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1 | ! 1 THE CLEARING AND COLLECTION OF CHECKS By WALTER EARL SPAHR , Ph.D. Assistant Professor of Economics New York University With Introduction by H. PARKER WILLIS , Ph . D. Professor of Banking , Columbia University NEW YORK THE BANKERS PUBLISHING CO . 1926 HG2 : 06 so 1 3 JH Copyright 1926 The Bankers Publishing Company TE . PRINTED IN THE U. THE S, A, BY WARREN PUBLICATIONS PRESS CAMBRIDGE , MASS . 97c PREFACE Among the few questions in the field of currency and banking which have not received a thorough and systematic treatment, there is none of greater importance than that of the clearing and collection of checks. It seems remarkable, when one considers the important part deposit currency plays in everyday life, that this significant aspect of currency and banking should be neglected so long. Checks and drafts, as evidences of deposits in the process of transfer, are the principal connecting links between the indi vidual and his bank. Not only the individual, but practically every department of aa bank, comes in contact with them on every side. Indeed, the principal function of commercial banks today is to receive and create deposits and to provide the proper mechan ism for their transfer and collection. But even though the ques tions involved in the clearing and collection of checks are of such importance to the individual and to the bank, there is probably no subject in the field of currency and banking to which so much vagueness attaches. This is true not only for the layman but for the great majority of persons directly connected with banks. Perhaps the most important controversy in the currency and banking field at present is the par collection controversy and yet relatively few people are in a position to pass a mature judgment on the merits of the questions involved. It is the purpose of this book to show not only the manner of origin and actual functioning of our present clearing and collection system , but to examine the merits of the various questions involved in the par collection con troversy. As a resultthis book deals not onlywith the historical and theoretical aspects of our clearing and collection system, but with its practical operation as well and should meet the needs of the instructor, student, banker, and layman. The material has been arranged with this purpose in mind. The last chapter gives a summarized view of theclearing and collection system as it oper ates today and is designed primarily for those persons who have little time or inclination to inquire into the theoretical and con troversial aspects ofthequestion but who wish to get a picture of the system as itis functioningatpresent. For the great majority iii 605523 PREFACE iv of readers, however, the other chapters will be found necessary to give an adequate view of the problems involved. The writer has felt a great need for such material, not only in his university classes, but in classes composed entirely of persons connected with banks, and believes the book will fulfill a great need felt by in structors and students. In making recognition of the valuable suggestions which he has received in the preparation of this book, the writer wishes to make special mention of his obligations to Professor H. Parker Willis of Columbia University ; to Professors James D. Magee and Rine hart J. Swenson of New York University ; to Dean Chester A. Phillips of the University of Iowa ; to Dr. W. Randolph Burgess, Mr. Carl Snyder, Mr. Adolph J. Lins, and Miss Lucile Bagwell of the Federal Reserve Bank of New York ; and to Mr. Clarence E. Bacon of the New York Clearing House. While the writer's obligations to others, especially to those bankers who have written long and carefully-prepared letters to the writer in response to his queries, are set forth clearly in the footnotes, he wishes to make special acknowledgment of his indebtedness to Mr. Charles A. Peple of the Federal Reserve Bank of Richmond ; to Mr. H. F. Strater of the Federal Reserve Bank of Cleveland ; and to Messrs. Walter W. Stewart , Walter L. Eddy and J. C. Noell, members of the staff of the Federal Reserve Board. The writer is also deeply indebted to his wife, Beulah, for her suggestions and help in read ing proof. W. E. S. New York City, May, 1925. INTRODUCTION After more than a decade of experience in developing the Fed eral Reserve System , American bankers are beginning to realize that the complete reform of our banking methods cannot be at tained without extensive readjustment of existing practices and particularly the recognition of certain problems of a general nature whose solution must be approached upon the lines of public welfare rather than of individual business advantage. Students of banking had already reached these conclusions ; and some few of them have within the past few years given up the older type of semi-political discussion of banking legislation and the semi-dialectic analysis of abstract theories of prices and values. In their place, there have begun to come forward a series of fact-analyses designed to place current problems in their proper historical setting, and at the same time to supply the ma terials for a solution of doubtful or debatable questions of man agement. A new kind of banking study and investigation is thus being slowly developed ; and the results of it are finding their way to the public in the form of monographs on fundamental questions growing out of the banking inquiry and experience of the decade past. The Federal Reserve System has naturally attracted a large share of the attention of men with fundamental training and scientific outlook such as to enable them to appreciate banking problems from a national standpoint. Several well-conceived and thoroughly -prepared monographs dealing with varying phases of the System have already made their appearance. Among them may be mentioned recent inquiries into the fiscal functions of Fed eral reserve banks, into the discount policy of the Federal Reserve System, and into details of practice and method which have been analyzed from a variety of standpoints. The present volume by Dr. W. E. Spahr deals with one of the more technical and difficult phases of Federal reserve banking and seeks to set forth the ele ments of this branch of the problem in the detail that they deserve. Necessarily a study of the clearance and collection system of the Federal reserve banks must view the whole problem from a broad V vi INTRODUCTION historical standpoint, yet must be willing to take into careful account the contemporary phases, both legal and technical, in which the problem presents itself at the present time. Dr. Spahr has furnished exactly this kind of background, and has provided a wealth of material for the careful study of a branch of banking practice which has been too much neglected . He has, moreover, furnished the underlying basis for the analysis of a banking prob lem which in its theoretic aspects has thus far been given scarcely any weight save by a very few thinkers, of whom the late Professor Dunbar of Harvard was by far the most outstanding. When the Federal Reserve Act was first projected, it was sought to incorporate into that measure provision for the exer cise of clearing powers, in order that the System might become a Reserve System in truth as well as in name. It was recognized that, without these powers, the reserve banks would become merely the holders of dead balances carried for the member banks with out any service to them ; and, since the business public abhors an idle or unnecessary institution, just as nature is traditionally said to abhor a vacuum, it would not submit long to the needless burden created by such emergency institutions designed to " put out financial fire .” It was realized also that such measures as the Aldrich bill, adopted by the National Monetary Commission but apparently without thought on the part of its framers regarding any system of collection and clearance, would have met only a very small fraction of the necessities of the situation, and would consequently have corrected but a few of the fundamental faults to be found in Federal reserve banking. Hence the effort, early in the history of the System, to make use of the broad clearing authority which was finally granted by the law itself for the pur pose of creating a unified system of remittance and credit appli cable in every part of the United States. The undertaking seems today to have been obviously necessary ; yet at the time those who sought to secure success for it were obliged almost to fight for their reputations, and could maintain themselves and their cause only with the utmost difficulty. It is aa great tribute to the real service of the Federal Reserve System that it should have succeeded in some measure in over coming this kind of hostility both from within and without its own ranks, and should have advanced as far as it has in the task of ex emplifying what can be done for a nation by harmonizing its methods of collecting, clearing and remitting funds. It is not too much to say that, during the participation of the United States in INTRODUCTION vii the war, the clearing mechanism which had been provided, both in the form of the Gold Settlement Fund and in that of local clear ing systems in the several districts, was absolutely indispensable to the successful functioning of Treasury finance. Without it, undoubtedly, our system of financing the war would have broken down, funds would have become congested in various parts of the country and would have been correspondingly scarce elsewhere, banking embarrassment would have been common , and the tremen dous load of war finance, eventually borne with considerable suc cess, and with a minimum of suffering, would have crushed the nation's finances to the earth. And yet this conspicuous service could not be allowed to go on undisturbed . Ingratitude, more strong than traitors' arms, has more or less vanquished those who, aided by the urgent necessities of the war, had attained a partial success in installing a national system of collection and clearance. State banks in various parts of the country, irritated and aggra vated as they have been by tactless methods employed by unwise Federal reserve bankers, have sought and have obtained decisions from the courts which, while ambiguous and doubtful in their meaning, have none the less aided in breaking up the plan that had already been worked out. They have thus already introduced in many parts of the country a wide diversity of practice and of method which largely interferes with the effective application of the System as first conceived. It may be doubted whether we shall be willing long to submit to this kind of backward evolution. There are many bankers who perceive the danger of the further loss of ground, although they hardly know how to correct the situation which has thus grown up. A part of their embarrassment and difficulty is due to lack of knowledge. There is a widespread propaganda against national collection and clearance, and numerous assertions based upon per verted or erroneous ideas of the function of collection and clear ance have been widely disseminated. Dr. Spahr's volume traces this lengthy and entangled history, and sets forth dispassionately and without bias the various steps in the evolution of collection and clearance systems during recent years. It thus renders a decided service to the banker who is still seeking light with regard to his own business interest in the matter of clearance, just as it provides him with the material upon which to make up his mind regarding the public aspects of the whole question in the abstract. A reading of this volume should accordingly inform many pro fessional students of factors in the clearance situation, and of viii INTRODUCTION phases in the history of the development of the check as a medium of exchange, of which they have heretofore been ignorant, or which at all events they have ignored. The author has laboriously and carefully followed the subject back to its historic beginnings, just as he has painstakingly unravelled the threads of recent legis lation and litigation which have tended to confuse the contempo rary aspects of the whole problem. Dr. Spahr's book may thus be recommended , without reserva tion both to the banker who needs the information it contains for his professional information, to the academic student of banking and currency who has long sought for a compact body of available data on this subject, and to the legislator who must recognize the pressing character of the entire collection question as well as the probability that he must before long act upon it in practice in one way or another. It should be widely read for its own value. But it should receive a still wider attention, and it should be still more extensively studied, as an introduction to the practical problem of providing and rendering permanent an effective system for the clearance and collection of checks throughout the United States, and hence of economizing our specie and rendering effective our whole system of banking. H. PARKER WILLIS. CONTENTS Page CHAPTER 1–NATURE, ORIGIN , AND USE OF CHECKS The nature of checks 1 The advantages of checks 6 Limitations of checks 6 Need for a separate legal code for checks . The increasing use of checks The origin of checks ... 7 8 9 The check originated in Italy and Sicily 10 The Bank of Venice 10 12 The Bank of St. George Checks in Italy today The check in Germany 13 14 The check in Holland 15 The Bank of Amsterdam 16 The check in England 18 Checks in France . 20 The check in Austria 22 Checks in Hungary 23 Checks in Switzerland 23 Checks in Norway, Sweden, and Denmark 24 Checks in Belgium 26 The check in Spain and Portugal 26 The check in Russia 27 Checks in the Republics of Finland and Latvia Checks in southern European countries 28 Checks in China, Japan, and India 30 Checks in Canada Checks in Mexico 32 The use of checks in South America 33 29 32 Notes and deposits in the leading countries of the world in 36 1913 CHAPTER 11—USE OF CHECKS IN THE UNITED STATES PRIOR TO 1863 The use of checks during the Colonial period ... The development of banking during the Colonial period . ... 37 37 ix CONTENTS х Page Origin of checks, 1681 .... 38 Why deposit currency did not develop in the Colonies .. 40 Paper money and banking schemes of the Colonies . 41 43 Growth of deposit currency after the Revolution .. The extent to which checks were used ; attempts to determine 45 importance Deposits as an indication of the extent to which checks were 47 used The use of checks, 1791-1811 Use of checks, 1811-1816 . The second United States Bank and the use of checks, 1816 51 54 56 1836 The general banking and currency situation, 1816-1836 .. 58 The use of checks, 1836-1863 60 CHAPTER III CLEARING AND COLLECTION OF CHECKS PRIOR TO 1863 XVIeaning of clearing and collection of checks . 67 The origin of the practice of clearing YThe origin of clearing houses 70 69 Collection of checks before the days of the clearing house ... 71 The Suffolk principle of par collection 73 .. Banks must redeem their notes at once and in full when pre sented over the counter 74 The case of the Suffolk Bank v. the Lincoln Bank, 1821 ... The later years of the Suffolk System .. Other methods of note collection .. Gallatin recommended a clearing system for checks, 1841 .... 75 The New York City Clearing House, 1853 The clearing house in the panic of 1857 .. 80 82 78 78 79 CHAPTER IV–THE CLEARING AND COLLECTION SYS TEM, 1863-1914 The growth of deposit currency 84 Inquiries to determine the importance of checks .... 87 The relation of the clearing and collection system to the system of reserves Practice under the National Banking System. Local ex changes without clearing houses Local exchanges with clearing houses Inter-community clearing and collection 96 98 99 99 The defects of the old clearing and collection system . 101 Excessive charges Circuitous routing of checks 102 103 xi CONTENTS Page Remittance charges as a cause of circuitous routing. Legality of such charges Typical illustrations of circuitous routing of checks .. 103 105 108 Evil effects of circuitous routing of checks .. The " float ” ; giving immediate credit for out-of- town checks .. 109 110 Paying interest on uncollected funds .... The carrying of compensating balances with collecting banks solely for the purpose of obtaining par territory .. 110 The maintenance of reserve balances with banks for the sole purpose of getting items on which to charge exchange. . 111 Excessive gold movements 112 The absorption of collection charges by collecting banks Who bore the cost ? .. 112 112 2. The items of cost in collecting checks . 113 3. Who should bear the cost ? 117 1. Proposals for reform Attempts at reform The Sedalia, Missouri, plan , 1895 119 124 124 , The New York City plan, 1899 .. 125 The Boston country clearing house, 1899 . 126; County clearing houses 129 CHAPTER V - SPECIAL FUNCTIONS HOUSES PRIOR TO 1914 OF CLEARING special functions of the clearing house Extending loans to the government Rendering assistance to members Fixing uniform rates of interest on deposits... 131 131 132 134 Fixing uniform rates of exchange and of charges on collec tions Fixing reserve requirements 184 135 Examination of member banks by clearing houses . 135 Gathering credit data for members . 186 The issuing of public statements 137 Annual conferences 137 The issue of clearing house loan certificates. Their nature .. The use of clearing house loan certificates in 1860 .... 138 140 144 145 The New York issues of 1861 , 1863, and 1864 ...... Clearing house loan certificates and the panic of 1873 ....... Clearing house loan certificates in 1879, 1884, 1890, and 1891 146 Clearing house loan certificates and the panic of 1893 147 Loan certificates in 1895 and 1896 .... 149 Loan certificates and other currency substitutes issued during the panic of 1907 ... Clearing house loan certificates in large denominations . 151 150 xii CONTENTS Page Clearing house loan certificates in small denominations for general circulation .. 153 Clearing house checks in convenient denominations for gen eral circulation .... 154 Cashiers' checks issued in convenient denominations and pay able only through the clearing house Certificates of deposit Drafts on reserve banks 154 155 156 156 Pay checks payable to bearer 158 Official encouragement of suspension 159 Limiting the size of checks to be paid ... , The practice of requiring the larger customers to mark their checks " Payable only through the Clearing House ” ..... 159 The plan of Group No. 2 of the Ohio Bankers' Association .. 159 160 A general summary Did the currency substitutes violate the 10 per cent. tax pro vision of the Act of 1865 ? .. Clearing house loan certificates in 1914 .. 161 161 CHAPTER VI-HISTORY OF THE FEDERAL RESERVE CLEARING AND COLLECTION SYSTEM Legal provisions The institution of the system 164 165 Relation of the voluntary system to decentralized reserves ... 166 Initial steps preceding the voluntary system .. 167 Inter-district clearing system precedes voluntary intra -district system ; the Gold Settlement Fund .... The establishment of the Federal Reserve Agents ’ Fund . 169 170 The voluntary intra -district system, June, 1915-July, 1916 .. 171 The voluntary system a failure 173 Objections to the voluntary system . The compulsory system under decentralized reserves, July, 174 1916-June 21 , 1917 .. Checks sent direct by a Federal reserve bank to its drawee 177 member banks for collection 178 The deferred availability principle; the zone system .... 179 The nature of the time schedules 180 The deferred availability principle and the collection of intra district cash items 185 1. Collecting intra -district cash items through the Federal reserve bank 185 Collecting intra-district cash items through Federal re serve bank branches 3. 186 Sending intra -district items direct to drawee banks for 187 collection ... The collection of and settlement for inter - district cash items 189 CONTENTS xiii Page 1. Collecting inter-district cash items through a bank's own Federal reserve bank or branch ... 2. 190 Member and non-member clearing banks may send inter-district cash items direct to Federal reserve 3. banks and branches in other districts .... Sending items direct to member and non-member clear ing banks in other districts Service charges 190 191 192 193 The meaning of par collection under this system ... The question of reserves ; the Board's proposal to concentrate . 194 The question of non-member banks ; amendment of September 7 , 1916 The concentration of reserves, June -July, 1917 . Non -member banks admitted to the privileges of the system, June 21 , 1917 ... 196 196 197 198 Problem of collecting checks on non -member banks . The Hardwick Amendment, June 21 , 1917 Other attempts to develop the system .... 200 The collection of notes, drafts, and other items ... 201 200 Schedule for availability of proceeds of bankers' acceptances 205 Introduction of Federal reserve exchange and transfer drafts 206 The telegraphic transfer system 208 Service charges lowered and finally abolished July 1 , 1918 ... 211 Absorption of other costs by Federal reserve banks .... 213 Changes in the operation of the Gold Settlement and Federal Reserve Agents’ Funds .... 214 The leased wire system, June 4, 1918 Daily gold settlement plan, July 1 , 1918 ..... 214 215 Certain branches of Federal reserve banks clear directly through the Gold Settlement Fund 216 Relation of the Gold Settlement Fund to rediscounting between Federal reserve banks 216 The growth of membership in the Federal Reserve System ... 218 The growth of the clearing and collection system . 225 226 Opposition to the clearing and collection system ... Success of the Federal reserve clearing and collection system . 229 CHAPTER VII—THE PAR COLLECTION CONTROVERSY Growth of opposition to the Federal reserve par collection system The basis of opposition to par collection .. Arguments for par collection 232 235 240 The growth of the par lists ... 243 The increased opposition to par collection Common and concrete forms of opposition . 246 The Atlanta par collection case ... 256 249 CONTENTS xiv Page The San Francisco par collection case . 263 The Cleveland par collection case . 266 The Richmond par collection case ... 263 The case of the Pascagoula National Bank of Moss Point, Mississippi v. Federal Reserve Bank of Atlanta , et al ... 277 Regulation J amended as a result of the United States Su .. 282 preme Court decisions of June 11 , 1923 ..... Federal Reserve Bank of Richmond v. Malloy et al., trading 284 as Malloy Brothers Regulation J, Series of 1924 286 Conclusion 288 CHAPTER VIII-THE GOLD SETTLEMENT FUND Nature of the Gold Settlement Fund ..... Inter-district clearing before the creation of the Fund . Steps leading to the creation of the Gold Settlement Fund ... Provisions for the Gold Settlement Fund ... The gold in the Fund as part of legal reserve . Provision originally made for weekly settlements . 291 291 293 294 296 297 The voluntary intra-district system and the Gold Settlement Fund 297 Results for the year 1915 The Federal Reserve Agents ’ Fund 298 299 Discontinuance of gold order certificates, June 21 , 1917 .... The leased wire system, June 4, 1918 ..... 301 303 The telegraphic transfer system 304 > Relation of the Gold Settlement Fund to rediscounting between Federal reserve banks 304 Daily settlements supplant weekly settlements in the Gold Settlement Fund 305 Certain branches of Federal reserve banks clear. directly through the Gold Settlement Fund 307 Nature of the " cash items” cleared through the Gold Settle ment Fund The immediate and deferred credit system . ... 307 308 Method of making settlements through the Gold Settlement Fund 310 Transactions which are not included in the daily settlements . 315 319 Inter-district gold movements Gold distribution in the United States . 321 Factors affecting inter-district gold movements . 322 How clearings and transfers affect inter-district gold move ments Effect of the fiscal operations of the government on inter district gold movements 322 323 XV CONTENTS Page Effect of rediscount operations among Federal reserve banks 324 on inter-district gold movements Effect of inter-district movements of Federal reserve notes .. 326 CHAPTER IX—THE COMPUTATION OF RESERVES Reserve requirements of member banks of the Federal Re serve System Reserve requirements of the Federal reserve banks ... 330 Reserve requirements of Federal reserve bank branches .... Reserve requirements of State banks , trust companies, and 332 private banks Reserve requirements of banks outside continental United 334 331 339 States Reserve requirements of foreign branches of member banks.. 340 Reserve requirements of banking corporations authorized to do foreign banking business (so-called Edge Corpora 340 tions ) ... What constitutes reserves 341 Nature of the deposits against which reserves are carried .... 343 1. 343 In member banks Nature of deposits in Federal reserve banks ... 3. Nature of deposits in non -member State banks, trust 2. companies, and private banks 4. 347 349 The nature of deposits in Federal foreign banking as 350 sociations The computation of reserves. Of member banks . 350 The analysis of reserve account by member banks.... 354 1. The method of computing semi-monthly and daily reserve 355 requirements in a country national bank.. 360 The transit account of a country national bank . Distinction between individual and bank deposits in com ... 362 puting reserves of member banks Computation of reserves against balances held in foreign ... banks by member banks 362 Computation of reserve against balances due from foreign branches of domestic banks ... 363 No reserves required against balances due to foreign branches by member banks .. 363 Question of reserves against money paid by a customer in anticipation of acceptances 364 " Special savings deposits” are demand deposits for reserve purposes 364 Periods over which reserves are computed by member banks.. 365 Penalties for deficiencies of member bank reserves . 2. Computation of reserves by Federal reserve banks.. 366 369 xvi CONTENTS Page The question of reserve deficiencies in Federal reserve banks 371 Method of reporting the reserve condition of the Federal re serve banks 374 3. Computation of reserves in non -member State banks, 379 trust companies, and private banks..... 4. Computation of reserves by non-member national banks 381 5. The computation of reserves by Federal foreign bank 881 ing corporations CHAPTER X—THE CLEARING HOUSE Nature of clearing operations The New York Clearing House Association ..... The administration of the clearing house association .. The New York Clearing House committees . Membership in the association Certain non -member banks may clear through members .. Expenses of the association Clearing house departments Items eligible for clearing Indorsement of items for clearing Work of assembly racks . 383 383 384 385 387 390 390 391 391 392 393 The mail teller's work 394 Forms required at the New York Clearing House . 394 Clearing house sessions 396 Force for effecting clearing The clearing procedure 397 Settling clerk's statement Clearing house proof 397 398 400 The settlement of balances 402 The adjustment of errors 406 The city collection departmentof the clearing house . .... 408 Other methods of collecting city items The Federal clearing division of the Federal Reserve Bank 409 of New York .. 410 The city collection department of the Federal Reserve Bank of New York The country collection department The examination department 411 411 414 Penalties for violating New York Clearing House rules, and for errors Special functions of clearing houses Regulation of interest on deposits Regulation of exchange charges on out-of- town items . Regulation of reserves Rendering assistance to members 415 416 416 418 421 422 xvil CONTENTS Page Gathering credit data for members 423 The issue of clearing house loan certificates in times of stress . 423 Extending loans to the government ... The issue of public statements by clearing house banks.... Participation in annual conferences. The Clearing House Section of the American Bankers' Association ... .. 423 424 425 Clearings and balances of the New York Clearing House for a period of seventy years 428 CHAPTER XI-BANK ORGANIZATION FOR CLEARING AND COLLECTION Internal organization of a bank for purposes of clearing and collection 429 Method of handling items drawn on or payable at the bank itself. The paying teller's department The receiving teller's department The mail teller's department The check desk department The handling of clearing house items The city collection department of a bank . Type of items handled by this department . Sources of items handled by the city collection department of a bank 429 431 433 435 437 439 439 440 Territory covered by the city collection department of аa bank . 441 Procedure in collection 442 Disposition of the receipts of the city collection department . Settling for collections 444 Collection of notes, matured bonds, and coupons within the city 444 The transit department of a bank 448 The night force of the transit department . The morning and afternoon force 450 451 Letters of transmittal ... 452 The numerical transit system 458 Methods of settling for the proceeds of collections 462 463 The collection of out-of-town items Collection number, stamps , and record files for country items . 464 Method of sending collections through Federal reserve banks . 465 Methods of securing settlements for out-of-town collection items 465 467 Mechanism for handling telegraphic transfers Application for and sending of telegraphic orders for transfer 467 468 Making payments under telegraphic transfers ... The protest 469 The transit department of a Federal reserve bank . 470 471 The receipt of items by the transit department .. xviii CONTENTS Page The outgoing sections of the transit department .. 474 Principles followed in giving credit. The float. 474 The problem of handling checks on non -member par banks . . 475 CHAPTER XII -BANK CLEARINGS AS A BUSINESS BAROMETER What is meant by general business conditions ? Estimate of the total volume of trade . ... 478 479 Is there a single barometer of general business conditions ?.. 480 The question of clearings versus debits to individual accounts . 483 Debits to bank accounts versus debits to individual accounts . 487 Debits to individual accounts as reported by the Federal Re serve Board ... The Babson Compositplot 493 The Annalist Barometer and Business Index Line .. 497 The Standard Statistics Company's Barometer 497 500 488 The Brookmire Barometers The Harvard Index of General Business Conditions Carl Snyder's Index of the Volume of Trade ..... The velocity of de its as a measure of business activity ... 501 504 Bank clearings as aa business barometer 510 514 Conclusion 519 CHAPTER XIII–RÉSUMÉ OF THE PRESENT SYSTEM The meaning of clearing and collection I. 528 The Federal reserve clearing and collection system. A. The intra-district system . 1. Where banks are in the same town or city, but have no clearing house asso ciation 2. 529 Where banks in the same city have a clearing house asso ciation 531 3. Where some banks in the same city are members of the clearing house association while others are not......... 535 4. Where banks are not in the same city but are within the same Federal reserve district The time schedule in intra-district collections . 537 539 Federal reserve banks present items direct to the drawee banks 541 Deferred debits and credits 542 The problem of collecting checks on non -member par banks .. 543 The Immediate Credit Symbol System in the fifth Federal re serve district .... Federal reserve bank branches as collecting agents . ... 545 547 Intra-district clearing and collection through Federal reserve bank branches 550 CONTENTS xix Page Direct collections within a Federal reserve bank or branch district ... Member banks may collect through correspondents .. Non -member par banks collect through correspondents. The handling of intra -district collection items B. The inter-district clearing and collection system. 1. The Gold Settlement Fund .... 553 554 ... 555 555 556 2. The types of items and transactions for which settlement may be made through the Gold Settlement Fund . ...... 557 ( 1) The collection of and settlement for inter-district cash items .. (a) .. 558 Member and non -member clearing banks may collect through their own Federal reserve bank or branch ...... 558 (b) A member or non-member clearing bank in one district may send items direct to the Federal reserve bank or branch in another district 561 Abuses of the direct- routing system 567 ( c) Sending items direct to member and non-member clear ing banks in other districts (2) 568 The collection of and settlement for inter-district col lection items (3 ) (4 ) (5 ) (6 ) ( 7) (8) 570 571 Federal reserve transfer and exchange drafts . Telegraphic transfers Rediscounting between Federal reserve banks. 572 573 Special transfers by one Federal reserve bank to an other for the account of the Treasury Department ..... 573 Settlements resulting from the redemption of Federal reserve notes 573 Transfers from the Gold Settlement Fund to the Fed eral Reserve Agents Fund and vice versa . 574 Gold movements 575 The advantages of the Federal reserve clearing and collec tion system 576 Opposition to the Federal reserve clearing and collection sys tem 576 ... II. The practices of banks not connected with the Federal reserve clearing and collection system, directly or in ... 579 directly A. Where banks are in the same city. 1 . Where the banks ... 579 have no clearing house association . 2 . Where the banks are members of a clearing house associa tion ... 579 3. Where some of the banks are members of the clearing B. house association and others are not ... 579 Where the banks are not in the same city ... 580 TABLES Page I Metallic Reserves, Total Note Circulation, and Central Bank Deposits at the End of 1913 ... II Number of Colonial and State Banks, their Capital, Circulation, Deposits, Specie, and Loans in the Years Mentioned from 1774 to 1833 ... III 35 49 Condensed Statement of the Condition, at Different Intervals, of All Banks in the United States... IV Average Amount of Notes and Deposits of the Second Bank of the United States, 1819-1829 .... 50 57 V Number and Condition of Banks of the United States, January 1 , 1838 ... VI Number of Banks, Capital, Deposits and Circulation, 61 65 1830-1863 66 VII Condition of Banks by Sections, 1860-1861 .... VIII Circulation and Deposits of National, State, Savings, and Private Banks, Loan and Trust Companies... 84-85. IX The Use of Checks in Retail Transactions in 1895, in States Grouped According to the Grouping of the Census 88 X The Percentage of Checks in 1895 to Total Receipts in Groups of Cities According to Population .. 88 XI Money ( M ), its Velocity ( V) , Deposit Currency ( M ') , and its Velocity ( V' ) for the Years 1896-1909 ..... XII Annual Rate of Turnover of Bank Deposits, 1919 1923 91 93-94 XIII Circulation of Money and Deposits, 1881-1923 ....... XIV Issue of Loan Certificates by New York Banks, 1860 1893 95 140 XV Aggregate Issues of Clearing House Loan Certificates, 1873-1896 , Inclusive XVI XVII 141 Cash Restrictions and Currency Substitutes in Cities of More than 25,000 Inhabitants in 1907 ........ 156-157 Currency Substitutes in Cities of Less than 25,000 In habitants, 1907 ... 157-158 XVIII Clearing House Loan Certificates Issued in 1914 .... 162 XIX Growth of Voluntary Intra -District Clearing System .. 174. XX xxi TABLES Page XX Growth of Membership in the Federal Reserve System, 218 1914-1924 XXI Membership in the Federal Reserve System, June 30 222 and December 31 , 1923 .. XXII Membership in the Federal Reserve Clearing and Col lection System 225 XXIII Average Daily Number and Amount of Items Handled, 1916-1918, Inclusive 230 XXIV Operations of the Federal Reserve Clearing and Col 231 lection System for the Years 1919-1923 ... XXV Growth of Membership in the Federal Reserve Clear 247-249 ing and Collection System ... XXVI Operations of the Federal Reserve Agents' Fund. Sum mary of Transactions by Years, 1915-1923 .. 302 XXVII Operations of the Gold Settlement Fund. Summary of Transactions by Years, 1915-1923 XXVIII Average Weekly Volume of Clearings and Transfers 318 Combined for Each Year Since the Establishment of 319 the Gold Settlement Fund .. XXIX Gold Reserves of Each Federal Reserve Bank on Octo 325 ber 29, 1920, and on March 22, 1922 ... XXX Distribution of Total Inter-District Accommodation on 325 October 29, 1920 .... XXXI Inter -District Movement of Federal Reserve Notes ... 327 • . XXXII Reserves, Note Circulation, and Discounts of Federal Reserve Banks on Selected Dates 328-329 XXXIII Clearings and Balances of the New York Clearing 426-427 House for a Period of Seventy Years . XXXIV Monthly Debits to Individual Accounts for Each Fed eral Reserve District and for the United States Since XXXV 490-491 January, 1919 Debits to Individual Accounts as Reported by Banks in 141 of the Country's Leading Clearing House Cen Summary by Months for the Years 1919 ters . 1924 523-524 1 1 CHARTS Page I Debits to Individual Accounts in 140 Cities as a Meas ure of the Dollar Volume of Business in the United States II Index of Price Level Compared with Changes in .. Wholesale Prices and Wages, 1875-1920 ..... 492 509 III Annual Rate of Turnover of Deposits for Selected Cities, 1919-1923 .... 512 IV Velocity of Deposits in 141 Cities and in 8 Cities Com pared with Index of Volume of Trade, 1919-1923 .. 514 V Index of the Volume of Trade Compared with Debits Outside New York and with the Velocity of Deposits in 141 Cities, 1919-1925 ... 516 VI Clearing's Index of Business Compared with Velocity of Bank Deposits, 1875-1924 VII Clearing's Index of Business Compared with Pig Iron Production, 1875-1924 xxii 517 518 FIGURES Page 1 The Circuitous Route of a Check ( Hoboken , N. J., to Sag Harbor, L. I ) .. 2 The Circuitous Route of a Check ( Columbus, O., to Mt. Gilead, O.) 106 ... 106 3 The Circuitous Route of a Check ( Westerly, R. I., to Ston ington , Conn. ) 106 4 The Circuitous Route of aa Check ( Birmingham, Ala., to North Birmingham , Ala . ) 107 5 Clearing and Collection within a Federal Reserve District ... 550 6 Clearing and Collection between Federal Reserve Districts .. 559 FORMS Page 1 Form Prepared by the Federal Reserve Board for the Com putation of Reserves to be Carried by Member Banks with the Federal Reserve Banks 351 2 Analysis of Account with the Federal Reserve Bank of New York Showing the Amount Available as Legal Reserve . 354-355 3 Auditor's Proof of Individual Ledgers ( For a Country Na tional Bank) ... 357 4 Daily Statement of Required Reserve ( For a Country Bank) 359 5 Computation of Reserves in Non-Member State Banks, Trust Companies, and Private Banks .... 380 6 Computation of Reserves of Non-Member National Banks .. 382 7 The Small Ticket 395 8 Clearing House First or Credit Ticket The Nine O'clock Ticket .. 395 9 396 The Settling Clerk's Statement 399 11 The Clearing House Second Ticket 400 12 The Clearing House Proof New York Clearing House Manager's Certified List of Debit 401 10 13 and Credit Balances 14 Credit Ticket in Clearing for Return Items 15 Debit Ticket in Clearing for Return Items 403 407 407 16 Transmittal Form ( Used by National City Bank of New York) .. 453 17 Form for Direct Sending of City Items ( Used by Mechanics 18 Form for Direct Sending of Country Items ( Used by 19 Four Day Points. Report to Federal Reserve Bank of New York of Cash Letters Sent Direct ( By a Member Bank ) .. 456 & Metals National Bank of New York ) .. 454 Mechanics & Metals National Bank of New York ) ....... 455 20 Recapitulation of Cash Letters Sent Direct ( By National 21 Bank of Commerce in New York ) . Form of Advice for Direct Sending of Checks ( Fifth Dis 22 Statement of Cash Letters Sent Direct During a Month trict ) ( Fifth District ) xxiv 457 563 566 THE CLEARING AND COLLECTION OF CHECKS CHAPTER I NATURE, ORIGIN, AND USE OF CHECKS The nature of checks The Negotiable Instruments Law defines a check as a "bill of exchange drawn on a bank payable on demand .” 1 Although checks are treated under the same law as are bills of exchange, and are defined as a variety of bill of exchange, a marked difference between the two instruments is seen in the following more complete definition of the check : A check is an unconditional order in writing addressed by a person ( the drawer) , to a bank , signed by the drawer, requiring the bank to which it is addressed to pay a sum certain in money on demand to a person named or to his order or to bearer.2 A bill of exchange, on the other hand, is " an unconditional order in writing addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand or at a fixed or determinable future time a sum certain in money to order or to bearer." The Federal Reserve Board gives the following definition of a check : “ A check is generally defined as a draft or order upon a bank or banking house, purporting to be drawn upon a deposit of funds, for the payment at all events of a certain sum of money to the order of a certain person therein named, or to him or his order, or to bearer, and payable on demand ." 4 Considerable confusion has existed in the interpretation of the "Joseph Doddridge Brannon, The Negotiable Instruments Law Annotated, 3rd ed . ( Cincinnati, 1919 ), Section 185. 'H. W. Magee, A Treatise on the Law of National and State Banks, 3rd ed. ( Albany, N. Y., 1921 ) , pp. 307-310. See also John E. Brady, The Law of Bank Checks (New York, 1915 ), passim . *Brannon, op. cit., Section 126. Italics are the author's. 'Regulation on Check Clearing and Collection, issued periodically by the Federal Reserve Board . See Federal Reserve Bulletin , Vol. X ( 1924 ), pp. 489-491. 1 . CLEARING AND COLLECTION OF CHECKS bank's liabilities to the drawer and to the holder of the check. Before the Negotiable Instruments Law, the question whether a check is an assignment of any part of the drawer's deposit had been considered by the courts, both with respect to the rights of the holder against the drawee bank and against the drawer or the latter's creditors or estate, and there had been a conflict of author ities on both questions. Some courts held that the check is an equitable assignment of the amount in the hands of the banker to the payee or holder, and that there is an implied contract between the bank and the holder, so as to render the bank liable to the latter for its refusal to pay the check . The purpose of the Negotiable Instruments Law was to abrogate this conflict by de claring that a check does not operate as an assignment, and con sequently it seems to have made clear that the bank's contract is with the depositor only and that the holder of a check has no right of action against the bank on which his check is drawn for refusal to pay it, unless the bank has assumed an obligation to him by certifying or accepting it ; his only remedy in such a case is 6 against the drawer and indorsers. It becomes obvious, therefore, that the legal tender provisions of the Federal Constitution apply only as between the bank and the depositor. In other words, only the depositor can compel the bank to pay in legal tender to himself or to the holder. These provisions do not apply as between the bank and the holder since no contract exists, unless, as stated above, the bank certifies the check, in which case the contract is transferred from the drawer to the holder. The legal tender provisions then become effective. North Carolina, for example, passed a law in 1921? authorizing its banks to pay for checks by means of drafts on reserve deposits when presented to them by the Federal reserve bank, unless the *For a list of cases on both sides of the question, see Charles P. Norton , Handbook of the Law of Bills and Notes, 4th ed. ( St. Paul, 1914 ) , pp. 584-585. 'The Negotiable Instruments Law is based upon and largely copied from the English Bills of Exchange Act, a codification of the Law of England as to bills of exchange, promissory notes and checks, which was drawn by Judge Chalmers and enacted by Parliament. At a meeting of the National Conference of State Boards of Commissioners for Promoting Uniformity of Legislation in the United States, held in August, 1895, a committee was appointed which caused a draft of aa bill codifying the law of negotiable instruments to be prepared and submitted to the Conference at its annual meeting in August, 1896. This draft, entitled “The Negotiable Instruments Law , " was discussed by the Conference and was agreed upon for recommendation to the legislatures of the States. It has been adopted by the District of Columbia and all the States ( Georgia adopted it as the last State in 1924 ) , in a few cases with some modifications, but generally in the identical form recommended . ' Public Laws of North Carolina , 1921, Chap. 20, Sec. 2. Ratified and effec tive February 5, 1921. See pp. 252, 269-270 below . NATURE, ORIGIN , AND USE OF CHECKS 3 depositor specifically objected, and the United States Supreme Court upheld this law on the ground that the legal tender provi sions of the Constitution do not apply as between the bank and the holder. 88 The requisites of a check may be set forth as follows : ( 1 ) It must be dated unless presented by and payable to the customer himself.9 ( 2) It must be drawn on a bank. An instrument noti drawn on a bank is not a check, although it may be styled so 02 its face.10 This constitutes one of the chief differences between a check and a bill of exchange. A check is always drawn on a bank or banker, while a bill of exchange ordinarily is drawn on some person not a banker, although it may be drawn on a banker. On the European continent, however, checks may be drawn on a merchant if he is prepared to honor them.11 ( 3 ) A check must be payable to a person named, or to his order, or to bearer.12 ( 4 ) A check must specify a certain sum of money to be paid. In this respect it does not differ from aа bill of exchange.13 ( 5 ) It must be signed by the drawer. 14 ( 6 ) It purports to be drawn upon a de posit. It is to be observed that it is not always necessary that the drawer of the bill of exchange should have funds in the hands of drawee, while a check drawn against a bank in which the drawer had insufficient funds would be fraudulent.15 Technically a check is only an order on the bank, but legally it is an implied promise to pay on the part of the drawer of the check, and any person giving a check upon a bank in which he has no deposit account is liable to prosecution for obtaining money under false pretense. ( 7 ) A check is payable instantly on demand. A person deposits money with his bank or banker where it is subject to his order at * Farmers and Merchants Bank of Monroe, North Carolina , et al. o. Federal Reserve Bank of Richmond, Virginia , 262 U. S. 649 ( 1923 ) . See pp. 76-77, 272, 274 below. 'H. W. Magee , op. cit., p. 307. 1°Champion v. Gordon , 70 Pa. State Reports 475 ( 1872 ) ; Amsinck v. Rogers, 103 App. Div. 428, especially 435 (1905), 93 N. Y. Supp. 87 ( 1905 ), affirmed 189 N. Y. 252 ( 1907 ) , 82 N. E. 134 ( 1907 ) , 12 Lawyer's Reports Annotated ( New Series ) 875 ( 1907 ) . "C. A. Conant, “ Development of the Check," Bankers Magazine, Vola LXXXIII ( 1911 ) , p. 580 . " Negotiable Instruments Law of the New York Act, Section 20, Subdivision 4 ; J. W. Daniels, A Treatise on the Law of Negotiable Instruments, 6th ed. ( New York, 1913 ) , Section 1571 . 1Magee ,op. cit., p . 310 ; Daniels, op . cit., Section 1570 ; Bank of Mobile o. Brunn , 42 Ala. 108 ( 1868 ) . *Magee, p. 310 ; Bank v. Vogeli, 78 Kan. 264 ( 1908 ) . Daniels, Section 1569 ; Champion v. Gordon , 70 Pa. State Reports 474. ( 1872 ) ; Newman v . Kaufman, 28 La. Ann. 865 ( 1876 ) . > CLEARING AND COLLECTION OF CHECKS any time. By an order he appropriates so much of it to himself or to another person, and the bank or banker in consideration for the temporary use of the money, agrees to pay it in whole, or in part, to the depositor's order when demanded.16 The fact that a check, ordinarily, is not presented for acceptance, but for pay ment, further differentiates it from the bill of exchange.17 How ever, where a check is certified by a bank on which it is drawn, the certification is equivalent to an acceptance.18 It will be seen below that the fact that banks are required to pay in whole or in part, to the depositor's order when demanded has great significance.19 The check as defined above is to be distinguished from the cashier's check. A cashier's check, whether certified or not, is classed with bills of exchange payable on demand.20 It is an order on a bank drawn by its own cashier and differs from a bank draft only in the fact that it is drawn by the cashier on his own rather than on some other bank . Thus a cashier's check is to be thought of as a variety of draft and is distinguished readily from the ordinary check. Like certified checks, they are commonly used by persons whose personal checks would not be accepted so readily as the check of some known bank . Cashier's checks may be used also by persons not having a bank account and, therefore, unable to draw checks of their own. Some banks prefer to use cashier's checks instead of certified checks inasmuch as there is less oppor AP tunity for a banker's check to be tampered with subsequently 21 should it fall into the hands of an unscrupulous person . med A check, likewise, is distinguished easily from a certificate of deposit, although a certificate of deposit issued by a bank payable the to the order of the payee, in legal effect, is a check when returned properly indorsed.22 .ph By depositing a sum of money in a bank a person may receive, 1 Daniels, Section 1572 ; Goodwin v. American National Bank, 48 Conn . 550 ( 1881 ) ; especially Mt. Sterling National Bank v. Green, 99 Ky, 262 ( 1896 ) , 35 S. W.911 ( 1896 ) ; Merchants and Planters Bank v. Meyer, 56 Ark. 499 ( 1892) , 20 S. W. 406 ( 1892 ) . "Magee, op. cit . , p. 309. note s Brannan, Section 187. When a bank certifies a check it acknowledges that the drawer of the check has sufficient funds on deposit to pay it. Such checks are used commonly by persons when their ordinary personal checks would not be accepted readily . 19See pp. 75-77, 272-276 below. 20Brannan , Section 185 ; Singer Manufacturing Co. v. Summers, 143 N. C. 102 ( 1906 ) , 55 S. E. 524 ( 1906 ). aD . R. Dewey and M. Shugrue, Banking and Credit ( New York, 1922 ) , p. 45. Brannan, Section 185 ; State v. Garland, 65 Wash. 666 ( 1911 ) , 118 Pac. 907 ( 1911 ). inte 2 NATURE, ORIGIN, AND USE OF CHECKS 5 if he chooses, a certificate of deposit instead of a checking account. The certificate may be either negotiable or non-negotiable and may be made payable on demand or after a definite time. It may be drawn payable to any person whom the depositor may name. The demand certificate is used principally for the purpose of guaran teeing payment to a creditor and also as an old method followed by some banks in transferring cash to distant points.23 In analyzing the more general nature of checks, it must be noted that they are merely a means by which a deposit or a part of a deposit is transferred. They are evidences of deposits in the process of transfer. Checks like bank notes are demand liabilities of the bank . This one characteristic they have in common with bank notes in the United States today. Yet it must be recognized that while specie may be demanded by the presentation at the bank of either notes or checks, in practice specie is usually secured by the presentation of checks rather than notes. Furthermore, the reserve back of each in the United States today, and consequently the profit to the bank resulting from the use of each is different. Reserves in lawful money against demand deposits vary from seven to thirty -five per cent. for our national and Federal reserve banks, while those against bank notes are 100 per cent. United States bonds plus five per cent. lawful money, virtually 105 per cent. of reserve . As a result it is much more profitable for a bank to create deposits and have these circulated by means of checks than to lend the same amount of credit in the form of notes. Indeed , were the reserve against bank notes converted into lawful money and kept in the vaults of the banks as a reserve for building up loans, which, in turn, will create deposits in excess of this reserve, the bank would find it unprofitable to issue any notes whatever.24 If banks could supply themselves with enough gold and silver cer tificates, United States notes, or Federal reserve notes to meet the demands for paper money in cash payments as a substitute for specie, it would be to the interest of the bank to have no bank notes outstanding, except in times of depressions when they have surplus reserves which cannot be invested otherwise . In such times the low interest on the government bonds may yield a small profit. Prior to the inauguration of the National Banking System deposit currency had other characteristics in common with bank notes wherever general asset banking existed. The reserves back Dewey and Shugrue, op. cit., p. 53. * This same view is held by C. F. Dunbar, “ Deposits as Currency,” Quarterly Journal of Economics, Vol. I ( 1887 ) , pp. 414-415. 