Money and the Mechanism of Exchange
Book Credit and the Banking System
Considerable economy of the precious metals arises, as we have seen, from passing about pieces of paper representing gold coin, instead of the coin itself. But a far more potent source of economy is what we may call the Cheque and Clearing System, whereby debts are, not so much paid, as balanced off against each other. The germ of the method is to be found in the ordinary practice of book credit. If two firms have frequent transactions with each other, alternately buying and selling, it would be an absurd waste of money to settle each debt immediately it arose, when, in a few days, a corresponding debt might arise in the opposite direction. Accordingly, it is the common practice for firms having reciprocal transactions, to debit and credit each other in their books with the debt arising out of each transaction, and only to make a cash payment when the balance happens to become inconveniently great. An insurance broker is one who acts as a middleman between the owners of ships and the underwriters who insure them in shares. He has therefore to make many small payments to underwriters, for the premiums on policies, and at intervals has to receive back the indemnity for any insured vessel which has been lost. It is the common practice to avoid cash payments; the broker credits the underwriters with the premiums and debits him with losses, and only pays or receives the balance when large.
To represent the highly complex system of book credit which is organized by the bankers of a large kingdom, we shall have to employ a method of diagramatic notation. I will therefore remark that the simplest case or type of book-credit is represented by the formula
Each of the letters, P and Q, indicates a person or a firm, and the line indicates the existence of transactions between them. Only in special cases, however, will this direct balancing of accounts render the use of cash or of a more complex system unnecessary. Generally speaking, there will be a tendency for a surplus of goods to pass in one direction, so that money must pass in the opposite direction. The manufacturer sells to the wholesale dealer, the hatter sells to the retailer, and the retails retailer to the consumer. By the intervention of the banker, however, the transactions of many different individuals, or even of many branches of trade, are brought to a focus, and a large proportion of payments can be balanced off against each other.
Single Bank System.
To obtain a clear notion of the way in which bankers help us to avoid the use of money as the medium of exchange, we must follow up the rise of the system from the simplest case to the complete development of the complex organization now existing in the United Kingdom. Let us imagine, in the first place, that there is an isolated town having no appreciable dealings with other parts of the world, and possessing only a single bank, in which each inhabitant has deposited all his money. If any person a, then, wishes to make a payment to b, he need not go to his banker, draw out coin, and carry it to b, but may hand to b a cheque requiring the banker to pay the coins to b, if needed. But if b makes payments in the same way, he will not need to draw out any coin. It would be a mere formality for b to receive the coin due from a, and then pay it back over the counter to the credit of his account with the same banker. The payment is made by merely writing the sum of money to the debit of a's account, and to the credit of b's account. If b wishes to make another payment to c, a similar record in the banker's ledger will accomplish the business. However many other traders, d, e, etc., there may be, their mutual transactions may be settled in the same way, without their seeing a single coin. We may represent this elementary banking organization by the following diagram,
in which it is obvious that P represents the single banker, and a, b, c, d, e, his customers. The deposit banks of Amsterdam and Hamburg furor perfect illustrations of this arrangement.
So long as we regard only the internal transactions of a town, then, a stationary amount of coin, lying untouched in the bank, will allow the whole to be accomplished. If the traders never require to make payments to a distance the metallic money might be dispensed with altogether. But since any of the customers a, b, c, etc., may want his money, the banker ought to keep at least as much as will meet possible demands.
System of Two Banks.
