# Popular Science Monthly/Volume 27/August 1885/The Future of National Banking

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* THE FUTURE OF NATIONAL BANKING.
By E. R. LELAND.
THE ever-recurring question as to the methods which should be adopted for supplying the country with currency promises soon again to demand attention, and to be beset with all its old-time perplexities. It is the riddle which is presented in turn to each civilized nation, and, although the penalty of default is severe, no satisfactory answer has as yet been found.
The national banking system, which has frequently been declared to be the best yet devised, can not be said to offer a solution, for, although it served its temporary purpose very well, it lacks, so far as its currency is concerned, the essential element of permanency, being based upon a public debt that, fortunately, is not a perpetuity. Recently grave concern has been felt and expressed over the prospective contraction, if not total withdrawal, of the national-bank circulation which is likely to result from the diminished supply of Government bonds. The prospect is generally deplored. Sundry bills were introduced into the late Congress, looking to a mitigation or postponement of the consequent evils, but no conclusive action was taken, nor is there much reason to expect that the subject will receive serious congressional consideration until it compels attention.
It is true that the advocates of a let-alone policy might justify their course by pointing out that the danger of a currency contraction does not appear so imminent as it did nine months ago. Owing to diminished revenue, there have been no recent bond calls, and the reduction of the debt is for the time arrested. But the prices of bonds have so enhanced as substantially to rob the business of issuing ​notes of profit, and, even were the banks willing to keep out their circulation for the small recompense which now comes to them, little reliance can be placed upon a continuance of the present conditions. The reduction of the Government debt will be resumed, nor is the delay likely to give more time than will be needed in which to devise and put into operation some other plan for furnishing a currency supply.
There are many men—so many as to constitute a party considerable in number—who have an ever-ready remedy to administer for this or any similar trouble which threatens our financial system; that is, an additional supply of legal-tender notes. It is not intended here to discuss this proposition. The evils which are certain to attend an unlimited or largely increased issue of legal tenders have so often been shown, and the greenback clamor has so far died away, that there are grounds for the hope, which let us cherish, that a majority will not call for a Government paper circulation, albeit the United States Supreme Court has decided that Congress has uncontrolled power to create and regulate such an issue. For the purpose of this paper, therefore, it will be assumed that resort will not be had to legal-tender notes for a supply of paper money when the bond-secured national-bank notes shall be withdrawn.
There is a school of economists a title that can not properly be applied to the greenbackers—who hold that it is radically unsound and productive of evil for banks to assume the function of furnishing money; who maintain that there should be no money other than a metallic currency, or one which would in all respects act precisely as a metallic currency acts, because not only based upon but actually representing specie of a like amount deposited and held for its redemption. This school would doubtless regard the time of the retirement of national-bank notes as presenting an opportunity for inaugurating their system too good to be lost. Very recently suggestions in this line have been made and widely considered as, perhaps, offering solutions of both the paper currency and the silver problems; and, indeed, if the experiment were a wise one, it never could be made with less prospect of serious disturbance during the transition period, for the process is already begun by the issue of gold and silver certificates which could be increased, if specie were forthcoming, as bank-notes were withdrawn. If any plan embodying this idea were adopted, we should then have a system somewhat similar to that by which England has been supplied with paper money since the adoption of Peel's act in 1844. Under that act the Bank of England is now authorized to issue notes to the amount of fifteen million pounds sterling upon Government securities; beyond this sum the amount of circulation is determined solely by the amount of bullion which the public chooses to deposit, for the bank is bound to buy gold bullion at the mint price, whenever offered. The banking department and the issue ​department are separately managed, and of the latter the directors have no control. Professor Price says that it is not a department of the hank in any sense; that "it is a self-acting institution of the state, working on the bank's premises, by rules laid down by the state, and absolutely beyond the control of the directors."
If the terms of Peel's act were at all times rigidly adhered to, this description of the operation of the issue department would be correct. As a matter of fact, however, they are not adhered to, but are suspended in times of financial stress, and the directors assume control of the issue department for the relief of the strain upon the banking department and the business community. Three times since the adoption of the act has its operation been suspended. The supposition that a "suspension of the act" involves a suspension of specie payments is, perhaps, still common enough to warrant an explanation of its true nature.
