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X-217 > AN ANALYSIS OF THE SUBJECT OF AN "EXCHANGE” CHARGE ON CHECKS — 0O0--- U n t il the Federal Reserve Act went in to e ffe c t (1) and, indeed, u n t i l November 17, 19 16 , when the f i n a l tr a n s f e r of re serves was made, i t was p e rm issib le under the Na t io n a l Banking Act f o r banks to count a s p a rt of t h e ir le g a l required reserves funds redeposited in banks in oth e r c it ie s . There were only three c i t i e s in the country where t h i s was not perm itted, to -w it : L o u is; New York, Chicago and S t . - and those c i t i e s , b e in g C e n tra l Reserve c i t i e s , t h e ir n a t io n a l banks were n o t perm itted to count a s reserve, d e p o sits which they h eld in o th e r c i t i e s . Next in rank to these three C e n tra l Reserve c i t i e s , there were f if t y - t h r e e reserve c i t i e s . Banks in any o f these c i t i e s could keep a p a rt of t h e ir reserve d e p o sits in t h e ir own v a u lt s , and a p a rt in C e n tra l Reserve c i t i e s . Banks in a l l the oth er c i t i e s , towns and v i l l a g e s in ^he U nited S ta te s , known as non reserve c i t y banks, o r country banks, were perm itted to re d e p o sit t h r e e - f if t h s of t h e ir re se rve s in any Reserve o r C e n tra l Reserve c i t y bank. In c id e n t a lly i t should be p o in t ed out th a t the term country hank does not mean a sm a ll hank n e c e s s a r ily . Many la r g e c i t i e s , f o r example, Buf fa lo , New York, are nonreserve c it ie s ,a n d hanks in those c i t i e s , however h ig , are spoken of a s country hanks. Under the o p e ration s of t h is system hanks in Cen t r a l Reserve and Reserve c i t i e s competed a c t iv e ly f o r country hank * d e p o sits, p ayin g in t e r e s t on these d e p o sits and p erform ing oth er se r v ic e s of value f o r the country hanks. One of the recognized e v i l s of the o ld n a tio n a l hanking system which the Federal re serve system sought to* remedy, was the d u p lic a tio n of reserves, and the payment of in t e r e s t on reserve d e p o sits, which compelled the hanks h o ld in g those re serve s to use the funds a c t iv e ly . r e s u lt of t h i s , As a in tim es o f s t r e s s , the country hank was not always a b le to secure funds from i t s c i t y correspond ent. Hence, one of the main o b je c ts of the framers of the Federal of Reserve reserve Act d e p o sits was by to a vo id c r e a tin g th is ce n tra l d u p lic a t io n hanks which would receive the reserves from the hanks of t h e ir re sp e ct iv e d i s t r i c t s , p ay in g a t the same time no in t e r e s t on these re serve s, thus la r g e ly removing the n e c e ss ity fo r in v e s t in g X--217 -3 - these funds, which i t was intended should "be conserved and employed c h ie f ly as a b a s is fo r the e xten sio n o f c r e d it to member banks and., through them, to the p u b lic in tim es of need. (4) In c id e n t a l w ith the growth of the N a tio n a l Banking System and in p a rt due to some of the cumbersome fe a tu re s of t h e i r n o t e - is s u in g power, a system of bank checks came in to ge n e ral use. Indeed, there i s no co untry in the w orld which has developed the bank check so fa r and so com pletely as has the U nited S ta te s. W hile the bank check i s s p e c if ic a l l y the order by a d e p o sito r in a bank to pay to a named payee a c e r ta in s p e c ifie d sum of money, i t has come to per form n e a rly a l l the fu n c tio n s which bank notes perform in oth er c o u n trie s, fu r n is h in g a t the same time the added ad vantage of g i v in g the debtor a re c e ip t fo r the money p a id . I t must be obvious to any man o f a f f a i r s th a t the development o f the check system in the U nited S ta te s i n the l a s t f i f t y y e ars has been one of the most im portant, s a t is f a c t o r y and u s e f u l b y-p ro d u cts of our b u sin e ss a c t i v i t y . be done to hamper i t , N othing must fo r i t must be remembered th a t from n in e ty to n in e t y - f iv e per cent of the purchases and s a le s in t h i s country are e ffe c te d by check w ith ou t the use o f e ith e r > X-217 -14- sp ecie or tank notes. One of the o b je cts of the fram ers o f the Federal (5) Reserve Act, as a lre a d y explained, was the t r a n s f e r of the heserves from n a tio n a l banks in Reserve and C e n tra l Reserve c i t i e s to s p e c ia lly created banks, known a s Federal reserve banks, o f which there are tw elve. T h is done, the authors of the Act