As a second case, let us suppose that there is a town which is able to support two banks. Some of the inhabitants keep their money in one bank and soma in the other, but all whom it is requisite to consider have an account with one or the other. In the diagram,
let P and Q be the two bankers, a, b, c, d, being customers of P, and q, r, s, t, customers of Q. Now, the mutual transactions of a, b, c, d, will, as before, be balanced off in the books of P, and similarly with the customers of Q. But if a has to make a payment to q, the operation becomes somewhat more complex. He draws a cheque upon P, and hands it to q, who may, of course, demand the coin from P. Not wanting coin, he carries the cheque to his own banker, Q, and pays it in to his account in place of coin. It is the banker, Q, who will now have to present the cheque upon P, and it might seem as if the use of coin would be ultimately required. There will be other persons, however, making payments in the town in the same manner, and the probability is very great that some of these will result in giving P cheques upon Q, and some in giving Q cheques upon P. The two bankers, then, will be in the position of the two traders before described (p. 251), who have a running account. At the worst the payment to be made in coin will be only the balance of what is due in opposite directions; but as this balance will probably tend in one direction one day, and in the opposite direction the next day, the balance need only be paid when it assumes inconvenient proportions.
Complex Bank System.
A large commercial town usually possesses several or many banks, each with its distinct body of customers. The mutual transactions of each body will, as before, be balanced off in the books of their common bank, but the larger part of the transactions will now be cross ones, resulting in a claim by one banker upon another. The probability is very great, indeed, that each banker will have to receive, as well as to pay, each day; but it does not follow that he will pay to the same as those who are going to pay to him. The complexity of relations becomes considerable; thus among fourteen banks there are (14 × 13)/2 or 91 different pairs which may have mutual claims, and among fifty banks there would be no less than 1225 pairs. The result is, that P might happen to have a considerable balance to pay to Q, and yet might be going to receive about the same sum from R or S. The actual carrying about of coin under such circumstances would be absurd, because a manifest extension of the book-credit system at once meets the difficulty. The several banks need only agree to appoint, as it were, a bankers' bank, to hold a portion of the cash of each bank, and then the mutual indebtedness may be balanced off just as when a bank acts for individuals. In the figure we see four banks, P, Q, R, S, each with its own body of customers, but brought into connection with each other by the bankers' bank, X.
P need not now send a clerk to present bundles of cheques upon Q, R, and S, but can pay them into the central bank, X, where after being placed to the credit of P and sorted out, they will be joined to similar parcels of cheques received from Q, R, S, and finally presented at the banks upon which they are drawn. Thus all the payments made by cheques will be effected without the use of coin, just as if there were only a single bank in the town. What each bank has to pay each day will usually be balanced pretty closely by what it has to receive. Such balance as remains will be paid by a transfer in the books of X, the bankers' bank.
It is not precisely true that there is in any English town a bankers' bank, which thus arranges the payments between banks. The accountants' part of the work is carried out by an institution called the Clearing House, managed by a committee of bankers, and the Bank of England is employed to hold the deposits of the bankers, and make transfers which close the transactions of each day. The organization of the Clearing Douse will be described in the next chapter.
Branch Bank System.
It is impossible to avoid perceiving that the organization of the English bank system is undergoing a complete transformation, and is approximating to that which has existed for a century or more in Scotland. Instead of a great number of small, weak, disconnected banks, there is arising, by amalgamation and extinction of the weaker ones, a moderate number of important banks, each possessing numerous branches. The Scotch banks have long had many branches, and at present each of the eleven great banks has on the average 78 branches, the lowest number being 19, and the highest 125. Already a few of the English banks have equally extensive ramifications. Thus the London and County Bank, and the National Provincial Bank, which have especially developed the branch system, have respectively 148 and 137 branches; the Manchester and Liverpool District Bank has 50 branches and sub-branches. The Irish banks also adopt the same system, and the National Bank of Ireland has about 114 branches and sub-branches. It is interesting to observe that in Australia, too, the banking system has taken a similar form, and a comparatively small number of strong banks, such as the Bank of New South Wales, or the Bank of New Zealand, leave no rising village without its branch.