The Bank of England is the custodian of the principal portion of the reserve of all the banks and bankers of England, and to it the latter must look for money to meet the excessive and unusual demands that are made upon them in time of panic. At such times, therefore, a rapid inroad is made upon the bank's supply of gold, and, if the act of 1844 continues in force, a point is soon reached where the directors are compelled, for self-protection, to cease discounting even upon the best securities. Whenever the strain becomes unendurable, an appeal is made to the Government, through the Chancellor of the Exchequer, to suspend the act. If granted, the legal restrictions upon the bank's note-issues are removed, and the directors are authorized largely to increase their issue without reference to the amount of bullion in their vaults; the effect of which is that for the time both departments of the bank are under the management and control of the directors. They are not likely to use this privilege recklessly, for the obligation to redeem their notes in gold on demand remains in full effect. Moreover, for some reason not wholly apparent, it has become a custom—so far as three instances can make a custom—for the Government to stipulate that the bank shall charge a very high rate of interest, say ten or twelve per cent, upon the extra note-issues, the profit thereon to go to the state. The result of this is that prudence and self-interest combine to make the directors use the powers conferred upon them most sparingly, and they do so. In but one instance has there been an over-issue. This was in 1857, and to the extent of eight hundred thousand pounds. In 1847 and in 1860 the fact of suspension proved sufficient to allay the panic and to avert, at least, its worst consequences.
A recent writer recommends the mechanical and local separation of the issue department from the Bank of England to a Government office, as tending to the propagation of clearer ideas on the subject of note currency. No suggestion is offered as to the way in which relief could be afforded in emergencies similar to those which have ​heretofore been met by extending the bank's powers, nor is it obvious how any could be given except through the agency of the bank.
Extending the comparison between the English system and that of the United States, with the national-bank notes retired, the legal tenders, although much greater in volume, might be likened to the seventy-five million dollars that the Bank of England issues against its securities, while the bank's specie-secured issues would find their parallel in the gold and silver certificates. These now amount to something more than two hundred and fifty million dollars. They have not very far to go before they would equal the national-bank notes outstanding, and the expediency of largely increasing the issue is freely discussed.
But in the workings of the two systems here compared there would be an important difference.
When the act of 1844 was being urged, its advocates recognized that in extreme cases a rigid adherence to its provisions might be mischievous, and special governmental interference be found necessary. Experience has shown that such compelling emergencies do arise. Warned by this, Mr. Lowe, Chancellor of the Exchequer, introduced into the House of Commons in 1873 a bill providing for automatic suspension, so to speak. He proposed that the Government might lawfully suspend the bank act when certain conditions obtained, conditions presumed to be indicative of a panic; but the bill was not received with favor, and was withdrawn. What the effect of a strict adherence to the act in time of panic would be, it is difficult to predict—it has never been tried.
It is not easy to see how, even if it were made lawful, relief could be given in the case of a strictly governmental issue, consisting, for example, of specie certificates and legal tenders. If additional issues of the latter were authorized, how, in time of peace, would they be put afloat? Certainly few would be willing to have the Treasury Department take up the business of banking and make advances on miscellaneous securities. But the time would certainly come when the temporary relief given by clearing-house certificates would be found to be, or at least be thought to be, inadequate, and an increase of currency be demanded. Could there be any assurance that the power to make such increase resting in Government officials would be exercised with the caution shown by the Governor and Company of the Bank of England, who are restrained by considerations both of prudence and profit? An illustration of the course likely to be pursued was furnished in 1872-'73, when forty-four million dollars of legal tenders, which had been retired by Secretary McCulloch, were dubbed a reserve, the reissue of which was demanded and granted to the extent of twenty-six million dollars. There are ample grounds for the fear that any system under which the Government should furnish, in whatever form, the whole supply of the paper money of the country, would keep us constantly on the lee-shore of an inconvertible paper currency, ​the capacity of which for working mischief has often been pointed out.
It is not probable, however, that there will be any wide departure from existing methods. Outside of the straggling ranks of the greenbackers the national-bank notes are regarded with favor. It can not be gainsaid that the period during which they have been in existence has been a very comfortable one, so far as a good currency for the people could make it so. Whatever theoretical objections there may be to the system, it has worked singularly well, is justly popular, and it is easy to understand why its probable restriction and ultimate discontinuance should be looked forward to with concern.
