CHAPTER IV. OF THE SAFEST AND MOST PROFITABLE MODE OF INVESTING THE CAPITALS OF BANKS OF CIRCULATION.

IT has been shown that banks of discount upon the corporate or joint-stock principle could not generally he conducted to a profit, seeing that the income they derive from the loan of capital would not be as great as the income which the individual proprietors could have derived from lending their money without the agency of salaried officers and the rent and other expenses of a banking house. It has also been shown, that for the same reason, banks which perform the double function of banks of discount and banks of circulation, can make no banking profit by the mere lending of their capitals. All their profits are derived from lending their credit; for, although where the rate of interest is six per cent. per annum, the practice of taking the interest beforehand, and charging sixty-four days discount for the use of the money for sixty-three days, as in Philadelphia and other places, the actual rate received is 6 per cent., yet the additional four-tenths of one per cent, do not pay the proportion of the whole expenses of the bank, which the amount of its capital bears to the whole amount of its loans. Indeed, a little reflection will enable any one to perceive, that not only do all the profits beyond legal interest of a bank of discount and circulation, where it is successful, arise from the loan of its credit, but those profits must besides furnish a fund for making up the loss incident to the lending of its capital. Thus, if we suppose a bank of discount and circulation with a capital of one million of dollars, having loans out to the amount of one million and a half, and the whole annual expenses of the bank to be fifteen thousand dollars, or one per cent, upon the amount of the loans, it will be seen that two thirds of this expense attaches to the lending of the capital, and only one third to the lending of the credit of the bank, so that if separate accounts were kept of the expenses of each department of the institution, they would show a gain upon the lending of credit and a loss upon the lending of capital. If, therefore, the whole operation be profitable, the profit must arise from the lending of credit, and must consist’ of what remains after defraying the loss incident to the lending of the capital, which is precisely equal to the excess of the expenses of bank agency in loans over those of private agency, deducting the four-tenths of one per cent, which a bank charges, more than individuals would have a right to charge by law on loans.* At all events, no one will pretend that banks make more by the loan of their capitals than individuals could make, and even on this admission it is apparent that all the peculiar profits of what is usually called banking arise from the loan of credit.*

Now, if these positions be true, it follows as a necessary consequence, that the true policy of banks of discount and circulation is, to adopt the most economical and safe mode of lending their capitals, so as to lose as little as possible by the operation. Long loans, it is manifest, are attended with less expense than short ones, and the security of real estate or public funds is safer than the promissory notes of individuals. One officer can superintend loans on mortgage or investment in public securities, collect the interest, and keep all the accounts, as easily as four could attend to the discounting of an equal amount of notes at ninety days; and as to the difference between the security of mortgages and public stocks, and private paper, no one can fail to see the superiority of the former.

From these views, it is evident that banks of circulation derive no benefit whatever, but rather injury, from having capitals to lend. Why then, it may be asked, should they be connected with banks of discount? For no other reason than to give credit to their notes, which would not be allowed to get into circulation as money unless the public was assured of a responsible endorser. The bank of discount thus becomes the guarantee of the bank of circulation, and as the solidity of the guarantee is what the public most look after, how plain is it to be seen that a capital loaned upon real estate or state stocks would be a better security against insolvency than any promissory notes or bills of exchange could possibly be. In other words, a bank with a capital of one million of dollars loaned upon well secured mortgages and state stocks of undoubted solidity would offer a better security for the payment of its notes, than one with an equal capital loaned upon discounted notes and bills.

And not only is this true; not only would the credit of its notes be more perfectly secured as far as the public is concerned, but the interests of the stockholders themselves would be very greatly promoted by such a mode of lending the capital, first by a diminution in the expenses of management, and secondly by a diminution of the risk of lending.

