing to the great impor- tance of its subject. " I am always willing to run some hazard of being tedious in order to be sure that I am perspicuous," said Adam Smith, and was fortunate in being able to write so confidently. I have to face the certainty of being tedious, and can only hope that I run some hazard of being perspicuous. What I have tried to make clear is the enormously important function of the cheque-paying banks in the English money market. Recapitulated in tabular form it may be expressed thus :

By providing their customers with cheque-books they create the currency which settles the great majority of commercial and financial transactions and much of the retail traffic of daily life.

By discounting bills and making advances to bill-brokers and other customers they create the credits by which commerce and finance are carried on ; and these credits become in turn their liabilities on current and deposit account.

They regulate, in normal times, the current rates for money in London. They regulate, in normal times, the discount rates current in London, which have an important effect on the foreign exchanges, and so on the maintenance of London's gold reserve.

They are large acceptors of bills, and so, again, facilitate commerce and create instruments which are readily convertible into cash or credit.

By advancing to customers or stockbrokers against Stock Exchange securities they facilitate speculation, and thus to some extent affect the prices of stocks and shares.

It is a tremendous function, and it follows obviously that the cheque-paying banks are in the aggregate the most important members of the financial body. We shall find that, with one exception, the other members are more or less dependent on them, and can only work with the assistance of the credit created by them. The one exception is the Bank of England, which exercises special functions which will be more fully described hereafter, and in abnormal times regulates the whole course of .the money market. But even it derives much of its power from the fact that it acts as banker to the cheque-paying banks.

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