6 CLEARING AND COLLECTION OF CHECKS of each tended to be the same ; the profit to the bank arising from the use of each would be the same and both notes and deposit cur rency might originate in the same manner, that is, from the redis counting of a note. But only under the asset banking system, in which notes are issued against the general assets of the bank, is it immaterial to a bank whether it lends its credit in the form of notes or deposits. Due to the desire of writers to show the simi larity between notes and deposits, this fact has not been empha sized sufficiently . The advantages of checks Checks have certain advantages over notes which make them desirable instruments for effecting exchanges : ( 1 ) They have a short life which means that they inject great elasticity into the currency. They are called into existence to perform certain func tions and they are canceled as soon as they have performed those functions. Though the life of the check is limited it must be borne in mind that the life of the deposit continues ; it has been trans ferred merely from one party or bank to another. When a check is deposited in aa bank an additional deposit is created in that bank on which new checks may be drawn and the deposit may continue to circulate by means of new checks being drawn to replace the old. (2 ) Each debt is canceled by a single instrument that is made to fit the particular amount involved. Checks can be drawn to any amount and frequently are the most convenient means of payment. (3 ) Transactions are effected almost entirely by book entries with the minimum of money leaving the bank . This means a minimum wear and tear on the metallic and paper bases and a coincident tendency to regard them as being only theoretically present. ( 4 ) The substitution of the check for the note lessens the necessity of keeping vast hoards of money set aside. ( 5 ) Deposit currency secures the maximum of safety. The risk of loss, theft or destruction of money kept in any place outside a bank is obvi ated . ( 6 ) Checks have the advantage of serving as receipts for amounts paid. They constitute receipts of the best type and facilitate the keeping of records. Limitations of checks While checks have distinct advantages they are not without certain limitations which may be briefly summarized : ( 1 ) They have a limited acceptability as compared with bank notes. This acceptability rests upon the confidence in the integrity of the NATURE, ORIGIN, AND USE OF CHECKS 7 drawer which tends to be restricted to a limited circle of friends and business associates. Bank notes, on the other hand, pass freely and without regard to the integrity or credit standing of the person tendering them in payment. The reliability and sta bility of the bank are assumed with little, if any, thought ; most persons never examine their bank notes. ( 2 ) Checks are drawn in amounts designed to liquidate some specific obligation which makes them poorly adapted for other transactions. (3 ) Uncertainty as to their real value tends to hasten their deposit. A check itself bears no evidence that the drawer has sufficient funds to cover the amount, or, indeed, any deposit whatever. Moreover, checks must be presented to the bank on which they are drawn in a reasonable length of time. This objection to checks has validity only in sparsely settled districts where people are not in close touch with banks. In such places bank notes afford the better type of cur rency. ( 4) Another objection to checks which also has its great est validity in a sparsely settled country and which renders them undesirable if not entirely useless, under such circumstances, is that they cannot complete a transaction without reference to a bank , while bank notes do complete a transaction without the necessity of referring them to a bank unless it is necessary to ob tain small change. ( 5 ) To pass a check or to secure creditable relations with a bank, demands a degree of moral standing and personal intelligence not possessed by all the members of a com munity, and for those a form of currency is needed which easily attests its own authenticity . Need for a separate legal code for checks25 In addition to the limitations placed upon the use of checks due to their inherent qualities, there are two other limitations of an artificial nature : The one is the result of improper banking practices ; the other is the legal obstacles. Only the latter will be mentioned here ; the former is treated in some detail in Chapter IV. Since checks have come to occupy such a prominent place in exchange transactions, it is urged that a uniform check law has become a necessity. They should be separated in treatment from bills of exchange as they are now treated under the Uniform Negotiable Instruments Law. In this respect the United States 2See also Bills of Exchange , 63d Cong., 1st Sess., Sen. Doc. No. 162. This is a report of the American delegate, Mr. Conant, to the International Congress on Bills of Exchange which was held at The Hague in the summer of 1912 in an attempt to secure uniformity of law on bills of exchange and on checks. 8 CLEARING AND COLLECTION OF CHECKS is far behind the leading European countries which have already taken such steps. Among the present defects which appear and which should be cro corrected, the following are mentioned : ( 1 ) The permission under the Negotiable Instruments Law to endorse checks as bills of ex change, qualifiedly and conditionally, thus subjecting them to the cos complications of law, and imposing a burdensome duty on the TE! paying bank, should be abrogated. It is contended by some that legal endorsements on checks should be simplified to include only Ve those which are necessary to complete the transactions for which the check was issued.26 ( 2) Lack of definiteness in the prescribed form of drawing a check is a well recognized defect. ( 3 ) There is a lack of definiteness as to the length of time that may elapse after 13 delivery before a check is presented for payment. In Belgium , France, Switzerland, Germany and Japan the time limits are defi nitely set, and range from three to ten days.27 ( 4 )) There are wide differences among statutes and decisions regarding the relations between banks and depositors and banks and correspondents . It has been a common practice for banks to receive checks from de positors and give immediate credit for them. Despite this com Papa .. olig mon custom, the courts differ as to who is the real owner of the checks in question, and what liability the banks assume in their actions. ( 5 ) Many banks indulge in the practice of sending checks directly to the paying bank for redemption which is a vio lation of law.28 It is contended that a uniform statute should relieve banks of their responsibility for such practices, as it is considered a sound method by many leading bankers.29 TI The increasing use of checks With the growth in the density of population, the develop ment of rural life, the improved means of communication, the de * velopment and extension of sounder money and banking systems, and with increasing confidence being placed in checks by the masses, deposit currency, as evidenced by checks, has assumed first place as a medium of exchange in our currency system. It 20R . B. Cox, “Needed Reforms in Check Collection Laws and Methods, Pro ceedings of the American Bankers' Association ( 1913 ) , p. 564. ** Ibid ., p. 565. 38W . H. Magee, op. cit., pp. 518-521 . * Proceedings of the American Bankers' Association ( 1909 ) , 3rd Annual Re port of the Clearing House Section, pp. 25, 40, 42 ; op. cit . ( 1913 ) , p. 565. Reg ulation J, issued by the Federal Reserve Board, requires all banks which use the Federal reserve banks as collection agents to authorize them to send the items direct to the drawee banks . Thie NATURE , ORIGIN , AND USE OF CHECKS 9 represents the most refined type of medium . It is the cheapest and most convenient ; it means that we are rapidly attaining a refined credit economy after having passed through laboriously , in suc cession, a barter and a money economy. But with its develop ment have come problems, not the least of which is the method of making it work smoothly and automatically through a proper system of clearing and collection. The nature of the problem can be appreciated better and seen in a more accurate perspective after understanding first the origin and use of checks and the manner in which clearing and collection systems were introduced and developed The origin of checks Not only does the origin of the term check (English cheque ) 30 seem wrapped in obscurity and uncertainty,3° but writers are far from agreement as to the time and place of the origin of checks. H. D. Macleod seems to stand somewhat alone when he says the Romans invented the check sometime shortly after 352 B. C.81 J. J. Klein, after reviewing what other writers had learned as to the origin of checks, concludes that the check was not known among the ancients, although they were acquainted with bills of exchange and other forms of paper similar to our letters of credit.32 Joseph Bachem, writing on the historical development of checks, takes Macleod to task and insists that checks had their origin in the Middle Ages.33 Bachem's view seems to represent the more general one. He says that it has not been established that the Chinese, Egyptians, Assyrians and Babylonians had known the check and that " even the attempt of Macleod to recog nize the check among the Romans under the designation of attributio or prescriptio in some verse of Terenz and in the letters of Cicero and Atticus must be considered as unsuccessful even if it cannot be denied that the described occurrences in the • . mentioned places have some relation to the check today." 34 There is general agreement, however, that bills of exchange * See James W. Gilbart, “ A Practical Treatise on Banking, ” Part I , Section III, Bankers Magazine, Vol. V ( 1850-1851 ) , p. 480. " H. D. Macleod, Theory and Practice of Banking, Vol. I ( London, 1855 ) , pp. 350-351. *J. J. Klein, " The Development of Mercantile Instruments, ” Journal of Accountancy, Vol. XII ( 1911 ) , pp. 324-325 . * Joseph Bachem , Der Deutsche Scheck, Inaugural Dissertation der juris tischen Fakultät der Friederick Alexander Universität zu Erlanger (Borna Leipzig , 1909 ), p. 2. * Bachem , op . cit ., p. 2. CLEARING AND COLLECTION OF CHECKS 10 preceded checks. Klein learns from his investigations that bills of . exchange, and written orders of transfer in forms other than that of our modern check, were known as early as the ninth to seventh centuries B. C. among the Assyrians.35 Conant says,, " Traces of credit by compensation and by transfer orders are found in Assyria, Phoenicia and Egypt before the system attained full de velopment in Greece and Rome. The books of the old Sanskrit lawgiver, Manu, are full of regulations governing credit. He speaks of judicial proceedings in which credit instruments are bankers, usurers , and even of called for, of interest on loans, of " 36 2 the renewal of commercial paper. The check originated in Italy and Sicily Real checks, according to Bachem, originated in Italy and Sicily. The oldest ones came from Palermo in the year 1416 under the appellation polizze and were orders of the Office of State on the balances with bankers. Checks which were drawn by private persons against their balances with the bankers and payable at sight are found at Messina in 1543, Naples in 1573, Mailand ( Milan ) in 1593 ; those with the bearer's clause, in Bologna in 1606.37 The Bank of Venice The Bank of Venice, which originated in 1171 , provides us with one of the earliest experiments in the use of deposit currency, regarding which there is reliable information . The Bank of Venice was a public bank based upon a forced loan from some of the most opulent citizens. The subscribers to the loan became a specially constituted board for their own 'protection and for the manage ment of the loan . The book in which these loans were inscribed was authenticated by the government, and made evidence of the whole amount of the debt, with the proportion belonging to each subscriber. It was an easy step to commence the transfer of the loans in whole, or in part . Facility of transfer, coupled with the security of the State, led to a rapid circulation of this loan. The reimbursement of the loan ceased to be regarded as either neces sary or desirable. Every creditor was reimbursed when he trans ferred his claim on the books of the bank. Such claims became, by 1 * Klein , op. cit ., pp. 324-325 ; see also Macleod , op . cit . , pp. 350-351 . *C. A. Conant, Principles of Money and Banking, Vol. II ( New York, 1905 ) , . p . 168 . 37 Bachem , op. cit ., pp. 8-9. NATURE, ORIGIN, AND USE OF CHECKS 11 a natural process, a medium of payment in transactions of com merce. All money deposited for the purpose of obtaining a credit in the bank was accounted an addition to the original loan, and as such taken into the public treasury as money lent to the State. In 1423, it was decreed that all bills of exchange payable in Venice, whether domestic or foreign, should be paid, unless other wise stipulated and so expressed, in the bank ; and that all pay ments in gross, or in wholesale transactions, should be effected in the bank also. This at once brought the mass of the payments of that great commercial city to the bank . It also created at once a great additional demand for the funds of the bank, and brought large sums into the public coffers. All who had engagements to meet, found them in the bank, and all such persons either provided the bank with the funds necessary to meet them, or carried to the bank that amount of coins requisite for the purpose. Bank funds became so desirable and the premium on such funds over coins became so high, that it was fixed finally by law at 20 per cent. There seems to be some confusion among writers relative to the method used to transfer accounts at the bank. Stephen Colwell was quite positive, after what appears to have been a careful in vestigation , that checks were not used, and that the rules of the bank required the presence of the party transferring, either in person or by attorney ; and this was carried so far, that no en dorsed bills of exchange were permitted. The payee, or his attorney, alone could receive payment.38 The alphabet was sub divided, and each person applied to the bookkeeper to whose sub division the letters of his name assigned him. Every subdivision had two clerks, by whom all transfers and entries were made. The party making the transfer appeared before these two clerks, and dictated the entry or transfer to be made, and both clerks wrote in separate books from that dictation. The entry specified what was paid, whether a bill of exchange, or a balance of account, and if a bill, where drawn, or in some way designated the bill. This made the entries on the books of the bank good evidence of all payments, and safe vouchers . This experiment in the use of deposit currency was most suc cessful. In some respects the methods used were similar to those adopted by the Bank of Amsterdam nearly two hundred years later. The Venetian system required personal and oral transfers ; * Stephen Colwell, The Ways and Means of Payment: A Full Analysis of the Credit System , with its Various Modes of Adjustment ( Philadelphia, 1860 ) , Chap. XIII, but especially pp. 302-305. 12 CLEARING AND COLLECTION OF CHECKS the Bank of Amsterdam required personal and written transfers. The Venetian system provided an elastic deposit currency and made the bank a great clearing house, or place of adjustment, for merchants of many countries. Venice was for centuries the greatest entrepôt of commerce in Europe, if not in the world, and the chief payments or liquidations of this trade were effected at the bank. Payments to a great amount thus were effected at Venice upon transactions which occurred elsewhere ; it was found convenient and advantageous to have funds in Venice. Where everybody wanted funds everybody sent them. The demand, therefore, for the deposits in which the purchases of commerce were paid was as incessent as the movement of commerce itself. The bank deposits circulated on the books of the bank, precisely in accordance with the movements of trade, and the customers of the bank thus applied these credits, or the debts due them, to the discharge of the debts they owed.39 The Bank of St. George The Bank of St. George, commonly known as the Bank of Genoa, had its origin , like the Bank of Venice, in an attempt to reorganize the public finances. It originated in 1407 and was based upon the public debt. During the 13th and 14th Centuries the public debt had been held closely by a few powerful public creditors, known as compere, or purchasers. They became very powerful and saw to it that their loans were secured by the special assignment on the part of the government, of taxes, customs, or other revenue, sufficient to pay the interest. These public cred itors became virtually a financial imperium in imperio and were both respected and feared. In 1407 it was resolved to pay off this debt. This was done by floating a new loan divided into shares, which became the basis for the Bank of St. George. This much the bank had in common with the Bank of Venice, but the re mainder of its characteristics place it in striking contrast with the Venetian bank . The Bank of St. George was as watchful of its special interests as were its predecessors, the compere. It hedged itself about with detailed regulations and definite security in the form of assign ment of taxes and dues. The currency provided by this bank con sisted of the following : ( 1 ) The circulation of its shares, each 38Colwell, op. cit., Chap. XIII, passim. The Bank of Venice maintained a successful existence until Napoleon invaded Italy in 1797 and overthrew the Republic of Venice. NATURE, ORIGIN , AND USE OF CHECKS 13 share amounting to 100 lire of the public debt, (2 ) certificates of deposit in denominations to suit the depositor, ( 3 ) bank de posits, like those of the Bank of Venice, and transferred in the same manner, ( 4) deferred dividends of the bank, the par of which was 21 lire for each share, and ( 5 ) the usual coins of gold and silver . The outstanding feature peculiar to the Bank of St. George, in addition to the fact that it was one of the earliest banks which used deposit currency, was the fact that it issued notes. They were not issued in small amounts, nor in special denominations, but in the handwriting of the officers of the bank, and in sums requested by the depositors,' or persons applying. The Bank of Venice is important as the earliest bank, of which we have records, which developed the use of deposit currency based upon the public debt ; the Bank of St. George not only did this, but was the first to resort to the use of bank bills. The Bank of Genoa, by thus fully exhibiting the advantages of bank notes, is considered by Colwell, as the link which connected the deposit banks with those of circulation . 40 Checks in Italy today Although checks may have originated in Italy, the Italian medium of exchange has been and is primarily State and bank notes. The use of checks in Italy is limited, although it is devel oping in northern Italy where banking institutions are more Checks are seldom used in ordinary transactions, numerous. although certificates of deposit (bons de caisse) and similar credit instruments, such as cash orders, are sometimes used.41 Very recently the Italian government has tried to increase the use of checks in wholesale trade in order to decrease paper currency. In retail trade checks are not used at all. One of the reasons why their use is so restricted in Italy is the stamp tax imposed upon them and which very probably will be abolished .42 In February, 1924, the note circulation of the banks of issue " Colwell, op. cit., Chap. XIV. " Interviews on the Banking and Currency Systems of England, Scotland , France, Germany, Switzerland , and Italy, United States National Monetary Commission Publications, 61st Cong., 2d Sess., Sen. Doc. No. 405, p. 528, here after cited as Banking and Currency Systems; Carlo F. Ferrararis, Italian Banks of Issue, U. S. Nat. Mon. Com . Pubs., 61st Cong., 2d Sess., Sen. Doc. No. 575, pp . 242-248. The legal decisions concerning checks in Italy are found in Italy's Commercial Law Manual of 1882. See Bachem , pp. 8-9. "Letter from Mr. Romolo Angelone, Commercial Attaché, Royal Italian Embassy, New York City, August 4, 1924. CLEARING AND COLLECTION OF CHECKS 14 amounted to 8,852 million lire ; the note circulation for the State was 7,749 million lire ; total deposits amounted to only 2,517 mil lion lire. For December, 1923, the banks of issue had a note cir culation of 9,491 million lire ; the note circulation of the State was 7,754 million lire ; total deposits were 2,581 million lire. For leading private banks total deposits amounted to 11,277 million lire in December, 1923.43 The check in Germany Bachem, in considering the origin and development of the check, says that its forerunner in Germany was the quittanzien ( drafts ) which were used from the 13th to the 16th Century. These quittanzien were drafts of the emperors and princes on taxed cities ( abgaberpflichtize ), pale duties, and station duties í stationsgelden) , drawn up in receipt form. There were others of a similar nature, as the cessiones ( transfers ) of the imperial revenues of the city of Lubeck to the German Emperor. After 1466 the Polish kings drew against the Prussian cities, especially Dantzig. From that time on those cities had to pay heavy duties semi-annually, of which the king disposed by use of the quittan zien . With these they settled debts, and arranged for expenses in small or large amounts. Related to the quittanzien in certain respects were the drafts which the city of Luneburg directed against the owners of the in come from the salt tax.44 Inasmuch as the persons drawn upon occupied a position subordinate to that of the drawer, and as the drawer could press the payment of his draft with force, the quit tanzien were accepted willingly in payment. For the same reason, one cannot speak of this type of check in the same sense that we attach to the word today, as its payment resulted not so much because of a contract as because of the pressure of despots.45 With the establishment of the transfer or “ giro ” banks at Ham burg in 1619, and at Nuremberg ( Nurnberg) in 1621, written orders for transfers came to be used in much the same way as the modern check . 46 Checks have had a slow growth in Germany. The striking feature of the German system has been and is the transfer or giro system . As a liability in 1900, bank notes stood first and trans “ Federal Reserve Bulletin , Vol. X ( 1924 ) , pp. 432. “ Bachem , p. 4. "SIbid . "J. T. Holdsworth , Money and Banking , 2d ed . ( New York, 1919 ) , p. 130. NATURE , ORIGIN , AND USE OF CHECKS lò fers second. In 1908 a law was enacted establishing a legal status for checks for the purpose of increasing their use, it being hoped that their use would increase rapidly thereafter, although at that time it was stated that they played a small part in the transaction of business, it being effected almost entirely by the transfer or giro system. The slow development of the check system has been especially marked in small business circles.* 7 It is difficult to appraise the present situation in Germany. Abnormality characterizes several of the important factors. It can be said with certainty, however, that government and bank notes are more common media of exchange than is deposit cur rency evidenced by checks. Renten marks ( gold marks) and checks for the same currency are becoming common media since the extreme depreciation of government notes. Deposits become currency principally through giro or transfer transactions, although the use of checks is important. Checks are used quite extensively in wholesale trade, but up to the present time have never been used to any extent in retail transactions. Analysis of bank statements throws no light upon the relative importance of deposit as compared with note currency since deposits may be withdrawn or transferred through any sort of legal business transaction which may not involve the use of checks.48 The check in Holland Despite the early instances of the use of checks, Bachem con siders Holland the home of the check.49 It was first used in Amsterdam in the 16th Century when the people learned to deposit their cash with some third person for a small depository fee, rather than store it in their houses. These persons who received the deposits also assumed the duties of collection of obligations and cancellation of debts. From this arose the position of the so-called cashier. These cashiers made payments by means of kassiers-briefje, which were drawn up more in the form of receipts than in the form of drafts. They contained the voucher of the " The Reichsbank , 1876-1900, published by the Reichsbank , translated by Dr. F. W. C. Lieder, U. S. Nat. Mon. Com . Pubs ., 61st Cong., 2d Sess., Sen. Doc. No. 408, pp. 68, 116 ; Banking and Currency Systems, U. S. Nat. Mon. Com . Pubs., 61st Cong., 2d Sess., Sen. Doc. No. 405 , p. 497 ; Miscellaneous Articles on Ger man Banking, U. S. Nat. Mon. Com . Pubs., 61st Cong., 2d . Sess., Sen. Doc. No. 508, pp. 247-271. " Letter from the German Consul General, New York City, July 24, 1924. See also the Federal Reserve Bulletin , Vol. X ( 1924 ) , pp . 636-637. "See also the Bankers Magazine, Vol. XXIII , 3rd series ( 1889 ) , p. 787, which supports this view. CLEARING AND COLLECTION OF CHECKS 16 depositor to the effect that he had received the money from his cashier. By a keure of 1608, the merchants were forbidden to occupy themselves henceforth as cashiers. After this keure the greater part of the business of banking and dealing in money and exchange, so far as it had developed at that time, was concen trated by law in the hands of the Bank of Amsterdam (Amster damsche Wisselbank ) and its agents. The Bank of Amsterdam The Bank of Amsterdam was created by the ordinance of Jan uary 31 , 1609, under the guaranty of the city and the government of its magistrates. The avowed object was to afford some relief: against the intolerable nuisance of worn and defaced coins, which flowed into the great commercial mart of Amsterdam from all parts of the world. Briefly, the business of the bank was to re ceive, to keep and to pay. It received coins at their bullion value, that is, as valued in money of full weight and fineness; conse quently, the credit upon its books was the same as though it were based upon good coin. The coins and bullion thus deposited were not reclaimable, but, according to the theory of the bank, were locked up forever. The bank, however, did receive money for safe -keeping, which was returned on demand, the depositor pay ing a small fee for the service. The chief function of the bank was to keep the deposits of coin and bullion ( other than the special deposits of money ) and to make payments by a transfer from the account of the payer to the account of the payee. This was done by the party transfer ring, in person, or by his agent specially authorized, and by his delivering to the proper officer of the bank a written order or check. The following is an example of an order drawn on the bank :50 “ Folio 1609. “ Messrs. Commissioners of the Bank-Please pay to Isaac DeWitt the sum of One Thousand Florins, Four Sols and Six Deniers , “ Amsterdam , 25th March, 1709. “ F. 1000 4s . 6d . “ Samuel Moses." Colwell, op. cit., p. 176. For an account of the Bank of Amsterdam, see C. F. Dunbar, Chapters on the Theory and History of Banking, 2nd ed. ( New York , 1904 ), Chap. VIII ; Adam Smith , Wealth of Nations, Vol. II , 10th ed . (London, 1802), Bk. IV , Chap. III . An excellent bibliography dealing with sources generally unknown today, is to be found in Colwell, op. cit . , pp. 186-187. 1 NATURE, ORIGIN, AND USE OF CHECKS 17 On presentation of this paper by the drawer or his special agent, the sum expressed was debited to the drawer, and credited to the party to whom the payment was directed to be made. The transfers bore some resemblance to our modern check, but they should be called transfer orders rather than checks. No payee could call at the bank and demand payment ; it was necessary for the payer or his agent to appear and effect the transfer. Never theless, the Bank of Amsterdam took important steps towards the creation of bank credit and deposit currency as known today.51 Today specie and bank notes constitute the bulk of the medium of exchange in the Netherlands. Government notes were withdrawn several years ago. Something very similar to the check is used to some extent in wholesale trade, although hardly at all in retail transactions. There seems to be no information available as to the extent to which deposit currency is used in the Netherlands as compared with bank notes and other forms of cur rency. The Vice-Consul in New York City for the Netherlands points out that the general public in that country does not keep bank accounts. Those classes that save money invest it in stocks and bonds, which are either kept in the home or left with the stock brokers through which they make their purchases and sales. Nor will an analysis of bank deposits give more than a general idea of the importance of deposit currency as evidenced by checks, since a bank deposit can be drawn against by means of a letter ad dressed to the bank requesting it to pay out money. In addition to the banks and stock brokers with whom current accounts may be carried, there are two other institutions that make possible the use of deposit currency, viz., the postal savings bank, and the service of postal cheques. The first- named institu tion works in a way similar to kindred institutions in the United States. The second institution was established some years ago in order to decrease the demand for currency. This made it pos sible to have a cheque account with the post office. Cheque books are issued as is also another type of book containing forms which are used in demanding the post office to credit some other cheque account with the sum filled in the blank . This latter practice is 6 In 1790 it became known that for years favored depositors had been per mitted to overdraw their accounts and that enormous loans of specie had been made to the city and to the Dutch East India Company. These disclosures de stroyed confidence, the premium on bank money disappeared , and the bank be came insolvent. It was closed by royal decree in 1819. The Bank of Hamburg, established in 1619, was modeled after the Bank of Amsterdam and made transfers in the same manner. See Colwell, op. cit. , pp. 181-183. CLEARING AND COLLECTION OF CHECKS 18 in nature a “ giro ” system. The service of postal cheques has developed rapidly following a period during which great difficulty was experienced in attempting to popularize the idea . Indeed, the system became so successful that the staff proved inadequate to handle the business and some time ago the service was tempo rarily discontinued. The Vice-Consul thinks it has been resumed at this time.52 The check in England Checks originated in England in the latter part of the 17th Century when it was the practice to make deposits with gold smiths. The credits or the deposits with the goldsmiths were transferred by means of two forms : ( 1 ) The goldsmith gave his customer either a written promise to pay to himself, or to his order, or to the bearer on demand, a certain sum of money. These notes were in simple writing, and were called goldsmiths' notes. Out of these bank notes developed.53 ( 2 ) The customer might write a note to his goldsmith directing him to pay a certain sum to any person, or to his order, or to bearer, on demand. These notes were called cash notes at first, but were checks in the modern sense, and differed from the modern check principally in the fact that they were less formal. English checks (cheques) originated in the form of these cash notes.54 Although Bachem says the oldest instrument of this sort dates from 1681 , Powell gives examples of such instruments dated 1671 and 1675.55 He says that as early as April 12, 1671 , the check was found in the form of a letter requesting the addressee to pay to “ Phil Marsh or bearer the sum of £489.” In 1914 the Institute of Bankers in England added to its collection a check dated , 1675. A facsimile of the check was published and August 14, there described as the oldest check in that country . It was worded : 5 * Letter from Mr. G. P. Luden , Vice -Consul of the Netherlands, New York City, July 24, 1924. **Bachem , P. 7 . “H. D. Macleod , A History of Banking in Great Britain ( New York, 1896 ), p. 2 ; Bachem, p. 7 ; H. D. Macleod, The Theory and Practice of Banking, 3rd ed., Vol. I (London, 1875 ), pp. 208-210; A.M. Davis, "Currency and Banking in the Province of Massachusetts Bay," Publications of the American Eco nomic Association , Series 3, Vol. II ( 1901 ) , p. 34. WE . T. Powell, The Evolution of the Money Market, 1385-1915 ( London, 1915 ) , p. 101 . NATURE , ORIGIN, AND USE OF CHECKS 19 “ Mr. Thomas Ffowles. “ I desire you to pay unto Mr. Samuell Howard or order upon receipt hereof the sums of nine pounds thirteene shillings and sixe pence and place it to the account of 14 Augt. 1675 Ye servant, Edmond Warcupp . £9.13.6 " For Mr. Thomas ffowles, Gouldsmith at his shop between the two Temple gates, Fleete- streete.” On the back appeared the following endorsement by the payee : “ Rcd . in full of this bill the sume of nine pounds thirteen shillings sixpence. “ Saml. Howard ." 56 Powell points out that at this time checks were considered simply as a means of saving a customer the trouble of personal attendance at his bankers', but were not recognized as a facile mode of achieving the innumerable adjustments of bank balances which are the ultimate outcome of each day's business or as the supremely useful form of currency, destined to predominate over both notes and gold.57 The earliest printed checks appear to be those of Child :58 and are believed to date from 1762. Check books began to be issued about 1781.59 During the first half of the 18th Century, while the goldsmith -bankers of London were slowly being trans formed into bankers only, shopkeepers in outlying towns began to develop into bankers and by the end of the century were to be found in almost every town. Checks were known to these bankers as early as 1705.60 The Bank of England , as organized in 1694, was a bank of de posit as well as a bank of issue and provided for the use of the The bank, however, became principally a bank of issue check.661 5Powell, op. cit., pp. 101-102. Ibid. 48From Francis Child, credited with being the first banker, in the modern sense, in England . He was the inheritor of a goldsmith's business which is traced back to 1559. See Powell, p. 112. ** Powell, p. 103. "Powell, p. 117. Country banks undoubtedly developed from other origins also. " W. R. Bisschop, The Rise of the London Money Market (London , 1910 ) , pp . 86-92. 20 CLEARING AND COLLECTION OF CHECKS by 1800. The early monopoly of note issue given to the bank fos tered the development of deposit banking and the use of checks by the private banks.62 With the evolution of English banking, the check became the recognized credit instrument in business. As early as 1864 Sir Lubbock, making an inquiry into the character of receipts at his own bank, found that checks and bills of ex change constituted 96.8 per cent. of them. The importance of checks was evidenced by the introduction of the clearing system in London in 1873. Another and more comprehensive inquiry made by Pownall in 1881 , showed a lower percentage of checks in the total amounts paid into different classes of banks. London banks showed check payments in the proportion of 97.23 per cent. ; in country banks in 261 places checks constituted 72.86 per cent.68 The use of checks became so highly developed that they were looked upon as a distinctively British institution, Lord Ave bury dubbing them the “ Union Jack of Commerce” .64 Some idea of the importance of deposit currency in England may be gained from the statements of the Bank of England and the five leading joint-stock banks. The Bank of England reported as follows for December 27, 1922 : Notes in circulation , £ 124, 878,000 ; public deposits, £13,324,000 ; other deposits, £ 119, 903,000.65 The deposits of the five leading joint-stock banks on December 31 , 1922, amounted to £ 1,537,300,000.66 In March, 1924, the Bank of England reported bank notes in circulation amounting to £103,000,000 ; currency notes and certificates, £282,000,000 ; deposits, £127,000,000. Nine London clearing banks reported total deposits of £1,603,000,000.67 Checks in France In France the check had become of enough importance by the middle of the 19th Century to cause the drafting of legal regula tions. These regulations of 1865 constituted the first legal recog nition given to the check in France.68 The check was actually 62There was in operation for many years in England an institution called The Cheque Bank, created for the purpose of evading the bank-note law by the issue of checks payable only over the counters of other banks with which The Cheque Bank established relations, and which had practically the char acter of bank notes. * C . A. Conant, "Development of the Check," Bankers Magazine, Vol. LXXXIII ( 1911 ) , p. 581 . "Powell, op. cit. , 317-318. * Federal Reserve Bulletin , Vol. IX ( 1923 ) , p. 275. Loc. cit. , p. 333. 07Federal Reserve Bulletin , Vol. X ( 1924 ) , p. 432. ** C . A. Conant, op. cit. , pp. 581-582. $ NATURE, ORIGIN, AND USE OF CHECKS 21 known previously under the name bon de caisse, which is referred to by the French jurists as the chèque à l'etat embryonnaire. For their circulation, these checks were drawn up in the form of re ceipts called chèques reçus or chèques récépissés. The chief hin drance to the extension of the use of the check was the tax on all mandats de payment of one -half of 1 per cent. To meet the general demand the law of 1865 was passed by which the check was declared to be tax-exempt, but by a series of regulations its universal growth and use was retarded in order to prevent the supplanting of the highly-taxed note. By the law of 1879 the tax-exemption of the check was recalled and on the chèques de place à place a duty of 20 centimes, and on the chèques sur place a duty of 10 centimes, was placed.69 At the Bank of France, as at the Reichsbank, an enormous volume of business is done by transfer orders, but they are usually orders for the transfer of credit from one client of the bank to another client. However, the proportion of checks to coin and bank notes has steadily increased in the bank receipts since 1890. In that year transfers and checks constituted but little more than 50 per cent. of the total receipts of the Bank of France ; in 1900 , they constituted 68.6 per cent., and in 1910, 80.4 per cent. These proportions relate entirely to payments into banks and do not in dicate the relative importance of transfer orders as compared with checks, although Conant treats the percentages as an indica tion of the importance of checks. The ascertainment of the pro portion of checks figuring in outside transactions is more difficult and has rarely been attempted. There appears to be no valuable information available relative to the situation in France. It is generally believed that outside of Great Britain, the proportion of checks used in everyday transactions in France and other coun tries in Europe is much smaller than in the United States.70 In 1916 a step was taken which tended to give some impetus to the use of checks. The French Minister of Finance, in that year, announced that thereafter payment by the French govern ment would be made largely by check and that arrangements would be introduced whereby private establishments could make payment to the government in the same manner.71 Further en couragement to the use of checks was given by the passage of a law in August, 1924. Prior to that time holders of bills had been " Bachem , op. cit., P. 8 . " Conant, op. cit ., pp. 581-582. "Federal Reserve Bulletin , Vol. II ( 1916 ) , pp. 374-375. CLEARING AND COLLECTION OF CHECKS 22 reluctant to accept checks in payment, since in the event that checks were not honored, the holder had not only parted with the bill but had lost the opportunity to protest non-payment, as the law required that protest be made on the date following the due date, and checks ordinarily required at least twenty-four hours for clearance. The new law, among other things, extends the period allowed for protest to from five to eight days, and compels the debtor to restore the bill to the holder in the event of non payment of the check.72 A general idea of the extent to which bank notes predominate in France as a medium of exchange may be gained from recent statements issued by the Bank of France. On December 28, 1922, the Bank of France reported as follows : Bank notes in circulation, 36,358,387,000 francs ; government deposits, 20,482,000 francs ; other deposits, 2,289,667,000 francs.73 In March, 1924, the note circulation amounted to 39,950,000,000 francs, while de posits ( total ) amounted to but 3,242,000,000 francs.74 The check in Austria It seems that the check was known in Austria as early as the 18th Century, although it has attained importance only recently. The Vienna Endorsement and Cashiers' Association, the Lower Austrian Discount Association, the Austro-Hungarian Bank and the Royal Postal Savings Bank have exerted their influence to Nevertheless, the most common increase the use of checks.75 medium of exchange is the bank note issued by the Austrian Na tional Bank which was opened January 2, 1923. The charter of the old Austro-Hungarian Bank expired on December 31 , 1919, and thereafter the business of the bank was carried on separately for each of the succession States. The Aus trian section of the Austro-Hungarian Bank performed all the functions of a central bank of issue until the new Austrian Na tional Bank was opened. This bank took over the note circula tion of the Austrian section as well as its claims against the Aus trian government. The charter of the new bank differs but little from those of other central banks of issue in Europe, but the influence of the government on its operations is restricted closely."76 " John P. Young, European Currency and Finance, Commission of Gold and Silver Inquiry, United States Senate ( 1925 ), p . 311 . 73Federal Reserve Bulletin, Vol. IX ( 1923 ) , p. 275. " Federal Reserve Bulletin , Vol. X ( 1924 ) , p. 432. * Bachem , pp . 8-9 . **Federal Reserve Bulletin, Vol . IX ( 1923 ) , pp. 328-330. NATURE , ORIGIN , AND USE OF CHECKS 23 In December, 1922, the Austrian section had notes circulating to the extent of 4,080,177,238,000 kronen. Deposits and other demand liabilities amounted to 327,991,960,000 kronen. De posits of the Austrian government amounted to 528,254,403,000 kronen.77 This statement of liabilities, however, throws but little light on the relative importance of deposit currency in Austria today. While checks are of some importance, the bank note is the principal medium of exchange, there being no government notes issued. Checks are used mostly in the wholesale trade in trans acting large business, but hardly ever in retail trade. The amount of deposits as reported by Austrian banks is much larger than the amount for which checks are used. These deposits are usually drawn out by presenting the bank book, as is done in the United States in the case of savings accounts.78 Checks in Hungary Cash, composed largely of government notes, constitutes the principal medium of exchange in Hungary. Government notes were issued by the National ( government ) Bank until recently. Bank notes are issued at present by the the National Hungarian Bank, which was opened June 24, 1924. Checks are relatively unimportant as compared with the government notes. They are not used at all in retail trade and only by very large and well known firms in wholesale transactions. As in most countries outside of England and the United States, an analysis of bank statements in Hungary gives no definite indi cation of the extent to which checks are used. There are the following different types of deposits in Hungary : ( 1 ) There is a monthly deposit made for business purposes. It is made at the risk of the depositor and does not consist of a very large sum of because withdrawals can be made by telegram or even over money the telephone. ( 2 ) There is the regular savings bank deposit, from which money may be drawn only upon presentation of the savings bank book. (3 ) Deposits are made also against which checks can be drawn . But the bank must be notified of each check drawn against the account before it cashes the check.79 Checks in Switzerland Checks are used quite often in Switzerland, but are not as common as in England or the United States. The giro system, as " Ibid ., P. 650. **Letter from the Austrian Consulate General , New York City, July 22, 1924. tºLetter from Dr. Louis Alexy, acting Consul General of Hungary, New York City, July 23, 1924. 24 CLEARING AND COLLECTION OF CHECKS in Germany, is probably of far more importance, its development being encouraged by the Swiss National Bank. In the main, the medium of exchange is composed of bank checks, bank giros, postal checks, postal giros, and cash, the cash being composed, to a large extent, of bank notes issued by the Swiss National Bank . Checks are used extensively by the business world, although the retail trade is transacted principally through the medium of bank notes. Postal checks are used frequently , particularly for the payment of small transactions.80 But both bank and postal giro service are of increasing importance and popularity in Switzer land . It is probable that the bank statements issued in Switzerland give but a fair picture of the general situation relative to the im portance of deposit currency in that country. The volume of circulating notes of the National Bank of Switzerland has in creased considerably from 1913 to 1920 — in round numbers from about 300,000,000 to 1,000,000,000 francs. This increase, how ever, was moderate as compared with currency increases in other countries. Before the war notes in circulation were based on gold and commercial bills of exchange. With the outbreak of the war, documentary bills of exchange largely disappeared, being sup planted by short-term treasury notes. The increase of bank note circulation was accompanied by an increase of the metallic reserve held by the bank so that even at its lowest point in 1918, the ratio of gold to notes in circulation was 40 per cent., as compared with 54 per cent. in 1913. By July, 1923, the ratio had risen to 61.15 per cent., and if silver be included, to 73 per cent . The report of the National Bank of Switzerland for December 30, 1922, was as follows : Notes in circulation, 976,426,000 francs ; deposits, 165, 032,000 francs . In August, 1923, the notes in circulation amounted to 860,000,000 francs, while current accounts and de posits totalled 106,000,000 francs.81 Checks in Norway, Sweden, and Denmark Bank notes constitute the chief medium of exchange in all the Scandinavian countries. Nevertheless, the acting Consul General for Norway points out that checks are used frequently in that country. They are used extensively in wholesale trade, although probably very little in retail transactions. Bank notes are the most common medium for all transactions. No government notes BOLetter from the Consul of Switzerland, New York City, July 23, 1924. 81Federal Reserve Bulletin, Vol. X ( 1924 ) , p. 88. NATURE, ORIGIN , AND USE OF CHECKS 25 are issued. Although deposits may be withdrawn from banks by means other than checks, the acting Consul General thinks the amount of deposits as reported by the banks of that country will give some indication of the extent to which checks are used.82 The Bank of Norway reported for December 30, 1922, as follows : Notes in circulation, 384,775, 000 kroner ; deposits, 163, 429,000 kroner.83 The 103 private banks had deposits at the end of November, 1922, amounting to 2,887,000 kroner.84 However, it is unsafe to assume that these figures are a true indication of the relative importance of deposit currency as evidenced by checks, since the deposits may be withdrawn by other means. In Sweden an instrument possessing the more essential char acteristics of the check was being used at the beginning of the 18th Century.85 Nevertheless the most common medium of exchange today is the bank note, which is the only kind of note issued in Sweden . These are issued by the Bank of Sweden (Riksbanken) , which was established in 1668. It functions as a central bank and since 1904 is the only bank which is authorized to issue bank notes. Checks are used to some extent in wholesale trade, although drafts are more common ; in retail trade the check is used very little. An analysis of bank statements from Sweden, as for Norway and Den mark, gives no real indication of the extent to which checks arc used. In Sweden there are several types of deposits but only one kind, the "giro-rakning,” may be drawn out by means of checks.86 In December, 1922, the Riksbank reported a note circulation amounting to 584,000,000 kroner and total deposits of 389, 000,000 kroner.87 The same general situation obtains in Denmark. The most common medium of exchange is the bank note issued by the “ Nationalbanken,” which holds a government license for issuing bank notes. Government notes are not issued. Checks, however, are used to a great extent in wholesale trade, though seldom in retail transactions. Wages for laborers are sometimes paid in checks, but mostly in cash. The amount of deposits as shown by the bank statements exceeds the amount which is drawn out by " Letter from the acting Consul General of Norway, New York City, July 28 , 1924 . " Federal Reserve Bulletin , Vol. IX ( 1923) , p. 406 . * Ibid ., p. 134 . "A. W. Flux, The Swedish Banking System, U, S. Nat. Mon. Com . Pubs., 61st Cong., 2d Sess., Sen. Doc. No. 576, p. 18. sLetter from the Consul General of Sweden , New York City, July 31 , 1924. " Federal Reserde Bulletin, Vol. IX ( 1923 ) , p. 273. 