Now, the close connection which exists between the head office and each of the branches of an extensive bank leads to a great clearing off of claims. The diagram on p. 256 again serves to represent this relation, X being the head office, P, Q, R, S, branch banks, and a, b, c, etc., customers. If a pay m with a cheque on P, the cheque will be paid into R, credited to m, forwarded by post direct to P, and debited to a. The head office, being informed of this transaction in the usual daily statement, will close the business by transferring the sum from the account of P to that of R. Much accountants' work seems to arise, but it is work of mere routine which costs little. Cash remittances are seldom necessary, because each branch settles accounts only with the head office, so that many sums will be credited and debited during each week, and the balance will usually be small. The head office, in fact, acts in every way like a clearing house, or bankers' bank.
The question naturally arises, indeed, how will the branches of one bank transact business with those of another bank? The solution, however, is simple; for unless the branches happen to be in the same town, or for other reason, in close relation with each other, they will communicate through their head offices. A cheque upon any branch of the London and County Bank received by a branch of the National Provincial Bank, will be presented through the head office of the latter at the Clearing House upon the head office of the former.
Bank Agency System.
Another important feature of the banking system is the extensive organization of agencies. A large bank has various business to be transacted in each of the principal commercial towns of the kingdom, and if it has no branches in these towns employs a banker in each town to act as its agent. This agent-bank collects cheques, bills, notes, etc., payable in the district, cashes drafts drawn against them, retires bills according to instructions, and does almost all that a branch bank would do, the main difference being that the remuneration for this work consists of a commission. Each agent-bank has a running account with its principal, so that to a certain extent each important bank and its agencies form a clearing system analogous to that of a head bank and its branches.
London Agency System.
By insensible degrees there has grown up in England an all-comprehensive and most perfect system of relations between the provincial and London city banks. Every banker in the United Kingdom, without, I believe, any exception, employs one or other of the great London city banks to act as agent. There are twenty-six city clearing banks which thus undertake agencies, and on an average, each of these banks represents at least twelve country banks; but the number varies very much, and some country banks have two London agent-banks.
This agency system leads at once to a clearing of transactions, because, if any two country banks have the same London agent, all their mutual adjustments of accounts can be made by transfers in the books of the agent. The diagram on p. 256 applies for a third time, and X represents the city agent, having running accounts with P, Q, R, S, the country banks. The whole of the customers of all the banks, having the same London agent, are thus brought into close relation, though they may live in the most distant parts of the country. Each of the city banks maybe regarded as a bankers' bank and a clearing house on a small scale.
Country Clearing System.
Only one further step is required to complete the system of connections between each bank in the kingdom and all other banks. Every country bank, as we have seen, has a running account with some city bank, and all the city banks daily settle transactions with each other through the Clearing House. It follows that payment from any part of the country to any other part can be accomplished through London. In the following diagram, let P, Q, R be country banks having the London agent, X, and U, V, W, other country banks having the London agent, Y.
If a, a customer of P, wishes to pay r, a customer of U, he transmits by post a cheque upon his banker, P. The receiver, r, pays it into his account with U, who having no direct communication with P, forwards it to Y, who presents it through the Clearing House on X, who debits it to P, and forwards it by the next post. Nothing can exceed the simplicity and perfection of this arrangement.
It will be readily seen, too, that sums of money passing between London banks, or rather cleared off in the Lombard Street Clearing House, will frequently be the balances of extensive running accounts between country banks and their agents and correspondents. So long as the balance of accounts between any two banks does not assume large proportions, it need not be paid in cash at all, except for special reasons. When a balance has to be paid, and the banks happen to have the same London agent, it is only requisite for the debtor bank to direct their London agent to transfer so much money to the credit of the other country bank. If they have different London agents, and P, in the last diagram, desires to pay a balance to U, it is done by directing X to credit Y, the agent of U. The credit note effecting this payment passes through the Clearing House, amid a mass of other documents representing payments in one direction or the other, and will, in general, become an insignificant item in the general clearing. If it can be said to be paid in cash at all, it is in the form of a final transfer in the books of the Bank of England, as we shall see. Great as are the transactions daily settled in the London Clearing House, they are after all only those which have not been previously cleared off by any more direct communication, and they often represent the balances of multitudinous transactions which never pass through London at all.
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