But this is not all. The individual borrowers themselves, of the capitals of banks, would be greatly benefitted by such a system. They would obtain money at six per cent, per annum, instead of six per cent, and four-tenths; they would be able to borrow for such long periods at once, by giving the requisite security, as would give time for the winding up of the voyage or operation for the conducting of which the loan was required, instead of asking for renewals every sixty or ninety days, always accompanied with a degree of uncertainty, and generally attended with the additional tax of a loss of interest upon a balance in bank, tacitly, if not expressly required as the price of a continued accommodation; amounting, probably, to as much as with the four-tenths of one per cent, above referred to, may be equal to one per cent.

To this it may, perhaps, be objected, that all borrowers have not real estate or state stocks to pledge for loans of money. Farmers and manufacturers may have lands, houses, and factories, but merchants may not; and, at all events, it would deprive of the power of borrowing capital of banks all those persons who have no real estate or state stocks to offer as security. This is perfectly true, and it is precisely what ought to be, for banks are bound to obtain as good security on the loan of their capitals as their individual proprietors would demand; and we all know that individuals rarely lend their capitals for long periods at simple interest, as permanent investments, upon the mere personal security of persons engaged in trade, or hazardous enterprises. If they do occasionally depart from this rule, it is because they have such a knowledge of the affairs of the borrower as to render his personal promise equivalent, in their estimation, to a mortgage; and at all events they have a right to risk their own property if they choose, but as banks of discount stand towards the public in the position of guarantees to the banks of circulation, with which they are united, they act unwisely if they accept of any but the most perfect security, such as that afforded by mortgage on real estate, or by an investment in undoubted public securities.

What has been said, let it be remembered, relates only to the loans of its capital by a bank, and I trust that the reader will not fail to perceive the justice of the remarks. He will at least perceive, that as far as the lending of the capital of a bank goes, whether the loans be made for sixty days or twelve months, whether they be made on mortgage or to the government, or upon promissory notes and bills of exchange, the effect upon the currency is precisely the same. Neither mode makes money more or less abundant than the other; inasmuch as that which has been loaned is precisely the amount which previously existed in the community, and is, indeed, the precise amount which the individual stockholders of the bank would have had to loan, had they not associated together as a bank. The question, then, is a simple question as to the borrowers, and whilst those who could not give landed security for loans might think themselves deprived of a right to which they are entitled; yet it is evident, that the holders of bank notes and bank credits, and the owners of the capital, and all the rest of the community, who are to a man interested in the safe employment of the capital which belongs to the whole society, are manifestly benefitted. In truth, however, borrowers have no rights as regards the capital of a bank which they do not possess as regards the capital of an individual; and any one would see how preposterous it would be for a borrower of money to insist with an individual upon his right to borrow his capital upon a promissory note, when the individual should refuse to lend in any other way than upon mortgage.

I am aware that a plausible objection to this reasoning might be raised with reference to the banking system as carried on in the United States, by asserting the fact, that were it not for the demand of borrowers who have no real estate to offer as security, there would probably not be employment for one half the banking capital now existing in the United States. This, however, proves nothing more than that there is in existence double the amount of banking capital required to sustain the credit of the paper currency, which I have shown to be the only advantage derived from bank capitals, seeing that as far as the capitals go, nobody gains by their amount being loaned through corporate agencies, rather than by their individual proprietors. If the fact be that nearly all the capitals of all our banks are loaned out upon personal security in the discounting of promissory notes and bills of exchange, it is quite clear that the stockholders are not as secure from loss, and that their profits are not as great, as they would be if one half their capitals were returned to them, and loaned out by themselves individually upon landed security. There can be no doubt that in the United States great mischief results from so large a portion of the debts of the community being in the form of promissory notes discounted by the banks, instead of permanent loans, owing to the temptation of banks to expand, arising from the broad field upon which they suppose they can contract in case of need, which is much larger than it would be if all their capitals were loaned out upon permanent securities. I say, “suppose they can contract,” because the fact of their being able to contract at all times, may be considered as fully disproved by the stoppages of payment in 1837 by all the banks, and in 1839 by all the banks to the south of New York.