HUNT'S

MERCHANTS' MAGAZINE.·

MARCH, 1846.

Art. I.-BANKS AND BANK DIRECTORS.

A PRACTICAL VIEW OF THE MANAGEMENT OF BANKS, AND THE DUTY OF DIRECTORS.

I PROPOSE to address you this evening on the subject of that portion of the common business of life that is managed through banks. It is not my intention to go learnedly into their origin and history, or to attempt any grave speculations in political economy concerning the effects of banking on affairs of state. My object is rather to present a plain view of its practical operation, so that those who hear me may carry away with them a clear conception of what ought to be done by banks, and some aid in judging whether it is done. I infer that information of this nature may be generally useful, from having observed that many persons receive any short statement of the actual process of this business as if it were new to them; and that even learned men, who sit in halls of legislation to make laws for the management of banks, sometimes say and do things which they would themselves declare to be preposterous, if they had the practi cal experience of a single month in conducting one. I was once present in a distant part of the Union, when a man, distinguished for eloquence in the last Congress, at Washington, rose in the legislature of his native state, and denounced some of his own constituents in severe terms for placing a certain bank in a position, which, from his own statement, was clearly a very sound and proper position, although he did not know it until a few well-known principles were explained to him, when he readily retracted. There have been instances, too, among our own legislators, of similar injustice, without the like admission of error.

There are, doubtless, some persons present here, who know already all that I can say upon the subject. I crave their indulgence, while describing what may be familiar to them; but what will have the interest of

The present article was delivered, during the last season, as a lecture before the Mercantile Library Association of Boston, by Thomas G. Cary, Esq., and is now first published in the Merchants' Magazine from the manuscript copy politely furnished by the author.

novelty to others, who are, perhaps, to become bank directors and legislators, and who will apprehend more readily what they may hereafter be called to undertake, from having borne in mind an outline of the matters on which they are to act.

I crave their patience, too, in behalf of another portion of the audience, the ladies, who always perceive readily what is clearly stated, and can comprehend all that need be said upon the subject as well as any of us. Their own interests are often involved in the management of the banks. They are sometimes depressed, too, by the sight of grave countenances at home when there is trouble at the banks; and they are occasionally doomed to listen to discussions by no means exhilarating, which would be less wearisome to them, if they understood enough of the leading points to form opinions for themselves on what is said in their presence.

Their opinions, too, often furnish useful suggestions, when proper information is placed within their reach. Some men have, perhaps, owed their escape from failure to conjugal advice; and many a one, probably, has suffered evils which he would have avoided, if he had furnished the inseparable partner of his fortunes with the intelligence necessary to enable her to see clearly what he was about. It is characteristic of human frailty in unburthening the heart to prefer a listener who is not likely to discover more of error than one chooses to disclose. Like skilful dealers in paintings, who are careful in choosing their lights, men often hold up the picture of their troubles in such view as shall give prominence to misfortune, and keep fault in the shade. As they often impose, in this way, upon themselves, so they are sometimes insensibly cautious not to draw forth counsels that might be salutary, because they are, for the moment, unwelcome. Thus they lose the best benefit of that tender regard, of those nice perceptions, and of that instinctive sense of right closely allied, as it is, to wisdom, which they might call to their aid when in perplexity and distress.

A bank is generally supposed to be a place where a great quantity of gold and silver is, or ought to be, kept locked up; and from which bills to a large amount are issued, to be kept in circulation and to represent that gold and silver lying in the vaults. This supposition is in a great measure a mistaken one, as I shall attempt to show.

Let us suppose that a hundred persons of those present here, contributing one thousand dollars each, should combine to establish a bank with a capital of one hundred thousand dollars. Their purpose is to lend the money at the legal rate of interest, 6 per cent, and they hope to receive 6 per cent for what they contribute; otherwise they would prefer to use their money in some other way.