26 CLEARING AND COLLECTION OF CHECKS check, since deposits may be drawn out by other means. For ex ample, many deposits are made in the bank against a bank book and are drawn out by presenting the book and having the bank make a note therein.88 The Bank of Copenhagen, according to its report for December 30, 1922, had notes in circulation to the ex tent of 450,354,000 kroner ; government deposits, 2,711,000 kroner ; current account deposits, 163,557,000 kroner ; and all other deposits and creditors, 30,218,000 kroner.89 Checks in Belgium The situation in Belgium is not unlike that in France. Since the organization of the National Bank of Belgium in 1850, de posits have constituted but a small part of the liabilities as com pared with notes.90 The Bank of Belgium reported for December 28, 1922, notes in circulation to the extent of 6,700,886,000 francs. Deposits in current account were as follows : Government deposits, 215,902,000 francs ; other deposits, 283,010,000 francs .91 These figures will show the general situation, but nothing more ; it is doubtless true that the amount of deposits, as shown here exceed the amount drawn out by means of checks. The check in Spain and Portugal While the use of checks in all European countries is limited as compared with England, the United States and Canada, it seems that in the Latin countries they are limited to a much nar rower field than in other European countries.92 In Spain the chief medium of exchange is the bank note issued by the Banco de España. These are the only notes issued. Checks are used to some extent in wholesale trade, but not in retail transactions. Deposits, as shown by bank statements for that country, are no indication of the extent to which checks are used, since a large pro portion of them becomes a medium of exchange through "credit transferences ." 93 88I etter from Mr. M. J. Oluf, 1st Vice -Consul of Denmark, New York City, July 25, 1924. *Federal Reserve Bulletin, Vol. IX ( 1923) , p. 406. SOC . A. Conant, The National Bank of Belgium, U. S. Nat. Mon. Com . Pubs., 61st Cong., 2d Sess., Sen. Dóc. No. 400, passim , but especially pp. 193-195. "Federal Reserve Bulletin, Vol. IX ( 1923 ) , p. 276. " Letter from Mr. Romolo Angelone, Commercial Attaché, Royal Italian Embassy, New York City, August 4, 1924. " Letter from Mr. Alejandra Berea, Consul General for Spain, New York City, July 25, 1924. NATURE, ORIGIN , AND USE OF CHECKS 27 Bank notes issued only by the Bank of Portugal, a government bank, are the chief medium of exchange in Portugal also. Checks are used to some extent in wholesale trade, but seldom in retail transactions. Bank deposits in Portugal are no indication of the 94 extent to which checks are used in that country. The check in Russia Bank notes have been and are the most important medium of exchange in Russia. In 1910 notes were about three times as important as checks, although checks were becoming fairly well developed prior to the Revolution of 1917.95 The rather recent creation in Russia of industrial trusts and commercial enterprises on a capitalistic basis has made it neces sary to introduce some stability into the currency. The cher vonetz is the result. It is equal to 10 pre -war gold rubles, or ap proximately £1 . These chervontsi are issued by the new State Bank and are supposed to have a 25 per cent. security in gold, precious metals, or stable foreign currency, the remainder of the security being readily marketable goods, short-term bills of ex change, or other specified security. Although nominally redeem able in gold chervontsi, the chervontsi notes, in practice, are re deemed in soviet rubles at the current rate of exchange. There are, in fact, two independent currencies in circulation today : The State Bank notes ( chervontsi ) and the soviet ruble, of which a new series has been issued almost yearly by the Treasury since the beginning of the Soviet regime. The more or less stabilized currency has acted as a stimulus for the establishment of new banks and has encouraged the making of deposits and the extension of loans. It should be recalled that with the nationalization and liquidation of all banks during the years 1917-1919, payment for commodities and services by check or draft ceased. From that time until the beginning of 1922, all business transactions were carried on exclusively with the aid of paper notes . The State Bank was organized in November, 1921, and ab sorbed the Peoples' Bank which had been created following the nationalization and liquidation of all other banks. The State Bank was not given the right of note issue until November, 1922, at which time it was given the power to issue the new chervontsi. "Letters from the Consul General of Portugal, New York City, July 24, 1924 . *sProfessors Idelson and Lexis, Organization of Banking in Russia, U. S. Nat. Mon. Com . Pubs., 61st Cong., 2d Sess., Sen. Doc. No. 586, passim . CLEARING AND COLLECTION OF CHECKS 28 This bank is a bank with branches and resembles a central reserve bank, although it also performs the functions of an ordinary com mercial bank . With the adoption by the Soviet government of a more toler ant attitude towards private enterprise in business, it has become possible once more to engage in banking operations in Russia. During the second half of 1922 and the first half of 1923, a num ber of public and private banks were organized. Deposits are re turning as a medium of exchange. In some banks demand depositi, by April, 1923, were equal to about five times their capital and surplus. The most important banks are owned and operated by the State or co-operative associations, the activities of the private banks being closely restricted. Most of the banking institutions are located in Moscow, about 80 per cent. of all banking resources being concentrated there. The State Bank and the Industrial Bank, the two largest banks, have a number of branches over Russia, the State Bank alone having over 100 branches in the im portant towns. The Russian State Bank, according to its statement for May 1 , 1923, shows roughly the relative importance of notes and de posits as follows : Bank notes ( chervontsi ) in circulation, 6 , 000,000 ; current account and other deposits, 1,400,670,000 (in soviet rubles, issue of 1923 ) , and 7,094,000 chervontsi ; transfer operations, 17,097,000 rubles and 931,000 chervontsi.96 Checks in the Republics of Finland and Latvia The most common medium of exchange in the Republic of Fin land is the local currency composed principally of bank notes. The Bank of Finland, a government institution, is the only bank of issue. Commercial remittances are made largely by use of an equivalent to cashier's checks in the United States. Checks are used in the wholesale, but very little in retail trade. The Bank of Finland reported as follows for December 30, 1923 : Notes in circulation, 1,420,920,000 Finnish marks ; government deposits, 239,311,000 marks; current account deposits, 110,551,000 marks.97 But deposits, as shown in this statement, do not indi cate the importance of checks, since deposits may be withdrawn by presenting the pass book as well as by check.98 sFederal Reserve Bulletin , Vol . VIII ( 1922 ), pp. 936-942, 1200-1205 ; Vol. IX ( 1923 ) , pp. 1114-1119. Federal Reserve Bulletin , Vol. IX ( 1923 ) , p. 653. " Letter from Mr. Edvin Lundstrom, Vice -Consul for Finland, New York City, July 24, 1924 . NATURE , ORIGIN , AND USE OF CHECKS 29 The Republic of Latvia, one of the Baltic States which became separated from Russia after the 1917 Revolution, presents a somewhat similar situation. The Consul for that country reports that the use of checks in Latvia is being extended even though they play but a minor role as yet. The principal currency is the notes issued by the Bank of Latvia, a government institution, estab lished November 1 , 1922, with the exclusive right of issue. Rubles, which were issued before lats, were issued by the Treasury Depart ment. These are being replaced by the lats, which are virtually gold certificates in nature. Checks are favored for use by the government and are winning popularity gradually with the people. Their use in wholesale trade is limited as yet to persons who are well known, cash being the customary means of settling accounts. In retail transactions the part played by checks is negligible. Deposits may be drawn out by various means other than checks, such as letters of credit, special orders, or by presen tation of the pass book.99 Checks in southern European countries What has been said for the other European countries may be said, in general, for the Baltic States and other southern Euro pean countries. No effort will be made to describe in detail the nature of the currencies in the remainder of the European coun tries. For no country is the exact information obtainable. At the best only estimates and general statements can be secured , all of which may be summarized in the general statement that local currencies are the principal media of exchange, checks occupying a minor place . In Roumania, for a typical example, cash and bank notes are the most common medium of exchange, checks being used very little. The only notes in Roumania are those issued by the Na tional Bank of Roumania. These are the only legal currency aside from gold, silver, and nickel coins minted by the State Treas ury. Checks are seldom used even in wholesale trade and then only when it just happens that both parties are dealing with the same bank. Deposits, as shown by the Roumanian banks, may be withdrawn by other means than the check, as, for example, the letter of credit. Mr. Drutzu , the Vice-Consul of Roumania, in summarizing the situation in that country points out that the conditions as described above are due to the fact that the practice Letter from Mr. Arthur B. Lule, Consul of Latvia, New York City, July 25, 1924 . CLEARING AND COLLECTION OF CHECKS 30 of using the check can hardly be said to have been introduced in Roumania. This is partially responsible for the actual lack of currency in that country. The reason for this general situation is that the Roumanian government thus far has not passed any pro tective laws which would guard the banks against heavy losses in case of forgery, etc. He also points out that “ . the matter has lately been discussed even in France, and should it prove suc cessful we are hopeful that in the near future the application of the French law will be studied by the Roumanian government with a view to introducing the practice of using checks in Rou mania ."100 Checks in China, Japan , and India It is difficult to generalize with respect to the media of ex change in China. Almost anything can be found there. China has no unified system of currency. It is approximately true to say that she has parallel standards, silver and copper coins being used side by side, but with no fixed legal ratio between the two metals. Chinese currency, in reality, is composed of a number of systems. There is the copper cash ; the currency of silver bul lion based on the tael unit ; silver coins, the dollars of foreign as well as of provincial mintage ; and finally there are the minor silver coins, fractional parts of the dollar circulating independ ently of the mint and with no limitations upon their legal tender quality. A large proportion of the business transacted in the interior of China is carried on by means of silver payments ; what little gold is used is restricted almost entirely to international com merce. Bank notes occupy an important place in the currency,, but the use of checks is virtually negligible. Only the merchants in the treaty ports have any dealings with them.101 Silver is the principal medium of exchange in India. The use of bank notes is increasing, but the use of checks is increasing at a much greater rate. The use of checks is confined principally to such cities as Calcutta, Bombay, Madras, Cawnpore, Rangoon, and Karachi, and here checks are far more important than specie and notes. Legal tender money is required only for the purpose 16Letter from Mr. S. Drutzu, Vice -Consul of Roumania, New York City , July 24, 1924. inc. F. Remer, Readings in Economics for China ( Shanghi, 1922) , pp. 315 355 ; R. O. Hall, Chapters and Documents on Chinese National Banking (Shanghi, 1920 ) , passim ; Federal Reserve Bulletin, Vol. IX ( 1923 ) , p. 1014 ; E. T. Williams, China Yesterday and Today (New York, 1923) , pp. 195-196, 588 ; D. K. Lieu, “Gold Currency Scheme,” The Chinese Social and Political Science Review, Vol . III (1918 ) , pp. 225-277. NATURE, ORIGIN, AND USE OF CHECKS 31 of actual public circulation in connection with retail transactions, the payment of wages, and for reserves held by the banks against deposits. All the cities mentioned except Karachi have clearing houses. European merchants and the educated classes are the chief users of checks. A large proportion of the inland remit tances are carried on by bills of exchange called hundis. The average growth of the check in India from 1900 to 1919 was greater than the growth of business ; especially was this true during the War. Its growth was more than twice as great as all other circulation combined. Bank deposits increased 65 per cent. from 1913 to 1917. Outside of the towns, however, checks cannot circulate to any extent ; 94 per cent. of the population is illiterate, which is the main key to the reasons for the absorption of the precious metals. Were it not for the fact that stamps on checks are required and that signatures may not be in the vernacular but must be in English, the development of the check in India, un 102 doubtedly, would be more rapid ." The currency situation in Japan is quite different from that in China and India ; it is more akin to that in the United States. While it cannot be said that the use of checks in Japan is as gen eral or as highly developed as in the United States, checks are probably as important a medium of exchange as notes. The check seems to have been known in Japan as early as the 17th Century, although modern banking in that country really dates from about 1872.103 Banking development has been very rapid in Japan in recent years, the development assuming the form of larger banks with branches, rather than a mere increase in the number of independent banks. In fact, the number of independent banks is decreasing. 104 The Bank of Japan, which is the central bank of issue, re ported as follows for May, 1924 : Note circulation, 1,347,000,000 : yen ; government deposits, 511,000,000 yen ; private deposits, 46,000,000 yen. The Tokyo banks reported deposits for the same date amounting to 1,838,000,000 yen. The combined de posits exceed the note circulation.105 1036. Findlay Shirras, Indian Finance and Banking (London , 1920 ), pp. 9, 23, 230 , 407 ; B. Ramachandra Rau, Present- Day Banking in India (University of Calcutta , 1922 ) , pp. 271-275 ; H. Stanley Jevons, Money, Banking and Ex change in India (Simla , 1922 ) , pp. 86, 90, Chap. VIII ; Federal Reserve Bulletin , Vol. IX ( 1923 ) pp. 1011-1014. 16 Bachem , pp . 8-9; O. M. W. Sprague, The Banking System of Japan, U. S. Nat. Mon. Com . Pubs., 61st Cong., 2d Sess., Sen. Doc. No. 586, Part IV, passim . 16 Federal Reserve Bulletin, Vol. IX ( 1923 ) , pp. 804-810. 14 FederalReserve Bulletin , Vol. X ( 1924 ) , p. 432. 32 CLEARING AND COLLECTION OF CHECKS Checks in Canada Although checks and clearing houses developed somewhat later in Canada than in the United States, checks were in use in Canada by 1825. The circulation there is not unlike that in the United States with the exception that exchange is charged uni formly on checks, which tends to restrict their use somewhat. The use of checks is extensive, however, and is growing more rapidly than is the use of notes.106 In February, 1924, the bank note cir culation amounted to $163,000,000 ; dominion note circulation was $227,000,000 ; and individual deposits amounted to $ 2,000, 000,000.107 Checks in Mexico It was learned in the investigations of 1910 that checks played an important part in the medium of exchange in Mexico, this being partly due to the extensive operations of Americans in that country. It was observed, also, that the use of bank notes had developed slowly and that hard money was preferred for small transactions.108 Today the general situation does not differ widely. Gold and silver coin are the principal medium of exchange, but the use of checks is quite common. The Consul General of Mexico in New York City insists that the use of checks in Mexico is as common as in the United States. During the ten years of internal struggle following 1910, the Mexican system of banks was disrupted almost totally, and thera developed a tendency among the people either to hoard their funds or to deposit them in banks abroad. This situation made the monetary system virtually metallic and very inelastic. Formerly, banks under government concession issued notes, but the internal struggles caused this practice to be discontinued. Consequently, no bank notes are issued and only recently have provisions been made for a resumption of their issue. A law authorizing a central bank of issue, known as the Banco de Mexico, was approved by the legislative bodies of Mexico, January 20, 1923.109 When this bank begins to function Mexico will have bank notes once more, 100 Joseph French Johnson , The Canadian Banking System , U. S. Nat. Mon. Com . Pubs., 61st Cong ., 2d Sess., Sen. Doc. No. 583, pp. 99-100 ; Victor Ross, A History of the Canadian Bank of Commerce, Vol. I ( Toronto, 1920 ) , p. 60. 9 107Federal Reserve Bulletin , Vol. X ( 1924 ) , p. 432. 14C. A. Conant, The Banking System of Mexico , U. S. Nat. Mon. Com . Pubs . , 61st Cong. , 2d Sess ., Sen. Doc. No. 493, pp. 54-57 . 10º Federal Reserve Bulletin , Vol. IX ( 1923 ) , p. 590. NATURE, ORIGIN, AND USE OF CHECKS 33 and these may add some elasticity to the otherwise hard metallic base. Government notes are not issued . The Mexican Consul General reports that checks are used in both wholesale and retail trade in that country, and that de posits, especially current account deposits, as reported in Mexico, indicate fairly accurately the extent to which checks are used. He also pointed out that as in the United States, such deposits may be withdrawn by means of checks, drafts and other commercial documents.110 The use of checks in South America It would carry us too far afield to examine in any detail the monetary systems used in the various South American countries. Only Colombia and Brazil will be examined as perhaps typical of the countries of that continent. Until quite recently, Colombia has been dependent upon vari ous unsecured note currencies, both government notes and bank notes, but mostly government notes, for its medium of exchange. In July, 1923, a new central bank, called the Banco de la Repub lica, was organized as the result of the work of a mission of Amer ican financial counsellors, headed by Professor E. W. Kemmerer of Princeton University. This new bank, with a life of twenty years, and with one-half of the capital owned by the government, is to enjoy the exclusive privilege of note issue. The notes may be issued against specie, commercial paper, and for the purchase and retirement from circulation of a certain amount of treasury certificates. The gold reserve against the combined note and deposit liability must not be less than 60 per cent.111 These new notes are replacing the old and undoubtedly will be accepted as the currency of the country. It cannot be said that the use of checks in Colombia is very general. Sometimes checks appear in wholesale trade, but not fre quently. Other documents, such as drafts, promissory notes, bills of exchange, etc., are the more common media. The use of checks in wholesale trade is confined principally to the large cities. In retail trading, checks are seldom seen, it being the custom to make settlements in cash. Deposits, as reported by banks in Colombia give no definite idea of the extent to which checks are used . Only the accounts current are indicative. But in addition to this type 110Letter from Mr. Alberto Mascareñas, Consul General for Mexico, New York City , July 24, 1924. 11 Federal Reserve Bulletin , Vol. IX ( 1923 ) , p. 1123. CLEARING AND COLLECTION OF CHECKS 34 of account, there are certain special accounts, such as the savings accounts ( Caja de Ahorros ) , installment deposits ( A termino ), and other special deposits, which may be withdrawn by presenting the pass book or " title " . There are also deposits which may be withdrawn by means of telegraphs, cables, and letters . It is hoped and expected that the use of checks will become more gen eral as soon as the proper protective legislation can be enacted.11 : The monetary system of Brazil is composed principally of in convertible paper money, the use of checks not being widespread, although on the increase. While Brazil is nominally on a gold basis, paper money has been issued to such an extent since 1918 by the National Treasury and the Institution for the Permanent Protection of Coffee and Other Produce, that gold reserves against circulation dropped to 4 per cent. in May, 1923. In the latter part of 1922, the Banco do Brasil was transformed into a bank of issue with the exclusive right to issue notes which are designed to replace the government issue. These notes are issued against com mercial credits and are redeemable in gold at a fixed rate.113 One can do no better than quote directly from a letter from the Brazilian Consulate General relative to the use of checks in that country, who says, " . the use of checks has not become widespread in Brazil, as it has in European countries and in the United States. This is mainly due to the great distances which separate the commercial centers of Brazil. From Rio Janeiro, going north to Bahia, it is 750 miles ; from Bahia to Pernambuco, fully 400, and Pernambuco to the Amazons, 1,150 miles. In going south , Rio Grande do Sul is 875 miles. The two great centers, Rio Janeiro and São Paulo, are linked by rail 350 miles, but com ication between those other centers mentioned above is by sea. Owing to these distances, each center is, to a great extent, isolated and, therefore, banks at these outports, whether local or branches of the great institution, have to rely mainly upon their own re sources and retain a strong reserve of cash locked up in their safes. " Payment by check in Brazil is, however, coming into general practice, and, thanks to the initiative of the Banco do Brasil, clearing houses have been established in the two great centers, Rio Janeiro and São Paulo. At the outports the trader still looks with a certain amount of suspicion upon a check and looks for payment in cash and this involves a constant strain upon the 113Letter from the Consul General of Colonibia , New York City, July 31 , 113Federal Reserve Bulletin , Vol. IX ( 1923 ) , pp. 592-595, 706-707. 1924. 35 NATURE, ORIGIN, AND USE OF CHECKS TABLE I Metallic Reserves, Total Note Circulation, and Central Bank Deposits at the End of 1913 Per cent of metallic [ In thousands of dollars converted at par. ) Metallic reserves Austria - Hungary Belgium Denmark Greece Noteg in circulation 5,211 505.212 206,010 40,616 21,810 1,102,715 617,240 144,086 54,256 251.421 21.287 19,666 6,973 678,866 278, 453 7,394 802,388 344,339 170,245 5,746 Finland France Germany Great Britain Gold 304,410 58,941 48,062 170,245 Deposits 34,119 24,450 1,842 5,094 188,886 reserves to total note and de note and Total deposit posit lla liabilities bilities 639.331 66.4 230, 460 26.6 . 50.1 42 , 458 26,904 27.6 188,763 1,291,601 80-6,003 347,193 49,00-6 103,262 62.1 42.7: 34.7. 5.6 . 67.1 23.5 . 491,279 Italy : 287,791 22,627 265,455 22,627 440,717 96,321 63,513 Treasury 504,230 96,321 Total 310,418 288,082 1600,551 61.7 64,523 1,742 3,372 127,445 32,212 50.6 29,493 812,788 230,772 28.766 60,899 12,8 446 8,760 29,242 780,902 92,489 27,372 537,038 125,703 28,840 112,372 110,239 859 , 293 371,335 63,513 Netherlands Norway 36,823 3,258,871 issue... of Banks 12,846 17,692 Portugal Rumania Russia Spain Sweden Switzerland Total , Europe ... 11,667 5,793 124,039 39.9. 14.3 25.4 70.1 46.8 31.2 51.2 32,802 62,838 60,568 122,081 29,309 11,389 116,032 1,160,054 493 , 466 92,147 71,957 2,792,281 4,960,221 1,388,980 6,349,201 61.3 1,170,651 1,279,297 118,461 2.1 97.4 1,170,651 1,397,758 10.2 300,761 Canada : 27,142 27,142 108.646 Treasury 115,375 115,375 118,461 Total 142,517 142,517 227,107 227,880 229,100 105.4 1,398,531 1,626.858 23.6 349,485 89.7 30.8 39.7 Chartered banks... United States : Fed . Reserve Bks. 241 , 408 204,949 1,220 Total , No. Amer. Argentina 383,925 347 , 466 313,497 89,577 228,327 Brazil 89,577 12,499 Uruguay Total , So. Amer. Australia New Zealand 415,573 21,899 25,325 Total, Australasia India Japan : Bank 313,497 47,224 209,093 of Japan ... Government Total Total . Asia South Africa Grand total 10,826 290,933 22,275 413,900 21,899 25,325 662,693 48,212 8,147 47,224 109,170 66,359 321,728 111,846 24,427 9,187 290.933 31,462 61.91 125,230 671,880 48,212 133,377 125,230 181,589 26.0 321,728 66.0) 40.8: 9,187 45.4 19.0 . 212,555 61,397 273,952 212,555 45,010 61,397 273,962 49.7 10,027 3,901 48,911 44.1 119,197 26,581 579,293 10.619 65,298 198.947 6:44,591 56.9 236,828 209.566 113.0 4,709,374 3,756,619 6,497,512 3,186,173 9,683,685 48.6. 136,273 21,587 Java 349.485 366,953 1 · From the Federal Reserve Bulletin, Vol. VIII ( 1922 ) , p . 758. An excel lent table showing the amounts of notes in circulation in the principal countries. of the world at different dates since 1913 is given in the Federal Reserve Bulle tin, Vol. IX ( 1923 ), p . 1283. Unfortunately, the table gives no information relative to deposits, and for that reason will be omitted here. It is unsafe to infer from the data given in Table I that deposits serve as anything like an exact indication of the extent to which checks are used in any country . Only in the roughest way do they show the general tendencies. *Date of first statement of Federal Reserve Banks, Nov. 20, 1914. 36 CLEARING AND COLLECTION OF CHECKS banks' resources, especially during those seasons of the year when the crops have to be moved . In any case, checks are only current in the towns in which they are issued and the financing of the ship ments between ports is done by means of bills of exchange, gen erally drawn at 30, 60 and 90 days. The banker then when nego tiating these bills during the busy crop season will find his funds being withdrawn and accumulated at some other part of the re public, perhaps 1,000 miles away, and these funds have to be got back . Transfers may occasionally be arranged , but as the move ment is generally all one way in given seasons of the year, all the banks find themselves in the same position and the only alterna tive left to them is to have their accumulated balances shipped back, the cash being packed in boxes and placed on board the ship under bill of lading. These shipments naturally incur con siderable expense for freight and insurance, and this charge, to gether with the delay in receiving back their funds, has to be reck oned in the rate of discount in the negotiation of the bills. 114 Notes and deposits in the leading countries of the world in 1913 A rough picture of the general situation as it prevailed in the principal countries of the world at the close of the year 1913 is given in Table I. This table probably presents a better view of the general situation in the leading nations of the world than do more recent data. The orgy of inflation through which the principal countries of the world have passed in the last few years has tended to obscure what would be the usual practices under more normal conditions. Table I will give also some infor mation with respect to certain countries not mentioned above. *** Letter from Mr. J. C. Muniz, Deputy Consul for Brazil, New York City, July 21, 1924. CHAPTER II USE OF CHECKS IN THE UNITED STATES PRIOR TO 1863 The use of checks during the Colonial period In order to appreciate more fully the conditions under which checks originated in what is now the United States, it is necessary to survey briefly the development of banking institutions in the American Colonies. It is here that we are to find the origin of checks, although the banking institutions of the Colonial period were of such a nature that bank notes as compared with checks were by far the more common medium of exchange. The development of banking during the Colonial period The history of banking in the Colonies is primarily a history of paper money issues and of the so - called land banks. The term “ bank” as originally used in the Colonies had a peculiar connota tion ; the issue of paper money on the security of land or merchan dise was spoken of as “ raising a bank. ” The term bank had ref erence to the issue rather than to any particular institution or building. Being destitute of specie as a medium of exchange, and feeling a need for a convenient and cheap medium, the Colonists resorted to almost every known expedient to supply it. The idea of using land and merchandise as security for paper emissions was bor rowed from England, Scotland and France. Not only did the scarcity of specie as a basis for the development of deposit bank ing or the issue of notes probably furnish the prime reason for the creation of such notoriously bad banking schemes, but there was a general prevalence of fallacious theories advocating land banks and other unsound schemes. Mr. A. M. Davis finds that the prevailing monetary theories were an echo of what the same generation was then, or had just been, saying in the old countries .? A. M. Davis, “Currency and Banking in the Province of Massachusetts Bay,” Pubs. Amer. Econ. A 8800. (May , 1901 ) , p. 187. The pamphlet literature of this time supports Mr. Davis' conclusion. Benjamin Franklin was among the prominent persons who supported such theories. In 1729, he contended CLEARING AND COLLECTION OF CHECKS 38 Although almost every conceivable type of banking and paper money scheme could be found in the Colonies, there were a few outstanding and common ones which will be described briefly. Mr. Davis finds that a plan for a private bank was pre sented in 1671. The scheme for the bank was entitled, “ A Pro posal for erecting a Fund of Land, by Authority or Private Per sons, in the nature of a Money-Bank ; or Merchandise Lumbera to pass Credit upon, by Book - Entries; or Bills of Exchange, for great Payments and Change-bills for running Cash .” The rules laid down relative to the methods of issuing the bills and keeping the accounts of the depositors contemplated the establishment of a sort of clearing house where dealings between depositors could be adjusted by transfers of accounts. But virtually nothing is known as to the detailed manner in which the business was carried on . It seems to have lasted but a few months.4 Origin of checks, 1681 In the second experiment of which we have reliable information, is to be found the origin of the check in this country. This early instrument was devised in New England in 1681 in connection with a banking scheme called “ The Fund at Boston in New England ." 5 The plan stands forth among the pioneers in the financial experi ments of the world. The purpose of this Fund was to furnish credits similar to our modern deposit credit, which should be avail . able for business transactions through transfers of accounts be tween members of the Fund, and which might be accepted, ulti mately, by the public for use. Certain individuals (grantors ) mortgaged their lands to the that bills issued on land would be " coined land ” and as a result of the nature of the underlying security , would be more stable than those issued on the security of gold and silver which he considered more likely to fluctuate in value. He thought the value of the land would increase with the population which would permit the issuing of more bills, thus securing stabilization . See Works of Benjamin Franklin, Edited by John Bigelow, Vol . I ( New York, 1887 ) , pp. 374-376, " The word “ Lumber" was a corruption of Lombard according to Davis, op. cit., p. 10. It was frequently an adjunct of a land bank, staple merchandise of various sorts rather than land being used as security for issues. *Davis, op. cit. , p. 69; J. H. Trumbull, The First Essays at Banking and the First Paper -Money in New England ( Worcester, Mass. , 1884 ) , pp. 10-11 . 'W. G. Sumner, II istory of Banking in the United States ( New York, 1896 ) , p. 3. $ A . M. Davis, The Fund at Boston in New England. Reprinted from the Proceedings of the American Antiquarian Society ( Worcester, Mass., April 29, 1903 ). Much of the vagueness attaching to this experiment has been cleared up due to Mr. J. H. Trumbull, who found a rare pamphlet in the Watkinson Library, entitled Severals Relating to the Fund, which was published in 1682. CHECKS IN UNITED STATES PRIOR TO 1863 39 Fund, the mortgages including the power to sell, and received from the Fund a credit upon the books of the company. This credit was to be passed by book entries similar in principle to the method employed by the Bank of Amsterdam except that the credit in the latter rested upon coin, while the credit in the Fund rested upon land and merchandise. Two methods of passing credit were provided : “ Bils of Exchange for great Payments” and “ Change- bills for running cash .” The bills of exchange are sup posed to have been change-bills of large size. The second means of transferring credit was provided by pass-bills. After credi! on the books had been extended to the borrower on the basis of his mortgaged land, he could use his credit by securing change bills. To get these bills he made out “... the equivalent a counter check in modern use, in the following words, Charge my accompt, fol.— Debtor , forChange bill now received, Number— " This change-bill, which was largely in the nature of the modern letter of credit, was circulated in a cumbersome manner by entering the amount of the transactions on the back of the change-bill until the credit was exhausted . But the significant fact is that credit could be transferred in the Fund, " either at the Office or elsewhere, without the necessity of taking out change-bills. This was accomplished through the medium of the pass-bill, which consisted in an order on the man ager of the Fund to make the necessary transfers, couched in the to ac following language: 'Place of my credit in Fund, fol . the Sum of — :'.” For all practical purposes count of this constituted a check. Here was developed a system of credits which was used in a limited way among persons who had confi dence in each other and faith in the judgment of the management of the Fund, but which did not comprehend the idea of the emis sion of a denominational paper currency in such form as to be of general use in trade. This credit was made to circulate outside of the banks in the form of change- or pass-bills, the latter in the shape of checks. It is not known how far the business men of Boston joined in the enterprise, but the fact that some of the mortgages were kept alive for nearly four years shows that the acceptors found some use for their credit and would indicate that the scheme must have met with some support from sources not specifically set forth in any evidence at hand. It was the prototype of the proposed Land *Davis sets forth in detail the transactions in which change-bills were used . See op. cit ., pp. 14-15 . 40 CLEARING AND COLLECTION OF CHECKS Bank of 1686 ; of the similar project in 1714 ; of the Connecticut Land Bank in 1732 ; and of the well -known experiment made in 1740. It is not known whether pass-bills or checks gave way to denominational currency in 1686 or not, but it seemed to be the intention to use them in payments exceeding twenty shillings. By 1714, however, the public had become familiarized with paper money which was used and considered more simple than the quasi letters of credit and pass-bills or checks.7 From this time until the last quarter of the 18th Century we learn nothing more of checks. Paper money occupied the field for nearly a century and brought upon the people all the ills that can result from wild paper money schemes. Before completing the survey of the mone tary history of the Colonial period it will be instructive to learn why deposit currency did not develop until almost a century after this first experiment. Why deposit currency did not develop in the Colonies In order to have deposit banking there must be something to deposit that is in general demand, something that has stability of value, is readily transferable and into which the deposit can be con verted at will ; in other words, specie. The Colonists had very little specie to deposit, and land and merchandise could not meet the above requirements. Deposit banking implies that the inhab itants be in close touch with their banks in order to test readily the validity of their checks. Checks cannot develop easily in a sparsely settled country. Deposit banking implies good govern ment, security of personal and property rights, and confidence on the part of the people in the government as well as in the banking institutions. It implies a high degree of activity and competition in the pursuits of men, and of advancement in prosperity and wealth, a country relatively exempt from invasion and free from revolution. Where deposit banking is carried on, the banker is largely passive ; his deposits depend largely on the favor of others. In the issue of notes, however, the banker can do something. A paper circulation requires little effort on the part of the public and where the people are scattered, as is the case in most colonies, they can exercise little concerted effort and need the aid of the banker. Thus, as Walter Bagehot points out, paper issue is the natural prelude to and promotes deposit banking. No nation as 'Davis, op. cit., pp.16-17. CHECKS IN UNITED STATES PRIOR TO 1863 41 yet, he says, has arrived at a great system of deposit banking without first going through the preliminary stage of note issue . Paper money and banking schemes of the Colonies Whatever the cause assigned for the issue of paper money, whether lack of specie or some unsound monetary theory, virtually every conceivable type was issued either by private individuals, banks, or the Colonial governments. The first paper money ante dates the first banking scheme according to Mr. J. H. Trumbull, who mentions money passing current in 1652. In 1686 a Mr. Blackwell and others proposed to issue notes and make loans on the security of land and merchandise. Reference was made to this scheme again in 1714.10 The first bills of public credit found in the Colonies were issued by Massachusetts in 1690 in order to pay the soldiers who engaged in the expedition against Port Royal and Quebec in the French War ; they were virtually exchequer bills in anticipation of taxes. There is evidence that there were paper bills in circulation in 1684, but whether they were issued by the Colony or were merely the promises of individuals to pay is not known.11 The first issue against mortgage security was in Massachusetts in 1711 and repeated in 1714.12 Ordinarily, such notes as those issued by the government on mortgage security were loaned for a period of time, as five years, at about 5 per cent. interest, one- fifth of the principal to be re paid each year. Opportunity was given for a general subscription by the public. Unlike the scheme of 1690, no provision had to be made for redemption by laying taxes, and another advantage was found in the interest which the public treasury would receive with out any outlay of capital. Similar issues of loan bills took place in Massachusetts in 1716, 1721 and 1728 ; these circulated side by side with the ordinary bills of credit.13 In Rhode Island loan *Bagehot, Lombard Street , 14th ed. ( New York, 1920 ) , pp. 82-88 ; C. A. Conant , “ Banking and Business Assets," Sound Currency, Vol. IV, No. 23 ( New York, 1897 ), pp. 4-5 . 'J. H. Trumbull, The First Essays at Banking and the First Paper-Money in New England ( Worcester, Mass., 1884 ) , p . 7 . WW . G. Sumner, History of Banking in the United States ( New York, 1896 ) , pp. 3-4 . WTrumbull, op. cit., pp . 14-15 ; F. F. Macleod, “ The History of Fiat Money and Currency Inflation in New England from 1620-1789,” Annals of the Amer ican Academy, Vol. XII ( 1898 ), p . 233 ; A. M. Davis, “ Currency and Banking in the Province of Massachusetts Bay ," Pub8. Amer. Econ. A 8800. ( May, 1901 ) , p. 61 . " C. W. Macfarlane, “ Pennsylvania Paper Currency,” Annals of American Academy, Vol. VIII ( 1896 ), p . 72 ; D. Ř . Dewey, Financial History of the United States, 6th ed . ( New York, 1918 ) , p. 23. **Dewey, op. cit., p. 23. 42 CLEARING AND COLLECTION OF CHECKS bills, loaned out at interest to the people on mortgage security, were designated as “ banks.” Nine such “ banks” were issued in Rhode Island as a Colony and another by the State of Rhode Island, ten in all during the years 1710-1786.14 In the issue of paper currency, Massachusetts was quickly followed by New Hampshire, Rhode Island, Connecticut, New York, and New Jersey — all these previous to 1711. South Caro lina followed in 1712, Pennsylvania in 1723, Maryland in 1734, Delaware in 1739, Virginia in 1755, and Georgia in 1760. To use the words of Professor Dewey, . they were monotonously . alike in character, in origin , and in results. Ingenuity in devising variations of the main principle appears to have been exhausted. There were interest-bearing notes, some of which were legal tender, while others were not ; there were non-interest-bearing notes, some of which were legal tender for future obligations, but not for past debts ; some were legal tender for all purposes, and others not legal tender between private persons, but receivable for all public payments. In some instances funds arising from certain sources of taxation were pledged for the redemption of the notes, in others not . In some cases they were payable on demand ; in others at some future time. Sometimes they were issued" by committees, and sometimes by a specially designated official.” 15 Usually, where the Colonial governments issued bills of credit on the security of taxes or lands, the security was supposed to be at least double th : amount of the issue. Such issues were ordinarily made general legal tender. In addition to the above methods of issuing paper money, bills were frequently issued by loan offices. The well-known land banks were becoming common by 1737, and Mr. Davis says accounts were opened at the land banks and transfers of credit made upon the books of the banks.16 Perhaps the best known land bank was that created in Massachusetts in 1740. A rival bank known as the Silver Bank was created at the same time . 117 The land bank of 1740 was quite similar to the scheme of 1681 described briefly above. All these schemes were attempts to “ coin ” land or staples in order to get a substituto currency for the scarce specie. Private and public banks of every degree of insecurity were " E. R. Potter and S. S. Rider, “ Some Account of the Bills of Credit or Paper Money of Rhode Island from the First Issue in 1710 , to the Final Issue, 1786,” Rhode Island Historical Tracts, No. 8 ( Providence, 1880 ), p. 17. 19Dewey, op . cit . , pp. 23-24. 18A . M. Davis, op. cit . , p. 173. 17See Davis, Chap. VII. CHECKS IN UNITED STATES PRIOR TO 1863 43 organized to emit bills of credit. Notes of every description cir culated and these bankers were the inventors of practically every abuse known to banking. Banks were conceived primarily as a means of creating wealth, and the banking mania continued until the Bubble Act of 1741 put a temporary end to the Massachusetts Land Bank and the Silver Bank. In 1751 Parliament prohibited any further issue of legal-tender bills of credit by the New Eng land Colonies, and in 1764 this prohibition was extended to all the Colonies. The restriction, however , did not apply to treasury notes not legal tender which were issued for very brief periods in anticipation of taxes. During this period some of the Colonies endeavored to redeem their notes, usually at a great discount. But notes of loan banks which had not been suppressed , continued to circulate along with temporary treasury notes, so that in 1774 it was estimated that $12,000,000 were in circulation.18 As a result of these earlier experiences it hardly could be ex pected that the Colonists would turn away from paper money in the Revolution. The Continental Currency, first issued in May, 1775, was to be surik by means of taxes, each Colony to find ways and means to sirik its proportion of bills issued by the Congress. These notes were made legal tender in July, 1776, as were the notes of the several Colonies. In addition to the notes of the various Colonies and those of the Continental Congress, there cir culated riotes of the Bank of North America, notes of Robert Mor ris, and bills of exchange. The Continental Currency sank in value till it passed at 500 to one, and, to quote Pelatiah Webster, “ fineilly run itself out to nothing and [died ] not only without 919 aný tumult, but with the general satisfaction of the people." Growth of deposit currency after the Revolution At the close of the Revolution, we find checks again in use in the large centers and from this time on their use steadily in creased. With the assumption of the modern functions of deposit banking as well as the functions of note issue by the Bank of North America chartered by Congress December 21 , 1781 , and by the State of Pennsylvania April 1 , 1782, and by the Bank of New York started by Hamilton in 1784, it is not difficult to find evi dence of a rather extensive use of checks . Pelatiah Webster, writing in 1786 concerning the Bank of 18Davis, pp. 29-30 . 19Pelatiah Webster, Political Essays on the Nature and Operation of Money, Public Finances and other Subjects (Philadelphia, 1791 ) , p . 4. CLEARING AND COLLECTION OF CHECKS 44 North America and the advantages of banking in general, says : “The advantages would be still greater, if, instead of bank bills, the owner would take a bank credit, and draw checks on the bank whenever he needed his money ; this would enable him to pay the sum exactly, without trouble of making change; he would be able in any future time to prove his payments, if he preserved his checks which he received cancelled from the bank , as every man ought to do ; this would at once free him from all danger of loss by fire, robbers, mislaying, dropping them on the road, etc., etc. This practice is found by experience to be so very convenient, that it is almost universally adopted by people who keep their cash in our present bank ." 20 In another place Webster writes: " The present funds of the BANK of North -America, or the cash which supports it, is, 1st, the bank -stock, or the money paid in by the stock-holders, which is about 900,000 dollars : and, 2d . the money deposited by men of all descriptions, who may draw it out by checks on the bank when ever they please ." 21 In still another place he points out the ad vantages that are experienced by the State when public payments > are made by checks on the bank.22 In Domett's history of the Bank of New York are found some fac-similes of checks in use as early as 1784. Two of them read as follows : “ Cashier of the Bank, “ Pay to the Bearer John Bush one Hundred and Seventy four Dollars “ New - York , the 24th Day of August, 1784- - “ Aaron Burrº “ Cashier of the Bank, “ Pay to fourteen pounds... .........or Bearer, Paper. “ New - York, the 2d Day of April, 1789. £.14 “Gulian Verplanck :" 23 20P. Webster, op. cit., p. 434. Taken from the Essay on Credit, written in 1786 , and incorporated in the larger work of 1791 . *Ibid., p. 440. " Ibid ., pp. 433, 440 . H. W. Domett, A History of the Bank of New York, 1784-1884, 3rd ed. (Cambridge, Mass., 1884 ), p. 48. Among the rules adopted by the bank at the time of its opening, June 9, 1784, and in Article 19 of its constitution one finds mention of checks. See Domett, op. cit., pp. 14, 20; J. C. Hamilton, Works of Alexander Hamilton , Vol. II ( New York 1851 ) , p. 333. CHECKS IN UNITED STATES PRIOR TO 1863 45 We find in some old account books, dated 1790 and 1791, of one John Stille of Philadelphia, many accounts of checks drawn in favor of different persons. In the book recording his account with the Bank of North America in 1790-1793, we find that practically all of the transactions were carried on by check. The same was true for his accounts with the Bank of the United States in 1791 and 1792, and with the Bank of Pennsylvania in 1794.24 Hamilton , in his report on the proposed Bank of the United States in 1790, said :: " Every loan which a bank makes, is, in the first shape, a credit given to the borrower on its books, the amount of which it stands ready to pay, either in its own notes, or in gold or silver, at his option. But, in a great number of cases, no actual payment is made in either. The borrower, frequently, by a check or order, transfers his credit to some other person , to whom he has a payment to make ; who, in his turn, is as often content with a similar credit, because he is satisfied that he can, whenever he pleases, either convert it into cash, or pass it to some other hand, as an equivalent for it. And in this manner the credit keeps cir culating, performing in every stage the office of money till it is ex tinguished by some person who has a payment to make to the bank, to an equal or greater amount. Thus large sums are lent and paid, frequently through a variety of hands, without the in tervention of a single piece of coin ." 25 Thus, it will be seen that the use of checks was fairly common in the United States by the beginning of the 19th Century and even before the creation of the first United States Bank in 1791 . This was especially true in the cities, but to almost no degree in the smaller towns and rural districts. The extent to which checks were used ; attempts to determine importance Only general estimates have been relied upon thus far to indi cate the relative importance of checks. It is important to learn whether there is any method for determining the extent to which checks are used at any particular time. This is one of the greatest statistical problems in the field of banking and currency. Various attempts have been made at different times to esti mate the relative amount of checks used. The earliest inquiries " These books are in the possession of Professor Thurman Van Metre of Columbia University, who kindly loaned them to the author. 23“ Hamilton's Report on the National Bank, Dec. 13, 1790,” American State Papers, Vol. VII, p. 68 ; Works of Alexander Hamilton, Vol. I ( New York , 1810 ) , p. 62. CLEARING AND COLLECTION OF CHECKS 46 were made in England. The first was the Babbage inquiry of 1855. Babbage used what has been called the “ clearing house method ,” that is, noting the volume of clearings from time to time and their relation to the estimated volume of business. He at tempted , among other things, to determine the proportion of pay ments made in bank notes by the public, both in town and in the country. In 1857 William Slater analyzed the operations of a single banking house. The Lubbock inquiry of 1865 rested upon the operations of a single bank. Palgrave, in 1873, relied upon the clearing house and the operations of a few banks. The Pownall inquiry of 1864 was based upon the investigations of several banks, while the Martin inquiry of 1880 rested upon the operations of one bank.26 It must be obvious, even to the casual reader, that these Eng lish investigations are not valuable as a basis for conclusions ap plicable to this country. The bases for the inquiries were too narrow and in some instances not representative enough to yield valuable conclusions even for that country. The classes of people who used the banks in England at the times the investigations were made were chiefly the larger merchants, the great business firms and wealthy individuals. The first inquiry as to the relative importance of checks in the United States was the Garfield inquiry of 1877. Fifty-two banks, classified into three groups, were investigated, to deter mine the amount of transactions carried on by checks, drafts and commercial bills.27 In 1881 , John J. Knox, Comptroller of the Currency, made an investigation into the proportion of bank re ceipts composed of credit paper on two dates, June 30 and Sep tember 17, 1881. His investigation rested on about 2,000 na tional banks which showed for June 30 that 91.77 per cent. and for September 17, 91.85 per cent of the national bank receipts were in the form of checks, drafts and bills.28 A third inquiry was made in 1890 by Comptroller E. S. Lacey ; a fourth in 1892 by Comptroller A. B. Hepburn ; a fifth in 1894 by Comptroller Eckels ; a sixth in 1896 by the same Comptroller ; and a seventh in 1910 by the United States National Monetary Commission under the editorial supervision of Dr. David Kinley. This last inquiry was based upon the clearing house reports, deposits of 1 2*See David Kinley, The Use of Credit Instruments in Payments in the | United States, U. S. Nat . Mon. Com . Pubs., 61 Cong., 2d Sess., Sen. Doc. No. : 399 , pp . 