There has been little or nothing in the way of suggestion as to what can be done to perpetuate the national-bank issues. Various plans have been proposed for prolonging their existence; but closely adhering, as all these plans do, to the theory of a bond-secured currency, they are confined within narrow limits.
Secretary Folger and Secretary McCulloch, Comptrollers Knox and Cannon, have substantially agreed in their reports for two years past in recommending 1. The removal of the tax on bank circulation; 2. An increase of the percentage of currency which the banks may issue against bonds deposited; 3. The conversion of long bonds into three, or two and a half per cents, the latter being less likely to be withdrawn for reasons having no reference to the amount of circulation needed; and bills were introduced in both Houses of the last Congress providing for the practical application of these recommendations. Their adoption would, however, afford but temporary relief. It would have the merit, no small one it may be said, of enabling us to travel along the well-known road for a while longer, but it would only postpone the day when a solution of the currency problem must be confronted.
The true solution has, by some of the gentlemen referred to, been declared to be a reduction of the redundant revenue sufficient to retard the retirement of bonds, and finally to arrest it when their volume shall have reached, or closely approached, the amount requisite to secure the national-bank circulation.
To retard the payment of the public debt by reducing taxation would probably be expedient, it certainly would be popular; but wholly to arrest payment, and, for such a purpose, maintain the debt at a fixed sum, would be another and a very questionable matter. Moreover, a currency thus regulated as to volume would lack the important element of adaptability, or, as it is sometimes called, elasticity, for it is not likely that any one would go so far as to suggest that the bond debt should be increased and decreased in accordance with the demands for currency a method which, if not otherwise questionable, would be so clumsy and tardy in its operation as to serve but poorly. Who in such case should decide what amount of ​currency and consequently of bonds would be needful? The Secretary of the Treasury or the congressional committee who should be called upon to determine this point would require the same degree of omniscience that would be required to fix the proper limit of irredeemable legal tenders. The objections to any arbitrary regulation of the volume of currency have been so often pointed out as to make needless their recital in this connection.
To maintain, for the purposes of bank-note security, a Government debt anything in excess of the Government's needs, would be, in effect, to levy a tax upon the community at large for distribution as a bounty on bank-note circulation. It may be said that the benefits inuring to the issuers would be slight and incidental—a not undue reward for the service rendered—and that the real purpose would be the protection of the note-holder, which protection would be worth more than its cost. Thus stated, the proposition would be to make the note-holders a preferred class of creditors, secured at the public cost. It would be pertinent to ask here, By what logical method is the conclusion reached that this preference should be given to the note-holders alone? Are there not other classes of creditors with equal claims for protection? The depositors in savings-banks, the beneficiaries of life-insurance policies, and divers other corporate and private trusts, are now very largely secured by Government bonds, and it is not easy to see why, if the note-holders are to have special protection, these can not with perfect justice ask that they too shall continue to be cared for by the Government. That such demands should be acceded to few will assert, but it would be quite as proper for the Government to furnish security for all as for a part. But it is idle to discuss this proposition at length. Whatever differences of opinion there may be as to the rate at which reduction of the debt should go on, there is little difference as to the general principle that it should be reduced as fast as may be consistent with a proper distribution of the burden. The proposition that it is a good thing to pay one's debts, when abundantly able to do so, is sound, and it applies to an aggregate of individuals—the state—precisely as it does to a single individual. Public opinion will doubtless demand s it certainly would be right in demanding, that the volume of the public debt shall be regulated without reference to national-bank-note issues; the idea that it should, or might with propriety, be regulated with reference to their needs, is radically unsound. Nor, it maybe added, are there any reasons, economic or political, for a resort to such strained methods.
That a paper currency is one of the requirements of a great commercial country is generally admitted. That such a currency can best be furnished by banks of issue, if not so generally admitted, would seem to be demonstrated by universal custom among civilized nations. The issuance of circulating notes is a legitimate, if not necessary, function of the business of banking. It is one of the forms of the ​complicated system of credit which has made commercial growth possible, nor is there any reason why this particular form of banking obligation, constituting, as it does, but a minor part of the total, should, when created, have other or better safeguards than the remainder. The security furnished by the capital of the banks, by the ability and integrity of their management, aided by governmental supervision, which must needs serve for the greater part of their liabilities, should be adequate for the whole. The checks and precautions, the discrimination, which are applied to the use of credit in other branches of banking, the protection which is found to answer for depositors and holders of checks and drafts, should also be sufficient for the holders of that particular class of "memoranda of claims" known as bank-notes. That this protection can be made practically efficient is amply proved by the history of the national banking system in the United States. During an experience of more than twenty years the average annual loss to depositors has been only one twentieth of one per cent of the total.