But in order to divide 6 per cent every year, among themselves, they must contrive to earn that rate of interest on more than one hundred thousand dollars; for they have to pay the rent of their banking house and the salaries of a cashier and a clerk, or clerks. They have, likewise, to pay an annual tax to the state of 1 per cent, equal to one thousand dollars, for the privilege of banking. In order to divide six thousand dollars among themselves, then, they must earn what would amount to eight or nine thou sand dollars, that the surplus may cover the expenses attending the transaction of the business; and instead of one hundred thousand dollars, they must, to do this, lend nearly one hundred and fifty thousand dollars.

Their proceedings are regulated by the laws of the land, and they who make the laws know that more than one hundred thousand dollars is to be

lent. The law only provides, in that particular, that the loans shall never at any one time exceed two hundred thousand dollars, or double the capital. A board of directors and a president being chosen to decide upon the loans, and a cashier to make the loans, they commence the business with a hundred boxes, of one thousand silver dollars in each. Merchants and traders, who have sold goods on credit, apply for loans to meet their own immediate payments which are becoming due; and as security for the loans, they offer the promissory notes which they have taken from their own customers for the goods sold, putting their own names on the back, endorsing them as it is called, to make themselves, as well as the promissors, liable to the bank.

Let us suppose that on the first day, the directors should approve of loans to the extent of one-quarter of the capital, or twenty-five thousand dollars, on such promissory notes as would be payable in about four months.

The cashier would then proceed to pay out what passes as money for them, deducting two dollars, or thereabouts, on every hundred for the interest which is earned by the bank for one-third of the year. He would not use his silver dollars in paying out what is thus lent, but would give, instead, the bills of the bank, which are its promises to pay when called upon. Thus

The borrowers would then use these bank bills in paying their debts or making new purchases; and as the bills pass into other banks, or into the hands of those who want hard money, for remittances to Europe or otherwise, they would be returned to the bank that issued them, and be redeemed by the silver dollars from the vaults, which would then be paid out.

Of course, in four or five days of such business, the whole capital of the bank would have been lent; and if the directors should stop there—if the bank bills for the money lent should have been all brought in, and all re deemed by paying out the silver dollars, there would be no specie left in the vault, except the two thousand dollars, deducted for interest. Yet the bank, after parting with the dollars, would be perfectly strong; no power on earth could break it; for all its debts would be paid, and no person would hold one of its bills to make a demand upon.

As

The cashier might lend the remaining two thousand dollars, and still the bank would stand firm, though every other bank in the country should fail; provided he should lend no more for three or four months, when the notes that he had taken from his borrowers would begin to fall due. they are paid in, he would have money to lend again. And even if the promisers and endorsers should all fail to pay their notes, still the bank would not fail; for it would owe nobody, though the stockholders would lose their money. Supposing the notes to be punctually paid, however, as

they usually are, he would continue lending the money over and over again as it comes in. But, confining the loans to one hundred thousand dollars and the earnings, there would be but six thousand dollars earned at the end of the year; and deducting from this the expenses and the tax, there would be only four thousand dollars, or 4 per cent, left for the stockholders.

A bank that was managed with great caution was once very much in this position, when a friend of the cashier called upon him, and taking him aside, with a grave face, said, "I heard it asserted just now that you have not five thousand dollars left out of the one hundred thousand silver dollars that were lately paid into your new bank, and I hastened to tell you that you may show me your vaults, and give me the means to contradict the

"No," said the cashier, "the rumor is all true. What use do you suppose that I have for the silver ?"

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Why, to meet the run upon your bank, which must certainly come when this state of your affairs is generally known," was the reply.

"Let the run come," said the cashier, "and by way of beginning it, do you go into the street, collect all of our bills that you can find, and bring them to me, and I promise to give you hard dollars for them."

After some time his friend returned to say that he had not been able to find any of the bills of that particular bank, excepting a solitary one for five dollars, for which the silver was immediately offered him.