12-19. See also pp . 87-95 below. " Kinley, op . cit . , p. 20. ** Ibid ., p. 21 . CHECKS IN UNITED STATES PRIOR TO 1863 47 checks by retailers, wholesalers and all others in the different types of banks. This last method has provided , doubtless, the most reliable data that we have for any particular time. It was sound in prin ciple and extensive in scope. Unfortunately, space does not per mit a review at this point of the searching criticisms made by Dr. Kinley of the earlier American inquiries, although some attention will be given to them below.29 But regardless of their merits or defects, it is sufficient to note that for the period we now have under review there are no data which will show in any exact ness the extent to which checks were used. We are compelled to rely upon general statements of contemporary writers which, on the whole, give a fair picture of the situation in general. In re viewing the various writers of the period one is struck with the fre quency with which they resort to the comparative importance of the two items, “ circulation ” and “ deposits” in bank statements as an indication of the extent to which checks or notes were used . 30 This raises the question whether any valuable information can be gathered as to the relative importance of checks and bank notes by a study of the changes in the items “ circulation " and " deposits " during any period of time. Deposits as an indication of the extent to which checks were used When considering the value of the items as a rough indication of the growth of deposit currency, it must be borne in mind that during the period under consideration such reports were most irregular, were lacking in uniformity, and usually were not to be had at all . Banking at this time was largely shrouded in secrecy. Mr. Bland, a member of Congress from Maryland, in a speech made previous to the dissolution of the first United States Bank , said : “ The nature of the loans, the deposits, and all the bargains, dealings and contrivances, between the Government and the Bank, are wholly invisible to the public.“31 Mr. Carey, attempting to in vestigate banking about the same time, complained of the discour aging destitution of materials.32 “ A Friendly Monitor," 33 writing 2 " See below, pp. 87-95. *Gallatin relied upon these items as criteria, as did such writers as Condy Raguet, C. F. Dunbar, C. A. Conant, and others. "W. M. Gouge, A Short History of Paper Money and Banking in the United States ( Philadelphia, 1833 ), Part II, p. 219. "Gouge, op. cit., p. 219. 235 A Friendly Monitor” published a pamphlet in Philadelphia in December, 1819, and was supposed to have been William Jones, the first President of the second Bank of the United States. CLEARING AND COLLECTION OF CHECKS 48 in 1819, and finding considerable embarrassment in obtaining in formation relative to the second United States Bank, said : “ If I ask a director, the seal of his finger is significantly im impressed on his lips. There is a species of masonry in banking which to a certain extent is highly proper and necessary. It im plies a mutual pledge among the directors that nothing shall be divulged which may be prejudicial to the interests of the Bank .”" 34 Mr. Niles, during the excitement of 1818-1819, attempted to col . lect information respecting all banks then in existence, and though his correspondence was extensive, he apparently failed in his object, as the tables, which he gave notice of his intention of pub lishing, did not appear in his Register.35 Before suspension of specie payments in 1814, no regular returns were received by the legislature of Pennsylvania from the banks of that State and after that time, though accounts were published annually, some of the important banks for many years made no returns.36 In 1820, Mr. Crawford , the Secretary of the Treasury, made a re port on the state of the currency, in which he gave incomplete tables intended to show the amount of capital paid in, the notes in circulation, the public and private deposits, and the specie in the banks in 1819. In 1831 Mr. Gallatin published his Consider ations on the Currency and Banking System of the United States and his estimates vary widely from those of Crawford. More over, there was ambiguity in the bank statements that rendered them useless, not considering the fact that some of the banks were accused of rendering false and padded statements.37 Gouge, him self, after attempting for a period of seven years to collect the accounts of banks, decided in 1833 that they were not worth pub . Gallatin, writing in 1831, said : “The mystery with lishing:38 which it was formerly thought necessary to conceal the operations of those institutions, has been one of the most prolific causes of erroneous opinions on that subject and of mismanagement on their part." 39 The following tables may serve as an illustration of the type of data available , as well as afford some idea , though a very incomplete one, of the banking situation during the period covered by the tables ( Tables II and III ) . " Gouge, pp. 219-220. 35Ibid . 301 bid. 3 Ibid ., pp. 220-222. 38 Ibid ., p. 223. 3ºAlbert Gallatin, Considerations on the Currency and Banking System of the United States ( Philadelphia, 1831 ) , p . 70. CHECKS IN UNITED STATES PRIOR TO 1863 49 TABLE II Number of Colonial and State Banks, their Capital, Circulation , Deposits, Specie, and Loans, in the Years Mentioned from 1774 to 18331 Capital CirculaDeposits Specie Year 1774 .. 1784 . 1790 . 1791 . 1792 . 1793 . 1794 . 1795 . 1796 . 1797 . 1798 . 1799 1800 . 1801 . 1802 . 1803 . 1804 . 1805 . 1806 . 1807 . 1808 . 1809 . 1810 . 1811 . 1812 . 1813 . 1814 .. . No. of banks 3 4 6 16 17 17 23 24 25 25 26 28 31 32 36 59 75 159 162 169 2973 2991 88 2918 1815 . 208 1816 . 1817 . 1818 . 1819 . 1820 . 1821 1822 . 1823 . 1824 . 1825 . 246 1826 . 1827 . 1828 . 1829 . 1830 . 1831 1832 . 1833 . 27 307 280 332 34 : 379 41 ° 55 60 ° 1089 a 329 329 91's 1722 386 1753 35 ( In tion ( In millions ) millions ) 2.1 2.5 12.9 17.1 2.0 2.5 18.0 18.0 19.0 19.2 19.2 19.2 21.2 21.3 22.4 22.6 26.0 39.5 40.4 5.4 5.5 5.9 7.2 6.6 * 42.6 7.9 65.0 80.3 82.2 89.8 90.6 11.0 10.0 11.0 16.0 9.0 10.0 10.5 14.0 2.6 35.5 37.8 17.5 2.0 1.7 2.7 2.8 .9 .7 1.0 1.2 1.6 7.0 6.8 7.4 9.7 11.1 9.6 5.3 45.5 68.0 45.7 40.6 3.0 3.1 3.1 3.8 4.0 4.5 4.9 5.6 48.2 48.4 8,8 10.2 10.2 ( In 16.0 10.0 1.6 1.4 1.0 1.7 2.5 22.7 2.6 66.0 Loans 4.0 10.0 9.0 18.0 20.0 21.5 19.0 16.5 16.0 14.0 17.0 17.5 17.0 16.5 9.7 12.8 14.5 16.6 18.2 25.4 110.1 110.1 23.4 ( In millions) millions) millions) 9.0 11.5 11.0 11.6 11.0 10.5 72.3 102.1 9.8 10.8 11.6 ( In 2.9 11.1 31.2 5.4 3.2 3.1 4.0 28.0 12.9 117.0 17.0 19.0 150.0 1.1 9.8 12.5 73.6 16.7 3.0 .9 1.0 13.0 14.5 15.6 5.2 1.9 17.4 2.7 2.6 1.0 1.3 1.4 1.4 21.9 23.6 24.2 34.5 14.9 14.5 159.8 2.9 3.0 40.7 39.5 4.6 4.7 5.4 1.3 1.6 1.7 38.9 53.2 57.6 " These data which are found in the Report of the Comptroller of the Cur rency, Vol. II (1915 ) , p. 958, were compiled from data taken from the Report of the Comptroller of the Currency for 1876 and from Sound Currency, Vol. II, No. 13 (New York, 1895 ) . This table is in sad conflict with tables appended to of the Treasury, March 3, 1841, which are pre Secretary the Report of theform of Table III . sented here in the *Massachusetts. 'Rhode Island . Capital stock of Massachusetts only. Maine. 'New Hampshire. CLEARING AND COLLECTION OF CHECKS 50 TABLE III Condensed Statement of the Condition , at Different Intervals, of All Banks in the United States Dato Jan. 1 No. of banks Loans and discounts Specie Circulation 1811 89 15,400,000 1815 1816 203 246 17,000,000 45,500,000 19,000,000 1820 308 330 506 68,000,000 44,863,344 61,323,898 94,834,570 1830 1834 1835 1836 1837 1838 1839 1840 558 567 634 6-63 662 722 19,820,240 Deposits 28,100,000 35,950,470 5-5,659,928 75,666,986 200,451,214 324,119,499 316 5,163,834 22,114,917 43,937,625 103,692, 495 83,081,365 4-57,506,080 40,019,594 37.915,340 35,184,112 140,301,038 149,185,890 116,138,910 115,104,440 45,132,673 135 , 170,995 90,240,146 33,105.155 106,968,572 716,696,867 625 , 115,702 485,631,687 492,278,015 462,896,523 127,397,185 84,691,184 Capital 62,601,001 82,259,690 89,822,422 137,110,611 145,192,268 200,005,944 231,250,337 251,875,292 290,772,091 3.17,636,778 327,132,612 358,442,692 1Extract from tables appended to the " Report of the Secretary of the Treasury , March 3 , 1841 ;" also in J. R. Hurd, " A National Bank or No Banks" ( New York , 1842 ) , appendix . The number of branches is not given in this table , as it was not the practice to enumerate them prior to 1835 . The whole number of banks and branches at the commencement of 1840 was 901 . Were the materials available in sufficient quantity the follow ing considerations must be borne in mind : ( 1 ) In the reports as given, various items are blended, vague, and confused, which make them misleading, and errors in interpretation unavoidable. ( 2 ) The items " due from banks" and " due to banks" may also repre sent checks, drafts and notes. ( 3 ) The term “ deposits” in differ ent reports is found sometimes to mean demand deposits, some times demand and time, sometimes individual, which are both time and demand, and sometimes government deposits are included which fluctuate widely and have little connection with business transactions or serve in any sense as an indicator of the relative importance of deposit currency. Moreover, some banks used government deposits as a basis for note issue. ( 4) Deposits may be built up by the deposit of either bank notes or checks. If such deposits represented bank notes or cash deposited, one might say that these deposits were subject to check and to that extent an evidence of the use of checks. But these deposits may have been built up largely by the deposit of checks on other banks as well as on the same bank and these deposits are equally subject to check. In the latter case nearly twice as many checks are used as in the former case. In addition to the fact that these primary ( cash ) deposits may be built up in varying proportions by either notes or checks or both, it must be borne in mind that a large or small amount of the deposits may be derivative ( those resulting from loans ) which may be drawn out in the form of notes or checks and CHECKS IN UNITED STATES PRIOR TO 1863 51 which represent neither notes or checks deposited.40 ( 5 ) During a period of expansion the ratio of loans to deposits will steadily increase in many cases. This is especially true where banks lend for speculative purposes, as, for example, on call with Wall Street brokers. Loans tend to mount up, but the derivative deposits are drawn down. Deposits are relatively small, but they are drawn down by the use of checks, and the size of the deposits at such times would not be an indication of the extent to which checks are used . In 1893, for example, the ratio of loans of the New York Clearing House banks to deposits rose to 109 per cent. and the percentage of cash to loans fell to 13 per cent., causing call rates . to rise to 74 per cent. As a result of the drastic. liquidation which followed , the ratio of loans to deposits became 80 per cent., and that of cash to loans, 30 per cent. Certainly the increase of 41 deposits in this case did not indicate an increased use of checks. As a result of these observations, it is obvious that deposits, even demand deposits, are no exact indication of the extent to which checks are used during any period. They can serve, in con junction with the item " circulation ," only over a long period of time, as a rough indicator of general tendencies. For any par ticular period we are compelled to rely upon the general state ments, estimates, and approximations of the various contemporary writers. The use of checks, 1791-1811 During the period of the life of the first United States Bank we find ample evidence of the use of checks in the larger centers. In writing of the advantages which came to the community from the establishment of the bank at Hartford, Connecticut, in 1792, a Mr. P. H. Woodward says : “ Merchants and others learned to adjust by checks, balances due on mutual accounts. A large pro portion of domestic settlements was made by transfers of credit on the bank ledger without the handling of a dollar. Thus the "In 1909, for instance, Dr. David Kinley presented a diagram which showed that the percentage of checks in aggregate deposits by States ranged from 75 to 98 per cent. But this percentage had reference, apparently, to primary de posits - deposits in the sense of receipts — and not to derivative deposits also . Since derivative deposits were not included Dr. Kinley's data can give but an indefinite conclusion as to the extent to which demand deposits are repre sented by checks. See David Kinley, The Use of Credit Instruments in Pay ments in the United States, p. 220. Today derivative deposits are estimated to be nine or ten times larger than primary deposits. See C. A. Phillips, Bank Credit (New York, 1920 ), Chap. VI ; Dewey and Shugrue, Banking and Credit ( New York , 1922 ) , p. 151 . "S. S. Huebner, The Stock Market ( New York, 1922 ) , p. 302. 52 CLEARING AND COLLECTION OF CHECKS institution put into operation a set of appliances that manifolded the volume and effectiveness of the funds within reach of the com munity." 42 He also gives a fac -simile of a check drawn by Noah Webster on the bank in 1793 as follows : "Hartford Bank “ Hartford , Jany. 30th , 1793 “ Pay to NW ........ 20 Dollars or Bearer, Dollars “ Noah Webster .'943 Another interesting check drawn in 1798 was as follows : “Mount Vernon, May 18, 1798. “ The Cashier of Discount and Deposit - Baltimore, “Will please pay Robert Morris, Esq., or bearer the sum of one thousand dollars and chg. same to my acct. ( Signed ) “George Washington . “ 1,000 dollars. " 44 Mr. Erick Bollman, in analyzing the first six months' activities of the first United States Bank, concluded : “ These observations establish the important fact that six hundred and fifty thousand dollars specie [ the first quarterly installment required ] or active capital, were sufficient to do business to the amount of six million dollars. And , as it would hardly have been prudent to issue notes much beyond the means of the bank to answer them, the greatest part by far of these six million dollars loaned by the bank must have remained in the form of bank credits .” 45 In another place he says : “ Banking rests on the experience that bank credits are a more convenient circulating medium than specie, or even than bank notes. In consequence of which banks absorb specie, giving out some notes, but above all, much credit, portable, transferable and divisible, in the form of checks ; and by re-employing part of the specie absorbed, they double their profits.”46 : He thought it "P. H. Woodward, One Hundred Years of the Hartford Bank (Hartford , Conn., 1892 ) , p. 80. “Ibid., p. 49. “ Now York Times (July 1, 1923 ), p. 1. This check is in the possession of a Mr. Albert Bauer, Brookville, Pa. “Erick Bollman, Paragraphs on Banks ( Philadelphia , 1810 ) , pp. 32-33. **Ibid ., p. 34. 58 CHECKS IN UNITED STATES PRIOR TO 1863 highly improbable that the subsequent payments of the install ments resulted in much additional specie, as they would be paid largely in notes or checks on the bank itself. Further he says : “ The most favorable situation of a bank, therefore, would be to be the only one in the country, and to have for customers all the mer chants in it, because then all payments would be made in checks on the same bank and the call for notes would be extremely limited . For this reason the Bank of the United States was able to do so much business with so little specie when it was just established . As banks increase the custom naturally divides, which tends 9747 to cause the issue of more paper. . Noah Webster estimated in 1801 that the gold in the vaults of the 39 banks in the United States (including the six branches of the United States Bank) was about 23 millions, about the amount of their aggregate capital, and that the banks lent about one and one-half times their capital, or something over 34 millions in 1801. " But, ” he says, “ it must not be inferred from this fact that bank notes to the amount of 34 millions are constantly in circulation. So far is this from the truth, that in general the notes in circulation do not exceed the amount of the capital stock. To understand this, it must be considered , that in all trading towns, the merchants deposit their money in the bank—there they receive and make payments — and the payments are made without ever moving a cent of money from the vaults. The money of the merchants is lodged in the bank, and the property is transferred by check, or draft, payable to the bearer, the amount of which is debited to the drawer and credited to the bearer. The operation is simply a change of credit from A to B and the money is never touched by either party. The bank lends a thousand dollars to A, who has credit for the amount - A draws upon the bank in favor of B - and the amount is carried to his credit — no money is taken from the bank ." 48 Webster estimated that about one fourth to one-third of all the money lent by the principal banks was never removed, either in specie or notes, but stood on the books to the credit of the borrowers, or of those who receive it in payments through the use of checks. The notes in circulation, he thought, rarely exceeded the amount of the capital stock.49 Writing in 1810, Erick Bollman says : " The bank discovers " Ibid ., p. 37. " Noah Webster, Miscellaneous Papers on Political and Commercial Subjecte ( New York, 1802 ) , pp. 46-47. " Ibid . CLEARING AND COLLECTION OF CHECKS 54 that the greatest part of its actual disbursements are merely those required for the petty cash and house expenses of its customers, but that all the great payments are made in bank credits and are effected by transcribing certain sums from the accounts of one description of customers to the accounts of others." 50 In another place he says : “Invariable experience shows that the public prefers bank notes to specie, and bank credits to both, and must prefer them, because they answer the same purpose with less risk and much less trouble ." 51 The Treasury officials, during the entire time of the first United States Bank's existence, gave out no statement of its affairs except when Congress called for information. Only two reports which show notes and deposits seem to be in existence ; these were made to Congress in 1809 and 1811 by Gallatin and 'were as follows :52 Capital stock Circulating notes outstanding Individual deposits .. United States deposits January, 1809 January, 1811 . $ 10,000,000 4,500,000 8,500,000 $ 10,000,000 5,037,125 5,900,423 1,929,999 In addition to acting as a government depository the Bank transferred government funds from place to place without charge and gave the government immediate credit at any branch for funds deposited at any other branch. In Philadelphia, the United States Bank maintained close relations with the Bank of North America and the Bank of Pennsylvania, making daily settlements and ex change of notes. The same co - operation existed at first between the New York branch of the United States Bank and the Bank of New York . 53 Use of checks, 1811-1816 Soon after the expiration of the charter of the first United States Bank, a large number of local banks sprang up under the pecuniary exigencies produced by the withdrawal of so large an amount of bank credit, as necessarily resulted from the winding up of the affairs of the United States Bank-an amount falling “ Erick Bollman, op. cit., pp. 15-17. 51 Ibid., p. 36. 6aJ. T. Holdsworth, First Bank of the United States, U. S. Nat. Mon. Com . Pubs., 61st Cong., 2d Sess., Sen. Doc. No. 571 , p. 112. B3J . T. Holdsworth and D. R. Dewey, First and Second Banks of the United States, U. S. Nat. Mon. Com . Pubs., 61st Cong., 2d Sess ., Sen. Doc. No. 571 , pp. 40, 51 , 62, 63; Henry Adams, Writings of Gallatin, Vol. I ( Philadelphia, 1879 ), p. 171 . CHECKS IN UNITED STATES PRIOR TO 1863 55 little short of $15,000,000. In 1811 there were 89 banks in the United States ; in 1815 there were 208 ; and in 1816, 246. Circu lation increased from $28,100,000 in 1811 to $45,500,000 in 1815 , and to $68,000,000 in 1816. There are no data relative to deposits.54 These banks, released from the salutary control which the United States Bank had exercised over local institutions, com menced the system of imprudent trading and excessive issues, which speedily involved the country in all the embarrassments of a disordered currency. The extraordinary stimulus of a heavy war expenditure, derived principally from loans, and a corre sponding multiplication of local banks, hastened the catastrophe awaiting the government. “ The last year of the war presented the singular and melancholy spectacle of a nation abounding in resources, a people abounding in self-devoting patriotism, and a government reduced to the very brink of avowed bankruptcy, solely for the want of a national institution which, at the same time that it would have facilitated the government loans and other treasury operations, would have furnished aa circulating medium of general credit in every part of the Union ." 55 The depreciation of the currency ranged from various low degrees to as high as 25 per cent.56 Gouge, in writing on the con dition of the currency and banking during the years 1814-1816, quotes from a contemporary writer : " . we are subject to some inconveniences in our transactions at market, and in petty dealings ; but as we become accustomed to the use of paper money, the disadvantage will vanish. All large mercantile negotiations are conducted as they have hitherto been, by bank notes, or checks upon banks. " 57 Although checks were used during this period, especially in the larger transactions, the period is noted primarily for the rapid growth of weak banks and the issue of depreciated bank notes. Note brokers sprang up and the shaving of bills began to be a regular business. This general system of brokerage in the buying and selling of notes flourished from 1811 on down to the '30s and "Extract from tables appended to the Report of the Secretary of the Treas ury, March 3, 1841 ; also in J. R. Hurd, A National Bank or No Banks ( New York, 1842 ) , appendix. McDuffie's Report on Bank of United States, April, 1830, ” in T. H. God dard, A General History of the Most Prominent Banks of Europe, etc. ( New York, 1831 ) , p. 143. sNiles in his Weekly Register said that the rates of depreciation ranged from 12 of 1 per cent. to 75 per cent. See Niles' Weekly Register, Vol. XIII (Oct. 17, 1817 ), p. 97. " Gouge, op. cit., Part II , p. 70. 56 CLEARING AND COLLECTION OF CHECKS '40s. The merchant receiving bank notes sorted them into cur rent and uncurrent and could tell how great the discount would be by consulting the “ Bank Note Reporter” .58 The second United States Bank and the use of checks, 1816-1836 The second United States Bank, like the first, was a bank of deposit, discount and issue. The note issues rested upon the gen eral assets of the bank . In addition to receiving general and special deposits, it and its 19 branches acted as government depos itories, and transferred the public funds from place to place without charge. To individuals it furnished exchange at rates ranging from par to 112 per cent.,, the most common being 12 of 1 per cent. This bank was responsible for restoring the State cur rencies to their face value ; this was done by driving out of circula tion all that could not be made payable in specie on demand. It used its notorious branch drafts as one means of forcing State banks to contract their currency. These drafts were exchanged for State bank notes which were then presented to the State banks for redemption . It was also the practice of this bank to ex change notes with the neighboring banks once each week, and for the creditor bank to receive the difference in specie. This tended to prevent State banks from enlarging their issues beyond the limits of prudence.60 The United States Bank was the center of a “ single banking reserve system , " due not to the fact that State banks kept their reserves in its vaults, but to the fact that they made no particular effort to keep an adequate reserve and trusted the United States Bank to protect them in case of an unusual call for the precious metals.61 However, it was the announced policy of this bank not to furnish the State banks the facilities of exchange, the facilities for the clearing and collection of checks and drafts, or for the transporting of specie to liquidate balances, on the ground that " an accommodation of this sort would enable the State banks to extend to their customers all the facilities and advantages in ex change which the Bank of the United States could do. "962 . . SD. R. Dewey, State Banking Before the Civil War, U. S. Nat. Mon. Com . Pubs., 61st Cong., 2d Sess., Sen. Doc. No. 581 , pp. 107-112 . 6° R . C. H. Catterall , The Second Bank of the United States , ( Chicago , 1913 ) , pp . 441, 444. do Ibid ., p. 430. See George Tucker, The Theory of Money and Banks ( Boston, 1839 ), p. 277 . 62President Jones of the Bank of the United States to the office at New York , June 28 , 1817, American State Papers, Vol. LX, pp. 328-329. CHECKS IN UNITED STATES PRIOR TO 1863 87 As a result of this policy the New York branch was instructed to decline, in the future, to receive for collection the drafts or checks of the banks in that city upon banks in other cities until author ized by the board of the head office.68 Catterall, in a chart, shows deposits of the second Bank of the United States exceeding its note issues from January, 1817, to about June, 1830, after which date they dropped rather abruptly while note issues continued to increase.64 He says : “ The deposits, . which constituted by all odds the most important of these elements [ credit instruments ] in the bank's circulation, were almost or quite as large a part of the circulation as the note issue ." 65 But a large part of the deposits consisted of government deposits. Bear ing in mind the limitations to the value of any table as a true indication of the extent to which deposit currency is used, the following table may offer additional support to Catterall’s con tention ( Table IV ) : TABLE IV Average Amount of Notes and Deposits of the Second Bank of the United States, 1819-18291 1819 . 1820 . 1821 . 1822 . 1823 . 1824 . 1825 . 1826 . 1827 1828 . 1829 . Deposits Notes ( gross ) ' 5,734,682 6,581,628 6,990,073 6,365,570 10,401,786 12,918,108 12,885,829 12,578,523 13,727,274 14,454,169 15,172,164 5,056,829 4,410,332 5,609,220 5,562,335 4,671,271 5,935,496 8,836,646 10,235,528 10,808,244 12,414,390 15,011,352 *This table was taken from Henry Adams, Writings of Gallatin, Vol. III ( Philadelphia, 1879 ) , p. 363. " The actual amount of circulation is generally four -fifths of the gross amount, the rest being notes in transitu, or accumulating in offices where they are not payable. The circulation of bank notes was principally in the South and West and since the greatest business was in the East and North it seems fair to conclude that checks played a prominent part in those sections. The following statement shows the places where the notes of the United States Bank in actual circulation were payable in September, 1830 : * Loc . cit ., p. 329 . " Catterall, p. 427. € 1bid ., pp. 428-429 . " See above, pp. 47-51 . 58 CLEARING AND COLLECTION OF CHECKS $ 834,492 834,733 1,367,180 1,176,240 3,074,045 Payable in New England . Payable in New York . Payable in Philadelphia. Payable in Baltimore and Washington . Payable in Southern States .. Payable in Northwestern States including Buffalo and 3,261,547 Pittsburgh 4,799,420 Payable in Southwestern States.. $ 15,347,657 The general banking and currency situation, 1816-1836 The character of the local banks during this period varied greatly, depending upon the available amount of surplus capital in different sections of the country and the degree of past commer cial experience of the communities in which they were established. Each State worked out for itself a system which presented with some degree of accuracy the current stage of economic thought and development . Substantially three systems of note issues were tried in differ ent parts of the country : ( 1 ) Issues based only upon the general assets of a particular bank as in New England ; ( 2) issues based upon a general safety fund, introduced in New York in 1829 to supplement general asset banking ; and ( 3 ) issues based upon the credit and faith of the States, as in the South and West.68 In a general way it may be said that deposits were more im portant than notes in the larger cities while the reverse was true for the smaller cities and country towns. The city banks de pended upon the deposits resulting from discounts rather than upon the circulation of notes for profit, while the reverse was true for the country banks. The following report for the years 1820 and 1824 shows in a rough way the relative importance of deposits and notes for a few country banks in New York : Capital ( paid in ) $ 319,888.05 3 country banks, 1820 ... 6 country banks, 1824 642,816.05 8 New York City banks and 3 Al 11,252,160.00 bany banks, 1829 .... 11 country banks, 1829 . 2,906,413.00 Notes $ 394,018.00 1,096,974.07 3,528,623.00 3,137,510.00 Deposits $ 36,178,01 133,138.43 4,448,088.00 1,042,865,0070 Distinguishing the seven large cities of Boston, Salem, New 67 Adams, Writings of Gallatin, Vol . III, p. 453. See also Dewey, Financial History of the United States, 8th ed. ( New York, 1922 ) , p. 153. ** Dewey, op. cit., pp. 154, 155. "R. E. Chaddock, Safety - Fund Banking System in New York, U. S. Nat. Mon. Com . Pubs., 61st Cong., 2d Sess., Sen. Doc. No. 581 , p. 237. * Ibid ., pp. 239-240. CHECKS IN UNITED STATES PRIOR TO 1863 59 York, Philadelphia , Baltimore, Charleston, and New Orleans from the other cities, Gallatin showed the situation to be as follows in 1829 : Seven large cities.. The U. S. Bank . Remaining banks. Specie Notes Deposits Capital $ 53,211,605 $ 17,144,422 $ 23,137,129 $ 7,258,025 34,996,270 56,980,663 13,148,984 31,130,492 14,778,809 17,643,990 7,175,274 7,681,61871 Eleazor Lord, writing in 1834, said : “ The notes circulated by the banks in the principal cities probably do not amount to more than a quarter of one per centum of the amount of deposits and of payments received by those banks, that is, payments of notes discounted, and notes collected by them .”" 72 In another place he estimated the annual amount of transactions in the country to be eight or ten billions of dollars ; the whole amount of currency in specie and bank notes was reckoned at about one hundred millions. This, he thought, illustrated the great extent to which credit was used.73 From January, 1830, to January, 1837, 300 new banks were created with a capital of 145 millions. This increase was due partly to the great demand for capital applicable to commercial accommodation and other purposes and partly to the anticipa tion of and the expiration of the charter of the United States Bank.74 In fact, they increased their capital far beyond what might have been wanted for useful purposes, but the proportion of notes to deposits in 1837 was no greater, if as great, as in 1829. The following data will show the situation at the respective dates : 1829 Capital 329 banks ascertained and estimated . . $ 110,192,268 United States Bank .. 35,000,000 Total Notes $ 48,274,914 13,048,984 Deposits $ 40,781,119 14,778,809 $ 145,192,268 $ 61,323,898 $ 55,559,928 " 1837 No. of banks and branches ( 769 ) Pa. Bank of the U. S. ( 19 ) .. Total 788 . $ 255,772,091 $137,737,922 $125,064,776 35,000,000 11,447,968 2,332,409 . $ 290,772,091 $149,185,890 $ 127,397,185 " " Adams, Gallatin , Vol. III, p. 295 ; for additional data supporting this view, see op. cit., pp. 280, 296. * Eleazor Lord, Credit, Currency and Banking, 2d ed. ( New York, 1834 ), P. 20 . 7a Ibid ., pp. 34-35 . " Adams, Gallatin , Vol. III, pp. 386-387. 18 Ibid ., p. 296. * Reportof the Secretary of the Treasury, January 8, 1838, 25th Cong ., 3rd Sess ., Sen. Doc. No. 2, Vol. 1 ( 1838-1839), pp. 39-42; also in George Tucker, The Theory of Money and Banks ( Boston, 1839 ) , p. 404. It will be noted that the total of banks in 1837 which is given as 788, does not harmonize with data in Table VI on p. 65 below. 60 CLEARING AND COLLECTION OF CHECKS The use of checks, 1836-1863 In this period, distinguished for its wildcat banking, we find the practice of using checks in cities and bank notes in rural dis tricts continuing as in the earlier periods, with the difference that the use of deposit currency increased to such an extent that de posits surpassed notes before the end of the period. The definite determination in 1837 of the right of a State to establish under its control a bank with power of note 77 issue in the case of Briscoe v. The Commonwealth of Kentucky,” together with the dissolution of the second United States Bank, and the in troduction of the free banking system, which had its origin in New York in 1838 and was soon adopted in the West by other States, seemed to give an impetus to wildcat banking. The number of banks, which, in 1830, had been 330, with $145,000,000 of capital, had increased to 829 with a capital of $317,000,000 by January 1 , 1838. So great an increase of banks and the consequent distention of the circulation, contributed, with other circumstances, to the general suspension of 1837.78 Wildcat currency secured a new lease on life ; this was espe cially true in Indiana, Illinois, and Wisconsin where notes could be issued on the security of various types of bonds. The great weak nesses of the banking and currency systems manifested them selves in the panics of 1837, 1857, and 1861. The general sus pension of specie payments in 1837 began in New York and soon reached to the other States, the New England banks holding out the longest. In 1838 a rather general resumption took place, but was followed by a second suspension in 1839, which was accom panied by many failures especially in the West and South . This was the real collapse of the system ; 343 out of 850 banks closed entirely, and 62 partially. This second suspension lasted in Pennsylvania until January, 1841.79 The western free banks had a large circulation outstanding, when most of them went down in the crash of 1857, which was due partly to heavy railway expenditures and partly to general busi ness expenses. Out of the 94 free banks in Indiana, 51 had sus pended even before the panic of 1857. These banks went down again in the crash of 1861 and their securities pressed on the market sank to low figures, the notes falling even lower than the securities. In writing of these banks Horace White said : " What " 11 Pet. 257 ( 1837 ) . 18Tucker, op. cit ., p. 362. mw . G. Sumner, History of American Currency (New York, 1884 ), p. 132. CHECKS IN UNITED STATES PRIOR TO 1868 61 it turned ever may have been the design of the law-makers out to be a mere scheme to enable speculators to sell bonds to the . public, and continue to draw interest themselves. It was pos sible under these laws for a man to borrow, say, $ 100,000 of state bonds, deposit them with the auditor, receive from him circulating notes, buy wheat with these notes, send the wheat to New York, and sell it for money with which to buy more bonds to deposit with the auditor ; and so round and round. This was actually done in some cases, and it was considered an effective way of pro curing an adequate supply of money."80 This was not the experi ence, however, of those banks which issued notes on the basis of the general assets of the banks, as did the New England or the Louisiana banks, for example.81 Space will not permit even a general description of the char acteristics of the banking institutions as found in the different sections of the country during this period.82 Table V will give a fair picture of the sectional differences in 1838 : TABLE V Number and Condition of Banks of the United States, Jan. 1 , 1838 Local Division ' Eastern States No. .321 Middle States .213 Southern States Southwestern States Western States Pa. Bank of U. S.. Total 89 94 92 20 .829 Capital Notes in Circulation Deposits $ 65,257,540 81,169,776 32,111,573 75,048,052 29,049,837 $ 18,307,544 29,631,248 20,156,891 25,194,559 16,080,601 $ 11,412,803 35,000,000 6,768,067 2,617,253 $ 317,636,778 $116,138,910 $ 84,691,184 31,999,806 9,707,821 18,874,996 10,078,505 " Tucker, op . cit., p. 405. From the Report of the Secretary of the Treasury (Woodbury), June 7, 1838, 25th Cong., 20 Sess., Sen. Doc. No: 471, Vol. VÍ ( 1837-1838 ), p. 2. 'Eastern States — Maine, New Hampshire, Vermont, Massachusetts, Rhode Island, Connecticut. Middle States—New York, Pennsylvania, New Jersey, Delaware, Maryland, District of Columbia. Southern States— Virginia, North Carolina, South Carolina, Georgia, Florida. Southwestern States - Alabama, Louisiana, Mississippi, Arkansas, Tennessee. Western States — Kentucky, Mis souri, Illinois, Indiana, Ohio, Michigan, Wisconsin . The descriptions of the use of checks during the period, 1836 1863, are not strikingly different from those of the preceding period . Condy Raguet, writing in 1839, said : “ So true is it, that deposites [ sic ] constitute currency as much as bank notes, that in " Horace White, “National and State Banks, ” Sound Currency, Vol. IV, No. 10 ( New York, 1897 ) , pp. 8-9 . * C. A. Conant, “Banking on Business Assets," Sound Currency, Vol. IV, No. 23 ( New York, 1897 ) , p. 15. Such a description has been given by George Tucker, op. cit., pp. 362, 365, 366, 370-374 . 62 CLEARING AND COLLECTION OF CHECKS all our commercial cities, no other currency is used in all extensive transactions. In all the cities of the United States, nearly all pay ments of money, except in very small sums in retail transactions, are made in checks on banks, and it is very clear that if deposites were not as much currency in the money market as bank notes, all dealers and traders would be furnished with the latter, instead of the former ." 83 Deposits in large commercial cities constituted the largest portion of the currency. In the city of New York, on the 1st of June, 1837, shortly after the stoppage of specie pay ments, the amount of notes in circulation outstanding for all the city banks, was $5,283,950, while the amount of deposits, public and private, was $ 15,843,171 . By the contraction which sub sequently took place, the notes in circulation were reduced, by the 1st of April, 1838, to $2,322,186, and the deposits to $ 11, 492,486.84 He pointed out, moreover, that a large part of these notes were circulating at a distance from New York at all times. Condy Raguet said, further, that on November 3, 1838, the fifteen banks in Philadelphia, exclusive of the Pennsylvania Bank of the United States, had notes in circulation to the amount of $4,522,883, while the amount of the deposits was $6,813,503. " On the 1st of November of the same year, ” said Mr. Raguet, " the circulation of the [ Pennsylvania ] Bank of the United States (exclusive of post notes ) was $8,499,378, and the deposites $8,591,235, but of these notes by far the largest proportion were circulating at a distance from Philadelphia, and, consequently, formed no part of the currency of that city.985 The fact that in cities a very small amount of business was done by either bank notes or specie as compared with checks, while smaller towns used more notes and specie, and the isolated communities still more, was pointed out by H. C. Carey in 1840.86 Professor Dewey says that “... after 1840 there began to be an increase in deposits and a relative decrease in the use of bank notes. In that year de posits, for example, in New York amounted to only $16,000,000, but by 1860 they had increased over sevenfold, while capital and circulation increased only threefold. Specie holdings were about four times as much , but if the great increase in demand obligations of depositors is considered, this increase was entirely **Condy Raguet, A Treatise on Currency and Banking, 2nd ed. ( Philadel phia, 1840 ), p. 185. 841bid ., p. 186. 85Ibid ., p. 187. SºH . C. Carey, “ Medium of Exchange,” Hunt's Merchants' Magazine, Vol. III ( New York, 1840 ), p. 50. CHECKS IN UNITED STATES PRIOR TO 1863 63 inadequate. In 1857, when the panic occurred, the specie reserve amounted to only about 13 per cent. of the combined obligations of depositors and note holders. It was then realized as never be fore that deposits constituted a liability which it might be ex tremely difficult to meet in times of a crisis."87 Writing in 1841 , Gallatin pointed out that deposits consti tuted the principal currency in the larger cities but that country banks could not exist unless they had the right to issue notes.88 He insisted that the excess of note issues occurred principally in the western States and generally wherever country banks were established ; this was explained , as in Colonial days, on the ground of the lack of specie or capital.89 Stephen Colwell, writing in 1860, likewise pointed out tha: deposit currency constituted the principal medium of exchange and that after about 1835, bank notes steadily became of less im portance in the United States as compared with deposit currency. He said : “ . . . that the proportion of bank notes employed in Great Britain is decreasing, and has been for fifty years. A com parison of bank returns, in this country, for the last twenty - five years will exhibit a similar result. . • That which has been . most extensively employed, and which, to the greatest extent, sup planted the circulation of bank notes in Great Britain, and in the United States, is bank credits, which operate under the name of deposits. A very large proportion of the individual paper of men of business, in the United States, is discounted by the banks without taking the form of bank-notes, or being included in the circulation of the banks. The proceeds of the discounted paper are merely placed to the credit of the party, and take their place as deposits." 90 In another place he says : “The deposits in the principal cities greatly exceed in amount the circulation of the banks, and their operation or working is far more efficient and active than that of the bank -notes."91 He points out that the deposits consisted in part of bank notes absorbed from the circulation, but chiefly of credits granted upon the discount of commercial paper, and esti mated that probably not more than one per cent. of the deposits "D. R. Dewey, State Banking Before the Civil War, p. 215. * Adams, Gallatin , Vol. III, pp. 374-376. * Ibid ., p. 379. * Stephen Colwell, Ways and Means of Payment: A Full Analysis of the Credit System , with its Various Modes of Adjustment ( Philadelphia, 1860 ), p. 240 . Ibid. , p. 241 . 64 CLEARING AND COLLECTION OF CHECKS were made in gold or silver.2 In still another place, he pointed out that in the exercise of the agency of payment by banks, bank notes played but a small part.83 Further on he remarks : " The fund employed to effect payment of these great sums is mainly that which is called deposits in the banks. For, however great the amount of payments effected by the circulation of bank-notes deposits are the chief agent of the bank .”' 94 Finally he adds : “ A distinction should be made between country and city banks. The former issue bank-notes more largely, in propor tion to their capital and business, than the latter. The country banks, which rely for their business and profits upon their circu lation, have more to answer for, in reference to the over-issue of bank-notes."95 After the establishment of the Sub-Treasury System in 1846, the Federal government went on its way using specie in all its transactions, and gave up all responsibility for the currency used by the people. From this time until the Civil War, the country depended entirely on the local banks. But banking capital reached its lowest ebb in 1846, $196.9 millions ; bank note cur rency was at its lowest ebb in 1843, $58.6 millions. Banks dur ing this period had changed considerably as compared with any thing in their previous history. They ceased almost entirely to be political ; this was in part a consequence of their great number and the smallness of each. Banks also had ceased to be so mys terious. In spite of their opposition, they had been brought in this period to submit to the visitorial powers of the State and to make public statements of their affairs. In older parts of the country also the accumulation of capital had now become so great that the old banking system of paper-mongering was out of date, though the system was not given up by the banks in the country towns, by any means. “ The banker's art consisted still to a great extent, in getting a 'good circulation for his notes, and when to put them out and when to take them in ; but, at least in the large centers, the accumulation of capital was such as to feed the de posits and give the banks an opportunity for a higher art of bank ing.. In such places the circulation sank in importance. o Ibid ., p . 242. Ibid ., p. 445. «Ibid., p. 445 . esIbid ., p. 479. The CHECKS IN UNITED STATES PRIOR TO 1863 65 check began to supersede the bank note, and the predominance of the currency over the affairs of men began to decline."96 TABLE VI Number of Banks, Capital, Deposits and Circulation, 1830-1863 ( Capital, deposits and circulation in millions) Year 1830 ... 1831 . 1832 .. 1833 . 1834., No. of banks 394 426 448 472 506 Capital 182 186 191 198 200 1841. 784 231 251 290 317 327 358 313 1842 . 1843 . 692 260 691 696 707 707 715 751 782 824 879 228.9 210.9 206.0 196.9 750 1208 207.9 301.4 332.2 704 713 758 829 1835 . 1836 . 1837 . 1838 . 1839 . 1840 . 840 907 1844 . 1845 . 1846 . 1847 . 1848 . 1849 . 1850 . 1851 . 1852 . 1853 . 1854 . 1855 . 1856 . 1857 .. 1858 . 1859 . 1860 . 1861 . 1862 . 1863 . 1307 1398 1416 1422 1476 1562 1601 203.1 204.8 207.3 217.3 227.8 343.9 370.8 394.6 402.0 421.9 429.6 Deposits Circu lation 58 51 62 57 67 71 62 75 83 94 103 140 115 127 84 90 75 64 62 56.2 84.6 88.0 96.9 91.8 103.2 91.2 109.6 129.0 145.6 188.2 190.4 212.7 230.4 185.9 259.6 253.8 257.2 296.3 393.7 68 149 116 135 107 107 83.01 58.6 75.2 89.6 105.6 105.5 128.5 114.7 131.4 155.2 146.1 204.7 187.0 195.7 214.8 155 193.3 207.1 202.02 183.7 238.73 *Data for the years 1830-1842 from W. G. Sumner, A History of Banking in the United States ( New York, 1896 ) , p. 456. * Data for the years 1843-1861 from D. R. Dewey, Financial History of the United States, 8th ed. ( New York, 1922 ) , p. 260. 'Data for the years 1862-1863 from W. G. Sumner, History of American Currency (New York , 1884 ), p. 188 ; Report of the Comptroller of the Cur rency ( 1907 ) , p. 409. A general picture of the situation from 1830 to 1863 may seen from Tables VI and VII. be Although Table VI shows that "W. G. Sumner, History of Banking in the United States ( New York, 1896 ) , pp. 414-415 . 66 CLEARING AND COLLECTION OF CHECKS while deposits exceeded notes during the four years, 1830-1833, they did not succeed in passing them permanently until 1855.97 TABLE VII Condition of Banks by Sections, 1860-1861' No. of banks and Section Eastern States Middle States Southern States Southwestern States Western States Capital branches ( paid in ) $123,706,708 ..506 .488 .147 141 .319 160,085,360 56,282,622 62,941,011 26,577,012 Deposits $ 40,822,523 156,899,656 16,480,480 30,576,820 12,450,083 Notes $ 14,991,285 52,873,851 39,552,760 34,600,785 29,987,086 *Treasury Report of the United States on Finances for year ending 1861, pp. 278-280 . *Eastern States— Maine, New Hampshire, Vermont, Massachusetts, Rhode Island, Connecticut. Middle States — New York, New Jersey, Pennsylvania, Delaware ,Maryland. Southern States— Virginia , North and South Carolinas, Georgia, Florida. Southwestern States - Alabama, Louisiana, Mississippi, Ten nessee, Kentucky, Missouri. Western States — Illinois, Indiana, Ohio, Michigan, Wisconsin, Nebraska Territory, Minnesota, Kansas . It must not be supposed from the above discussion that all banks of issue were bad. Among the good banks of issue may be mentioned the Bank of Indiana, the banks of Louisiana and the banks in the Suffolk System of New England. But with the passing of the National Bank Act and the subsequent Act of 1865 the issues of all State banks alike were driven out. created a different situation. This Left without a medium which re sponded readily to the demands of trade, an extensive use of checks began, obviously not new in itself, but new in the sense that it took on an importance that has steadily increased. To the problems of this period a separate chapter is devoted. "Data and conclusions in Hunt's Merchants' Magazine, Vol. V ( New York, 1841 ), p. 186, do not harmonize with the data given by Sumner as set forth in Table VI. In the Merchants' Magazine it is said that from 1830 to 1840, cir culation exceeded every year the deposits commonly 20 per cent., and some times more. George Tucker in an article, “ Banks or No Banks, ” Hunt's Mer chants' Magazine, Vol. XXXVIII ( New York, 1858 ) , p. 150, says : “... from 1850 to 1856, while the circulation of all the banks in the United States had in creased from $ 105,000,000 to $ 175,000,000 — equal to an increase of 66 2-3 per cent., the deposits had increased in the same period from $90,000,000 to $ 240, 000,000_equal to 166 2-3 per cent., which last increase a recent English writer (Tooke, on Prices) notices as a most remarkable result. ” Such lack of harmony can be explained only on the ground of the inadequacy of official data. 1 CHAPTER III CLEARING AND COLLECTION OF CHECKS PRIOR TO 1869: Meaning of clearing and collection of checks In order to prevent confusion of thought, it is necessary, at the outset, to distinguish between the clearing and the collection of checks. A check is said to be collected when it reaches the bank on which drawn and arrangement is made to remit the proceeds. The actual payment of the debt is designated as collection. Sup pose there are but two banks, Bank A and Bank B, in a small town. Bank A receives checks on Bank B drawn by Mr. X, who is a depositor in Bank A. Bank A sends the checks by messenger to Bank B. The messenger presents the checks over the counter and Bank B, finding the checks valid, pays the messenger the amount called for. The checks are now collected. Suppose Bank B had checks on Bank A for the same amount ; Bank B would offset the claims of Bank A by presenting to the messenger an equal amount of claims. No money would be needed. The checks would now be cleared, but not collected so far as Bank A is concerned , as that. bank has had no chance to examine the checks delivered to the messenger. The messenger returns to Bank A with his checks and there it is learned that one is a forgery, another constitutes an overdraft, and still another has had payment on it stopped. These checks will not be paid, and will be returned to Bank B, either with or without protest, according to the practice of protesting. This should make clear the fact that clearing, which, in short , is an off setting of claims, is quite distinct from collection. With these checks returned to Bank B, Bank B is now obliged to settle the further claims of Bank A. When these claims are settled all the > checks are not only cleared but collected. It has just been said that the actual payment of a check is designated as collection. At what time in the physical handling of the check by the drawee bank is it paid ? The check is paid at the time it is charged to the drawer's account , and is cancelled ; there after the fund is held for the credit of the holder, the control of 67 68 CLEARING AND COLLECTION OF CHECKS the drawer ceases, and he has no right to stop payment, even though actual remittance has not been made. Where a check against sufficient funds is received by the drawee through the mail, it is paid at the time it is charged to the drawer's account and cancelled ; so that thereafter the drawer cannot stop payment, nor can a receiver or assignee of the drawer claim the fund, although remittance has not been made. Some courts hold the check paid even before charged to account, where it has been can celled and filed as paid. But where a check against insufficient funds or a forged check received through the mail is marked " paid ” by mistake and the mistake corrected before it is charged to the account, some authorities support the conclusion that the check is not paid finally, but that the mistake may be corrected and the check returned.2 Clearing, on the other hand , means an offsetting of claims, leaving only the net differences to be paid in some satisfactory manner. Clearing houses are perhaps our best examples of the offsetting process. All banks which are members of the clearing house association meet together, present their claims on each other and receive or pay favorable or unfavorable balances. Perfect clearing means a complete offsetting of claims with no payment of balances. If all banks in the United States could be brought into one clearing organization the offset would tend towards perfec tion, and all obligations resulting from the use of checks could be liquidated without the use of a more expensive medium. This would bring about the most effective use of deposit currency. Collection of checks must be effected regardless of whether there is a clearing mechanism. If there is a clearing of checks they yet remain to be collected, that is, sent to the drawee banks where arrangement is made for their payment. If the collection of checks is unaccompanied by any provision for offsetting, how ever , a great waste of time and money is involved. Under such a system, checks would be sent in every direction ; their paths would cross and recross one another ; messengers from one bank would be obliged to call at every other bank with all the attendant waste in time and energy. Consequently, it is of the utmost importance that the clearing principle be introduced wherever practicable in *T. B. Paton, Jr., Digest of Legal Opinions ( New York, 1922) , p. 198. Numerous cases are cited by Paton to uphold these views. 