perm itted a co n sid e rab le red uction in re se rve s, a sa fe expedient under the circum stances. I t was apparent, however; th a t an in c id e n ta l; though very n e ce ssary func t io n of these reserve banks must be to act as c le a r in g houses fo r the t r a n s f e r o f funds from one s e c tio n o f the country to anoth er, and fo r h a n d lin g the v a s t system of check c o lle c t io n . In the l a s t year a f a i r b e g in n in g has been made and the checks upon a l l n a t io n a l banks, some seven thousand s i x hundred in number, and upon an even g r e a te r number of State banks and t r u s t companies, may be c o lle c te d a t p a r through Federal re se rv e banks. fo r perform ing t h is se rv ic e v a r ie s now from The charge l<p to 24 per item, and should be fu rth e r reduced as the work develops. The bank d e p o s it in g i t s checks i s giv e n immediate c r e d it fo r the g r o s s d e p o sit which i s made a v a ila b le a s soon as i t can be c o lle c te d . W hile the in tro d u c tio n of t h i s system of check c le a r in g has met w ith much favorab le comment i t JU217 -5 has been the cause of a very v ig o ro u s p r o te s t from many country bankers who claim th at they have been deprived o f a charge fo r "exchange tn a t i s , a c o lle c t io n fee* I t i s proper, th erefore, to study e x a c tly what t h i s charge i s and how i t operates* In order to analyze i t f a i r l y we must c o n sid e r i t from o p p osite p o in ts o f view. THE CITY MERCHANT'S POINT OF VIEW. The customer of the c it y bank i s a ffe c te d in the fo llo w in g manner: When he d e p o sits checks which have been sent to him in payment fo r a r t i c l e s so ld , he i s to ld by the t e l l e r of the c it y bank there i s a deduction of a c e r ta in fix e d percentage on t h i s and th at check, ra n g in g in the p a st from, say, 10 cents per thousand to $2 . 50 * There i s n o th in g on the face of the check to show what deduction would be made, and the re c ip ie n t o f a check had n oth in g to in d ic a te the amount of the charge except the p ayin g t e l l e r Ts word tha.t a c e r t a in deduction was r ig h t and proper* The ex p la n a tio n u s u a lly made by the p ayin g t e l l e r of the c i t y bank was th a t he was ch argin g the customer only the exant amount which the country bank deducted from the face o f i t s check* I f the c it y merchant complained to h is country c lie n t he m ight be t o ld th a t other c i t y merchants accepted country checks and t h a t i f he o b je c te d the buyer would go else w h ere . THE COUNTRY MERCHANT'S POINT OF VIEW. Let us see how the country merchant looks at it. The country merchant may possibly be interested in the bank: If not actually interested, he is likely to be the friend and neighbor of the banker; the banker might also be paying him yfi, bf> or 5^ interest on his deposit , and when the country merchant receives letters from the city merchant complaining of deduction for collection, the country hanker suggests just the sort of response which has been referred to in the fore going. While it is not agreeable to assume that the country merchant intentionally pays the bill due the city merchant with "short change” yet, it has been repeatedly argued by defenders of the system of deduction from checks for collec tion, that the city merchant charges enough more for his goods to cover the deduction for collection of checks and that therefore a deduction is justifiable. Thus, we are forced to two conclusions, first, that the country merchant to some extent connives at defrauding the city merchant, and second, that the city merchant, recognizing the fraud, adds to the price of his goods enough to cover the deduction. The cost of the deduction, therefore, by the banker, falls upon X-217 -7the merchants, tut in the end on the ultimate consumer as a part of the cost of distribution. THE CITY BANKER *S POINT OF VIEW. (c) The city banker is not opposed to the collection or exchange charge, partly because, he is able, to some extent, to pass it 6n to his customer, but, chiefly because, even if he is not able to so pass it on, he uses this payment to his country bank correspondent as a bait to secure country bank deposits. analysis. The service rendered is susceptible of close The city banker pays interest on the country bank deposits and also pays the deduction which the country banker makes for remitting for his checks. "exchange" charge This so-called the city banker analyzes most carefully, and rightfully demands compensation for the service he ren ders and the mone}^ he