The public have become so accustomed to the use of a bond-secured currency, and have so generally credited the satisfactory results to the feature of special security, that the suggestion of an unsecured currency, or, rather, a currency not secured by special deposits, is not likely, at the outset, to be received with favor. To many it will recall the days of wild-cat banking, when the country was flooded with money that was practically irredeemable, and wide-spread and serious loss was inflicted on the community, especially upon the poorer classes, by having worthless issues forced upon them. But there is little danger and no need of a revival of that vicious system.
The lessons of the past have not been wasted; nor are we a "nation of rascals," in spite of sundry recent revelations of rascality and weakness. More and more, as civilization advances, does the tendency of people to trust each other increase. Yearly the average of prudence and trustworthiness grows larger. If not because of a stronger sense of moral obligation, then because of a better appreciation of the necessity therefor in the conduct of business, men show a growing respect for each other's rights, and place a greater reliance upon the relations of contract.
Mr. Spencer says, "Given a nation of perfectly honest men, and nearly all trade among its members may be carried on by memoranda of claims." We have not, it is needless to say, reached an ideal state of perfect honesty—far from it. The adoption, therefore, of an absolutely free banking system, without limitations or restrictions, would be an experiment too hazardous to be tried. There is, however, a degree of honesty which suffices to maintain a credit system of great extent and complexity, involving the use of enormous sums of promises to pay, and the extension of that system to cover the use of the particular form of promises to pay known as bank-notes is logical, natural, and, with proper restrictions, safe.
​It is true that notes which pass from hand to hand as money are not scanned as closely as are other evidences of debt, nor can there be the same discrimination exercised in their use. They must, if circulated in small denominations, of necessity be taken by many who have no means of forming correct conclusions as to the soundness of the issues, and who can least afford to suffer loss. But the circulation of small notes of any sort is to be deprecated. Adam Smith pointed out the difference in the forms of money required for dealers and for consumers; that for the uses of the latter, paper money is not fitted, no matter what its form or security. The soundness of this view has been largely discussed since his time, but the preponderance of opinion has been in its favor. Mr. McCulloch, in his recent report, recommended the discontinuance of small notes. It would bring out a large amount of silver and small gold, which furnish the best kind of money for the smaller transactions of trade, and afford the best possible protection for the small dealers, the wage-earners—men, women, and children—who suffer most from a defective currency. If small notes were retired, the smaller savings, the stocking-hoards, would consist of gold and silver, and obviously it is best that this part of the country's reserve—no inconsiderable part—should be of specie. The aggregate issue of legal-tender and national-bank notes of denominations under ten dollars is about two hundred and twenty million dollars. It is probable that nearly this entire amount could be replaced with gold and silver before the point of specie saturation would be reached. Such a volume of hard money would supply the best obtainable guarantee against currency disturbances.
That, if relieved from the function of furnishing wage and pocket money, a bank currency, suited for the larger operations of trade, and yet not handicapped with the obligation of special bond deposits, could be established with safety, may be asserted. That banks of issue can be safely conducted and furnish a sound currency has been sufficiently shown under conditions far more unfavorable than now obtain in the United States. The Scotch banks are examples. So well have they been conducted that Professor Jevons admitted that their system would be an excellent one for general adoption, "if we were all Scotchmen." It may be fairly doubted, however, whether the satisfactory results in Scotland are wholly due to exceptional integrity, sagacity, and caution on the part of Scottish managers. May it not be that the bank-currency system, properly conducted, has had a fairer trial in Scotland than elsewhere?