'Ibid. See also pp . 528-529 below . CLEARING AND COLLECTION PRIOR TO 1863 69 order to eliminate to the greatest possible extent all collections which are not subsequent to clearings. It has been a general practice in the past to deposit checks for credit and collection, a practice that has given rise to one of the most serious problems in our clearing and collection system, of which more will be said later. These items must be distinguished from the items usually spoken of as " collection items” or simply “ collections" which are deposited for collection and credit, in stead of credit and collection as is the usual case with checks. Collection items are more often notes, time and sight drafts, etc., although they may consist also of checks and bank drafts. The origin of the practice of clearing The clearing system is a development of a principle of Roman commercial law known as compensatio — the setting off of a debt one owes to another by a claim against him. This system at tained a high degree of perfection in the Middle Ages at the fairs of Lyons. Under an ordinance of Louis XI ( March 8, 1463 ) four fairs were authorized at stated intervals in each year, each of which was followed by a day of settlement fixed at the fair next preceding. Every banker came to these settlements prepared with a balance-sheet of his debts and credits. Three steps were required in completing settlements; first, the acceptance of bills by those upon whom drawn. This was necessary in order to de termine what items actually could be cleared. Then came the con parison of accounts, and finally the4 settlement in money, of which very little was ultimately required .* Rates of exchange for western Europe were fixed largely at Lyons, until the end of the 16th Century and the beginning of the 17th Century, then the Genoese attained predominance in financial matters, and the fairs of Placenzia became the clearing house of Europe. Admission to the clearings at Lyons required a guaran tee of 2,000 crowns, and paper to be settled there rested in a meas 'H. P. Willis, The Federal Reserve ( New York, 1915 ) , p. 223 ; J. T. Tal bert, “ Clearing-House and Domestic -Exchange Functions of the Federal Re serve Banks,” Proceedings of the Academy of Political Science, Vol. IV ( 1913 1914 ) , pp. 193-194 ; 0. Howard Wolfe, Practical Banking ( Chicago, 1920 ), Chaps. V , VI, XIII ;L. H. Langston, Practical Bank Operation, Vol. 1 ( New York , 1921 ), Chaps. IV -VII. * C. A. Conant, Principles of Money and Banking, Vol. II ( New York, 1905 ) , Bk. V, pp. 239-240. For an excellent account of the principal Mediaeva ) fairs, see Stephen Colwell, Ways and Means of Payment: A Full Analysis of the Credit System with its Various Modes of Adjustment ( Philadelphia, 1860 ) , Chap. XII . 70 CLEARING AND COLLECTION OF CHECKS ure upon the combined credit of all the great exchange houses of Europe. The quarterly settlements were made in a handsome building (a loge des changes ) erected by Soufflot, and were con tinued until the Revolution. The last settlement was in April, 1793.5 Knowledge of the methods of clearing practiced at Lyons was spread in the 18th Century over Europe by the translation of the work of Savary, Le Parfait Negociant. The origin of clearing houses The business of the clearing house is defined to be “ the effect ing, at one place, of the daily exchanges between several associated banks, and the payment at the same place of balances resulting from such exchanges." 7 To be more exact, a clearing house is an association of banks, ordinarily voluntary, to simplify and facili tate the exchanges of such items as notes, checks, bills and drafts, to facilitate settlements of balances among the banks, and to serve as a medium for united action upon all questions affecting their common welfare. In the words of Macleod, “The Clearing system is a device by which all the Banks which join in it are formed, for the purpose of transferring credits from one bank to another without the use of coin ; just in the same way as credits 8 are transferred in the same bank from one account to another, without the use of coin .” Clearing is, beyond all question, the simplest, the most economical, and when applicable, the most effi cient of all modes of paying debts. The first modern clearing house is said to be that founded at "C. A. Conant, “The Extension of the Clearing System,” Bankers' Maga zine, Vol . LXX ( 1905 ) , pp. 433-441. "C. A. Conant, Principles, etc., Vol. II, Chap. V ; Stephen Colwell, “ Principles of Finance, " Bankers' Magazine, Vol. XIII , old series ( July, 1858 -June, 1859 ), pp. 790-791 . H. D. McLeod takes issue with those who find in the old Mediaeval fairs the origin of our present clearing system. He insists that the present system has to do with bank credit and consequently could have had its origin only after bank credit came to be used generally. This system, he says, is not to be confused with the " set-off ” of debts which was practiced at the great Mediaeval fairs like those at Lyons. It seems, however, that Macleod's distinction between commercial credit set -offs and the clearing of bank credit has little value or validity and that it can be said that the germ of the clearing idea was to be found at the old Mediaeval fairs. See H. D. Macleod , The Theory and Practice of Banking, Vol. II ( London, 1876) , pp. 461-462 . O'Brien v. Grant, 146 N. Y. 163, 166 ( 1895 ) . *Banks are prohibited by statute in Mississippi (Code Section 3628 et seq.) from becoming members of unincorporated clearing house associations. See T. W. Paton, Jr., Digest of Legal Opinions ( New York, 1922 ) , p. 225. *H . D. Macleod, The Theory of Credit, Vol. II ( London, 1890 ) , p. 380. CLEARING AND COLLECTION PRIOR TO 1863 71 Edinburgh, Scotland, in 1760.10 The London Clearing House was founded in 1773 ; Dublin followed in 1846 ; New York City, 1853 ; Paris, 1872 ; Vienna, 1872, although some local banks cleared as early as 1864 ; Berlin, 1883 ; St. Petersburg in 1898. In the United States there were but six clearing houses in existence at the outbreak of the Civil War. They were organized in the following order : New York City, 1853 ; Boston, 1855 ; Philadel phia, 1858 ; Baltimore, 1858 ; Cleveland, 1858 ; and Worcester, Massachusetts, 1861.11 Collection of checks before the days of the clearing house Before the days of the clearing house in this county, the clear ing or liquidation among banks of all mutual claims, except those arising from their circulation, was accomplished mainly on their ledgers, and by correspondence. Whatever sum was received for the account of any bank by another, was credited accordingly ; whatever claim was received by one bank on another, was charged. These debtor and creditor transactions thus became items of book account, the accounts running from year to year, being balanced as often as necessary to make out the balance sheet. So far as the respective charges and credits balanced each other, the mutual indebtedness of the banks was paid, and the claims held by the cus tomers of one bank against the customers of another were dis charged, due solely to bookkeeping operations and correspondence among the banks involved. The effect was much the same as if all 10C . A. Conant, “The Extension of the Clearing System,” Bankers Maga zine, Vol. LXX ( 1905) , pp. 433-441. Mr. Conant receives no support for this statement. William H. Howarth, Our Clearing System and Clearing Houses House, but ( London, 1897 ) , p. 24 , does not mention the Edinburgh Clearing System was no doubt that the Clearing says that there seems to be “ established before 1773, though its early days are shrouded in the darkest of origin of the clearing house in London. W. Stanley Jevons, Money and the and most profound mystery." The year 1775 frequently is given as the date Mechanism of Exchange ( New York, 1876 ) , pp. 263-264, says it originated about 1775. Mr. R. M. Holland, The London Bankers Clearing House , U. S. Nat . Mon. Com . Pubs., 61st Cong, 2d Sess. , Sen. Doc. No. 492, pp . 268-269, says that about the year 1770, according to tradition, the walk clerks from the city and West End banks had made a practice of meeting at lunch time at a public house and exchanging checks, the balances being settled in notes and cash. He finds proof that a room was rented in 1773 for this purpose. Mr. Ralph Van Vechten says it is not certain just when clearing houses originated, but claims that there was one in Florence in 800 A. D., and something very similar to a clearing house in Tokio about 2600 B. C. No authority is cited for these statements, and the writer has been unable to find any support for them . See his statements in Proceedings of the American Bankers' Association ( 1912 ) , p. 506 . " D. P. Bailey, The Clearing House System ( New York, 1890 ) , pp . 4 , 36 ; Bankers' Magazine, Vol. XLIV ( 1890-1891), pp. 606, 660, 919 ; Vol. XLV ( 1890-1891 ) , pp. 25, 28, 108, 684-685. 72 CLEARING AND COLLECTION OF CHECKS the customers had kept their accounts with one central bank and had all their claims offset on its books. The practice of keeping mutual accounts ( not deposits ) was widespread, and most of the settlements were effected in this manner, thus reducing to a mini mum the shipments of actual money required to liquidate adverse balances. Roughly, the result of these accounts and the corre spondence by which they were maintained was much the same as if they all had had a clearing office, except, of course, that the system was much less effective and economical. At the best, there were many shipments of money to liquidate adverse balances. The banks also kept deposits with each other. The position of many banks and the nature of the trade among their customers made it necessary for such banks to keep deposits in financial cen ters. Against these deposits the banks drew bills to meet the dis tant obligations of their customers, or built them up by having distant sums collected and credited to their accounts. Most banks found it necessary to carry deposits in leading financial centers. Some bore interest, while others did not ; various arrangements were made, many favors and concessions were granted. Such correspondent relations are still common among banks in this country, despite the fact that the Federal Reserve System is at tempting to provide a more ideal and effective system.12 During certain seasons of the year, it frequently became diffi cult to maintain sufficient balances in the financial centers to meet the demands of their customers for drafts on those centers. Funds in those centers then would command a premium. At such times, banks frequently would dispose of checks which they held drawn on banks of such cities at a profit.13 On checks drawn on New York funds and payable in eight or ten days, the National Bank of Providence during the '30s frequently charged 12 of 1 per cent. premium and interest. Providence banks were known to have taken as high as 1 per cent. on checks in addition to the time the checks had to run, while the Newport Exchange Bank charged 14 as much as 11/2 per cent. on New York checks payable at sight. 12Colwell, op. cit ., pp. 269-272. 15J. J. Klein , “The Development of Mercantile Instruments,” Journal of Accountancy, Vol. XII ( 1911 ), p. 537. " Report of the Committee Appointed by the General Assembly of the State of Rhode Island and Providence Plantations to Visit and Examine the Banks in this State ( Newport and Providence, 1836 ) , pp. 15, 19, 22. In connection with discounting, a practice which seemed to be common prior to about 1820 was for banks, such as those in Baltimore, for example, which had eastern funds in excess, to refuse to discount notes unless the owners would take checks on Philadelphia instead of receiving credit on the banks' books for the result of the discount. See Klein, op. cit., p. 440 . 78 CLEARING AND COLLECTION PRIOR TO 1863 Rates of exchange and discounts and premiums on checks seemed to vary with the avarice of the dealers in exchange, the necessity of the borrowers, the state of the money market, and the charges of other banks . With but few exceptions it was the general practice, prior to the introduction of the clearing house, for banks with checks on other banks within the same city to effect their collections by pres entation over the counters through the agency of messengers. It is definitely known, however, that by 1793 the United States Bank maintained close relations with the Bank of North America and the Bank of Pennsylvania, making daily settlements and exchang ing notes daily. The same co-operation existed at first between the New York branch of the United States Bank and the Bank of New York . It is presumed that checks were included in the settlements.15 The Suffolk principle of par collection One of the best-known instances in which the principle of speedy collection was applied in this country was under the so called Suffolk Bank System of New England where it was applied to bank notes. This principle which has proved so important not only in note collection but more recently in the collection of checks, deserves a brief study. The Suffolk Plan was inaugurated in 1819 by the Suffolk Bank of Boston in order to force country banks to redeem at par their notes which were circulating in Boston at a discount and against which the notes of the Boston banks could not make headway, as the Boston notes were speedily redeemed over the counters of the Boston banks. In that year the Suffolk Bank announced that iſ any bank would deposit with it $5,000 as a permanent deposit , with such further sums as would be sufficient from time to time to redeem its bills taken by the Suffolk Bank, such bank should have the privilege of receiving its own bills at the same discount at which they were purchased. Should any bank refuse to make such a deposit its bills were to be sent home for payment at such times and in such manner as the Suffolk Bank might see fit. The Suffolk Bank, competing with the New England Bank, which since 1813 had been doing much to reduce the rate of dis count on country bank notes by offering to send them home for customers at cost, failed to drive country bank notes out of Bos 165. T. Holdsworth, First Bank of the United States, U. S. Nat. Mon. Com . Pubs., 61st Cong., 2d Sess., Sen. Doc. No. 571 , p. 40. CLEARING AND COLLECTION OF CHECKS 74 ton. In 1824 the Suffolk Bank entered into an agreement with six other Boston banks by which they were to subscribe to a fund of $ 300,000, to be kept in the Suffolk Bank, and to be used for the purpose of buying up country bank notes at a discount to send home for redemption, thus creating a vacuum for the currency of the seven Boston banks. After a year's experience the Suffolk Bank agreed to receive the notes of any New England bank at par provided it would carry a minimum permanent deposit of $2,000, free of interest, the amount depending upon the capital and business of the depositing bank. “ In consideration of this deposit the Suffolk Bank redeemed all the bills of that bank which might come in from any source, charging the redeemed bills to the issuing bank once a week, or whenever they amounted to aa certain fixed sum ; provided, the bank kept a sufficient amount of funds to its credit, independent of the permanent deposit, to redeem all of its bills which might come into possession of the Suffolk Bank ; the latter charging interest when ever the amount redeemed should exceed the funds to its credit ; and if at any time the excess should be greater than the perma nent deposit, the Suffolk Bank reserved the right of sending home the bills for specie redemption. In payment the Suffolk Bank re ceived from any of the New England banks which kept an account with it the bills of any New England bank in good standing, at par, placing them to the credit of the bank sending them on the day following their receipt." 16 When any bank refused to join in the Suffolk System, the Suffolk Bank simply presented its notes for payment at its counter. Most of the State banks soon gave up the struggle against the system with the result that bank note currency was soon circulating at par and on a sound basis throughout New England. This established the system of par collection of notes for New England. The United States is now endeavoring to apply the same principle to the collection of checks. Banks must redeem their notes at once and in full when presented over the counter Out of the opposition to the establishment of the system of par collection of bank notes came another principle which has its significance today with reference to checks, that is , that a bank 19L . Carroll Root, “ New England Bank Currency,” Sound Currency, Vol. II , No. 13 ( New York, 1895 ) , p. 278. CLEARING AND COLLECTION PRIOR TO 1863 75 must redeem its notes at par, to any amount, and at once when presented over its counter if there is no statute to the contrary. The case of the Suffolk Bank v . the Lincoln Bank, 182117 Action was taken by the Suffolk Bank in 1821 against the Lin coln Bank at Bath, Maine, for dilatory practices which resulted in an important decision relative to the prompt redemption of notes. An agent from the Suffolk Bank presented at the Lincoln Bank bills to the amount of $3,000 very soon after the commence ment of the usual banking hours. The cashier immediately offered to pay the amount in the bills of the banks in Boston, and among others, partly in those of the Suffolk Bank, or by check or draft on a bank in Boston, both of which proposals were declined by the agent, who demanded payment in specie. The cashier then began to count small pieces of silver change in denominations no larger than a quarter of a dollar. At the rate of counting he could not count more than $1,000 before closing time. The Suffolk Bank agent offered to take the specie at the count of the bank, but the cashier declined to deliver it. The agent left the bank with his bills and the Suffolk Bank entered suit in the Circuit Court of the United States at Portland. Associate Justice Story, in summing up to the jury, said, among other things : " The act of Massachusetts ( Stat. 1809, ch. 38) , under which this suit was brought,18 declares, that, 'if any incorporated bank shall refuse or neglect to pay on demand any bill or bills by such bank issued, such bank shall be liable to pay to the holder of such bill or bills after the rate of two per cent. per month on the amount thereof from the time of such neglect or refusal, to be recovered as additional damages in any action against the bank for the recovery of the said bill or bills.' It is the duty of every bank to pay its bills in specie on demand, if such demand is made at the bank within the usual banking hours, and the omission to pay under such circumstances, is a neglect or "The President, Directors, and Company of the Suffolk Bank v . The President, Directors, and Company of the Lincoln Bank, 3 Mason 1 (1821). See also J. Collection,” 18It will Bath under D. Magee, “ Historical Analogy to the Fight Against Par Check Journal of Political Economy, Vol. XXXI ( 1923 ), pp. 433-415. be noticed that this suit was brought against a Maine bank at a Massachusetts law. Maine became a State separate from Massa chusetts in March, 1820, and apparently carried into the new State this law until such time as it could develop its own laws. The Veazie Bank of Bangor, which offered strenuous opposition to the Suffolk Bank System, later succeeded in getting a law passed giving the banks of Maine a certain delay, after the demand at their counters, in which to redeem their notes in specie. See D. R. Whitney, The Suffolk Bank ( Cambridge, 1878 ) , p. 49. 76 CLEARING AND COLLECTION OF CHECKS refusal within the meaning of the act. There is no pretense to say, that a bank has a right to delay the holder of its bills, day after day, while its officers can count out change so as to make up the amount in the smallest species of coin in their own way. Every bank is bound either to have its specie counted or weighed, and ready for delivery, or to have servants sufficient to count and weigh it, and to pay it out for all demands made during the usual bank ing hours. I do not say, that if a very large demand be made just before the closing of a bank , so that a reasonable time may not exist to count, weigh, or deliver it, an omission to pay until the next day would, under the circumstances, be unjustifiable. But on this point, I give no opinion, as it is not necessary in the . present case. . . “ It is said that the cashier offered to pay the amount in Boston bills, or by draft on Boston. But this constitutes no legal excuse. Every bank is bound to pay specie for its bills, and . nothing else is of good tender. Every other arrangement is a matter of courtesy, and not of right. . . Now as a matter of . prudence it may be admitted to have been proper for the cashier to count his specie before delivery ; but as matter of right, his con duct cannot be justified, if his intention was thereby unreasonably to delay payment to the agent, and thus to create an impossibility of his receiving the amount on that day. I go farther and hold, that if in fact, by such conduct, the payment of the amount on the day of demand was necessarily defeated, it comes within the provi sion of the act, whether there was wrongful intention or not. It was a neglect to pay, and occasioned by the want of due diligence on the part of the officers of the bank. .. It has been inti mated that each bank-bill should have been separately presented for payment and separately paid. But there is no foundation in law for that suggestion. The holder had a right to demand the whole at once as an aggregate sum, and the bank was bound to pay the whole.” The verdict was for the plaintiff with 2 per cent. damages. The same principle was upheld in Massachusetts in 19 1827 in the case of the Suffolk Bank v. The Worcester Bank . The principles set forth in the above cases are important not only because of the clearness with which the court established the liabilities and responsibilities of banks with respect to their note issues, but because of the indirect bearing of these principles upon the banks' liabilities and responsibilities with respect to deposit 1922 Mass. 106 ( 1827 ) . CLEARING AND COLLECTION PRIOR TO 1863 77 currency as evidenced by checks. Writers in the field of banking have emphasized continually the similarity between notes and de posits as demand liabilities of the bank ; indeed, some of them have entered into lengthy arguments to demonstrate the practical iden tity of the two types of demand liabilities so far as the bank is concerned. This view has been held generally. Consequently, the natural conclusion has been that if the holder of bank notes has the right to demand the whole at once as an aggregate suni, and the bank is bound to pay the whole, the same principle applies to checks when presented over the counter. In general, this prin ciple has been applied to checks by various courts which have long held that when checks are presented directly over the counters of the drawee banks they must be paid at once and in full without de duction. The reasoning from this analogy frequently has been that just as bank notes are demand liabilities of the bank and payable in lawful money to the holder upon demand, so are checks payable in lawful money to the holder when presented directly over the counter of the drawee bank. In fact, the definition of the check might lead to such conclusions ; the usual definition being something like the following : A check is an unconditional order in writing addressed by a person ( the drawer) to a bank, signed by the drawer, requiring the bank to which it is addressed to pay a sum certain in money on demand to a person named or to his order or to bearer.20 The United States Supreme Court has taken a different position recently with respect to the drawee bank's lia bility to any holder other than the depositor for checks presented directly over its counter.21 It holds that the bank's liability is to the depositor only, and not to the holder, and may pay the holder in drafts on reserve deposits provided the depositor does not ob ject, and he is assumed to agree unless he specifies to the con trary on the check when he draws it on the bank. This decision is in harmony with the majority of opinions interpreting the Nego tiable Instruments Law with respect to the nature of checks and makes it obviously unsafe to be insistent upon the similarity be tween the two types of demand liabilities of banks . 20J. D. Brannan , The Negotiable Instruments Law Annotated, 3rd ed. ( Cincinnati, 1919 ) , Sections 126, 185 ; H. W. Magee, A Treatise on the Law of National and State Banks, 3rd ed . ( Albany, N. Y., 1921 ) , p. 310. See also pp. 1-2 above. " Farmers and Merchants Bank of Monroe, North Carolina, et al. v. Federal Reserve Bank of Richmond, Virginia , 262 U. S. 619 ( 1923 ). See Chapter VII , but especially pp. 272-274 below . CLEARING AND COLLECTION OF CHECKS 78 The later years of the Suffolk System The suspension of specie payments in 1837 put an end to the coercive measures on the part of the Suffolk Bank, and conse quently each bank was left to its own volition. Many of them con tinued to redeem their bills at the Suffolk Bank as they had dono in the past, with the result that these bills passed current all over the country and in some places even commanded a premium. At the resumption of specie payments the Suffolk Bank was able to take its old place at the head of the redemption system which it maintained until about 1858, when it gave way largely to the Bank of Mutual Redemption. This bank had been organized to take over the functions of the Suffolk Bank ; it was to be owned by the New England banks so that they could share in the profits which had gone exclusively to the Suffolk Bank . Although the Bank of Mutual Redemption asumed most of the redemption func tions of the Suffolk Bank, both banks shared the business until the suspension of specie payments in 1861 which practically broke down the system , although the currency was of well -recognized soundness when the National Banking System appeared upon the scene . 22 Other methods of note collection No effort will be made to give an account of the methods used in other sections of the country for the collection of bank notes except to say that collection agencies were commonly established for the purpose. By 1850 there were two agencies in New York State and seventy in the western States.23 Some of the notes of every bank were returned to it through the agency of brokers, who, “ like separate and peculiar absorbents, soaked up, by pur chase at a small discount, bank notes which had been casually car. ried out of their proper sphere of action, and thereby became a sort of merchandise more or less depreciated in value, as the notes wandered far from home, and lost their properties as currency.24 Special arrangements were made in different localities at differ ent times for note redemption. For example, the second United States Bank, as a means of securing resumption of specie pay *D. R. Whitney, op. cit., passim ; L. Carroll Root, op. cit., passim . *Bankers' Magazine, Vol . V ( 1850-1851 ) , pp . 467, 514. See also Merchants ' Magazine , Vol . XXII ( 1850 ) , pp . 225-226 ; Vol. XXV ( 1851 ) , pp. 112-113 ; Vol. XXXIII ( 1855 ) , pp . 475-477 ; Vol . XXXVI ( 1857 ) , pp . 727-728 ; and Vol. XXXVIII ( 1858 ) , pp. 733-731. **A . B. Johnson, “ A Treatise on Banking , " The Bankers' Common -Place . 9 Book ( New York, 1857 ) , p. 23. CLEARING AND COLLECTION PRIOR TO 1863 79 ments, made an arrangement with the State banks establishing a rule by which they were to settle for their notes at least а once each week . Gallatin recommended a clearing system for checks, 1841 Gallatin, writing in 1841 relative to the situation following suspension of specie payments in 1837, said : “ Few regulations would be more useful in preventing dangerous expansions of discounts and issues on the part of the city banks than a regu lar exchange of notes and checks, and an actual daily or semi weekly payment of the balances." 25 After mentioning the Scotch and English clearing systems, he continued : “ The principal diffi culty in the way of an arrangement for that purpose is the want of a common medium other than specie for effecting the payment of balances. These are daily fluctuating ; and a perpetual draw ing and redrawing of specie from and into the banks is unpopular and inconvenient. " In order to remedy this it has been suggested that a general cash office might be established in which each bank should place a sum in specie proportionate to its capital, which would be carried to its credit in the books of the office. Each bank would be daily debited and credited in those books for the balance of its account with all the other banks. Each bank might at any time draw for specie on the office for the excess of credit beyond its quota, and each bank should be obliged to replenish its quota whenever it was " diminished one-half, or in any other proportion agreed on . " 26 He thought that some similar arrangement might be made in every other county or larger convenient district of the United States, without the necessity of establishing there a general cash office, the balances to be paid by drafts on New York.27 In the same year a Mr. Wetmore of New York City proposed a plan for a National Bank with branches, and among the provi sions in the plan was one for the clearing and collection of checks * Adams, Writings of Galatin, Vol. III, ( Philadelphia, 1879 ) , p. 424. * Ibid ., pp. 424-425 . ** Ibid . James G. Cannon in his Clearing Houses (New York, 1900) , pp. 130–131, says Gallatin recommended clearing houses in 1831. He is in error on this point since he relies for his authority upon a pamphlet written by Gallatin in 1841, entitled, “Suggestions on the Banks and Currency of the several United States, in reference principally to the suspension of specie payments.” The same article is in Adams, Writings of Gallatin , III, pp. 424 425. Cannon may have relied upon Gibbons for this information as the quotations are identical in every respect with the exception of the date. See J. S. Gibbons, The Banks of New York, Their Dealers, The Clearing House and the Panic of 1857 ( New York , 1859 ) , pp . 339-340. CLEARING AND COLLECTION OF CHECKS 80 at par. Balances were to be settled daily by the bank and branches, at their places of business, and weekly with those banks at a distance.28 Although no clearing house was established before 1853, Phil adelphia had taken steps to simplify city clearings and collections by 1852. The clerks of the various banks met every morning at the Philadelphia Bank to make the exchanges by reception from each other of notes and checks received the day previous. The cashiers met twice each week to settle balances, with the exception of the months of July and August when they met but once each week . At these meetings the banks were called over by the chair man, each cashier announcing how he stood, either debit or credit ; when all were called over by the chairman, the aggregate credits and debits balanced. The debtor banks gave checks for the amount of their indebtedness to the creditor banks.29 The New York City Clearing House, 1853 The banks of New York City, in 1853, organized the first clearing house established in the United States. According to James C. Hallock, Jr., the plan was devised by his father, although there are evidences of many similar, if not identical, plans sug gested during the few years just prior to 1853. At that time each of the fifty -two banks had daily received over its counter, or by mail, checks on every other bank in the city . To collect them the banks had opened deposit accounts with one another ; each bank had become a depositor in fifty -one other banks. The pass-books used were of the ordinary form. Each bank, however, did not send a messenger to fifty -one banks daily ; they had simplified that work by one-half. For many years prior to 1853 the banks had tacitly agreed that each would send mes sengers to the other half for six months. For example, the Chatham Bank would have checks on the Merchant's Bank. It would list them on a deposit slip, charge the Merchant's Bank with the amount in its pass-book and place the checks on the book which the messenger would carry to the Merchant's Bank and de liver to its receiving teller. The latter would remove the checks and, having some on the Chatham Bank with list attached, he would credit his bank with the amount in the pass-book, place the package in it and hand it back thus refilled to the messenger. 18W. S. Wetmore,“ Plan of a National Bank , " Merchants' Magazine, Vol. IV ( New York, 1841 ) , pp. 531-533. "Bankers' Magazine, Vol. VI ( 1851-1852 ) , pp. 657-658. CLEARING AND COLLECTION PRIOR TO 1863 81 When banks exchanged checks in the above manner the amounts were almost always unequal, leaving a balance for one to pay and the other to receive. Had each bank settled daily there would have been fifty -one balances to pay and receive. Instead of attempting to settle balances daily, which would have consumed hours and caused much annoyance, as balances were payable in coin, the banks made weekly settlements after the exchange of Friday morning. On settlement day the cashier of each bank would draw drafts for every debt due him by other banks, and send out the messengers to collect them. “ Over fifty porters were out at once with an aggregate of several hundred bank drafts in their pockets, balking each other, drawing specie at some places, and depositing it in others ; and the whole process was one of con fusion, disputes and unavoidable blunders, of which no description could give an exact impression." 30 The institution of the New York Clearing House in 1853 altered the entire situation. Every bank sent to the clearing house by messenger all the checks it had on all the other member banks and charged the whole amount against the clearing house. Every bank received there all the checks which all the other banks had on it, the sum representing the total of the claims which the clearing house had against it. A balance was struck and if the bank had a debit balance, it paid the clearing house ; if it had a credit balance the clearing house paid the bank. Since the original clearing house was in principle and daily routine practically the same as the one of today, a detailed de scription of the clearing house will be reserved until a later chap ter in which the operations of the modern clearing house will be studied.31 The newly -organized clearing house saved every bank in the city, on the average, about twenty -five daily trips to exchange checks with other banks ; it saved every bank in the association the payment or receipt, mostly in coin, of approximately fifty balances on settlement day ; it substituted daily for weekly set tlements and at the same time saved the banks all the drudgery, irritation and anxiety which had made daily settlements imprac ticable ; it saved all the banks the trouble of keeping accounts with one another ; it relieved them of the risk of transporting *OJ. S. Gibbons, op. cit., pp. 293-294 ; also quoted by J. C. Hallock, Jr., Clearing Out-of- Town Checks ( St. Louis, 1903) , pp. 7-8 . nSee Chapter X below . An excellent account, with cuts , of the original clearing house, is given by J. S. Gibbons, op. cit., Chap. XVIII ; for another account see Merchants' Magazine, Vol. XLII ( 1860 ) , pp. 213-214 . 82 CLEARING AND COLLECTION OF CHECKS money from place to place ; it freed them from all injurious de pendence on each other ; and finally, the books of the clearing house afforded facility for knowing at all times the management and standing of every bank in the association. "Regular periodic statements as to condition were required from the associated banks by the clearing housemat that time weekly and quarterly statements — which tended to secure greater reliability and accu racy than was accomplished prior to that time when the banks “ dressed up” weekly statements before publishing them in the newspapers, and quarterly statements before sending them to the Bank Department at Albany. This situation was changed because the clearing house transactions revealed their conditions and forced the banks to liquidate among themselves.. Aside from requiring regular reports from the associated banks the clearing house assumed few of the special functions and practices so common with modern clearing houses. The settle ment of balances was effected in clearing house certificates, the gold to which the certificates constituted claims, being deposited in one of the banks designated as a depository. But of clearing house loan certificates as a means of meeting times of stress, the association knew nothing . The clearing house in the panic of 1857 The newly-organized clearing house was virtually helpless in the panic of 1857 which was precipitated so suddenly in August of that year by the failure of the Ohio Life Insurance & Trust Company. Indeed, it was not only helpless, but contributed some what to the hard times through its exactions from the struggling member banks. The failure of the Ohio Life Insurance & Trust Company was followed rapidly by the failure of the Bank of Pennsylvania in Philadelphia, which, in turn, was followed by other banks in that city, by those in Baltimore, and by those in the southern Atlantii: States generally. Commercial business was suspended everywhere. The avalanche of discredit swept down merchants, bankers, moneyed corporations, and manufacturing companies, without Old houses, with accumulated capital which had withstood the violence of former panics, were prostrated in a day, distinction . when they believed themselves safe against misfortune. The bank suspension of New York and New England, in the middle of Octo ber, caused primarily by the calls of interior depositing banks and CLEARING AND COLLECTION PRIOR TO 1863 83 • the action of the home depositors, was the climax of this commer cial hurricane 32 In the midst of this panic the New York Clearing House was helpless. The reports of the clearing house were watched by the community with anxiety, which had every effect other than that of creating confidence. The clearing house daily settlements in coin exerted a crushing influence on the commercial interests and became a new source of terror. “ What in ordinary times was a safeguard against the unwise expansion of bank credits, was now a remorseless power compelling the smaller banks — the majority of the wholeto a violent contraction of their loans to dealers , forcing them into the sacrifice of property, and finally into bank ruptcy ; thus sending out through a thousand channels new streams of misfortune. Default at the Clearing House, was the presiding spectre at every Bank Board of the smaller institu tions. "33 It did not occur to the managing committee of the clearing house to relax its destructive energy while there was yet a chance of preserving specie payments. They thought of it after it was too late to be of any material service to the merchants. They later admitted bank currency, representing the State debt and the debt of the United States, as a substitute for coin in the daily settlements, and found it of great service in preventing further depreciation, and in repairing the mischief that had been done. Gibbons summarized the situation by saying : “ It is often the case, that things good in themselves become hurtful by a change of cir cumstances which destroys their fitness. This may be said of the clearing house, without detracting from its real value to our financial interests ." 34 In subsequent panics, however, the clearing houses resorted to loan certificates and similar instruments as the most effective weapons at their command and were more successful in aiding the member banks. An account of the use of such emergency meas ures as well as other special functions assumed by clearing houses. after the establishment of the National Banking System is given in Chapter V. " Gibbons, op. cit., Chap. XIX. * Ibid ., p. 363. " Ibid ., p. 364. CHAPTER IV THE CLEARING AND COLLECTION SYSTEM, 1863-1914 The growth of deposit currency As we have seen , deposits definitely passed bank note cur rency in 1855 and according to the data given in Table VIII below, have maintained that supremacy and steadily increased in importance since that time. By taxing State bank notes out of existence in 1865, a vacuum was created which gave an added im petus to the use of deposit currency. Other factors which were responsible for the increasing use of deposit currency , and con sequently, checks, were the inelastic note currency, better means of communication, the cheap and uniform postage rates, and the denser population. TABLE VIII Circulation and Deposits of National, State, Savings, and Private Banks, Loan and Trust Companies [ Amounts in millions ) Year 1855 1856 1857 1858 1859 1860 1861 1862 1863 1864 1865 1866 1867 1868 1869 1870 Circu lation U.S. Individual Total deposits deposits deposits 186.9 195.7 214.8 155.2 193.3 207.1 202.0 190.4 212.7 230.4 185.9 259.6 253.8 257.2 296.3 293.7 183.8 1871 238.7 163.4 131.5 267.8 291.8 294.9 292.7 291.8 315.5 1872 327.1 1873 1874 338.7 310.2 355.7 355.7 58.0 640.0 39.1 815.8 876.6 968.6 698.0 854.9 33.3 28.3 12.8 13.2 11.1 12.4 15.1 10.6 909.9 996.9 1,032.2 1,034.8 1,051.3 1,064.5 1,262.7 1,251.6 1,353.8 1,421.2 1,526.5 1,366.2 1,436.3 1,537.1 With the establishment of the penny postage in London in 1840, country checks began to stream into London. J. C. Hallock, Jr., Clearing Out-of- Town Checks ( St. Louis, 1903 ) , p. 28. 84 86 CLEARING AND COLLECTION, 1863-1914 TABLE VIII- ( Continued ) Year 1875 1876 1877 1878 1879 1880 1881 1882 1883 1884 1885 1886 1887 1888 1889 1890 1891 1892 1893 1894 1895 1896 1897 1898 1899 1900 1901 1902 1903 1904 1905 1906 1907 1908 1909 1910 1911 1912 * 1913 1914) 1915 1916 1917 1918 1919 1920 1921 19221 1929 ° 1924 Circu lation 318.8 294.8 290.4 300.4 307.7 318.4 312.5 309.2 312.2 295.3 269.2 238.0 166.8 155.5 129.0 126.5 124.0 141.2 155.1 171.8 178.8 199.2 196.6 189.9 199.4 265.3 319.0 309.4 359.2 399.6 445.5 510.9 547.9 613.7 636.3 675.6 681.7 745.1 759.2 750.7 867.1 ° 902.5 ° 1,256.00 2,430.8 ° 3,307.59 4,017.0 " 3,558.8° 2,938.34 2,966.4 ° 2,587.0° U.S. Individual Total deposits deposits deposits 1,797.2 1,789.7 10.2 1,787,0 11.1 1,778.6 10.9 1,813.6 1,717.4 1,694.2 1,951.6 2,296.8 2,460.1 2,568.4 2,566.4 2,734.3 2,812.0 1,743.0 1,946.3 1,962.3 2,309.0 2,472.7 2,582.3 2,580.6 2,748.3 2,829.1 3,308,2 3,331.4 3,422.7 3,778.1 4,062.5 4,196.8 4,664.9 4,627.3 4,651.2 4,921.3 3,481.1 3,824.8 4,093,1 4,222.7 4,679.1 4,641.0 4,665.3 4,934.5 4,960.5 6,111.1 5,741.1 6,845.0 7,337.8 8,559.7 9,228.7 9,700.9 10,110.8 11,426.0 12,305.7 13,280.3 12,914.8 25.6 252.1 10.7 12.2 12.6 13.9 14.2 14.0 17.1 23.2 58.4 26.7 30.6 25.9 14.2 13,7 14.1 13.2 15.4 16.4 52.9 76.3 98.9 99.1 124.0 147.3 110.3 75.3 89.9 180.7 130.3 70.4 54.5 48.5 58.18 49.3 65.8% 49.09 39.5 133.0 1,037.8 566.8 175.8 390.2 128.9 238.4 4,945.1 5,094.7 5,688,2 6,768.7 7,238.9 8,460.6 9,104.7 9,553.6 10,000.5 11,350.7 12,215.8 1,824.5 13,099.6 12,784.5 14,035.5 15,283.4 15,906.3 17,024.0 17,475.8 18,517.7 19,135.4 22,873,5 19,184.4 22,913.0 26,396.2 26,529.2 27,956.4 33,211.6 37,830.0 35,459.2 37,194.3 40,034.2 28,994.2 33,778.4 38,005.8 35,849.4 14,105.9 15,337.9 15,954.8 17,082.1 17,525.1 18,583.5 37,323.2 40,272.6 *Data for the years 1855-1864 are found in the Report of the Comptrolhør of the Currency ( 1907 ), pp. 150, 409. These data do not harmonize with data given on pp. 412-413 of the same report, and can serve only as a rough indica tion of general conditions. Data for the years 1864-1907 were compiled from the same report, p. 413, and from the Report of the Comptroller of the Currency ( 1911 ) , pp. 804-805. The years 1864-1911 include State bank circulation. The term “ circulation” is consistently smaller than theamount of “ national bank notes outstanding ” as given in other tables. Furthermore, there are glaring. CLEARING AND COLLECTION OF CHECKS 86 discrepancies between this table and the table given on p . 150 of the 1907 report. Items of circulation, in the table given here (Table VIII ) , appear to be net rather than gross; this seems to be the only grounds on which to explain the discrepancies. This table is virtually the same as that given by Mr. A. P. Andrew , stics of the United States, 1867-1909, U. S. Nat . Mon. Com. Pubs., 61st Cong., 2d Sess., Sen. Doc. No. 570, p. 42. Further discrepancies are to be seen in the Report of the Comptroller of the Currency ( 1911 ) , pp. 111-114, and Vol. II (1920 ) , pp. 55, 151. Months are not indicated for the years 1855-1911 . It must be borne in mind, also, that all individual deposits are not sub ject to check . Some of them represent deposits in savings banks and others deposits not subject to check. On the other hand, government deposits would be represented by checks in many cases. This table should be compared with a table constructed by Professor Irving Fisher for the period 1896-1909, in which he estimated the individual deposits subject to check. See his Pur chasing Power of Money ( New York, 1911 ), p. 281. Prior to 1915, the reports for nation banks did not segregate deposits subject to check from time deposits. On this point see Holbrook Working, “ Circulating Medium, 1890 1921," Quarterly Journal of Economics, Vol. XXXVII (Feb., 1923 ) , p. 255. Individual deposits are considerably larger than demand deposits. The re search staff at the Federal Reserve Bank of New York estimated that total individual deposits in all national banks in the United States amounted to about 140 per cent. of demand deposits in 1910 and about 170 per cent . in 1923. For demand deposits subject to check , 1890-1911 , see Wesley C. Mitchell, Business Cycles ( University of California, 1913 ), p. 302. These data do not agree with those given by W. I. King in Table XIII, p. 95 below. 'Report of the Comptroller of the Currency, Vol. II ( 1914) , p . 36. Circula tion is national bank circulation outstanding as of June 30. ` All dates for 1912-1922 are for June 30 unless otherwise indicated , *Report of the Comptroller of the Currency ( 1912 ) , p. 46. As of June 14 ; in United States only, does not include Alaska and island possessions. *Report of the Comptroller of the Currency ( 1913 ) , p. 50. As of June 4 ; in United States only . 'Report of the Comptroller of the Currency , Vol. II (1914 ) , p. 751. In United States only. Treasury Department Circulation Statements (July 1 ) . Includes na tional bank notes, Federal reserve bank notes, and Federal reserve notes. 'Report of the Comptroller of the Currency ( 1922 ) , p. 18. * June 23. *For June 30. Report of the Comptroller of the Currency ( 1923 ) , pp. 122-123. Brief mention has been made elsewhere of the various investi gations that have been made in the United States in an effort to determine with some exactness the relative importance of checks as a part of the currency. The question of the proper method of computing the relative importance of checks and notes has been and is a difficult one. The usual methods have included the analysis of the clearing house returns, of aggregate receipts by banks and of particular receipts of banks, such as wholesale, retail, and all others. No one method has been satisfactory and all have been criticised freely. Most of the comparisons have been between checks and money rather than between checks and notes. Space precludes any careful and detailed criticism of the methods and data used in the various surveys. The reader will find those else CLEARING AND COLLECTION, 1863-1914 87 where. It will be sufficient for our purposes to bear in mind that the data presented are rough and only approximate, although they will serve, safely enough, to show general tendencies, the end desired here. Inquiries to determine the importance of checks The first inquiry into the importance of checks in this period was the Garfield inquiry of 1877 which was based upon 52 banks, classified in three groups : ( 1 ) City banks, ( 2 ) those in cities the size of Toledo and Dayton in Ohio, and ( 3 ) the " countriest” banks —the smallest that could be found, at points removed from rail roads and telegraph. In this inquiry it was thought that 88 per cent. of business was transacted in checks, drafts and commercial bills. This left undetermined, however, the exact importance of checks.3 Comptroller Knox made a more extensive inquiry in 1881 ; it rested upon the returns received from 1,966 banks for June 30 and from 2,132 banks for September 17, the latter number being all the national banks in operation at that date. For June 30 he found that the proportion of checks and drafts in the receipts of the 1,966 banks was 91.77 per cent ., or 95.1 per cent. including clearing house certificates ; on September 17 for the 2,132 banks it was 91.85 per cent., or 94.1 per cent. including clearing house certificates.4 In 1890 Comptroller Lacey made an investigation of the re ceipts of 3,438 national banks ; 3,364 reported, showing their re ceipts for July 1 and September 17. For July 1 , 92.50 per cent. of the receipts of 3,364 banks consisted of checks, drafts, bills of exchange, etc., in which were included exchanges for the clearing *See H. P. Willis, “ Credit Devices and the Quantity Theory , ” Journal of Political Economy, Vol. IV ( 1895-1896 ) , pp. 281-308 ; David Kinley, “Credit Instruments in Business Transactions,” Journal of Political Economy, Vol. V ( 1896-1897 ) , pp. 157-174 ; E. W. Kemmerer, Money and Credit Instruments in Their Relation to General Prices (New York, 1907 ), Chaps. II-IV ; Irving Fisher, Purchasing Power of Money (New York, 1911) , passim ; B. M.Ander son, Jr., Value of Money ( New York , 1917 ) , Chap XIX ; W. Randolph Burgess, "Velocity of Bank Deposits,” Journal of the American Statistical Association, Vol. XVIII (June, 1923 ), pp. 727-740 ; W. I. King, “ Is Our Currency Elastic ?" Bankers Statistics Corporation, Special Service , Vol. II, No. 23 ° (Sept. 21 , 1920 ) ; Holbrook Working,“ Prices and the Quantity of Circulating Medium , 1890-1921," The Quarterly Journal of Economics, Vol. XXXVII ( Feb., 1923 ) , pp. 228-256. Some careful studies in this field have been made by the Reports Department of the Federal Reserve Bank of New York under the direction of Mr. Carl Snyder. *Report of Comptroller of the Currency ( 1881 ) , pp. 14-15. ' Loc. cit., pp. 15-19 ; Bankers' Magazine, Vol. XXXVIII ( 1884 ) , pp. 485-486 . 