pays in interest on balances. The city bank handles the country account only so long as its value, lay reason of its size and earning capacity, is suf ficient to compensate for the interest he has paid the coun try bank, plus exchange charges, and all other expenses. ^* £-217 -8 - THE COUNTRY BANKER1S POINT OF VIEW. (d) * The country banker, very n a t u r a lly , lo o k s a t the su b ject in a d if f e r e n t way. F ir s t , he fe e ls very s t r o n g ly th a t the c i t y banker has oppo r t u n it ie s fo r m aking money which are su p e rio r to those in the country, and th e re fo re he has a, grievan ce* He has not the same f a c i l i t i e s fo r c lo s e ly a n a ly s in g the co st of d oing b u sin e ss, and would not be j u s t i f ie d in c r e a tin g such f a c i l i t i e s * The r e s u lt i s th a t, w h ile te n a c io u sly h o ld in g to the p r o f i t s made by ch a rgin g "exchange11 - th a t i s , a deduction from the face value of h is own checks presented through c it y correspond ents - he ofte n f a i l s to a p p re ciate th a t the c i t y banker i s not ren d erin g t h i s se r v ic e fo r him free, but i s doing i t only when he c a r r ie s a compensating balance* Thus i t i s th a t country banks have u n w ittin g ly c a rr ie d f a r g re a te r b a lan ce s w ith c i t y banks than they were required under the law to keep, and have c a rrie d these balan ces a t, say, 2fo in t e r e s t , when the money was needed a t home, and could have been p r o f it a b ly employed a t home to help lo c a l e n te rp rise at 51° anc* Furthermore, not in fre q u e n tly the c i t y banker, g lu tte d with funds upon which he was p ayin g in t e r e st, has o fte n been compelled to send h is money in to the X-217 -9- same d i s t r i c t from which i t o r ig in a te d and lend i t in so m p e titio n w ith the country hanker. The country banker has undoubtedly reason to f e e l th a t he should receive some compensationswhen, he i s required to rem it Cash to pay h is own checks ra th e r than o f f s e t t in g item s. I f the flow of b u sin e ss i s such th a t he i s able to pay checks drawn on him by checks received by him, but drawn on the c it y , he can f e e l th at "one hand washes the o th e r", but i f he must pay, say l / 3 o r 1/2 o f h is d a ily b alan ce s by re m ittin g burrency, which of course r a r e ly happens* he is j u s t i f i e d in f e e lin g th at he should receive some com pen sation, and the compensation should be enough to cover the expense of re m ittin g the currency and perhaps a ls o the expense of re p le n ish in g th a t sto ck of currency th u s d e p le te d . T h is statement i s on the assum ption th a t in some country d i s t r i c t s there i s a tendency f o r currency to flow away from the. country to the c it y , and th a t t h is must be made good by shipments of currency from the c i t y to the country. 'As,a general, .thing, the in t e r io r , be cause i t rep resents the p roduction o f raw m a t e r ia ls , i s r e c e iv in g c i t y checks and d r a ft s to pay fo r i t s produce# Thus country communities, g e n e r a lly speaking, re ce iv e in checks and d r a f t s somewhat more than they pay out fo r pur chases in the city. There ce.n he no doubt as to the jus tice of allowing the country hanker compensation where he is thus situated* and the Federal Reserve Board has that power* The question which has arisen has been wholly how this compensation shall he provided for. In the past it has been accomplished by charging the customer of the pay ee hank ' in the city,, whereas, many students of the question take the position that the charge should he made against the drawer or maker of the check. But the country hanker will say that this will put a tax upon the maker of the check, which he will resentjand he will shovtf his resentment by withdrawing his deposit with the country hank, and thereafter keep it with the city bank* The pub lic is interested, in a. correct and equitable adjustment of the question. If it is fair, as above outlined, that the country hanker should receive compensation for main taining his balance o f trade with the city by paying for the shipment of currency, then the question to be decided is how shall that compensation be provided. If a small tax is put upon the maker of the country check sent to pay a distant bill, he will perhaps cease to use his checks to pay city accounts. In other words, he will use his country bank account, if at all, only to pay his neighbors in the country, and, if he wants to pay a hill in the city he will either pay it with a check