"Just so," said the cashier, "almost all the bills that I have issued have already been sent in, and I have paid out the silver for them. But in doing so I have emptied most of those boxes of dollars. The money was given me to lend; and I have lent it for about four months. But I could

not lend it and keep it too. I have, therefore, very little gold or silver in the vaults. So long as I have the small amount that is necessary to redeem the few bills that remain out, and the two thousand dollars which I have earned for the stockholders, I am easy. You may go back to the street, if you will, and defy the world to break our bank. We shall lend nothing more until the promissory notes that we have taken as security begin to fall due. As they are paid in, with hard dollars, or the bills of other banks, we shall have the means to lend money again.'

If the matter has been clearly stated, it will be perceived that the cashier was perfectly right.,

"But where then," it will be asked, "is money to come from for the tax of 1 per cent on the capital, and for the expenses of banking, if the stockholders expect to receive 6 per cent for themselves? How is the loan to be extended to one hundred and fifty thousand dollars on a capital of one hundred thousand dollars?"

It is in this way. The cashier reports to the directors that although he has issued bills for about one hundred thousand dollars, only seventy or eighty thousand dollars have been brought in, though some time has elapsed; and it is supposed that the remaining twenty or thirty thousand are in the pockets of people who want them for daily use as a circulating medium, preferring them to specie, for convenience, so long as they know that silver or gold can be had for them whenever required. It is inferred, then, that it will be safe to make short loans of fifteen or twenty thousand dollars more on the strength of this, in the belief that a similar amount of bills will always remain in circulation, which is usually the case.

Here the danger of any future trouble begins. The cashier likewise reports that large sums are left with him on deposit for safe keeping; and that, although large sums are daily taken out, yet so much is replaced by fresh deposits, that the amount left with him by depositors never, on any one day, falls below fifty thousand dollars. It is concluded, therefore, that it will be safe to lend twenty or thirty thousand dollars of this also on short loans.

Instead, then, of confining the loan to one hundred thousand dollars, it is extended to one hundred and thirty or one hundred and fifty thousand. And instead of receiving only six thousand dollars in a year for interest, the gains amount to eight thousand or nine thousand dollars, thus furnishing two or three thousand for the expenses of banking and for the tax to the government, besides leaving 6 per cent to be divided among the stockholders.

We have seen that while the bank confined its loans to the capital, it stood strong and could never fail, whatever might happen to its stockholders, or to the rest of the world. When it goes beyond that limit, it becomes exposed to the fluctuations of commerce. When they grow dangerous, the bank must be brought again, as speedily as possible, within the limit of safety, to the great inconvenience of borrowers, who find themselves deprived of its aid just at the time when it is most desirable.

If what is called a pressure for money should come, then, when the loan is extended to one hundred and fifty thousand dollars, if the bills that are in circulation should be gathered up in order to demand gold and silver from the bank for them; and the depositors, finding a want for all that they have, should begin to withdraw their deposits, the bank must curtail its loans. But how far must it curtail, and how soon can it be done? One hundred thousand dollars of the loan belongs to the bank; and, as we have seen, may always be kept lent out on interest. There need not, therefore, be any curtailment of that. Of the other fifty thousand dollars which the directors have ventured to lend on the strength of deposits and of circulation, the whole need not be called in. Unless the bank fails entirely, it is scarcely possible that there should ever come a time when there is not some money to be left in the banks on deposit, or when some bills are not absolutely required for circulation; and some of the bills are likely to have been lost or destroyed, so that they can never come back. If we suppose the loan to have been reduced as notes are paid in, by thus retaining thirty thousand out of this fifty thousand, so that the bank owes only about one hundred and twenty thousand dollars, we shall have as great a reduction as takes place, usually, in times of great scarcity. And how soon can this reduction be made? I have spoken of the notes taken for the loans as having four months to run. But that time is meant as an average. If the affairs of the bank are judiciously managed, the loans have been so divided in time that receipts are constantly coming in, and a due proportion of the notes are falling due in each month; so that in less than sixty days the regular receipts would probably amount to the sum required. If no new loans have been made during that time, the bank has then taken care of itself, as the directors are bound to see that it does, whatever may happen to themselves or others. It stands strong, and it may go on to lend again any of the money that it has to receive, as it comes in from the payment of other notes.

Thus it appears that the reduction in such cases is but one-fifth of the