One does not need to be very old to remember when this country, especially the West, was dependent upon a paper currency that was, for the most part, of a very trashy kind; and to remember, also, that ​even then, and in that region, there were notable exceptions. Bank officials will remember how a stray note of the ugly issues of the State Bank of Indiana, or the Wisconsin Marine and Fire Insurance Company, coming in with a pile of gaudy wild-cats, used to "shine out like a good deed in a naughty world," and was promptly sorted out and laid away as a part of the reserve. Those banks, with a few others, having relatively very large issues, were conducted safely through the vicissitudes of those days, promptly redeeming their notes on the advent of the national system without the loss of a dollar to the holders. But the honestly and prudently conducted banks of that period were not numerous nor strong enough to redeem the vices nor avert the evils of paper-money banking as it was then carried on. The story of recklessness, fraud, and suffering does not need to be retold, and no one would be willing to see the way opened for a repetition of its experiences.
The conditions now are very different. The operation of the national banking system for twenty years has brought to its management a class of trained and educated bankers, who are, for the most part, fit custodians of the people's money, and to whom might be intrusted the work of furnishing paper money for the country with greater economy and less risk of loss than would attend the adoption of any other system. The machinery is at hand, is in excellent working order, and would need but slight modifications to fit it to perform its work after the obligation to deposit Government bonds against note issues had been canceled. There are now over twenty-six hundred national banks in operation. They have been organized and located, not with reference to issuing currency, but to supply the legitimate needs of the business community. To guard against the formation of banks for purposes of circulation only, the right to issue might for the present be confined to those now in existence, with a permanent provision that such right should be extended to new banks only after three or five years of successful operation: no permits to be granted except under the conditions now imposed as to location, ratio of capital to population, and of circulation to paid-up capital. A Government bureau should continue its supervision, and should engrave, print, and furnish the note impressions as a precaution against the possibility of over-issues; this and any other labor or expense imposed upon the bureau to be paid for by a continuance of the tax on currency. Existing regulations as to reports, examinations, and control in cases of bankruptcy should be maintained, and it might be well to give preference to the claims of note-holders. Notes should, of course, be redeemed in coin or legal tenders on demand, with provision for central redemption. At present there is, practically, no redemption except of mutilated notes. Under the system suggested redemption would be real, and the amount of note circulation be, as it should be, regulated by trade requirements, with no danger of a sudden and ​unnecessary increase, such as has been seen in the former history of free banking.
The question of the constitutional power of Congress to authorize such a system can only be alluded to. It would very likely be raised; but it may be assumed that it would not prove an insuperable objection. It might be made a condition of granting charters or licenses to banks that they should be required to lend a certain percentage of their capital to the Government whenever called upon, and also under proper restrictions be made depositories of public moneys; thus, as has been suggested, doing away with the expensive and primitive system of local sub-treasuries.
Bankers to make money on their issues must keep them in circulation, which could be done by the same means, and those only, that are employed to build up a line of deposits; that is to say, they must establish their credit by promptly performing their engagements. Governmental interference should be exercised solely with reference to insistence upon such performance.
That in some cases there would be mismanagement, dishonesty, and consequent loss, in the future as in the past, is certain; but the control and supervision of banking should not, any more than that of other branches of business, be regulated upon the hypothesis of fraud. The losses which might come would be comparatively small, would follow quickly upon their causes, would have the advantage of being directly traceable, and so permit the prompt application of remedial measures. With the existing means of swift communication, with the wide distribution of national banks, and the watchfulness which they employ toward each other, and, finally, with the smaller transactions carried on by means of specie, the losses upon bank-notes would not only be small, but would, for the most part, fall upon the banks themselves, they being the constant custodians of the greater part of the currency; and they could be trusted to see to it that only such circulated as was worthy to have circulation.