88 CLEARING AND COLLECTION OF CHECKS houses, clear house certificates, and miscellaneous items. Of the receipts of the 3,474 national banks reporting for September 17, 91.04 per cent. were in checks, drafts and other substitutes 5 for money. Comptroller Hepburn made a similar survey in 1892 and reported that 90.61 per cent. of the receipts of 3,473 banks as reported for September 15, 1892, were composed of checks, drafts, exchanges and other substitutes for money. “ Checks etc., " apparently meaning checks and drafts, constituted 46.79 per cent., as compared with national bank notes which con stituted apparently 1.04 per cent. Comptroller Eckels, at the suggestion and with the aid of Dr. David Kinley, made a survey of the national banks in 1895 in an effort to learn the proportion of credit instruments used in retail transactions. On the basis of replies received from 2,465 banks, with the amount of retail transactions aggregating approximately $6,000,000, it was found that 58.9 per cent. were in checks and store orders and 41.1 per cent, in various kinds of money. In this report, it appears that the use of checks in retail transactions did not necessarily increase as population increased, but on the con trary decreased relatively after a certain density of population was reached. This conclusion cannot be accepted as a definite fact, however, as it rests upon but one investigation which was very defective. The following tables will show something of the results of the survey : TABLE IX The Use of Checks in Retail Transactions in 1895, in States Grouped According to the Grouping of the Census Division North Atlantic South Atlantic Per Cent. 56.1 62.3 North Central 54.3 South Central 65.6 Western 59.7 Population 17,400,000 8,900,000 22,400,000 11,000,000 3,000,000 TABLE X The Percentage of Checks in 1895 to Total Receipts in Groups of Cities Ac cording to Population In cities of 500,000 and over 200,000 and over 100,000 and over 50,000 and over 25,000 and over 10,000 and over Below 10,000 Number of cities Per cent. 4 11 55.9 65.3 10 25 41 70.9 53.8 59 309 53.0 66.1 55.6 'Report of the Comptroller of the Currency ( 1890 ) , pp. 22-32 ; Bankers' Magazine, Vol. XXV, 3rd series ( 1891 ) , p. 519. 'Report of the Comptroller of the Currency ( 1892 ) , p. 32. 89 CLEARING AND COLLECTION , 1863-1914 The discrepancy between the results of this report and the previous reports is to be explained partially on the ground that the earlier reports had to do with the use of checks in general, while this report covered the use of checks in retail transactions only. In large cities many banks had no depositors in retail business. In New York, for example, 24 banks reported that they had no such deposits or only an exceedingly small amount of them. With these facts in mind, it was concluded that this report was, on the whole, in line with previous reports as to the importance of credit instruments in payments and exchanges generally and that credit instruments comprised between 90 and 92 per cent. of the exchange media when wholesale as well as retail transactions were included.? In 1896, Comptroller Eckels, again with the aid of Dr. Kinley, made a more extensive investigation in which 5,530 banks re ported , among other things, the amount and character of deposits made in the bank ( 1 ) by retail dealers, ( 2 ) by wholesale dealers, and ( 3 ) by all other depositors. This report called for deposits rather than receipts. Deposits, obviously, would be less than re ceipts ; but it was thought that deposits would represent more accurately the real business transactions of the country.8 For July 1 , 1896, 3,474 banks reported that checks constituted 67.9 per cent. of their retail deposits, 95.6 per cent. of their wholesale deposits, 95.8 per cent. of all other deposits, and for all deposits combined in the 3,474 national banks, checks constituted 93.4 per cent. Combining the national bank reports with the State bank reports, 5,530 banks reported that their deposits were as follows : Retail deposits Per cent. of gold .... 2.4 Per cent. of silver 3.2 Percent . of currency ... 26.7 Per cent. of checks ..... 67.4 Grand total Wholesale 0.3 0.4 4.0 95.3 All other 0.4 0.2 4.1 95.1 of deposits 0.6 0.5 6.3 92.5 After a careful analysis of the data gathered, Dr. Kinley con cluded relative to the per cent. of retail trade transacted by the use of credit instruments , that 40 per cent. was as low as in reason could be claimed to be correct and that 55 per cent. rather than 67.4 per cent. was probably about correct, all things considered. 'Report of the Comptroller of the Currency ( 1894 ) , pp. 17-24. For an additional answer to this apparent discrepancy, see H. P. Willis, op . cit . , pp. 299-301 . *Receipts include checks presented for collection and not credited until the collection is made. 90 CLEARING AND COLLECTION OF CHECKS He thought 95 per cent. for the wholesale deposits about correct and that combining retail and wholesale with proper weights, 75 per cent. represented the best conclusion as to the relative impor tance of credit instruments in both kinds of deposits, and com bined with all other deposits, properly weighted and discounted, thought 80 per cent. was a reasonable estimate for all data pre sented, although in a later review of the work he settled finally upon 75 per cent . as a safe minimum. This made check transac tions at least three times as important as money transactions.9 The National Monetary Commission, in 1909, made another investigation along lines similar to those followed in 1896.10 Banks reported for March 16, 1909, the per cent. of checks, drafts, etc., in the deposits made by retail dealers, wholesale dealers, and all other depositors, the estimated amount of checks used in pay rolls, and other relevant facts. Of the retail deposits, 73.2 per cent. were in checks as against 67.4 per cent . in 1896. The largest volume of deposits was in the returns of the national banks, and the percentage of checks in those deposits was 74.6 per cent., the highest shown in any class of banks. In representative reserve cities 80.0 per cent . of the retail deposits were in checks ; for the rest of the country 68.7 per cent. were in checks. Of the aggregate wholesale deposits of all banks, 96.4 were checks. In 44 States the percentage of checks in wholesale deposits for na tional banks was over 90 ; in 24 States it was over 95. For repre sentative reserve cities checks constituted 97.4 per cent . of the wholesale deposits of all banks ; for the rest of the country ap proximtely 94 per cent . Of all other deposits, Dr. Kinley found that 95.9 per cent. were in checks; of all the deposits combined, checks constituted 94.1 per cent. In his final conclụsions, Dr. Kinley estimated that the per centage of checks in the retail payments was about 60 and the percentage for wholesale about 95 which , with his weighting, gave 86 per cent. as an average, and combining the results with " all others" he reached the final conclusion that the average per centage for all payments was from 80 to 85 per cent.11 'Report of the Comptroller of the Currency ( 1896 ) , pp. 57-90 ; Bankers' Magazine, Vol. LIII ( 1896 ) , p. 704. 10 The results of this investigation were compiled by Dr. David Kinley and constitute the most careful and extensive study of the subject made up to date. See Kinley, The Use of Credit Instruments in Payments in the United States, U. S. Nat. Mon. Com . Pubs., 61st Cong., 2d sess., Sen. Doc. No. 399, passim . 11 " About 70 per cent . of weekly pay rolls were in checks. See Kinley, op. cit . , passim . See also the Report of the Comptroller of the Currency ( 1912) , 91 CLEARING AND COLLECTION, 1863-1914 As we have already seen, Dr. Kinley estimated in 1896 that check transactions were at least three times as important as money transactions. Using these data, Professor Kemmerer went a step further in 1906 and computed the velocity or rapidity of turnover of money, but was satisfied to consider the total amount of check deposits equal to the total amount of transactions effected by means of checks.12 He accepted the same conclusion that check transactions were approximately three times money transac tions . 13 It was left for Professor Fisher in 1911 to make the greatest step forward in this direction working upon the material pro vided by Dr. Kinley in 1896 and 1909. Professor Fisher com puted the importance not only of money (M ) and its velocity ( V ) for the years 1896-1909, but also deposit currency ( M ) and its velocity ( V' ) . The following table will show the results : TABLE XI M M' in bil in bil liong V 2 3 Ilong V" Year 1 1896 1897 1898 1899 1900 1901 1902 1903 1904 1905 1906 1907 1908 1909 .88 .90 .97 1.03 1.18 1.22 1.25 1.39 1.36 18.8 2.71 19.9 2.86 20.2 21.5 20.4 3.22 2.88 21.8 21.6 5.13 20.9 20.4 1.45 21.6 1.58 1.63 21.5 21.3 1.62 19.7 1.61 21.1 4.24 MV M'V ' In billions M'V ' M' MV M 8 9 10 11 6.2 3.1 3.2 .20 .20 13.0 14.0 3.3 .19 16.9 3.8 3.6 4.2 4.3 3.4 5.7 4.5 4.3 4.4 4.0 4.1 .20 .26 .32 19.4 16.3 16.0 .31 .36 13.1 5 6 36.6 39.4 16 18 40.6 42.0 40.1 40.6 2022 24 27 40.5 27 39.7 29 28 228 7.8 8.2 31+ 279+ 9.0 34 25 315 323 9.3 9.2 32 294 34 353 9.2 10.4 5.40 4.73 7.77 39.6 6.54 6.81 42.7 46.3 7.1 6.54 6.68 45 45.0 52.8 7 99 112 131 163 170 208 219 227 Note M circu lation Note in bil . circui . lions lation 6.2 6.5 7.4 7.1 7.4 8.1 .40 .44 .51 .55 .61 .64 17.4 19.4 14.9 13.3 13.0 10.7 10.4 Columns 1-7 from Fisher, op. cit ., p. 304 ; columns 8, 9 computed from columns 1-7 ; column 10 from Table XIII , p. 95 ; column 11 computed Cf. W. C. Mitchell, op. cit ., pp. 321-322. It will be noticed in the above table that the ratio between money ( M ) and deposit currency ( M ) is much smaller than the ratio between money transactions ( MV ) and total transactions p. 124 for a table combining all these reports. The table is given in sub sequent reports also. B. M. Anderson, Jr., op. cit. , Chap. XIX , should be con sulted for a careful analysis of the data on this point. Other authorities which should be consulted in this connection are E. W. Kemmerer, op. cit., Bk. II , Chap. III, and Irving Fisher, op. cit., Chap. XII. **Professor Kemmerer estimated the velocity of money to be 47, an esti mate criticized later by Professor Fisher who thought 18 or 20 nearer the truth. See Fisher, p. 277. 13E . W. Kemmerer, op. cit ., Chaps. III - V . 92 CLEARING AND COLLECTION OF CHECKS effected by means of checks (M'V ). There seems to be little doubt but that MV gives a more accurate picture of the relative importance of checks as compared with money, assuming the accu racy of the velocities. Total transactions in deposit currency as against total transactions in notes present a more accurate pic ture of the importance of each. However, with the present un certainty attaching to the velocities, V and V', the other compari sons may present a picture almost as accurate. Thus we see that in 1909 the business carried on by deposit credit was approximately ten times that carried on by means of > money, that is, coin, bank, notes, certificates, etc. At the same date the demand deposits—not the transactions effected with de posit currency ( M'V' ) —seemed to be about ten times the note circulation, although in 1899 and 1904 they were almost twenty times as great. For more recent years according to Holbrook Working,14 Professor Fisher's estimates assign progressively in creasing importance to deposit credit. This conclusion is sup ported by Dr. W. I. King, who insists that the ratio of deposit currency to money in actual circulation has been steadily increas ing for the last 40 years.15 The Reports Department of the Fed eral Reserve Bank of New York has been engaged for some time in a careful study of the velocity of deposits, and has estimated that the velocity of deposit currency for the country as a whole in 1920 and 1921 ranged from 25 to 35 times a year, which is con siderably below Professor Fisher's estimate. This would reduce the relative importance of deposit currency somewhat if Profes sor Fisher's velocity is demonstrated to be too high.14 The Federal Reserve Bank of New York also found the widest variations in the velocities of deposits in different sections of the country. The velocity for 39 banks in New York City was found to be considerably above that for banks in other cities, the velocity for the New York City banks ranging from 91.3 in November, 1919, to 58.7 in August, 1921. The velocity for groups of banks "Holbrook Working, op. cit., p. 234. 1W. I. King, op. cit., p. 4. 10The work done by the Reports Department of the Federal Reserve Bank of New York relative to the velocity of deposit currency is reported by W. Randolph Burgess, “ Velocity of Bank Deposits,” Journal of the American Statistical Association , Vol. XVIII ( June, 1923 ) , pp. 727-740 ; Federal Reserve Bulletin, Vol. IX ( 1923 ), pp. 562-566. Summary results of this study have been reported currently in the Monthly Review of the Federal Reserve Bank of New York . The Reports Department of the Federal Reserve Bank of New York was aided by the statistical offices of the Federal reserve banks of Boston, Chicago, and San Francisco, as well as by Professor Irving Fisher, Professor E. W. Kemmerer, Mr. J. H. Riddle, and Mr. Clark A. Warburton. CLEARING AND COLLECTION, 1863-1914 93 in 8 cities, for each month since January, 1919, ranged from a minimum of seven times a year for Syracuse, N. Y., to about ninety times a year in New York City. The following table gives a summarized view of the velocity of deposits as computed by the Federal Reserve Bank of New York : TABLE XII Annual Rate of Turnover of Bank Deposits Total 4 up Syra- San Fran banks Boston banks Chicago cisco 14 11 banks State cities banks cu se 6 3 39 banks Rochester banks 10 banks banks bank, Year Buffalo Albany 22 New York City 1919 January ..64.7 . 18.8 18.6 31.7 30.5 31.4 31.2 34.2 37.3 38.2 16.6 33.8 16.8 35.4 42.9 August September 74.5 39.0 29.1 27.4 34.2 40.6 49.0 43.1 28.9 30.3 16.5 17.0 17.8 18.8 18.4 19.4 17.9 17.5 October ... 85.4 35.0 20.6 November .91.3 33.8 39.2 18.4 19.0 19.7 9.7 10.2 9.9 10.4 11.5 19.6 12.2 18.7 18.8 20.4 12.1 19.7 21.0 19.4 18.6 20.0 19.6 11.6 10.8 19.2 10.0 17.4 18.8 19.9 20.9 20.5 20.6 20.4 19.8 21.4 21.9 21.9 11.7 11.4 11.7 12.8 11.6 18.9 19.5 19.2 21.0 19.0 19.9 21.2 20.5 22.5 11.5 21.3 20.9 19.2 16.9 18.2 18.0 21.7 20.3 19.3 21.5 19.8 10.1 9.2 8.6 16.7 9.1 8.9 17.9 18.6 February .63.6 March April May . June . July .62.1 .63.7 72.4 .81.2 .81.3 ..72.6 December .89.5 16.5 16.7 17.0 16.7 18.4 17.5 18.9 18.5 17.7 19.2 15.3 11.4 9.0 9.8 8.6 17.1 16.0 18.2 18.0 19.8 35.5 39.6 89.0 34.0 38.0 45.1 47.6 47.8 50.2 44.3 46.4 47.0 46.5 51.3 38.5 41.9 43.1 44.2 42.8 42.5 44.9 18.9 42.5 50.0 18.5 37.4 38.0 44.1 40.9 42.6 43.1 40.3 40.7 39.4 38.5 35.4 41.6 41.6 40.2 41.8 1920 January ..83.1 February ..77.0 28.7 March 25.7 April May June ..76.6 .77.3 .70.6 .68.7 .67.1 July August ... 62.7 September 66.0 October ... 77.5 November .79.1 December .83.8 24.6 32.2 34.6 32.9 35.0 32.1 31.8 32.6 31.8 35.9 19.4 22.3 19.9 21.1 22.8 22.2 23.1 11.4 11.6 13.2 45.3 38.0 36.1 46.3 47.0 49.7 36.2 48.2 39.4 30.8 46.3 34.4 37.0 38.0 39.0 51.5 19.1 33.5 46.4 17.8 30.9 42.4 30.0 30.0 31.1 30.4 41.3 42.7 50.8 46.9 49.4 1921 January ..76.3 February .68.0 March April May June .64.1 .62.9 ..68.7 ... 66.2 26.4 24.8 27.0 27.4 36.8 30.5 18.3 21.4 8.6 18.0 66.2 ... 58.7 28.1 22.5 19.2 8.8 7.0 September 65.7 24.4 26.0 16.1 17.8 19.9 19.6 18.3 21.4 27.7 30.5 20.2 17.8 14.9 16.7 18.1 18.5 18.8 July August October ... 70.4 November .75.7 December .77.1 19.9 8.1 29.3 25.9 28.2 40.2 42.0 42.3 43.6 41.5 36.7 44.1 46.6 33.6 32.8 47.4 48.4 47.3 49.7 49.3 47.1 22.0 21.8 21.7 8.3 18.6 18.9 17.3 16.4 32.4 29.6 32.7 18.6 33.6 42.4 43.3 32.2 9.0 9.8 9.1 21.8 39.4 37.7 42.8 38.9 38.6 42.2 37.4 42.8 1922 January ..74.2 28.5 February .75.2 25.4 March ... 75.4 April ..... 79.9 22.4 20.1 18.9 18.0 19.2 8.2 8.1 29.4 19.5 19.9 9.2 * From the Federal Reserve Bulletin , Vol IX ( 1923 ) , p. 566. 43.9 37.7 41.2 39.4 CLEARING AND COLLECTION OF CHECKS 94 TABLE XII-(Continued ) Total 4 up 8.4 22.0 July .74.2 August ... 65.2 September 68.6 24.3 22.1 21.6 21.9 18.3 20.4 19.7 17.8 October ... 86.3 24.0 November .77.4 December .79.9 1923 25.8 31.4 22.6 23.0 21.1 23.6 22.3 8.5 8.8 7.3 8.4 24.5 22.7 9.6 January ..79.9 February .82.3 23.5 24.6 25.1 21.4 21.4 24.2 21.4 8.7 8.6 9.7 3 9 19.1 20.2 6 19.7 26.2 Fran cisco banks 28.6 75.7 Chicago 14 .77.8 June San Boston banks May Year 22 Albany 10 City Stato cities 11 11sa banks Syra . egter banks Rooh banks banks banks 39 banks Buffalo banks New York 1922 March .... 84.0 26.0 23.9 8.8 9.7 44.5 45.6 37.3 41.7 38.4 37.1 34.4 40.7 18.1 18.3 18.7 15.9 17.5 24.7 28.6 19.3 34.3 43.7 19.6 21.0 32.5 35.4 41.4 45.9 37.4 39.7 39.9 19.2 34.7 35.7 38.0 47.0 50.3 46.4 39.7 42.6 20.0 19.8 31.4 33.4 32.3 41.9 37.6 39.0 There proved to be a close relationship or correlation between the size of the city and the velocity of deposits, but a still closer relationship between the amount of bank deposits in the city and the velocity.17 For 282 clearing house centers the average veloc ity for December, 1921, was estimated at 36 times a year. The final tentative estimate, as pointed out above, places the velocity of bank deposits in the United States as a whole between 25 and 35 times a year. Among other interesting conclusions of Dr. Burgess we find that seasonal changes in bank clearings are largely accounted for by large seasonal variations in the velocity of de posits. Dr. King compiled a table covering the period 1880-1920, with results for the years 1896-1909 quite similar to those already given above in Table XI. Table XIII was compiled from the one developed by Dr. King. 18 This table will show in a rough . way the steady growth of deposits subject to check as compared with note and money cir culation for the years 1881-1923, although these tables are obviously subject to correction in many respects due to the present uncertainty attaching to some of the principal.magni tudes . For seven cities of New York , the highest coefficient of correlation was that between the logarithm of velocity and the logarithm of bank deposits, amounting, by the Pearson method, to 0.94. See Burgess, “Velocity of Bank Deposits,” Journal of the American Statistical Association, Vol. XVIII (June, 1923 ), p. 733. 18W . I. King, op. cit . , p . 9. CLEARING AND COLLECTION , 1863-1914 95 TABLE XIII Circulation ion Circulat Note to Deposits Demand All Ratio of Spending for' Available Money Demand Deposits Year)( June Demand Deposits ...... M)(' ( In millions) Individual All Money and Deposits Available for Spending Money Circulation Money for Private Use in millions ) Deposits Money to Demand Circulation Private Use for Medium Available M' in() billions Corporation and M' M 1881 1882 1883 1884 1885 1886 1887 1888 1889 1890 1891 1892 1893 1894 1895 1896 1897 1898 1899 1900 1901 1902 1903 1904 1905 1906 1907 1908 1909 1910 1911 1912 1913 1914 1915 1916 1917 1918 1919 1920 1921 1922 656.3 730.0 738.4 742.0 653.8 650.0 773.4 809.3 785.8 8 49.9 957.3 898.4 1,018.9 845.6 801.7 873.6 877.6 969.6 1,032.1 1,165.8 1,809.5 2.010.5 2,302.9 2,002.8 1,945.1 2,214.0 1,947.2 2,019.6 2,168.0 2,338.3 357.6 2,587.7 2,505.3 2,599.8 2,719.5 2,22.6 2,820.6 3,433.4 4,089.4 4,490.4 1,231.4 5,321.6 1,260.0 1,38 2.5 5,872.5 1,368.8 1,456.7 5.7 49.9 6.087.5 6,56 0.9 1,58 9.0 1,619.6 1,623.4 1,622.0 6.717.8 7,092.6 6,506.2 1,639.6 1,614.1 6,873.2 7,782.1 7,794.4 7,720.5 6.704.1 891.7 965.1 980.6 1,821.7 2.023.2 985.3 2,017.0 1,939.1 898.7 858.7 1,970.5 989.9 1,019.1 2,613.9 2,729.7 1.167.0 2.738.0 2,837.0 3,486.3 1,143.4 1,205.3 1,318.1 1,450.3 2,519.0 4,165.7 4,589.3 6,197.8 2,629.3 3,810.3 18.933.9 21.081.33 4,270.3 4,770.2 3,557.9 2 , 368.9 2,383.5 2,601.9 1,653.2 1,751.9 1.922.3 1,962.2 1,96 4.1 1,922.1 1,356.8 1,956 1 2,042.0 2,1 26.9 2.06 9.1 2,117.0 2,388.4 16,78 4.5 1923 ( Jan . ) .... 3,749.0 2,214.7 5. 420.7 5.873.9 6.019.6 2,36 0.9 3,450.0 3,686.0 4,331.39 3,911.1 2,078.0 1,539.2 1.5 73.3 1,699.5 8,963.7 11,198.1 14,186.2 2,230.5 1,089.3 1,128.6 1,06 4.1 1,105.8 1,1377 1,049.3 1,161.0 1,677.6 1,770.6 1,732.5 1,771.6 2,090.2 8,880.0 2,316.8 19.620.4 20,6 26.9 21.491.0 6,636.2 6,807.7 7,273.3 6,636.5 6,778.6 6,927.7 7.730.6 7.85 3.3 7,770.2 8,946.7 9,012.7 11,388.7 14,815.0 16,906.8 19,574.3 21,071.1 2.76 2.75 3.12 2.70 2.98 3.41 2.52 2.50 2.76 2.75 2.46 2.88 2.46 3.08 3.39 3.12 3.21 3.54 3.96 3.85 4.32 4.56 4.25 2.45 4.50 4.23 4.38 4.01 4.13 4.19 4.82 4.65 2.04 .31 2.10 2.36 .31 2.05 2.18 2.33 1.81 1.84 .17 11.5 2.14 2.09 2.48 2.17 2.64 2.68 .16 .13 .13 .12 .14 .15 .17 .18 2.35 .20 2.48 2.89 3.16 3.16 3.52 3.73 3.54 3.75 3.79 3.54 3.70 3.38 3.53 .20 .19 .20 .26 .32 .31 .36 .40 12.6 16.8 18.0 19.7 18.5 16.7 16.3 15.1 13.6 14.1 18.0 2.08 3.54 4.00 3.84 4.36 3.65 5.12 5.06 4.32 4.26 5.36 4.75 5.64 4.44 6.01 4.58 5.15 4.878 5.8 6.5 7.4 7.0 7.2 9.2 21 .29 .27 .24 4.58 4.42 .51 .55 .61 .64 .68 .68 .74 .76 .75 .87 .90 1.26 2.43 3.31 4.02 5.02 3.56 5.80 5.73 2.94 3.12 20.4 17.3 16.3 18.b 16.3 15 2 14.9 13 2 12.9 10 7 10.5 101 11.3 10 10.2 11 8 10.3 12 4 11.3 65 5.7 5.2 5.5 7.0 6.9 'Government supply of ready cash and deinand deposits included , as well as amounts available for use of individuals. *Corrected by Miss Bagwell of the Federal Reserve Bank of New York. King's figures were 4,337.4. *Corrected by Miss Bagwell ; Dr. King's figures were 20.941.2. Miss Bagwell's figures ; Dr. King's were 5.14 . Miss Bagwell's ; Dr. King's were 1.83 . " Miss Bagweil developed the table for the years 1921 to January, 1923 . Dr. CLEARING AND COLLECTION OF CHECKS 96 The relation of the clearing and collection system to the system of reserves Any system of clearing and collection of checks tends to re flect the system of reserves which obtains among the banks in volved . If the reserves are decentralized as was the case under the National Banking System prior to 1913, or partially cen tralized as during the first three years of our Federal Reserve Sys tem, the system of clearing and collection will be decentralized or partially centralized accordingly. With the centralization of re serves which was effected by the amendment of June 21 , 1917, to the Federal Reserve Act, the clearing and collection system has tended to become highly centralized. The concentration of reserves and the centralization of the clearing system are necessary prerequisites to the most effective use of deposit currency ; and deposit currency is the most econom ical, speedy and desirable currency that the world has been able to devise thus far. It behooves any nation, therefore, to see to it that it is providing the proper mechanism for the most complete and economical use of its best medium of exchange. A concentration of reserves is one of the first and most neces sary steps in the proper direction. Concentration of reserves minimizes the necessity for such large reserves because it renders them more mobile and more effective. At the same time it enables the same amount of reserves to support, with no greater strain on the specie base, a much larger superstructure of credit which, in turn, permits the price level to rise higher than would be pos sible were the reserves scattered. But, above all, a greater degree of elasticity is injected into the currency system . If a centralized clearing system accompanies the concentration of reserves — and this is the tendency — even greater effective ness is given to the use of deposit currency. To the extent that all banks participate in a centralized clearing, all debits and credits will tend to equalize and offset each other. This fact fur ther minimizes the necessity for reserves. Were reserves not neces sary to meet other obligations such as the demands for cash and to meet adverse trade balances, a perfect clearing or offset system would require no reserves. And to the extent that deposit cur rency is not covered by reserves or does not call out cash finally to liquidate it, it acts as a potent factor in maintaining or raising prices . On the other hand, to the extent that there is not a per fect offset in clearing, there is a necessity for reserves to liquidate the adverse balances. Thus a concentration of reserves accom CLEARING AND COLLECTION, 1863-1914 97 panied by a perfectly centralized clearing system will permit a maximum expansion of purchasing power on the basis of the avail able reserves. Such a system brings not only a greater degree but also a greater ease in the expansion of the purchasing power, and this fact implies at the same time both a greater danger and a greater advantage to the nation. The danger is increased be cause the price level can rise to greater heights without any greater strain on the reserve base ; the greater advantage lies in the increased elasticity of the system. Whether such a system be comes a blessing or a cause of injury to a nation depends upon the soundness of the banking administration. Under sound banking methods the elasticity in the system can be used as an important foctor in stabilizing the price level. Under unsound methods infla tion can creep in, and the price level can rise to dizzy heights with all the attendant evils which accompany that well-known financial disease. The extent to which our present credit system permits prices to rise and fall has been seen in the phenomenal rise from 1913 to 1920 and in the unprecedented fall which followed . In flation may be followed in turn by deflation, thereby doubling all the injustice that is experienced during the period of inflation. Deposit currency by its very nature makes inflation easy. To the extent that credit is advanced by banks without being cov ered by reserves or commodities and services equal in value to the credit advanced, inflation exists. This depends, of course, upon the wisdom of the individual bankers. The mere placing in their hands of a good mechanism with which to work does not insure its But no nation can expect to accomplish much towards a stabilization of prices until the proper mechanism is proper use . provided. Success in its use can be attained as time brings home new lessons. A proper mechanism is provided through concentrating the reserves and centralizing the clearing system. But a more perfect functioning of the clearing system involves, not only absolute centralization with all banks participating, but remittance at par by all the banks. Par remittance is a technique in clearance and collection which permits deposit currency to circulate at its face value, on an equal plane with notes, facilitates its circulation, and equalizes and minimizes the burdens resting upon business activi ties as a result of using deposit currency. Thus the ideal mech anism will be provided, the best use of deposit currency secured, and the maximum benefits secured to a nation through the use of deposit currency only when these three conditions are met, namely, 98 CLEARING AND COLLECTION OF CHECKS concentration of reserves, centralization of clearing with all banks participating, and par remittance. But the transition to concentration of reserves, to the cen tralization of clearing, and to par remittance, has not been taking place without serious opposition on the part of banks which think they found the old system profitable. In order to understand better the system under which the United States is now working, the problems that have arisen in connection with its development, and the causes for the opposition to the new system, a survey will be made of the clearing and collection practices that existed just prior to the introduction of the Federal Reserve System. Practice under the National Banking System . Local exchanges without clearing houses For convenience and simplicity of treatment the practice of clearing and collection may be treated according to whether it is ( 1 ) local, or ( 2 ) inter-community. Local exchanges, in turn , may be divided into two classes according to whether the commu nity is small and without a clearing house, or larger and with a clearing house . In aa small community with but a few banks, checks and drafts, drawn upon one local institution and deposited with another in the same locality were and are collected by the direct presentation of the paper to the bank on which it is drawn, which bank pays in current funds the amount due. Where the banks were located in different towns or villages, but within traveling distance of an hour or so, checks might be presented over the counter by mes senger, daily, two or three times per week , or at given times agreed upon, and the messenger may have traveled the distance in any one of several ways-train, trolley, carriage, boat, or auto. This practice was used where it was found to be more profitable than to use the mails which required more time, or for other reasons that might be peculiar to the communities concerned. It has also been a common practice to use the express companies for collec tion purposes. But, in general, unless unique conditions existed, the mails were the common means of collection. Indeed, it is diffi cult to generalize. Peculiar practices have been indulged in by banks, and the reasons lying behind such practices have been equally peculiar. Arrangements, understandings, discrimina tions, all inspired by the desire for profit, were the order of the day. This profit was to a large extent determined by the ability of the bank to collect exchange and at the same time avoid paying such charges to other banks remitting to it . As a result there CLEARING AND COLLECTION, 1863-1914 99 were no uniform practices that could be dignified by the name " system . ” Local exchanges with clearing houses In large cities, the method of procedure just described , although practiced in the early days of banking, is dangerous and expensive, and the clearing house has been devised to take its place. These early clearing houses accepted only local checks and other items on the members. Checks and drafts on out-of-town banks had to be collected in other ways. The process of clearing treated fully in another chapter requires no explanation here fur ther than to say that in principle it brings the reciprocal claim ants together. Each bank presents its claims to the other clearing member banks and, in turn, receives claims from them. Each bank then totals its debits and credits on a balance sheet and deter mines the amount due by or to itself, as the case may be. These balance sheets are then sent up to the central desk, where the manager of the clearing house presides, and accounts between the various banks are settled there in a manner which simplifies set tlements. It has been and is yet a common practice for those from whom payments are due to pay the amount in one form or another to the manager of the clearing house, and for those to whom sums are due to receive the amounts from him. Balances are paid in various ways. In some clearing houses banks are required to pay in specie ; in others by means of clear ing house certificates which represent either gold or some other accepted medium ; in others they are permitted to carry accounts with the clearing house ; in others debtor members are permitted to borrow from other members to effect settlements ; in others the balances are paid in drafts on some large institution which has extensive connections with all the other banks in question ; and in still others, balances are settled through the Federal reserve banks , in which the member banks of the clearing house association carry reserve deposits. There is an increasing tendency to settle through the Federal reserve banks. Arrangements are often made by banks which are members of the clearing house association to clear for other non-member banks in the community provided they keep accounts with the clearing banks. Inter-community clearing and collection The great variety of economic transactions arising between in dividuals in different communities gives rise to inter-community 100 CLEARING AND COLLECTION OF CHECKS claims. Banks are the chief agencies for the conduct of these inter - community exchanges, usually called out -of -town exchanges, and must offer facilities to their customers either in remitting to or in collecting on other centers. This means that banks have been obliged to keep funds on deposit in other cities, not neces sarily in every city in which customers may desire to do business, but in certain commercial centers through the banks of which arrangements may be made for the conduct of exchanges with any place desired . The burden of collection has been almost en tirely on the reserve and central reserve city banker. In selecting the reserve city in which he purposed to carry the reserve funds of his bank, the country banker naturally selected the one to which his section was tributary. Thus the banks of New England, with few exceptions, selected Boston and New York as their reserve cities. Those in the middle States selected New York and Phil adelphia ; the south Atlantic States selected Baltimore and New Orleans; the middle West was divided among Cincinnati, Cleve land and Chicago, although Chicago exchange occupied the im portant place. All Michigan drew on Detroit. St. Louis was the center for the southern Mississippi valley and the Southwest ; San Francisco for the Pacific Coast. But few were the banks that did not have at least one New York correspondent, New York exchange being in the greatest demand, as New York was and is the commercial and financial center of the country. Besides cor responding with the central reserve and reserve city banks, each bank corresponded with from three to a dozen banks in neighbor ing counties, among which the checks of each circulated freely and with which settlements were made weekly or semi-weekly, as the case supposedly required. The existence of such balances with correspondent banks ren dered necessary the movement of money from one place to another, since creditor banks might demand from the debtor banks pay ment in cash. Whether they did exact such payments depended upon the relative demand for money at home as compared with that in the community of their correspondents. If the home de mand for loans and for hand - to -hand money did not justify the banks in calling for shipments of currency from their correspond ents, they probably loaned surplus funds in the cities in which their correspondents were located, or in other cities, or perhaps left them on deposit with their correspondents at a rate of inter est agreed upon, in which case the funds were loaned ordinarily by the correspondent at rates sufficiently high, supposedly, to as sure a fair profit. CLEARING AND COLLECTION , 1863-1914 101 Almost every type of reciprocal arrangement was made. A large volume of checks was handled by many banks and trust com panies in reserve cities and smaller places through special recipro cal arrangements, consisting of the mutual exchange of checks within certain territory or of checks drawn on certain specified points and handled at par. Some banks would agree to collect for others at par not to get the same favors but primarily to induce country banks to carry deposits with them for the sake of the profit which was supposed to result from the lending of such re serve deposits on call. Competition for such deposits became so keen that banks, such as those in New York City, made a practice of paying interest of about 2 per cent. on the deposits. Some of these city banks even went so far as to agree to pay collection charges to these same country banks. The practice of entering into such arrangements was widespread. Chicago at one time of fered to collect at par in 29 entire States.19 In some instances two banks would make arrangements to carry balances with each other free of interest, the so - called “ double-headed” accounts, in order to have their items collected at par in the respective dis tricts, the remittance of accumulated balances being made at par in exchange on central points at stated intervals. Other schemes were employed, involving an evasion of direct charges and outlays in the form of exchange paid, but entailing, nevertheless, cost in some form . As has been indicated in another connection, the clearing and collection system is determined largely by the system of re serves underlying. The decentralized system of reserves which existed under the National Banking System gave rise to certain practices which made obvious the great defects of the old systein of clearing and collection. The defects of the old clearing and collection system The defects of the former clearing and collection system, which were associated almost entirely with inter-community settle ments, and which gave rise to the Federal reserve system of clear ing and collection, may be classified as follows: ( 1 ) Excessive charges, ( 2 ) indirect routing of checks to avoid remittance charges, (3 ) giving immediate credit for uncollected funds, (4 ) paying interest on uncollected funds, 45 ) the carrying of com pensating balances with collecting banks solely for the purpose of obtaining par territory, ( 6 ) the maintenance of reserve bal " Hallock, op. cit., p. 25. 102 CLEARING AND COLLECTION OF CHECKS ances with banks for the sole purpose of getting items on which to charge exchange, ( 7 ) excessive gold movements, and (8 ) the absorption of collection charges by collecting banks. Each of these defects or, perhaps one should say, malpractices, will now be re viewed briefly . Excessive charges The question of excessive charges has reference not only to charges exacted for drafts, designated as exchange, but to deduc tions or charges made by banks in remitting funds in payment of checks presented by other banks, commonly called exchange charges, although when considered from the point of view of the remitting bank they were, in nature, remittance charges. Such charges rested upon the theory that banks might find it necessary to ship funds to meet adverse claims as well as upon the fact that other expenses were incurred in meeting the customer's distant obligations. It has been noticed already that in the thirties, charges on checks and drafts ranged from zero to 112 per cent.20 Comp troller Knox later estimated that the average cost of southern and western exchange upon New York in 1859 " was not less than from 1 to 112 per cent.” Although the higher rates were charged by western and southern banks the average rate in 1890 was about 12 of 1 per cent.21 Since 1890 the charges have not varied widely from 1/10 to 14 of 1 per cent. Such charges are claimed to be in part a survival of the stage coach days when drafts on New York City were the safest and most convenient means of carrying funds and for the conversion of which the early banker charged roundly.22 One of the principal causes of excessive charges has been the wastefulness of the inde pendent system of collections. For example, a small bank at Clay ton, Mo. , just outside of St. Louis, received one day twelve letters, inclosing checks, from St. Louis banks . Remittance was made to each of twelve banks by draft on its St. Louis correspondent. Twenty-four letters were written and postage paid on them, whereas a central agency could have handled all the business with one letter each way.23 What was true of the Clayton bank was true in almost every section of the United States. 20See Chap. III , p. 72. " Report of the Comptroller of the Currency ( 1890 ) , pp. 14-22 ; H. H. Preston, “ The Federal Reserve Banks' System of Par Collection,” Journal of Political Economy, Vol. XXVIII, No. 7 ( July 1 , 1920 ) , p. 566. " Preston, op. cit ., pp. 565-566. #Hallock, op . cit . , p. 14. CLEARING AND COLLECTION, 1863-1914 103 The rate of exchange on drafts and the remittance charges made by the remitting banks for checks received were arbitrary, as a rule, depending more upon the value of the purchaser as a patron of the bank along some other line than on the actual ele ments of cost. As the banks grew in numbers and the use of checks in payment of foreign ( out-of-town) bills became more general , the banker found he could charge the collecting bank a maximum rate with less compunction than he could charge his depositor a minimum rate on drafts, and so he encouraged the use of the check. This, in turn, caused more trouble for other banks who had to col lect the checks . From the increased use of checks for meeting out-of-town obligations many of the evils associated with the old clearing and collection system developed. Circuitous routing of checks Doubtless, the greatest evil in connection with the collection of out-of-town checks was the practice of sending them on long, devious and circuitous routes in order to avoid remittance charges. This practice in itself increased the delay and waste in the system. It was possible to find routes open in which there were no remittance charges because of the reciprocal arrange ments which were made between correspondent banks to pay checks at par for each other. Remittance charges as a cause of circuitous routing. Legality of such charges At this point it becomes necessary to understand what banks could charge for remittances . Under the common law, as ordi narily interpreted , no bank legally could make charges for pay ment when checks were presented at its counter . was to pay Its obligation the holder at once and in full.24 If checks are mailed to " In re Brown, 2 Story, 502, 517 ( 1843 ) ; Story on Promissory Notes, Section 489; Boehm v . Sterling, 7 Term Rep. 429 , The English Reports, Vol. CI ( 1797 ) ; 3 Kent's Commentaries, 104, note c ; Senter v. Continental Bank, 7 Mo. App. 532 ( 1879 ) ; Fogarties and Stillman v. The State Bank--David A. Ambler v. the Same, 12 Richardson ( S. Car. L. Rep . ) , 518 ( 1859 ) . The Negotiable Instruments Law has now superseded the common law in all the States with respect to checks and according to this law a bank's liability to pay cash without deduction applies to the depositor ( drawer ) only. Therefore any other holder who presents a check at the bank's counter for payment may be compelled to accept a draft and suffer a deduction in the form of an exchange charge. Eight States since 1920 have passed laws limiting the freedom of certain holders of checks in this manner . The United States Supreme Court, in the case of Farmers and Merchants Bank of Monroe, North Carolina, et al. v. Federal Reserve Bank of Richmond , l'irginia , 262 U. S. 649 ( 1923 ), upheld such a law passed in North Carolina. See pp. 1-3, 76-77 above, and pp. 269-276 below . 104 CLEARING AND COLLECTION OF CHECKS the bank on which drawn the bank then becomes its own agent for collection and may deduct charges for remittance. However, it is considered negligence on the part of a bank to send a check di rectly to the bank on which drawn. In the case of Merchants' National Bank of Philadelphia v. Goodman et al.,25 the Supreme Court of Pennsylvania said : “ We think that the principle may be stated as a true one that no firm , bank, corporation , or individual can be deemed a suitable agent, in contemplation of law, to enforce in behalf of another a claim against itself. We interpret the cases to which we have referred as establishing the rule of transmission to a suitable correspondent or agent to mean that such suitable agent must, from the nature of the case, be some other than the person who is to make the payment. By no other rule can the rights of endorsers be protected if it is the interest of the party who is to make the payment to hindei , post pone, or defeat payment." 26 In the case of Drovers' National Bank v. Anglo -American Packing and Provision Company,27 the Supreme Court of Illinois said that if the collecting bank has no proper agent at the place through which to make the collection it should so inform the customer and act on his instructions . But if it takes the check without special stipulation, the customer is authorized to assume that it has a suitable agent to whom the paper may be transmitted , and that it will make the collection through such agent.28 Every State except New York has upheld this ruling.29 Thus, since banks could not legally send checks di rect to the banks on which drawn without assuming the liabilities attached they would send them to agents for collection. Often they had no correspondent agents in the towns on which they had checks and consequently would be subjected to remittance charges by the collecting agents. Thus it will be observed that it was the final collecting banks ( or the drawee banks, if collecting on themselves) which made the charges for remittance and which pocketed the profits resulting from such transactions, as the banks on which the checks were drawn could not make such charges if the checks were presented over the counter or through 25109 Pa. St. 428 ( 1885 ) . 2 Also in the Bankers' Magazine, Vol. LVI ( 1898 ) , p. 727. 27117, Ill . 107, 108 ( 1886 ). 28 38 Bankers' Magazine, Vol . LVI ( 1898 ) , p. 728. 2See also German National Bank of Denver v. Burns, 12 Colo. 539 ( 1889 ) ; Lowenstein and Brothers v . Bresler, 109 Ala. 326 ( 1895 ) ; Anderson v. Rodgers , 53 Kans. 542 ( 1894 ) ; First National Bank of Chicago v. Citizens Savings Bank of Detroit , 123 Mich . 336 ( 1900 ). For a further list of cases see W. H. Kniffin , The Practical Work of a Bank ( New York, 1919 ) , p. 173. CLEARING AND COLLECTION , 1863-1914 105 the local clearing house which, of course, was the same as direct presentation over the counter. The last collecting banks, then, which charged for remitting, were the ones responsible for the circuitous routing of checks. This legal aspect of collection had its weaknesses, however. In cases where there were but two banks in a town, one strong and one weak, the collecting banks would be obliged to send all the checks on the strong bank to the weak one for collection in order to protect themselves from liability. At the same time it was for the interests of the depositors to have their checks sent to the strong bank rather than to the weak bank which might collapse and deprive them of their funds. In New England some of the weaknesses of the small out-of-town banks were exposed by having the check collection business taken from them after the creation of the country collection system in 1899. This was done when they proved slow in making remittances or offered insufficient ex cuses for the delays. With the introduction of the country col lection system some of them went into bankruptcy.30 Some collecting banks, however, rather than risk the weak banks as agencies, often sent items direct and themselves assumed the liabilities. This was a practice which steadily developed. It was indulged in by most banks in large cities as well as by those clearing houses which had country clearing departments, such as Boston, Atlanta, and Kansas City, Mo. Obviously, however, it was a practice that could not be supported in law.31 Typical illustrations of circuitous routing of checks It is possible to give several peculiar and interesting examples of the indirect routing of checks. Hallock gives an example, probably the best known and most widely quoted, of a check drawn on a bank in Sag Harbor, N. Y. , and deposited in a bank at Hoboken, N. J., which passed through eleven banks, traveled about 1,500 miles, and was in transit about eleven days, due to the effort of the Hoboken bank to avoid paying remittance charges in collecting on the bank about 100 miles distant.32 30Proceedings of the New York State Bankers' Association ( 1912 ) , pp . 70-71 . a Proceedings of the American Bankers' Association (1909 ), Third Annual Report of the Clearing House Section, pp . 25, 40, 42. * Hallock, op. cit. , pp. 19-22 ; J. G. Cannon, Clearing Houses, U. S. Nat. Mon. Com . Pubs., 61st Cong., 2d Sess., Sen. Doc. No. 491, Chap. IX ; J. D. Magee, Materials for the Study of Banking ( New York, 1923 ) , pp. 233-239. 106 CLEARING AND COLLECTION OF CHECKS 3 N.H. VT. MASS. N. Y. CONN R. 1. PA . N.J. FIGURE 1 . The accompanying diagram shows how a check was pushed along from place to place in its erratic course. The check was drawn on a bank in Sag Harbor, L. I. ( 1 ) and deposited in a bank in Hoboken, N. J. (2) . The Hoboken bank sent it to a bank in New York City ( 3 ) , which had no cor respondent in the neighborhood of the drawee, consequently, the New York bank sent it along with some other checks to its correspondent in Boston (4) . This bank, in turn, sent it to its correspondent at Tonawanda, N. Y. (5 ) , which sent it in a homeward direction by sending it to a bank in Albany ( 6 ) . The Albany bank sent it to its correspondent at Port Jefferson, L. I. ( 7), which diverted it from its course by sending it to its correspondent at Far Rockaway (8) , from which point it was sent back to a New YorkCity bank, then to Riverhead, L. I. (9 ) , then back to Brooklyn ( 10) , and finally home to Sag Harbor. This practice was not peculiar to any section of the country, nor is the above case a particularly unique one, as the following examples will show . MASS NY . CONN OHIO 'NJ LI Mela Mig . 