drawn on a city bank, or go to his country bank and get a draft upon a city bank, for which the country banker may make a change if he sees fit. the The evil of/present method of charging is that it confuses the situation, and makes it impossible clearly to determine the entire expense; and yet that the expense is borne by the ultimate consumer, or the general public, can not be doubted. THE PUBLIC'S POINT OF VIEW. The general public, by which is meant the con sumer, who is neither merchant, manufacturer nor banker, does not know a great deal about the subject. The indiv idual receiving a check upon which a deduction is made by the paying bank knows nothing about the justice of the charge or propriety of the deduction. The further fact that he is being taxed a small amount on every article which he purchases is not appreciated by him. In fact the ultimate consumer's rights must be safeguarded for him be cause he is without organization or protection except that ' « X-217 > -12- which the legislator affords him. ( 6) The problem before the Federal Reserve Board is primarily to carry out the objects of the Federal Reserve Act. The twelve Federal reserve cities, each operating as a nerve center for an important area of country, connected together as they are by a central Gold Settlement Fund through which balances between them can be settled by wire, provides an ideal machine for check collection. Further more, it is a machine which can be enlarged and expanded by the establishment of branches, and collection agencies in the larger districts. The problem is two-fold. First, to create a machine which will operate as economically as poseve ry sible, and there is/reason to believe that one can be created to operate very much more efficiently and economical ly than any thafchas heretofore existed. Second, to distri bute expense with reasonable justice and equity. At the present time the Federal reserve banks are charging their member banks a service charge, varying from 1# to It is hoped soon to reduce this. per item. It might indeed be arranged so that country banks be permitted to remit for checks sent to them for collection any offsetting items, such as checks drawn on other banks in the same Federal reserve district. When currency must be sent, the Federal reserve bank now pays x-217 -13~ for the shipment of currency. There is some question whether, in view of the equities of the case, Federal re serve hanks should not go further in helping out the coun try banker by a remission, for example, of charges in the case of checks sent direct by member banks to the Federal reserve bank, that is, upon all checks bearing only one bank indorsement. This would enable every country bank 1 to offset (making due allowance for collection time) with out expense the items sent against it. The payment of postage or express charges might properly be borne by the Federal reserve bank and, possibly the shipment of currency to the country bank might be borne by the Federal reserve bank when such shipment was necessary by reason of deple tion due to the operation of what might be termed the"balance of trade". The whole question is one of very consid erable difficulty, and is highly technical. It is so closely related to the question of reserves that it cannot it well be disassociated from it, and/was for this reason that the Federal Reserve Board was inclined to think that the fairest and surest way of compensating country banks was by reducing the balances which they were compelled to %eep with their reserve banks to a minimum figure. Coupled with the general provision of clearing all checks, the low re~ ** V X-217 -1U- serve requirement becomes of great value to the country bank. Balances no longer need be kept in various cities far in excess of reserve requirements, and a bank is able to render a larger service in its own community and to offset its losses on exchange by earnings received from loaning its funds at home. However,, if it appears that the country banks are still at a disadvantage, it may be said with some force that there is a great chance for profit by a reduction of excessive interest rates now commonly allowed to depositors. The Comptroller of the Currency and the Federal Reserve Board have always stood ready to help in the accomplishment of this much desired reform, for the reason that bank customers cannot hope for low interest rates on loans if banks continue the in sane policy, usually the result of competition for depos its, of paying exhorbitant rates of interest for deposits. F. W ashington, June 16, 1917 A* DELANO.
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