This brings us to a suggestion which is put forth with much hesitation, and only as a suggestion, notwithstanding it is believed that it is sound in principle, and might be made safe in practice. It is simply that the banks should assume the risk, and, as a whole, undertake to protect the rest of the community from loss upon note-issues. To effect this it would only be necessary, so far as legislation is concerned, to continue in force that provision of the existing law which makes national-bank notes a legal tender to national banks. It would seem to be well-nigh certain that the banks could assume this risk of loss, whatever it might prove to be, and still the business of issuing notes afford a larger margin of profit than it now does. For this would be but an application of the insurance principle to one class of the accidents to which the banking business is liable. The banking interest, as a whole, would undertake to indemnify the public against losses ​arising from the failure of individual banks to redeem their notes. As to the nature and extent of such losses, they already have a much better basis for estimating them than was available to life or fire and marine insurance companies in their inception. A perfectly trustworthy "table of experience" is supplied by the record of the losses to depositors in national banks for the last twenty years; these, as before stated, have been only one twentieth of one per cent per annum. This interval covers two periods of panic and consequent depression, and may be presumed to have included most, if not all, of the vicissitudes of the business. If from abundant caution the estimate of probable loss should be put at tenfold that which past experience with the national system has shown, and the present Government tax on currency be added, we should have a total of one and a half per cent on the volume of currency to cover losses and expenses. The premium out of which to pay this charge would be the interest on the excess of the average amount of currency in circulation over the reserve required to be held against it, or say from three to seven per cent, varying with the state of the money market and the location of the banks. This certainly offers an ample margin.
The idea is not altogether novel even in its application. It was adopted in the case of the various branches of the State Bank of Indiana, and worked satisfactorily. Slightly modified, it is applied by the guarantee companies, which, for a much smaller premium, guarantee employers against the fraud and insolvency of their servants. The suggestion may be somewhat startling to bankers, who, as a class, are proverbially and properly conservative, but the soundness of the principle which underlies it has been demonstrated by long experience and is constantly finding wider application. Bankers daily risk, without thought of fear, far larger sums than such an insurance of currency would involve upon guarantees that are much less stable, that is upon the indemnity furnished by insurance companies, which, both as regards sums at risk and premiums charged, conduct their business on comparatively small margins. Should the liability seem too great if extended commonly to all the banks, geographical districts might be created with redemption centers, the mutual guarantee of the banks not to extend beyond the limits of their districts.
Objection may be taken that such a system of currency would increase the profits of banking. That it would do so, in some degree, is probable, but it is not in the interest of that business that the suggestion is made. The public have the deepest interest in the avoidance of perturbations or disturbance in the currency supply. If the principles presented be sound, and their application correct, it would seem to be clear that the existing banks could continue their present circulation, and guarantee it, with safety to themselves and their note holders; and that thus might be accomplished the desideratum of paying off the Government bonds, when the time comes, without ​canceling the bank circulation. If, later, need should arise for a greater volume of currency, arrangements might be devised for increasing the circulation of existing banks or creating new ones. Obviously, the banks themselves should, in such event, have a voice in determining the methods by which this should be done, and in the selection of the persons or corporations to whom the right of issue should be extended. Similarly, in regard to examinations; thoroughness should be assured, nor need this be difficult. When the banks of a clearing-house are called upon to care for some embarrassed member, a brief inspection enables them correctly to determine the real condition of the applicant; they have a direct interest in getting at the facts. Examiners should be chosen, or at least nominated, by the banks.
The bureau which supervises the other operations of the banks could, with but little addition of labor or responsibility, conduct the redemption of the notes of insolvent banks, and levy and collect whatever assessments might be needed to make good deficiencies.
But it is needless to enter into an elaboration of details; they would present no serious difficulties when, if ever, it became necessary to deal with them.
It may be said of any suggestions in this connection, that, whatever opinion may be held of their worth, they are not premature, nor without value, if they provoke the attention of men who are able to do better thinking. The occasional desertion of national banks to the ranks of state institutions, and the contemplated separation of others, as well as the prospect of enforced relinquishment of circulation by all, indicate, plainly enough, that it is none too soon to consider some modification of the national banking system, if it is to be maintained, and it has worked too well to be needlessly abandoned.
It would probably be assuming too much to expect that any system of bank issues without special security, however surrounded by safeguards, would find present favor with our national legislators, or indeed secure many adherents. A few years ago, some of our ablest financiers, both in and out of Congress, predicted that free banking would follow swift upon the resumption of specie payments; but present indications do not point that way. More crude and less scientific expedients are likely first to be tried—and to fail. But it seems not over-presumptuous to predict that ultimately resort will be had to some form of that system. Its convenience and economy are obvious, and will assert themselves. The evils which it involves are such, and such only, as are inherent in the general conduct of business, such as will inhere so long as honesty and mutual confidence are imperfect; as these improve, the risks will lessen. While the causes exist, the losses will fall; there can be no perfect safeguards, nor of such as are possible can a paternal government afford the best: they must be looked for at the hands of the people themselves.