2 . Fig.3 FIGURE 2 . Figure 2 shows a check drawn on Mt. Gilead, Ohio ( 1 ) , and deposited in a Columbus bank (2 ) , from which it was sent in the opposite direction to Cin cinnati (3 ) , then to Cleveland ( 4 ) , to Uhrichsville (5), to Coshocton ( 6 ), to Newark ( 7 ), and back to Columbus again, from which it was sent to Card ington (8), and finally to Mt. Gilead . The check traveled about 650 miles CLEARING AND COLLECTION , 1863-1914 107 instead of the necessary 60, and was gone about eight days. As the check was not paid, “it had to be sent back through the same hands again , and during 23 days this worthless check stood on the books of the bank to the credit of the depositor, and the bank was actually taxed two cents on it which looks like adding insult to injury. " Bankers' Magazine, Vol. XVII, 3rd series, ( 1882 ), pp. 466-467. FIGURE 3 . Figure 3 shows a check for less than $ 50 drawn on a Stonington , Conn. bank ( 1) and deposited at Westerly, R. I. (2 ) , six miles from Stonington, which it reached after many days and a thousand miles of travel over the following route : Westerly ( 2 ) to Providence (3) , Providence to Boston (4), Boston to New York City (5), New York City to Boston again (6 ) , Boston to New York City again (7 ), New York City to New Haven (8) , New Haven to Saybrook ( 9 ), Saybrook to New London ( 10) , and New London to Stoning ton ( 11 ). Hallock , " The Practicability of a Clearing House for Country Items,” Bankers' Magazine, Vol. LVII, (1898 ), p. 69 ; also in his Clearing Out of - Town Checks, p. 72. MICH. PA . ILL . OHIO IND. N.J. MD. W.VA KY. TENN . N.C. S.C. MISS. ALA . GA FLA FIGURE 4. Figure 4 shows a check on a North Birmingham bank ( 1 ) and deposited in a Birmingham bank (2 ) , 4 miles distant. In order to avoid remittance charges the check was sent to Jacksonville, Florida (3) , 488 miles; then to Philadelphia (4 ) 817 miles ; then back to Birmingham ( 5 ) , 941 miles ; and finally to North Birmingham ( 6 ) , 4 miles. As the check was not paid it was returned to the Birmingham bank (7 ), 4 miles ; then to Philadelphia (8 ) , 941 miles ; then Jacksonville ( 9 ) , 817 miles ; and then back to the Birming ham bank ( 10 ) , 488 miles, which returned the check to the depositor. The check had traveled 4,500 miles and had been 14 days in transit. From a pam phlet called - of service to banks and business, Federal Reserve System , ex hibit at annual convention of American Bankers' Association ( Atlantic City, Sept. 24-27, 1923) , p. 12. See Bankers' Magazine, Vol. XXXVII ( 1882 ) , pp. 466-468, and Vol. LIV ( 1896 ) , pp. 237-239, for other illustrations. The practice of sending such items through the same city more than once became so pronounced that Cincinnati sent à circular letter to the banks in Ohio, Indiana, Kentucky and other States announcing that it would refuse to receive any items that had been in Cincinnati before. 108 CLEARING AND COLLECTION OF CHECKS Evil effects of circuitous routing of checks The evils resulting from the circuitous routing of checks may be summarized as follows: ( 1 ) It caused an immense amount of trouble to banks in the form of much unnecessary correspondence, the requirement of additional clerks, excessive postal charges, complicated bookkeeping, and redundant book entries, many of them in banks not really concerned . (2 ) Many country mer chants, depending on checks being out a week or more, paid bills with them, trusting to luck to be able to deposit the money before their presentation. (3 ) Banks had to pay a tax of 1/24 per cent. a month on deposits which were not real deposits, but simply items in process of collection. ( 4) In the case of Gifford v. Hardell33 the Supreme Court of Wisconsin decided that the in dorser of a check is absolutely discharged if presentment be not made in a reasonable time, and in the same year the Supreme Court of Nebraska decided in the case of First National Bank of Nymore v. Miller34 that the forwarding of checks by circuitous route would operate to discharge the indorser .35 (5 ) Reserve balances were often diverted from their natural channel and the amount due from reserve agents, which should have been immedi ately available as cash, was made up largely of items in transit. This fact was brought forcibly to our attention in the panic of 1907.36 ( 6) Circuitous routing of checks, combined with the prac tice of giving immediate credit for checks deposited, made pos sible an evil known as check kiting. As an example, suppose Mr. A deposits $5,000 in a bank in New York City. He draws a check on his New York account and deposits it in a bank at Eliza beth, Pa.; he now has two deposits, each of $5,000 to his credit and even though the check deposited at Elizabeth should be sent direct to New York it would be about two days before it would arrive and be charged to his account. If the check were sent indirectly Mr. A would have the use of the deposits that much longer. But Mr. A goes still further and opens an account at Columbia, S. C., by depositing a check drawn on the Elizabeth bank for $ 5,000. He now has $15,000 at his command if he is given immediate credit, although he has rightful claim to but $5,000. He could now draw checks for, say, $4,000 on each of the banks and meet obligations amounting to $12,000 and still have at 2398 Wis. 538 ( 1895 ) . 3443 Neb. 794 ( 1895 ) . asBanker's Magazine, Vol. LIV ( 1896 ) , pp. 237-238 ; Rhodes' Journal of Banking ( Jan., 1895 ) , p. 35, and ( April, 1895 ) , p. 435 . 38Proceedings of the American Bankers' Association ( 1911 ) , p. 713. CLEARING AND COLLECTION, 1863-1914 his command in the banks $ 3,000 . 109 His balance in each bank could be maintained as long as he would continue to draw a check on one bank in favor of another and as long as each bank con tinued to give him immediate credit upon receipt of the checks. The more deposits he created and the more indirectly the checks were routed the easier it would be for Mr. A to continue the prac tice. It is obvious that Mr. A is getting loans from the banks without being required to pay interest. Indeed, banks were fortu nate if they were not finally defrauded of the funds entirely. The “ float' ' ; giving immediate credit for out-of-town checks Another practice, excused on the ground of convenience, in which many commercial banks indulged, was to credit the re serve account of the correspondent bank and itself carry the so called “ float” ; that is, the reserve bank would not debit the reserve of the country bank to which checks were being sent for collection until the country bank remitted, and checks sent to the reserve bank by the country bank for collection were counted as available reserve by the country bank as soon as put into the mail. A country bank in this way knew how its reserve account stood, and herein lay the convenience, but a fictitious reserve was created and the correspondent reserve bank carried the “ float” . Checks in the mail for several days might be returned later for want of funds while the various banks that had handled them during this time would count as reserve these unavailable funds. Moreover, the deposited reserve of the country bank was built up in the city to a large extent by the deposit of checks and drafts with a very small percentage of cash . The items so forwarded were immediately counted by the country bank as reserve, when mailed to the city reserve agent, although they were not received and collected by the city bank until several days later. This condition created a paper reserve, or a reserve, a large part of which consisted of uncollected checks in transit . Such a reserve, obviously repre sented an unhealthy, if not a dangerous situation, as was appar ent in the panic of 1907 when banks endeavored to realize on their paper reserves . A further result of giving immediate credit was that banks became accustomed to allow customers the right to draw checks against uncollected funds . This practice was thoroughly devel oped by 1885 and was frequently condemned . Twenty -five years earlier such practice was uncommon , the banks accepting checks for collection only . Banks brought the evil on themselves. Com 110 CLEARING AND COLLECTION OF CHECKS petition among themselves for business brought about bargains on their part with dealers to receive checks drawn upon distant banks, at first for a smaller charge than the usual one, later on, a nominal charge, ending with the general practice of making no charge for collection and for giving immediate credit. This com petition for customers on the part of the banks and for trade on the part of the banks' customers, encouraged the use of checks for out-of-town remittances which, in turn, confronted the banks with one of their chief problems.37 Paying interest on uncollected funds Some banks practiced the payment of interest on current bal ances, a practice opposed by many conservative bankers. But in addition to paying interest on current balances banks would receive at par items on outside points, and make collections with out charge to an extent which, when computed, would show that they were suffering a loss which amounted to a much greater rate of interest than any bank in the country could be induced to pay on daily balances. Competition for business and lack of co-opera tion among the banks were again responsible for this loss to banks. An actual calculation in some instances showed that by doing this work gratuitously the banks were paying for the account at the rate of 6 or 8 per cent., as shown by the daily balance - sheet. . This computation was on the basis of absolute cost of handling, without taking into consideration the labor and risk involved.38 The carrying of compensating balances with collecting banks solely for the purpose of obtaining par territory After New York began to charge in 1899 for collecting out of-town checks, Philadelphia and Baltimore became the dumping ground of western banks for the eastern exchange. As these cities, as well as Chicago, offered tempting par lists many bal ances went to these cities. Some of the depositing banks and other concerns would thus get their checks collected at par, then carry the proceeds or at least part of the proceeds in New York banks. Very often the Philadelphia and Baltimore banks would be charged by the remitting banks.39 But if these country banks frequently profited at the expenso *For a typical protest against the practice, see A. W. Blye, " Collection of Country Checks,” Bankers' Magazine, Vol. XX, 3rd series ( 1885 ) , pp. 278-284. * Bankers' Magazine, Vol. LV ( 1897 ) , p. 579. **Bankers' Magazine, Vol. LXVII ( 1903 ), pp. 996-998 . 111 CLEARING AND COLLECTION, 1863-1914 of the city banks, they also frequently lost. By maintaining large fixed compensating balances in return for par territory a large proportion of a bank's working capital was tied up and could not be converted into New York exchange or currency when most needed to supply demands from the bank's customers. If such funds were not needed for working capital they should have been used for loaning purposes instead of earning only 2 or 3 per cent. interest. Par facilities for compensating balances did not mean that the items were really cleared without cost ; the expense merely came out of the interest account where it was not noticed.40 Furthermore, the balances held by banks in reserve cities for the purpose of compensating the reserve banks for the collection of the depositing banks' checks were frequently meant to serve as re serve balances, thus confusing the subject of reserves with that of compensation for other services. The maintenance of reserve balances with banks for the sole pur pose of getting items on which to charge exchange It has been pointed out above that after New York City began to make charges for collection of country checks many bank bal ances were moved elsewhere. Other cities competed for these re serve balances and as a result of this competition some flagrant abuses developed. One was the practice of country banks divid ing a reserve account of ( say ) $25,000 among six or eight corre spondents, ostensibly for the purpose of greater safety, but really for the purpose of corralling most of the exchange drawn on itself. The collecting banks expected a balance, the income of which would be sufficient to cover the expenses of collecting the checks sent in by the country bank, for on these banks fell the burden of collection for the country bank. Often these banks suffered losses because of the divided accounts. Then these banks were obliged to pay perhaps the same collection charges to this country bank when collecting on it as to a bank which carried a large re serve balance. This practice of divided reserve accounts was prev alent only in a town where there were two or more banks, because the one-bank-town banker was certain to get all checks drawn on his bank and at his own terms . Where there were two or more banks in the town the checks would come to the other bank or banks and be presented over the counter, for which payment it par would have to be made. Some country banks, favoring their correspondent-collecting bank or banks with an agreement to re “ Proceedings of the American Bankers' Association ( 1911 ) , p. 714. CLEARING AND COLLECTION OF CHECKS 112 mit at par, would connect with reserve banks having a small country business so there would be few checks to collect, but at the same time would let the reserve correspondents collect their items as well as they could. On the other hand, not having recip rocal relations with a reserve bank with a large country business, the country bank could make a profit by charging a certain rate of exchange. As a result of this extensive division of reserves among so many banks it was frequently true that no balance was large enough to warrant the reserve agent in extending credit when the time came to borrow.41 Excessive gold movements With reserves scattered over the entire country rather than held in some central agency, there was no convenient method by which banks with surplus funds could lend to banks in need with out actual shipments of currency. Had there been a centralized reserve system much could have been accomplished by means of simple transfers on the books of the central reserve agency and the actual shipments of currency would have been reduced to a minimum. Instead, the various sectional and seasonal demands caused the constant shipping back and forth of specie at a heavy expense in insurance, loss of interest and express charges, and with a constant abrasion of the specie. 42 The absorption of collection charges by collecting banks At this point it is important to learn who really bore the cost of collecting these out-of-town checks. Equally important is it to know what items entered into the expense, and finally, who should have borne the cost. These latter questions will be dis cussed after the first has been disposed of. 1. Who bore the cost ? It has been contended that where charges were levied on de positors of out-of-town checks the expense seemed to fall on the merchants and business men whose accounts with their customers were settled with such checks . It is admitted that they could reimburse themselves by charging more for their goods or services, or refuse to receive such checks. But it seems clear that compe 411bid. 42For an account of cash movements during the years, 1905-1908, see Ivan Wright, Bank Credit and Agriculture ( New York , 1922 ) , Chap. VII. On the economy in transfers through the agency of the Gold Settlement Fund, see Wright, op. cit ., Chap. XVI. CLEARING AND COLLECTION , 1863-1914 113 tition prevented them from trying to shift the burden to their customers. There is rather general agreement that the cost is not often shifted backwards to the drawer of the check . Others have insisted that the competition among the banks for business has forced them to absorb the costs. This point of view has been well supported. Except where clearing house rules require the member banks to charge for collecting such checks, it probably has been true in the great majority of cases that the collecting banks have absorbed the collection charges. Even clear ing house banks have been known to violate secretly the clearing house rules in order to favor customers and thus absorb the charges. It has been pointed out frequently that the city banker who absorbs the costs of out -of -town collections has brought the so called evil of which he complains upon himself. He solicited country accounts by offering frequently to pay exchange to the country banker, and, in addition, agreed to take all items within a large territory, sometimes the entire United States, at par. The country bank was thus encouraged to charge exchange, but did not have to pay it, while the city banker absorbed all the exchange charges, both coming and going, as a premium on get ting the business, besides paying the country banker a liberal rate 43 of interest on his average balance.4 2. The items of cost in collecting checks ( 1 ) Every bank which collected out-of-town checks for its depositors was and is confronted with additional expenses in the form of bookkeeping, postage, stationery, etc. This general ex pense has been estimated at 34 of 1 per cent.44 In this connec tion might be mentioned the cost involved in making the proper 45 presentation ." ( 2 ) It was the general practice of banks to give immediate credit for out-of-town checks when deposited. As national banks were taxed on their deposits at the rate of 12 of 1 per cent . per year, they were paying taxes to this extent on items in the process of collection and which were in no sense deposits.46 * Proceedings of the American Bankers' Association ( 1911 ) , p. 713 . “B. J. Shreve, “Country Checks and Country Bank Accounts , " Bankers' Magazine, Vol. LVI ( 1898) , pp. 221-223. " See R. D.Kent, “ The Elements of Cost in Collecting Out-of-Town Checks,” Bankers' Magazine, Vol. LXI ( 1900 ) , pp . 738-739. “ United States Revised Statutes, Section 5214. This section was repealed in 1883 but was reenacted in 1908. 114 CLEARING AND COLLECTION OF CHECKS (3 ) The time element was an important item of cost in the form of loss of interest. In addition to the fact that great dis tances often had to be covered, few country banks remitted at once . The nearest thing to immediate remittance was semi weekly. But there was no uniformity of practice. There were weekly remittances, three times per month, semi-monthly, and monthly. Mr. Shreve computed the cash cost for semi-weekly remittances, at a distance of one day's time, at 75 cents per $1,000, and for weekly remittances $1 per $1,000.47 ( 4 ) Collection charges, when absorbed by the collecting bank, whether for the correspondent bank or the individual depositor constituted an additional expense ranging from 1/40 of 1 per cent. to 12 of 1 per cent. Rates were often fixed by agreements among banks and often varied widely. From 10 to 25 cents was a common charge for small items ranging from $5 to $100 ; 1/10 of 1 per cent. to 1/4 of 1 per cent. for items ranging from $100 to $1,000 ; and ordinarily 1/20 to 1/10 of 1 per cent. on items over $1,000. It is obvious that the smaller banks were forced to pay more in proportion than the larger ones for their collections.48 It was estimated that 1/8 of 1 per cent. was a fair average cost to the New York banks for the general run of country checks. ( 5 ) Where banks, like the New York banks, indulged in the practice of paying 2 per cent. interest per annum on the deposits carried by other banks in addition to giving credit at par on re ceipt for a daily amount of country checks equal to, say, 5 per cent. of the balance, another expense item of some consequence was added. This expense item has reference, however, only to the expenses involved in collections for correspondent banks, and not to the expenses resulting from collections for the ordinary indi vidual depositor . In 1898 it was estimated that some banks which were paying 2 per cent. interest on deposits of correspondent banks as well as extending the usual favors of par collections were actually paying 4.65 per cent. on the available deposits . Another account was costing the bank 4.37 per cent . per annum . One illustration may be apropos : An out-of-town bank kept an average balance of $200,000 with its New York correspondent on which it received 2 per cent. interest per annum and in addition received credit at par on receipt for a daily amount of country checks equal to 5 per cent. of the balance. Putting the cost of the country checks * B . J. Shreve, op. cit. , pp. * Loc. cit ., pp. 222-223. 221-222 . CLEARING AND COLLECTION, 1863-1914 115 at the low estimate of four days average time and 50 cents per $ 1,000 exchange, the loanable funds of that account cost as follows : Average balance - $ 200,000 Four days' time on $ 10,000 in country checks absorbed .... 40,000 Balance less country checks . $ 160,000 This balance, less the 25 per cent. required for reserves, would serve as a basis of loans to the extent of $141,177 as explained below. The cost for the amount loaned would be as follows : . $ 4,000.00 2 per cent. interest paid on $ 200,000 $10,000 in country checks at 50 cents per $ 1,000 ( 300 days) 1,500.00 General expense of handling the business, estimated to be 1,058.82 three- fourths of 1 per cent. ... Total expense . $6,558.82 This expense amounts to 4.65 per cent. on the amount loaned .49 Suppose the bank loaned the available reserve deposit at 6 per cent. interest, what would be its profit ? After deducting country checks outstanding, there remains a balance of $ 160,000 against which a reserve of 25 per cent. was required. If it is assumed that 20 per cent. of the deposits resulting from the loans remain in the bank as derivative deposits (represented by K) , the bank will lend as follows, if the Phillips formula for loan expan sion is used as a basis for computation :50 C ( 1 -r) $ 160,000 ( .75 ) $ 120,000 X = $141,177 loaned Kr+ 1 -K .20 X.25 + .80 Interest at 6 per cent. Cost Net profit .85 . $ 8,470.62 6,558.82 $ 1,961.80 The net profit amounts to 1.4 per cent. on the basis of the loan. If the bank could lend the funds at but 4 or even 41/2 per cent. it would suffer a net loss. Thus, whether the banks made any profit depended upon the rate of interest at which they could lend their available cash de " This expense has been computed from data given by Mr. Shreve, op. cit., p. 225, but the method of computation varies from his. He thinks that but $120,000 is available for lending by the reserve bank and computes the cost as 4.58 per cent. His method seems inaccurate. sFor an explanation of this theory of credit expansion, see C. A. Phillips .. Bank Credit ( New York, 1920 ) , Chap. III . 116 CLEARING AND COLLECTION OF CHECKS posits. By taking the average of all the loans of a bank as the basis, Mr. Shreve thought it possible to compute a profit, but in sisted that this method was unfair, as city deposits carried with them less expense than the deposits of correspondents. He in sisted that it would require an average loan of at least 4 per cent. to secure any profit, and some 5 and 6 per cent. loans would be necessary. It was estimated that the demand for 6 per cent. loans which came from the city customers hardly absorbed their own cash deposits and that the country bank deposits had to be loaned on call at rates ranging from 1 to 5 per cent ., ordinarily 2 to 3 per cent., with a resultant loss . Thus, while the banks may have made profits if computed on the basis of their loans as a whole, the carrying of country bank deposits when taken alone was unprofitable. Mr. Shreve concludes : " A careful investiga tion of the statements of the New York banks shows that some of the banks without country bank accounts make a net profit of over 1 per cent. per annum on their deposits ; while the large banks with a liberal supply of country bank accounts show a profit of less than 12 of 1 per cent. on their total deposits, and in some cases it is less than 1/4 of 1 per cent. on their deposits." 51 The costs to the banks for collecting the checks of correspond ents were summarized by Mr. Shreve as follows : ( 1 ) Interest paid on balances available for loans, 2 2/3 per cent. per annum. That is, 2 per cent. was commonly paid on deposits of which 14 had to be kept as reserve, leaving but 34 available. The 2 per cent. on the whole would amount to 2 2/3 per cent . on the amount available ; ( 2) the cost of collection of checks which was estimated to be 12 of 1 per cent. of the available funds on deposit ; ( 3 ) the expense of handling the business of the bank , estimated at 34 of 1 per cent. of the available funds. Thus, according to this esti mate the average cost of country bank balances was at the rate of 3.91 per cent. per annum, and it was estimated further that the loanable funds of fully 60 per cent . of all the country balances kept in New York cost the New York banks at the rate of 4 per 52 cent. per annum . In attempting to compute the costs of collecting out-of-town checks for customers, not correspondent banks, so many variables are present that any safe generalization is rendered virtually im possible. The question of distance, times of remittance, whether remittance is at par or at any one of many rates of discount , 51Shreve, op. cit . , p. 231 . 52 Ibid . CLEARING AND COLLECTION, 1863-1914 117 whether immediate credit is given, apportionment of general over head expenses, all combined in various ways, preclude computa tion . 3. Who should bear the cost ? Any one of four parties might bear the cost of collecting out of-town checks : The drawer of the check, the payee, the bank in which the payee deposits the check, or the drawer's bank. Argu ments have been presented in favor of each of the parties. ( 1 ) Should the drawer pay ? It is contended that the drawer of the check is the one who receives the chief benefit from its use . Whereas in earlier times he would have been compelled to go to his bank and purchase a draft for remittance, he could now save himself the time and expense by remitting his check. It has the added advantage of serving as a better receipt for him. than does the bank draft which is not readily accessible and fre quently becomes lost in the bank files. The check is the substi tute for the actual money which the purchaser wishes to have transmitted — he is the one seeking the favor and should bear the expense. The banks provide the facilitiesfor such transfer accom modations and should receive remuneration for their services.53 ( 2 ) Should the payee bear the expense ? It has been urged that merchants who deposit out -of-town checks should pay the cost of collection. If they received remittances in the form of checks it was because they were driven to it by competition or because they were satisfield with such payments. If they wished to have the checks converted into money they should pay the bank for the expense involved or refuse to accept such instruments in payment. The collecting bank should not be com pelled to bear the expense, as it provides the necessary facilities for collection and every branch of the banking business should be made self-sustaining. To have the collecting bank absorb the cost rather than the depositor means that those who borrow money from the bank are forced indirectly to pay for free collection for others in the form of higher interest charges.54 ( 3 ) Should the collecting bank bear the expense ? In favor of the collecting bank bearing the expense it is urged that the increase in the deposits as a result of accommodating customers more than recompenses the banks for their expense in collecting checks. Further, it is argued that there is no more reason for 5*See A. W. Blye, op. cit ., pp. 278-279. " Bankers' Magazine, Vol. XXXVII ( 1882 ) , p. 468. 118 CLEARING AND COLLECTION OF CHECKS complaining of the expense of collection as a result of the greater use of checks than there is of complaining of the expense of printing bank notes and that it is as logical to suppress the use of bank notes as checks. Nor is it any more reasonable, it is in sisted, to charge for collections than it is for the check books, de posit books and other miscellaneous books and papers, or for counsel, advice and other services freely given.55 The fact that competition among banks has forced them to collect at par seems to show, it is claimed, that the practice is in harmony with good business principles. Also despite the expenses of collection the banks pay large dividends which are proof of the fact that they could absorb the charges, thus relieving business of the charge. ( 4 ) Should the drawer's bank bear the expense ? Since these banks are the ones that receive the benefit of the delay in the pres entation of the checks for payment it is claimed that they can well afford to bear the expense of remittance and the depositors in such banks should require their banks to keep sufficient funds at money centers to cause checks drawn upon them to be at par in those centers, by refusing to deposit money in any bank that will not agree to make its checks equal to par at any of the money centers. If collection charges are made and are high enough to yield a profit they belong to the bank of the payee. The country banker should recognize the advantages of having his customers' checks circulate at par at the collecting centers and over a wide field and to keep them at par implies that he will remit for them without charging the collecting centers.56 Although there is a degree of validity in each of these conten tions, it seems fairly clear that the burden should not rest upon the banks if, indeed , they do not get their compensation indirectly . They offer facilities for effecting exchanges for which they have a legitimate right to receive compensation. No agency should be expected to offer its services without a return sufficient to justify the expense involved. If the services cannot exact a return suffi cient to cover costs the services are not needed by the business community. As between the drawer and payee it would seem that the burden should fall upon the drawer. He is the one to whom falls the greatest advantages. The drawer could be com pelled to pay the costs by having prices raised by the amount of the collection charges. But this is seldom done. Competition among sellers has forced them to absorb the charges in most cases 65Bankers' Magazine, Vol. LXVII ( 1903 ) , p. 167. 5*Proceedings of the American Bankers' Association ( 1911), p. 715 ; Bankers' Magazine, Vol. LVIII ( 1898 ) , p. 165 ; Vol. LXXXV ( 1912 ) , p. 136. CLEARING AND COLLECTION , 1863-1914 119 if they could not shift the burden to their collecting bank. Conse quently , the question has resolved itself into whether there might not be some way to relieve the payee and his bank from the burden. In many instances the burden rests upon the payee and it is rather generally agreed that the collecting bank should not be compelled to bear the burden. It seems true, however, that all parties secure some advantages from the wide circulation of the check . It is clear that the drawer gains ; the payee apparently feels recompensed to a degree, at least, else he would not let competition force him to accept them in payment ; the banks gain something indirectly in the form of increased deposits and increased business. As a result, it has been urged that since all gain all should bear the burden. How can all be made to share the burden ? In answer it may be pointed out that just as the Federal government was finally responsible for making bank notes circulate everywhere at par so the govern ment again could make checks circulate at par and place the ex pense so that it will fall lightly, but nevertheless indirectly, on all. All banks, business, and customers, would then be placed on a more even plane of competition. Before reaching the ultimate solution, a brief survey will be made of the proposals for reform which have been offered and the actual attempts which have been made to correct the recognized evils of the old system . Proposals for reform Since numberless proposals for reform were made, only a few of the typical and more outstanding ones will be mentioned. They are valuable only because they show the halting steps that were made toward the ultimate solution which can be better understood and seen in clearer perspective. 1. State clearing houses. In 1885 Mr. A. W. Blye submitted a plan to the American Bankers' Association which provided for a central concern in each State to act as a State clearing house. This central agency was to be either a large bank with a separate department devoted to the work , or some central office under the control of all the banks to be located in the commercial center of each State . Each central concern was to undertake all the clear ing and collection of the items within a given distance of twelve or twenty hours from the clearing center ; interstate exchanges were to be effected by the correspondence of one center with another. In addition to the reduction of expenses, additional advantages CLEARING AND COLLECTION OF CHECKS 120 were to be secured by having monthly records of the full ex changes of the entire country reported as well as the dissemination of other information vital to business interests.57 2. Out-of-town collection agencies. At the annual meeting of the American Bankers' Association in 1890 another plan for handling out-of-town checks was submitted by a Mr. C. W. Ham mond. The purposes of this plan were similar to the one pre sented by Mr. Blye, although the plan itself was quite different. It provided for stock companies in centers with ten or more banks which would handle all out-of-town items. Each collecting agency was to divide the country into collection districts on the basis of time involved in receiving returns, furnish each of its contributing banks a schedule showing the charges for the collec . tion of items in each district, the charges to be graded on the basis of the time required to receive items by the most direct route. Upon receipt of items, the agency was to issue certificates payable in cash or New York exchange at the end of the time allowed for returns from the district involved less the schedule charge for collection, or the agency would cash the certificates for an additional charge. The plan in general had a decidedly modern flavor. It was claimed that expenses of banks would be reduced , due to the saving of clerk hire and stationery, that the danger of competition to the detriment of profit would be re moved, and that much time and risk would be saved by routing the checks directly.58 3. A national clearing agency. A national or Federal clear ing house was also proposed at various times. It was suggested that it be a chartered corporation with capital subscribed by the local member clearing houses which were also to be corporations.50 4. Country checks to be sent through the clearing house to correspondent banks. In 1899 it was proposed that all country checks be sent through the clearing houses to the city correspond ents of the drawee banks and by them charged immediately to the account of the drawee. This plan, apparently so simple, had $7A. W. Blye, op . cit., pp. 282–284 . ** C . W. Hammond, " Clearings and Country Collections, " Bankers' Magazine, Vol. XXV, 3rd series ( 1890 ), pp. 292-296. BOJ. M.Elliott, “ A National Clearing House as a Safeguard Against Panics," Annals of the American Academy of Political and Social Science, Vol. XXXI ( 1908 ), pp. 460-462; see also Bankers' Magazine, Vol. LXVII ( 1903 ), pp. 980-982. A plan for Federal clearing houses was also developed by Theodore Gilman, but his plan had reference more particularly to the securing of elas ticity in note currency rather than to solving the question of the collection of country checks. See Theodore Gilman , Ferieral Cearing Houses ( New York , 1899 ) . CLEARING AND COLLECTION, 1863-1914 121 obvious objections. For example, John Smith, a Chicago mer chant, owes John Jones, in New York, $1,000. Mr. Smith draws his check on the First National Bank, Chicago, to the order of Mr. Jones and sends it to him in New York . Mr. Jones deposits this check in his bank, which presents it through the clearing house to the National City Bank, the correspondent of the First Na tional Bank of Chicago. Of course the National City Bank does not know whether the check represents a deposit in the Chicago bank, but nevertheless charges the amount to the account of that bank. The Chicago bank is placed in the unfortunate position of never knowing how its account stands at any particular time and of having checks charged against it before it can see and verify them.60 5. Place the burden upon the drawer. Another plan which had for its purpose the placing of the burden on the drawer of the check provided that checks be used by customers in making remit tances with such wording as : “ The Nineteenth National Bank, New York, will cash this check at par as the agent solely of the endorsers. Exchange hereon will be paid to said bank by the maker. " 61 6. Uniform exchange charges. In 1905 and 1911 proposals were made for universal exchange charges. In 1905 the Coni mittee on Conference of Clearing Houses of the United States an nounced itself in favor of charging exchange for the handling of out-of-town items and recommended that the clearing house asso ciations of the country establish rules for their members regula ting the collection charges.62 When a universal exchange charge was proposed in 1911 opposition speedily developed. The oppo nents contended that such a plan would only add to the cost of collecting by increasing the rates charged by the banks upon which the checks were drawn ; that banks at par points would begin to charge and the banks at charge points would increase their rates . Furthermore, the plan was not considered practical, as it seemed impossible to obtain concerted action by the banks in all the collecting centers.63 7. Universal par system.64 At various times a universal par « However this plan was tried with some degree of success in Sedalia, Missouri, and other places . See below , pp. 124-125. « Bankers ' Magazine, Vol . LVIII ( 1899 ) , p . 870. * Proceedings of the American Bankers' Association ( 1906 ), pp. 103-104. *Ibid. ( 1911 ) , p. 714. " The par system recommended here refers not only to remittances at par but to collections without charge. The same point of view is represented by the arguments presented for and against the plan. 122 CLEARING AND COLLECTION OF CHECKS system was proposed and just as frequently opposed. The advo cates of the system offered the following arguments in its support : ( 1 ) It would eliminate the circuitous routing of checks. ( 2 ) The increased use of checks would increase the deposits, thus increas ing the banks' returns to an extent that would more than offset the expense involved. (3) Each bank collecting and remitting at par would receive equal favors which would tend to compensate it for any expenses incurred . ( 4 ) It would encourage the use of checks, thus giving more elasticity to the currency and thereby benefit not only the entire country but every banker as well. ( 5 ) Checks, or rather deposits, are the most common medium of exchange and for that reason everything possible should be done to cause them to circulate at par. Bank notes play a relatively small part in business transactions and yet their parity is in violable. ( 6) Collection charges make the creditor receive less than the amount for which he sold his goods or the debtor pay more than the amount upon which he agreed. ( 7 ) The acceptance of checks at par is in direct accordance with the rigid policy of maintaining the parity of the medium of exchange. The opponents of the par system presented the following argu ments in support of their position : ( 1 ) Checks when deposited with a bank are not cash, and the bank must wait for some time before it can get its cash. Checks are often returned for want of funds also. Banks are not always able to tell the genuineness of checks presented. (2 ) Giving credit for uncollected checks means lending money without interest. Sometimes such checks will exceed in amount the customer's balance. ( 3 ) In addition to the time element involved the bank has certain expenses to meet, like postage, clerical help, bookkeeping, telegrams, protest fees, etc. ( 4 ) Often the exchange received is not suited to the needs of the bank and makes necessary a great deal of transfering to other parts of the country, sometimes at a large expense, for which the bank cannot be reimbursed. ( 5 ) To remit for checks at par forces the bank to carry deposits in leading banking centers, which is ex pensive. ( 6 ) The cost of par collections and remittances must be made up in the form of higher interest rates which places the burden on the borrowers in favor of the large depositor who does not borrow. It also means less borrowing and less total profits for a bank . 8. Par points and charge points with country clearing houses. Considering both uniform charges and a universal par system impracticable, it was proposed that the country checks be CLEARING AND COLLECTION, 1863-1914 123 divided into two classes, those that could be collected at their face value and those that could be collected only at a discount. Each bank would classify itself, and banks could then recognize the two classes and act accordingly. Co-operation with the country bankers on the part of the collecting centers was to be secured by providing country clearing houses through which the checks could be collected, and by furnishing correspondents with lists of the clearing house par points.65 Country clearing houses, usually in the form of a separate department within the city clearing house, were frequently proposed, and as it will be seen below, were successfully established in several important centers.66 . The general tone of the discussion was one of despair of any effectual remedy. Plan after plan fell by the wayside. But the bankers in their discussions of the evils of local checks lost sight of the fact that their use gave a general impetus to banking and that if their use by any means were repressed there would be a great falling off of deposits and loanable funds. The convenience in business of the use of local checks was doubtless one reason for the establishment of banks in all parts of the country ; every little business community found a bank necessary to its prosperity. If it had been possible for the bankers of the country to restrict or abolish the use of local checks it is a question whether, from the broadest standpoint of banking welfare, they would not have injured themselves. Repressive measures were beside the point, for with the improved means of communication which tended to eliminate distance, the use of local checks steadily increased. Their use should have been looked upon as a token of advancing business methods. The main defect was not from their increased use but from the inequality of the benefits which accrued to certain mem bers of the community from their use. The large dealer whose account was sought by the banks had no difficulty in using his bank as an agent to collect at par the out-of-town checks which he accepted in payment. On the other hand, the holder of the less desirable account was more likely to be charged something. In the agitation for country clearing houses or some similar plan, the large city banks, however, were found frequently to oppose such reform because of the effect that it might produce upon the country bank balances they had secured as a result of offering certain collection facilities . & Proceedings of the American Bankers' Association ( 1911 ) , pp. 714, 715. " Bankers' Magazine, Vol. LXII ( 1901 ) , p. 108. 124 CLEARING AND COLLECTION OF CHECKS Attempts at reform Some obscurity is attached to the first attempts to regulate the collection of country checks. Mr. F. E. Farnsworth, in his report to the American Bankers' Association in 1906, pointed out that the regulation of the country check was undertaken first by west ern clearing houses and also that St. Joseph, Mo., claimed to have been the first association to take such action.67 Hallock says that as early as 1875 Pittsburgh had made arrangements to clear out-of-town checks by exchanging the checks on their correspond ents and then forwarding them in their own letters. This prac tice seems to have lasted about ten years, when competition be tween the banks broke up the scheme of mutual accommodation.68 The Sedalia, Missouri, plan, 1895 A similar plan was instituted by Sedalia, Mo., in 1895. Hal lock lays great stress upon this plan of country clearing and insists that great credit is due Sedalia as the pioneer in estab lishing sound methods of country clearing. He also insists that it was a modification of the London plan of country clearing established in 1858, but entirely independent in the sense that the originators of the Sedalia plan knew nothing of the English practice.88 Soon after establishing a clearing house in 1893, the Sedalia banks turned their attention to the possible handling of the out-of town checks . It was observed that a country bank some distance out would have reciprocal accounts with all of the five banks in Sedalia and received checks from all, which it required five letters The Sedalia banks altogether would have more checks on this bank than it would have on them and consequently it would be constantly in their debt. The Sedalia bankers finally to forward . proposed that the bank should keep a balance with some one of them on which interest would be paid and against which any checks drawn on the bank could be charged . At the same time any checks forwarded to Sedalia by the bank for collection would be credited to its account at par and with interest allowed on the resulting balance. Gradually such arrangements were made with the sur rounding banks and completed about 1895. The plan compre hended some 22 banks at fifteen points, 13 of the points lying in a 07 Proceedings of the American Bankers' Association ( 1906) , p. 104. & Hallock , op. cit., p. 47. See Hallock, op. cit., Chap. III for a description of the London plan. CLEARING AND COLLECTION, 1863-1914 125 circle with a radius of some thirty miles ; two of the points lay farther away, one as far as 102 miles. When a check on one of the out-of-town banks was received by its Sedalia correspondent the account of the out-of-town bank was charged and the check mailed to the bank in the afternoon of the same day. If the check were received by another Sedalia bank in the morning mail it was presented to the country bank's corre spondent at the clearing house and paid there as if it were the correspondent's own check. The correspondent charged it against the country bank's account and forwarded it in the afternoon . If the other Sedalia bank did not receive it in the morning, but later in the day, it was held over and presented at the clearing house on the following day. If for any reason the out-of-town bank de clined to pay a check it returned it to its correspondent who duly credited it, and if the check were cleared, at once collected the amount upon delivery at the counter of the Sedalia bank that put the check through the clearing. The advantages of the plan were soon apparent. Sedalia was able to forward the checks to each out-of-town bank in a single letter. Payment was obtained , as a rule, at once in Sedalia before mailing the checks. The out-of-town banks, instead of being in debt to Sedalia as formerly now kept from $150,000 to $200,000 on deposit there. Each out-of-town bank was, in effect, a branch, not only of its correspondent, but also of every bank in Sedalia. The advantage was mutual . Checks on the out-of-town banks were the same as Sedalia funds and were received at par from depositors ; the benefits being enjoyed by the members of the clear ing house, customers and correspondents.To The New York City plan , 1899 New York City adopted a repressive policy during the nine ties and attempted unsuccessfully to exclude out-of-town checks , or at least penalize them, a policy contrary to business growth and quite the reserve of that adopted in other sections of the United States and some of the continental countries, particularly Belgium, who in 1901 made arrangements for free checks, appar ently regarding it as the true banking policy to foster the use of banking instruments for transmitting funds, and thus bring into the banks a large amount of money that would otherwise go into other channels. 71 " Hallock , op. cit ., Chap. IV. " Bankers' Magazine, Vol . LV ( 1897 ) , p. 579 ; Vol . LXVI ( 1903 ), pp . 10-11 . 126 CLEARING AND COLLECTION OF CHECKS In 1899 the member banks of the New York City Clearing House entered into an agreement to levy uniform charges for collection of out-of-town checks, a practice they have followed since that time. This charge with few exceptions was to be 1/10 or 14 of 1 per cent. of the amount of the items collected , according to the distance. No charge was to be less than 10 cents. There were certain points on which the charge was discretionary. A penalty of $5,000 for violation of the rules was attached, with the possibility of expulsion from the clearing house association for a second violation.72 Other cities had tried the same plan but failed, but the New York banks were more firmly united than were banks elsewhere, and succeeded in eliminating this burdensome form of competition from among themselves.73 This plan , although relaxed somewhat at a later date, threw the burden upon the holder and much friction resulted.74 Some critics of the plan carry balances with claimed it was done to force country banks to 75 them so that their checks would pass at par." A similar plan had been in operation in St. Louis since 1894 ; Chicago followed in 1905 , and soon many other cities had adopted it. But once it became general the advantages to any group of banks tended to be neutralized. Philadelphia did not follow the New York idea and as a result secured a large number of New York's reserve deposits. The New York plan did not put the country check out of circulation nor decrease its volume appre ciably, but simply shifted, to some extent, the burden of collecting from New York to other eastern collecting centers which did the work, even though not as favorably situated as New York to col 76 lect in the East, particularly in New York State and New Jersey. The Boston country clearing house, 1899 In 1899, Boston banks undertook to solve the problem of coun try check collection. At that time they estimated that their cost of collecting New England checks was not less than $700,000 per 52J . G. Cannon, Clearing Houses and the Currency, Columbia University Press ( 1908 ) , p. 100. ** Bankers ' Magazine, Vol. LVIII ( 1899 ) , pp. 518-519, 811 . “ In 1913 the New York Clearing House relaxed the rules to the extent that the banks were permitted to accept for free collection checks on such banks and trust companies in the States of New York, New Jersey, Massachu setts , Connecticut, and Rhode Island , as remitted at par and on the day of receipt of the checks drawn on them . Bankers' Magazine, Vol LXXXVI ( 1913 ) , pp. 134-135. ** Ibid ., Vol . LXVII ( 1903 ), p. 712. * Proceedings of the American Bankers' Association ( 1911 ) , p. 713. CLEARING AND COLLECTION, 1863-1914 year.77 127 Rather than adopt the repressive policies applied by New York City, Boston sought a more scientific solution , one in har mony with business growth and one that would encourage rather than hamper the growth of deposit currency . The solution was found in the establishment of a country clearing department in the Boston Clearing House, commonly called the country clearing house. The Boston plan was the most successful attempt to solve the problem of country check collection prior to the establishment of the Federal Reserve System . The system adopted was modeled after the old Suffolk System for the redemption of bank notes and brought distinction to the New England banks with respect to deposit currency just as the earlier system had distinguished them with respect to bank note currency . It caused checks to circulate at par just as the earlier system forced bank notes to circulate at par. The plan provided for the clearing of country checks with practically the same machinery that was used to clear Boston checks. Boston checks were cleared in the morning, country or New England checks in the afternoon in the same room and at the same desks. Both clearings were under the same management. The plan centered around the manager of the clearing house who acted as agent for the banks in clearing country checks. Country checks deposited in Boston banks were taken to the clearing house in packages, sorted by States and alphabetically by towns. Slips were attached showing totals, name and location of bank , the accompanying slips varying in color according to the State to which the checks were directed . Each slip had attached to it a coupon or stub which was detached and retained at the clearing house as a record of the packages forwarded to their destination. There were two deliveries daily ; those checks going some distance had to be in the clearing house before one o'clock, others not later than three o'clock. It was the duty of the man ager to mail them direct to the country banks drawn on, collect or return them , and account for the proceeds to the Boston banks to whom they belonged. As it took but two nights to obtain most of the remittances, the manager settled with the city banks on the second morning, when he distributed the proceeds through the reg ular city clearing. Remittances were made in either New York exchange, Boston exchange, or currency, at the expense of the " Proceedings of the New York State Bankers' Association ( 1912) , pp. 66-74. 128 CLEARING AND COLLECTION OF CHECKS clearing house. Almost 90 per cent. of the remittances were in drafts on Boston.78 It was the aim of the plan to place all banks in New England on the par plan and this was all but successful. As a result, New England checks were more widely received throughout the coun try than checks on any other section. In 1900, Boston banks put into effect a plan to charge exchange on all checks deposited which were drawn on banks not remitting at par. It was expected that by thus putting the customers of such banks at a disadvantage the banks would be brought into line. For a few months in 1901 efforts were made to force all banks to remit at par by sending checks to them by express. These banks retaliated by having silver coin transported to them at the expense of the government 79 which was then sent to the clearing house at the latter's expense . Although the Boston banks were never able to force all banks into the system, approximately 97 per cent. of the checks in New Eng . land were collected at par.80 In 1912, 560 out of 642 banks out side of Boston which paid their checks through the clearing house. remitted at par. The Boston banks charged the depositors of these non-par checks the same rates that they themselves were charged . 81 The Boston plan was highly successful. Costs were reduced from an amount ranging from $ 1.00 to $1.50 per thousand dollars to a charge varying from six to seven cents per thousand dollars. The time factor was reduced also by an amount varying from two to four days in the middle and southern Atlantic States. In 1912 the Boston Clearing House was collecting New England checks to the amount of $600,000,000 or $700,000,000 a year at this small expense of time and money . 82 In 1905, the Kansas City, Mo. , Clearing House organized a country clearing house or collection department. This plan was similar in principle to the Boston plan. At first it covered about 300 of the most expensive points, then was extended to the States of Oklahoma , Kansas, Colorado, New Mexico, Texas, Nebraska, and Missouri, the idea being to increase gradually. the territory of 78Bankers' Magazine, Vol. LXVII ( 1903 ) , p. 992. **From August 27, to November 8, 1901 , checks amounting to $ 3,544,813 were thus presented to non-par banks. In retaliation 58 of them had $ 2,316,250 in silver coin transported from the sub - treasuries at a cost to the government of $ 2,700 and to the Boston clearing house of $ 8,500. Hallock , op . cit ., p. 64. RO Ibid ., p. 61 . * ** Proceedings of the New York State Bankers' Association ( 1912 ) , pp. 69-72. " Bankers' Magazine, Vol. LXVII ( 1903 ) , p. 992 ; Vol. LXXII (1905 ) , p. 94; Proceedings of the New York State Bankers' Association (1912 ), pp. 69-72. CLEARING AND COLLECTION, 1863-1914 129 the country clearing house until it covered all the territory trib utary or accessible to Kansas City. The country clearing depart ment was a member of the clearing house to all intents and pur poses except in the matter of government. All members of the clearing house were obliged to send to this department all country items on points in the country clearing house territory where a cost of 10 cents or more per hundred would be charged if sent direct. A great saving in postage, stationery, and labor was effected and the plan was considered of great value.83 It was claimed in 1912 that a saving of over 50 per cent. in the gross ex pense in the handling of the items was effected and the time re quired in securing returns was reduced about 25 per cent.84 The banks of Atlanta, in 1908, copying the Boston plan, organized the Georgia collection department-a department of the clearing house - grouping all items received by the six Atlanta banks and sending out under one cover all items on a town or bank where more than one bank existed. After six months Florida and Alabama were added to the list. The plan resulted in a saving in exchange, in postage and clerical force.86 The country clearing house plan gradually spread until 14 cities, by 1916, had country clearing houses or departments.86 In 1911 , the Reserve City Bankers' Association started a movement to establish country clearing houses in the various re serve cities to facilitate the collection of country items, both in relation to cost and to the direct handling. The movement was started in twenty - five reserve cities, but stopped short with the passage of the Federal Reserve Act which seemed to obviate the necessity of country.clearing houses. County clearing houses In 1906, the ten banks and trust companies of Lancaster, Pa., undertook to simplify the problem of collecting checks on the 40 banks within the county by establishing a county clearing house. There are at present about six such clearing house associations.87 * Proceedings of the American Bankers' Association ( 1909 ), Third Annual Report of the Clearing House Section, pp. 41-44. *Ibid. ( 1912 ) , p. 513. *sIbid . ( 1909 ) , pp. 24-25 ; ( 1910 ) , pp. 715-725. *Ibid. ( 1916 ) , pp. 468-469. At the present time there are but two, located at St. Louis, Mo., and Nashville, Tenn . Detroit has such a department in a limited degree, the department of the clearing house collecting all checks on Highland Park, a city within the corporate limits of Detroit. Information secured from the Clearing House Section of the American Bankers' Association. ** There are county clearing houses in the Pennsylvania Counties of Lancaster, Lebanon , and Beaver ; four towns in Connecticut - Shelton, Ansonia, Derby, and Seymour, in Fairfield and New Haven Counties — have a similar association ; 130 CLEARING AND COLLECTION OF CHECKS The ten city banks in Lancaster were either chosen or assigned as correspondents of the outside county banks. Instead of one out of-town bank now having ten correspondents in Lancaster City and several more in the county, it now had but one correspondent and received all checks coming to it in the course of business and drawn on any one of the fifty banks of Lancaster County. This meant that with but a single letter to a correspondent in Lan caster, the out-of-town bank was able to send through the clearing house on the following day, all checks received on any or all of the fifty banks constituting the association and have them at their destination on the second day, thus obviating the necessity of starting checks on an unchartered sea without the possibility of knowing their whereabouts or when they would reach their desti nation. At the same time, the representative in Lancaster honors and forwards all the checks drawn on the out-of-town bank that may be presented at the clearing house by the other nine members, including all checks received from their correspondents in Lan caster County. At the end of the day, any amount in excess of $1,000 owing to the county bank's city correspondent or owing to the county bank, is paid by draft. That is, should the county bank's books show that it owed $2,600, the county bank encloses with its remittance a draft for $2,000. Should the city corre spondent's books show them in debt , the plan is the same. They send their check for $2,000 with their remittance letter. Settle ments are made in full once a week to verify all accounts.88 There were other plans tried but they were of no particular significance. It was felt rather generally among bankers that nothing of great importance could be accomplished without con certed action, which seemed quite improbable. It was seen that a concerted action which would result perhaps in par collection throughout the country would also result in a shifting of reserves to natural centers of exchange. Philadelphia would lose her coun try balances to New York City as would Baltimore. Boston would gain also. Naturally such cities as Philadelphia and Balti more would oppose such concerted action and it seemed that it could be accomplished only by bringing all banks of deposit finally under Federal control. How this was brought about, and the extent to which it had been accomplished , is told in Chapter VI. another is to be found in the Northern New Jersey Clearing House Associa tion which includes the banks in Hudson County ; and a tri-city association in Illinois may be counted as a sixth . Information secured from the Clearing House Section of the American Bankers' Association. A8 Information furnished by the Clearing House Section of the American Bankers' Association. CHAPTER V SPECIAL FUNCTIONS OF CLEARING HOUSES PRIOR TO 1914 Special functions of the clearing house In its primary and simplest form a clearing house is merely a conveniently located place where checks, drafts, bills, notes, or other kinds of credit instruments coming into the possession of the banks are brought to be exchanged for their equivalent in other credit instruments or for cash. Probably no clearing house exists in this simple form today. As necessity has arisen new functions have been assumed until the special functions of clearing house associations have become a subject of importance. Some of the special functions as exercised in the past have been of prime im portance ; this has been particularly true of clearing houses in times of stress when they supplied an element of elasticity to the currency in the form of clearing house loan certificates. Because of the importance of the special functions exercised by clearing houses in the past, as well as in the present, it will be appropriate to make a general study of them at this time, reserving to a later chapter the study of clearing houses as clearing centers, their main function as found today. The most common of the special functions may be summarized as follows : ( 1 ) Extending loans to the government, ( 2 ) render ing assistance to members, ( 3 ) fixing uniform rates of inter est on deposits, ( 4 ) fixing uniform rates of exchange and of charges on collections, ( 5 ) fixing reserve requirements, ( 6 ) exam ining member banks, ( 7 ) gathering credit data for members, ( 8 ) publishing statements relative to clearings and condition of member banks, ( 9 ) participating in annual conferences, and ( 10 ), issuing clearing house loan certificates in times of stress. Extending loans to the government During the Civil War the clearing house associations of New York, Philadelphia, and Boston responded with practical unanim ity on the part of the member banks to the call of the government 131. 132 CLEARING AND COLLECTION OF CHECKS 'for loans. In 1861 the New York banks by combination and equalization of their resources were enabled, through the facilities afforded by the clearing house, to unite in advancing to the United States government $150,000,000, which at once restored its declining credit and enabled it to equip and arm its newly formed military forces and provide for its immediate require 'ments. As the Spanish-American War gave rise to no serious monetary problems, no such action was taken by the clearing houses during that war. At the outbreak of the recent European War, the Federal Reserve Board called representatives of the clearing houses of the reserve cities in conference, September 4, 1914, to consider ways and means of meeting the adverse balance due to Europe. It was estimated that the United States had approximately $500,000,000 in obligations to meet. To experience such a large drain of gold at that particular time with foreign exchange markets disrupted 'was considered dangerous for our banking structure. Out of the conference came a plan for the creation of a gold exchange fund of $100,000,000 to meet the first instalments due. On September 21, 1914, letters were sent to the presidents of the clearing house associations throughout the country asking that their associa tions subscribe for the allotted amount. The associations re sponded quickly and oversubscribed the fund. Although but a small percentage of the amount subscribed was actually called for, their action saved the situation and by the time of the opening of the Federal reserve banks, the premium had disappeared on gold and the danger of immediate gold exports had been removed.2 During the various loan drives on the part of the government to finance the War many associations volunteered their services, organized the work in their own districts, and secured the desired results in the most effective manner and in the shortest possible time. This is the last important move made by the clearing house associations to aid the government directly. The organization and development of the Federal Reserve System has obviated the necessity. Rendering assistance to members In times of stress it has been common practice for weak banks to go to other members of the association for aid. The appeals W. A. Camp, “ The New York Clearing House ," North American Review , Vol. CLIV ( 1892 ) , pp. 685-686. ' First Annual Report of the Federal Reserve Board ( 1914 ) , pp. 12-13. CLEARING HOUSES PRIOR TO 1914 and the aid extended have taken various forms. 133 For instance, during the period just preceding the panic of 1907, the Mercan tile National Bank in New York reached a situation where it did not see its way clear to meet its obligations and pay cash balances. debited to it after the daily clearings at the clearing house. It appealed to the associated banks for assistance. The clearing house committee had it examined, decided it was solvent and should be assisted. The committee thereupon assessed a certain number of banks in the clearing house membership amounts suffi cient to meet the daily balances against the Mercantile so long as such aid should be imperative. Before granting this assistance, however, the committee stipulated that the entire board of direc tors, not only of the Mercantile, but of several affiliated institu tions, should resign, that its president should retire, and that certain officers prominently identified with its management should virtually withdraw from the banking field in New York City. The Mercantile consented, as it was the price of solvency.: Any question of common interest is likely to be discussed at the regular meetings of a clearing house association. In some asso ciations it is customary to discuss the question of loans to individ uals who go from bank to bank seeking accommodations. “Good customers ” of one bank are frequently discovered to be " good cus tomers ” of other banks and knowledge of this fact serves as a protection to the banks. An undesirable customer is also less liable to force a concession from one bank under threat of going to the bank across the street. Instead of playing one bank against another without profit to either, the customer and the bank usually get together, but upon terms more favorable to the bank and less favorable to the customer. Other questions that arise are those connected with the deposit of public funds frequently not pro rated among the banks, the charges for handling accounts where the average balance falls below a certain amount, opening and closing hours, the policy to be adopted in answering inquiries in order to protect banks from the abuse of this courtesy which they generally extend, the question of the policy to be adopted in connection with the safekeeping of securities and the rental to be charged for safety deposit boxes, fixing a minimum per trans action and per thousand dollars for handling matters in escrow, arranging for all requests for donations of certain amounts to be referred to a special committee, submitting to a committee period ically a list of all past due paper and overdrafts, not to mention 'A. D. Noyes, “The Clearing House Committee,” Independent, Vol. LXIII ( 1907 ) , pp . 1029-1030 . CLEARING AND COLLECTION OF CHECKS 134 many other problems that arise from time to time.4 Extending aid to members often has assumed its most important form in the issu ance of clearing house loan certificates described below , as well as in other ways discussed in the following pages. Fixing uniform rates of interest on deposits Some clearing house associations have not hesitated to fis uniform rates of interest on deposits. Others have regarded the legality of such action as a moot question and have been reluctant to enforce such a rule. The purpose of such regulation, of course, has been to regulate competition among the member banks. As early as 1881 , the association in Buffalo agreed upon rates of interest which were observed practically without violation for some nine years thereafter and they were broken at last only be cause of their non-observance by new banks which at the outset refused to become members of the clearing house association.” The practice of regulating interest rates to be paid on deposits is quite common today in clearing house associations. Fixing uniform rates of exchange and of charges on collections In 1881 , also in Buffalo , a prominent banker in that city suc ceeded in uniting the banks on rates to be charged on drafts and for collecting out-of-town checks. The promoter of the enter prise was well known for rate cutting and had been able to meet competition successfully. Consequently when he proposed the reform the other banks were only too glad to consider the propo sition. The rates were not high, but were arranged to do justice to both the banks and the depositors. The plan was so satisfac tory that it remained in continuous operation for nearly ninc years. The non-observance of the collection exchange rules by the new banks made its continuance an injustice to the member banks . In 1899, the banks in the New York Clearing House Associa tion entered into an agreement to levy uniform charges for the “Raymond F. McNally, Clearing House Organizations from the Standpoint of a Country Banker, a pamphlet published by the Clearing House Section of the American Bankers' Association ( Sept. 7, 1915 ) ; Wayne Hummer, Clear ing Houses in Smaller Communities, à pamphlet also published by the Clearing House Section of the American Bankers' Association , published sometime after 1918 ; The Clearing House, etc. , a pamphlet published in the same manner in 1923. Clearing house associations assume prominent parts in civic movements. Many respond to the call of charity whether local, national, or foreign. 'J. G. Cannon, Clearing Houses and the Currency ( Columbia University Press, 1908 ) , p . 99 . 135 CLEARING HOUSES PRIOR TO 1914 collection of out-of-town checks, based upon a zoning system, and have continued to regulate the charges since that time. A similar plan had been in operation in St. Louis for some time. Chicago adopted a similar plan in 1905. In 1899, Boston adopted a par system for country checks in New England, but the next year provided for uniform charges on all checks drawn on banks which would not remit at par. At present it is the uniform prac tice of clearing house associations to regulate such charges. Fixing reserve requirements Clearing house associations in the interest of increased safety may require a higher per cent. of reserves than that required by law. For example, the Clearing House Association in New York City adopted an amendment to its constitution in January, 1908, requiring all member banks thereafter to maintain in their vaults a cash reserve of 25 per cent. against deposits, although it had been the general practice of the member banks to keep a 25 per cent . reserve.6 This regulation was made a condition of admis sion and was applied to trust companies which were admitted to membership.? Examination of member banks by clearing houses The New York Clearing House adopted an amendment to its constitution in June, 1884, which authorized the clearing house committee to examine any bank in the association. The experi ences of May, 1884, had justified this step. The committee was authorized to examine any bank in the association whenever it considered such examination to be for the interest of the asso ciated banks in general, and to require from such bank the sur render of its securities for purposes of protection. In June, 1906, an examinations department was added to the Chicago Clearing House. The object of this movement was to detect in stances of unsound banking in any direction among the members of the clearing house association. It was expected that such ex aminations would enable the clearing house to take preventive rather than remedial measures by applying an earlier remedy than was possible for national or State officials, and by such early action to remove unwholesome conditions from any bank in the as •For the law regulating reserve requirements in New York State see pp . 334-339 below. 'J. G. Cannon , Clearing Houses and the Currency, p. 106. *A. D. Noyes, op. cit., p. 1033 . CLEARING AND COLLECTION OF CHECKS 136 sociation. As the system has developed it has become possible for the clearing house as a body to exercise such supervision over any weak bank as to amount to a virtual taking over of its manage ment until it regains a sound condition. This has proved val uable during times of stress when the announcement of clearing house support to a weak bank has been sufficient to avert a run on the bank . The Clearing House Section of the American Bankers’ Asso ciation has used its best efforts to secure such examiners and claims the following advantages for the system : ( 1 ) Such exam iners have the assistance of the clearing house committee who are better judges of local credits than any bureau at Washington possibly could be. This so fortifies the judgment of the examiner that it is as nearly correct as human imperfections permit. Cer tainly his judgment is more likely to be superior to the very best examiner sent from the office of the Comptroller of the Currency. ( 2 ) The slightest expression of a wish from the clearing house committee to a bank under its jurisdiction must have prompt at tention. A delinquent bank may argue for months and even years with the department of the Comptroller of the Currency, but it dare not dally with the clearing house committee. 10 Gathering credit data for members For some years it has been common practice for a few clear ing house associations to gather valuable credit data for members. Large borrowers are indexed and observed, and facts as to their 'Stanley Young, “ Enlargement of Clearing House Functions,” Annals of the American Academy of Political and Social Science, Vol. XXXVI ( 1910 ) , P. 608 . 10Proceedings of the American Bankers' Association ( 1909 ) , pp. 7-8, 15. Following is a list of cities where the Clearing House System of Examination was in successful operation in 1921 : Boston, Mass., Chicago , Ill., Cleveland , Ohio, Columbus, Ohio , Denver, Colo., Detroit, Mich., Hutchinson, Kan., Indian apolis, Ind ., Kansas City, Kan., Kansas City , Mo., La Crosse, Wis., Los Angeles, Calif., Louisville, Ky ., Milwaukee, Wisc ., Minneapolis, Minn ., Montgomery, Ala., Nashville, Tenn ., Newark, N. J., New Haven, Conn., New Orleans, La., New York City, Northern Anthracite Bankers' Association ( Scranton, Pittston and Forest City, Pa .), Ogden, Utah, Oklahoma City, Okla ., Omaha, Neb., Pasadena, Calif. , Philadelphia , Pa ., Portland, Ore . , St. Louis, Mo., St. Paul, Minn . Salt Lake City , Utah, Seattle, Wash ., Sioux City, Ia., Tulsa, Okla., Wichita, Kan. The Clearing House Idea and the Examiner System , a pam phlet published by the Clearing House Section of the American Bankers' Asso ciation ( 1921 ) . For an account of the efforts of the Clearing House Section of the Ameri can Bankers' Association in behalf of the clearing house examiner system , see American Bankers' Association Journal, Vol . XVII ( Oct., 1924 ) , p. 261. This Section is also encouraging Bank Auditors Conferences looking forward to a national organization , and is trying to educate the banks on the value of the analysis of accounts. CLEARING HOUSES PRIOR TO 1914 137 total local obligations are made available quickly upon request for any interested member of the association. It may be easily learned whether there are duplications of borrowings by the same client from different banks.11 It is a common practice to ex change credit information on all customers who patronize two or more banks or who seek to change their connections. Another practice is to require annual statements from all customers having a line of ( say ) $1,000 or more, and to encourage the procuring of statements from all borrowers. 12 The issuing of public statements It has been and is the practice of a few clearing house associa tions to require periodic statements from members showing their condition, although very few associations publish such statements. Nearly all clearing house associations, however, give the totals of monthly clearings to the financial press and some also give daily and weekly clearings. Not only does such information give the public some idea of the condition of member banks, but it serves, in a general way, as a basis for judging the general tendencies in business. Such information, combined with the knowledge secured through clearing house bank examinations, also places the clear ing house in possession of valuable information so that it is able to detect weaknesses and unwise tendencies before it is too late.13 Annual conferences The annual conferences held by representatives of clearing houses date from 1899, being the outcome of resolutions passed by the Michigan Bankers’ Association, which, in that year, recom mended such conferences to consider the unsatisfactory and con fused conditions pertaining to collection and exchange charges. The first conference was held in Cleveland in 1899 with the conven tion of the American Bankers' Association, and effected a formal organization. In 1905 the organization, which had met annually since 1899, was formally recognized by the American Bankers' " Stanley Young, op. cit. , pp. 130-132. 12 The Clearing House, etc., a pamphlet published by the Clearing House Section of the American Bankers' Association ( 1923 ). Bureaus of Credit have been installed in five clearing house associations: Indianapolis, Chattanooga, Mobile, Allentown, Pa ., and Camden , N. J. One county association, the Jasper County Bankers' Association of Missouri, also has such a bureau . See American Bankers' Association Journal, Vol. XVII ( Oct., 1924 ) , p. 261 . The results of clearing house examinations are not put in possession of other members of the association. 138 CLEARING AND COLLECTION OF CHECKS Association in the appointment of a special committee, to which was intrusted the future work of the Clearing House Conferences. In 1906 the Clearing House Section of the American Bankers' Association was organized and this gave the section representa tion on the executive council of the association . Annual reports as part of the Proceedings of the American Bankers' Association have been made since that time. These cover the general activities of the section. For example, in 1907, plans were formulated to reduce to a minimum certain lines of clerical work in clearing house banks by the use of certain forms of remittance sheets, and the adoption of a system of letters and numbers for cities and clearing house banks. Among other things, the section also has been instrumental in creating sentiment in favor of the appoint ment of clearing house examiners, the suppression of note kiting, the publication of clearing house totals, the country clearing house, the no-protest symbol plan, and uniform counter checks. The issue of clearing house loan certificates. Their nature Clearing house loan certificates must be distinguished from clearing house certificates. The latter are merely substitutes for specie or currency, and are used by member banks of a clearing house association for the settlement of balances. These certifi cates constitute claims to currency and obviate the necessity of counting and recounting it. They are issued upon the deposit of currency and are used in ordinary times, solely as a method of economizing time and labor and reducing risk in handling large sums of currency . Clearing house loan certificates, on the other hand, are issued in times of stress upon the deposit of collateral securities . Although both are intended for use in the settlement of balances at the clearing house, the circumstances that call them forth, the results effected by their use, and the parts they have played in banking economy are quite different. Under Section 5192 of the Revised Statutes, clearing house certificates for pur poses of reserve are deemed to be lawful money in the possession of any association belonging to the clearing house issuing the certifi cates. 14 Clearing house loan certificates are negotiable, as a rule, only among the members of the association, and originally were not regarded as currency. Ordinarily, they did not pass from bank to bank except in payment of clearing house balances and * Report of the Comptroller of the Currency ( 1907 ) , p. 64 ; C. F. Dunbar, Chapters on Theory and History of Banking, 2nd ed. ( New York, 1904 ) , pp. 43-44 , 175. CLEARING HOUSES PRIOR TO 1914 139 were not seen by the business community. While this has been true in general, it will be seen that there have been important exceptions to the rule. Clearing house loan certificates have been resorted to as a means of injecting some elasticity into the currency which was not only not elastic, but perversely inelastic. Taking the place of money in settlements at the clearing house, they saved the use of so much cash, which enabled the banks to meet their balances, to make additional loans and discounts, and to meet other obliga tions, and thus to that extent expand the volume of currency. Although originally designed for use in settlements at the clear ing houses only, they were put into actual circulation in some cases after 1893, thus assuming an additional function which at times became quite important. When the stringency in the money market seemed sufficient, the clearing house association would meet and appoint a so-called loan committee, which, in New York City, usually consisted of five bank officers, to act in concurrence with the president of the clearing house association, who served as ex -officio member. The clearing house loan certificates would be taken out by the clearing house members through this committee. It was the duty of the committee to meet each morning at the clearing house and ex amine the collateral offered as security by the banks and issue the loan certificates thereon in such denominations and proportions as were agreed upon. Cannon says the denominations have varied from 25 cents to $20,000 in the different associations, and in pro portions of 50 to 100 per cent. of collateral deposited.15 Interest rates varied from 6 to 9 per cent. per annum, payable by the banks to which they were issued, to the banks receiving the certificates in settlement of daily balances. As a result the interest charged against certain banks should exactly equal that credited to cer tain other banks. The aim was to fix the rate sufficiently high to insure the retirement of the certificates as soon as the emergency which called them forth had passed. It was not the general practice for all the members to take out loan certificates when such issues were arranged. Some were in such condition that they could weather the storm without them while others were weak and in need of relief. Some banks regarded their use as a reflection upon their standing and refused to apply for them unless driven to it by sheer necessity, while others re garded it as in no way prejudicial to their interests, but , on the uJ. G. Cannon, Clearing Houses ( New York, 1900 ), p . 82. CLEARING AND COLLECTION OF CHECKS 140 contrary, as a proper movement in which all the banks should en gage for the general welfare of the community as a whole. It has been the general policy of the members of the New York Clear ing House to take out loan certificates regardless of their strength. They have distinguished themselves in this respect and in one instance, when a member bank refused to share the bur dens of the associated banks, it was suspended from the privi TABLE XIV Issue of Loan Certificate by New York Banks, 1860-18931 Loan mittee of 1860 1861 1863 1864 1873 1884 1890 1893 Date of Date of first issue com Nov. 23 , 1860 Sept. 19, 1861 Nov. 6 , 1863 Mar. 7, 1864 Sept. May Nov. June 22 , 16, 12 , 21 , 1873 1884 1890 1893 last issue Feb. 27 , 1861 Feb. 17 , 1862 Jan. 9 , 1864 April 26 , 1864 Nov. 20, 1873 June 6 , 1884 Dec. 22 , 1890 Sept. 6 , 1893 Date of Anal cancellation Mar. April Jan. June Jan. 9 , 1361 28 , 1862 Aggregate issue $ 7,375,000 22,686,000 Maximum amount outstanding $ 6,860,000 21,960.000 9,608,000 16,418,000 Rate or interest 7 6 6 30 , 1864 11,471,000 13 , 1864 14 , 1874 Sept. 23 , 1886 17,728,000 26,565,000 24,915,000 Feb. 7 , 1891 16,645,000 15,205,000 6 Nov. 1 , 1893 41,490,000 38,280,000 6 6 22,410,000 7 21,885,000 6 Report of the Comptroller of the currency ( 1907 ) , p. 66 ; W. W. Swanson , "The Crisis of 1860 and the First Issue of Clearing -House Certificates, " Journal of Po litical Economy , Vol . XVI ( 1908 ) , p. 221 . Nature of collaterals : 1860-U . S. stocks, Treasury notes, stocks of State of New York . 1861 — Temporary receipts of the U. S. for purchase of governmont bonds. 1863—U. S. or New York State bonds, etc. , or temporary receipts as in 1861. 1864 - Same as in 1863 . 1873 --- Bills receivable , stocks, bonds, and other securities. 1884 Same as in 1873. 1890 - Do . 1893-Do. leges of the clearing house for more than three months. The total amount of balances is not always paid in clearing house loan certificates by a bank to which such certificates have been issued ; a bank may pay all or only part in such certificates with the balance in gold or gold certificates. Clearing house loan cer tificates have been issued repeatedly in this country as Tables, XIV and XV will show . The use of clearing house loan certificates in 1860 The crisis of 1860 was brought on by the rupture of business relations between the North and South and aggravated by the sus pension of normal trade relations between the East and West. To 141 CLEARING HOUSES PRIOR TO 1914 appreciate this condition it must be borne in mind that business had been expanding by leaps and bounds during 1859 and never TABLE XV Aggregate Issues of Clearing House Loan Certificates, 1873-1896, Inclusive Aggregate Aggregate Year Association New York Philadelphia Boston 1873 Baltimore St. Louis New Orleans Cincinnati Amount 26,565,000 6,785,000 4,800,000 1,326,000 1,472,5003 1,067,0003 515,0000 Year 1893 Association Amount New York 41,490,000 New Orleans Boston 11,445,000 ? Philadelphia 10,965,000 $ 998,000® Baltimore Buffalo 1,475,000 985,00010 987,000 360,000 " 127,000 " Pittsburgh Detroit 1879 New Orleans Atlanta 54,000 * 13 Birmingham 1884 1890 New York ....... New York Boston Philadelphia 24,915,000 16,645,000 5,065,000 9,655,000 1891 Louisville, Ky... Amt. unknown 1895 Cincinnati 10 Chattanooga 10 Boston 235,000 " Philadelphia 1896 New Orleans 8,220,000 " • • • 399,0004 * Report of the Comptroller of the Currency ( 1907 ), p. 66, for the years 1873-1893. 'Approximate maximum outstanding at any one time. Cannon, Clearing Houses, U. S. Nat. Mon. Com . Pubs., 61st Cong., 2d Sess., Sen. Doc. No. 491, P. 86 . ' Cannon , op cit., p. 89 . ' Ibid ., p. 90 . ' Ibid ., p . 95. *Maximum , Cannon , p. 105 . A. P. Andrew , “ Substitutes for Cash in the Panic of 1907,” Quarterly Journal of Economics, Vol. XXII ( 1908 ) , pp. 506-507 , gives $ 1,029,000 . 'Cannon says this represents the maximum amount, and that the aggregate was $ 11,645,000. Loc. cit., p. 98. 'Cannon again says this is the maximum amount and that the aggregate was $ 11,470,000. Ibid. 'Maximum according to Cannon, p. 98. 10 Aggregate. Cannon, p. 105. The maximum was $ 925,000. Maximum. Cannon , p. 107. A. P. Andrew , op. cit ., gives $ 500,000. " Maximum . Cannon, p. 109. Had general circulation. "Amount not known. Had general circulation. * Amount not known. " Cannon , pp . 112-113. 10Maximum amount. Cannon, p. 113. in the history of the country had the outlook been more encour aging than in the first few months of the disastrous year 1860. During the fiscal year which ended June 30, 1860, foreign trade > 142 CLEARING AND COLLECTION OF CHECKS reached the highest mark yet attained.18 New York City banks had expanded their loans liberally at the beginning of the year, but by October and especially in November after the election of Lincoln, hostility in the South accompanied by fear and distrust in almost every section of the country, disrupted the banking sys tem and threatened a panic. The banks, in general, hesitated to advance loans and obtained from their customers as rapidly as possible the payment of obligations. Call loans commanded 7 per cent., and the paper of some of the best houses went begging at 24 per cent. The banks in the New York Clearing House, on the other hand, wished to extend their loans liberally to check the incipient panic. In order to effect this end and to facilitate the settlement of exchanges among the banks themselves, it was de cided by an agreement of November 21 , 1860, that any bank in the clearing house association might deposit at its option with a select committee of five members chosen by the association, any amount it desired of its bills receivable, United States stocks, Treasury notes, or approved stocks of the State of New York, and receive in return certificates of deposit, on which it would be required to pay interest at 7 per cent. per annum. These certifi cates were to be in denominations of five and ten thousand dollars, were to be issued up to 75 per cent. of the value of the securities pledged, and could be used to settle balances at the clearing house only for a period of thirty days from the date of issue. A creditor bank was obliged to accept each day from the clearing house by this agreement, such a proportion of the certifi cates offered as its own balance bore to the total amount settled. Under such an arrangement some banks would be unable to main tain their reserves, if certificates of deposit were used to any considerable extent by debtor banks in settling balances. The banks receiving these certificates were themselves obliged to pay out gold on demand to depositors, thus depleting their own re serves and introducing a new kind of paper into their assets. To obviate this difficulty, the specie of the associated banks was pooled and treated as a common fund for their common benefit and protection. The clearing house committee was given power to equalize this common reserve by assessment or otherwise. For this purpose banks were required to make statements each morn ing before commencement of business to the committee on the following items: ( 1 ) Loans and discounts, ( 2 ) deposits, ( 3 ) loan 10W . W. Swanson, “ The Crisis of 1860 and the First Issue of Clearing -House Certificates, ” Journal of Political Economy, Vol. XVI ( 1908 ) , passim . ] CLEARING HOUSES PRIOR TO 1914 certificates, and ( 4 ) specie. 143 These data enabled the committee to determine daily which banks were carrying a disproportionate amount of specie in comparison with other banks in the clearing house association. The common specie reserve was then, accord ing to agreement, equalized among the banks by assessment. It was also provided that interest which might accrue upon these certificates, at the expiration of the thirty days, should be appor tioned among the banks which had held them during that time. The committee was authorized to exchange any portion of the securities for an equal amount of others, to be approved by them at the request of the depositing bank, and had power to demand additional security either by exchange or by an increased amount . The amount of certificates which the committee might issue was not to exceed five million dollars. On December 3, 1860, it was voted to increase the limit to ten millions, and something over seven millions were issued. After February 1 , 1861 , every bank in the clearing house association was to have on hand at all times, in specie, an amount equal to one- quarter of its net liabilities, and any bank whose specie fell below that proportion, was not to make loans or discounts until its position was re-established. The banks also agreed not to exchange with any bank which showed by two successive weekly statements that it had violated the agree ment . 17 This meant the virtual fusion of the banks of New York18 into one central bank and the issue of the certificates marked the turn ing-point in the panic and postponed the suspension of specie payments which came thirteen months later. The banks extended their loans freely, but the customers usually placed them as de posits on the books of the bank and very little specie was with drawn. Deposits increased and commercial paper,, which formerly could not be sold at 20 per cent. discount, was now marketed freely at 7 to 8 per cent. Although it may be said that there was a suspension of specie payments among the banks since they settled among themselves by the pledge of securities, there was no sus pension so far as the public was concerned. The aggregate issue was $7,375,000 ; the last certificate was cancelled March 9, 1'Hunt's Merchants' Magazine, Vol. XLIV ( 1861 ) , pp. 91-92 ; W. W. Swan son , op. cit., pp. 219-220. 18All the New York banks entered into this combination, except the Chemical Bank, an institution with remarkably large and steady deposits and small cir culation, which preferred to leave the clearing house rather than throw its large specie into the common stock . C. F. Dunbar, op. cit ., p. 82 ; Hunt's Merchants' Magazine, Vol. XLIV ( 1861 ) , p. 77. CLEARING AND COLLECTION OF CHECKS 144 1861 , and the total period from the date of first issue was 106 days.19 Although there were four other clearing houses established prior to 1860 — at Boston, Philadelphia, Baltimore, and Cleve land—they did not resort to clearing house loan certificates. On November 24, the Boston banks followed the example of those of New York in so far as to agree among themselves to discount freely. Banks owing balances at the clearing house were per mitted to settle in their own notes up to 50 per cent . of the bal ances due, in amounts ranging from $10,000 to $100,000, ac cording to the capital of the bank tendering them.20 But they did not make a common fund of their specie, however, as did the banks of New York City. As the banks refrained from mutual demands for specie, they were able to weather the storm.21 The Baltimore and Philadelphia banks suspended specie payments on November 22 ; other banks followed in rapid succession especially throughout the South.22 The New York issues of 1861, 1863, and 1864 The relief afforded by the certificates in 1860 was but tempo rary for the country soon was plunged into the Civil War, which paralyzed trade and industry and caused great distrust and un certainty in business in general. As a result, the New York Clearing House Association authorized another issue of loan cer tificates September 19, 1861 . The aggregate issue was $ 22, 585,000. The last certificates were called April 28, 1862, more than seven months after the date of their first issue. The nature of the collateral, the rate of interest , the maximum amount out standing at any one time, are set forth in the table above, p. 140. The third and fourth issues of 1863 and 1864, respectively, are also set forth in the same table . These issues were the result of the prolongation of the war, with the consequent unrest in busi ness circles. No more loan certificates were issued until the panic of 1873 . 1"Dunbar says $ 10,000,000 of such certificates were issued under this agree ment, all to be redeemed by February 1 , 1861. He is incorrect in this state ment according to the Report of the Comptroller of the Currency ( 1907 ) , p. 66. sºHunt's Merchants' Magazine, Vol. XLIV ( 1861 ) , p. 77. W. W. Swanson, op. cit ., p . 222. * According to D. P. Bailey, The Clearing House System ( New York, 1890 ) , p. 22, there are no records of the Cleveland Clearing House prior to 1877. CLEARING HOUSES PRIOR TO 1914 145 Clearing house loan certificates and the panic of 1873 It was not until the panic of 1873 that other clearing house associations followed the practice of New York and issued loan certificates. New York followed the precedent established in 1860 and was joined by the clearing house associations of Boston, Philadelphia, Baltimore, Cincinnati, St. Louis, and New Orleans. The severe panic of 1873 affected every operation of finance and commerce. The result of inflation , an enormous railway ex pansion in anticipation of demand, and the burden of heavy for eign indebtedness largely in the form of interest charges on bor rowed money, the panic of 1873 plunged the United States into disaster with little preparation or anticipation by financial inter ests.. When Congress met in December, 1873, demands for gov ernment action took every form known to finance. The panic reached its climax in September and was so severe that the New York Stock Exchange closed its doors on September 20 for an indefinite time, although it reopened them ten days later. The usual resolutions were passed by the New York Clearing House, authorizing the issue of loan certificates, and the first issue was made September 22, 1873.23 Although the amount was fixed at the outset at $10,000,000, more than $26,500,000 were issued in less than four months. But the announcement that the ten millions would be issued, coupled with the announcement that the government would purchase the same amount of bonds, caused a rapid subsidence of the panic and in about three days its most acute stages were over.24 Cannon points out that attempts on the part of the business community were made in vain to discover what banks had taken out certificates, but the information was withheld. For more than two months, covering the worst period of the panic, no weekly statements of their condition were made to the clearing house by the banks, the object being to prevent a general knowledge of the weak condition of some of the members, which , if disclosed might have invited runs upon them . The Boston Clearing House Association on September 27, 1873, voted to suspend currency payments and to appoint a loan committee, with power to issue loan certificates to the amount of $10,000,000 upon substantially the same basis as at New York . On October 20, the amount outstanding reached its maximum of 23See table above, p. 140 . " Cannon , Clearing Houses, U. S. Nat. Mon. Com . Pubs., 61st Cong., 2d Sess., Sen. Doc. No. 491 ( 1910 ) , p. 85. Hereafter cited as Cannon, I. 146 CLEARING AND COLLECTION OF CHECKS approximately $4,800,000. Similarly, the Philadelphia Associa tion adopted for the first time the plan of issuing loan certificates by a resolution of September 24, 1873, amended October 18, 1873, with provisions quite similar to those adopted by the New York Clearing House Association in 1860 as set forth above. The max imum amount outstanding at any one time was $6,285,000, reached on December 1 , 1873 ; the aggregate amount was $ 6 , 785,000. Baltimore began to issue similar certificates on Septem ber 24, which amounted in the aggregate to $1,326,000. The last of these was retired January 2, 1874, one hundred days after the date of the first issue. The St. Louis Association issued its cer tificates on September 25, and retired them forty-six days later, the aggregate amount having been $1,472,500. At New Orleans the maximum amount outstanding was $1,067,000, reached October 10, 1873. The Cincinnati Clearing House Association issued loan certificates during a period of only fourteen days and to the amount of $515,400, the last of which were cancelled six weeks after the date of the first issue. Among the resolutions issued by the association on September 25 was one that they would follow the plan adopted by New York City, namely, they would not pay out currency on checks, except for small sums, to be optional with the banks and bankers on whom they were drawn ; but they would certify checks drawn on balances in their hands, payable through the clearing house only. When such checks were drawn in payment of notes or drafts, the bank holding them was not required to deliver the paper until after the check in payment had been paid to the clearing house.25 Clearing house loan certificates in 1879, 1884, 1890, and 1891 The next issue of clearing house loan certificates was in 1879, when the New Orleans Association alone issued a small amount only $ 54,000 — to satisfy conditions of a purely local character.26 The year 1884 marked the next issue of such certificates. Although a commercial and financial crisis occurred in that year, resulting largely from an excessive construction of railways, the New York Clearing House Association was the only one which issued loan certificates. The amount taken out was almost as large as that of 1873 ; the issue beginning early in the year to prevent a widespread panic. The first issue was on May 15, and **Cannon , I , p . 89. * 7bid ., p. 90. CLEARING HOUSES PRIOR TO 1914 147 reached the maximum of $21,885,00027 on May 24. The last cer tificates were issued June 6, and the last were retired September 23. The aggregate amount was $24,915,000. The next six years were free from unusual financial disturb ances and as a result no more loan certificates appeared until 1890. Up to midsummer of that year the country had experienced un usual prosperity. But there was an unwholesome tendency to overtrading and expansion which required the extension of large sums of money upon security. Early in the year the deposits in the banks of New York City began to fall off, and by May 17, the shrinkage had amounted to more than $44,831,000, of which over $13,500,000 consisted of balances drawn out by banks in the interior and in other reserve cities. Boston, New York , and Philadelphia were the cities subjected to the heavy drains, and to protect themselves they issued loan certificates. New York City took the first action on November 11 , 1890. Next day she issued the first certificates and the last issue was December 22 . The maximum amount outstanding at any one time was $15,205,000 ; the aggregate amount was $16,645,000.28 November 19 with loan certificates. Boston followed on The last were issued Decem ber 6, and the last issue was cancelled January 6, 1891. The amount issued totaled $5,065,000. On November 19, Philadel phia also made her first issue, on practically the same plan as followed in 1873. The issue ceased May 22, 1891 , the total issue being $9,655,000, with the maximum of $8,870,000, which was reached on January 9, 1891. The certificates were all retired, excepting $170,000 issued to the Keystone and Spring Garden National Banks, institutions which were carried down in the panic. 29 Louisville, Ky., has the distinction of being the only city in which aa clearing house association issued loan certificates in 1891 and peculiarly enough this was the only time the association ever issued loan certificates. The issue was small, the exact amount. not being known . Clearing house loan certificates and the panic of 1893 Late in 1891 the United States entered again into a period of expansion which resulted in the panic of 1893. Bad harvests in Europe and abundant harvests in the United States stimulated "Cannon says $ 21,881,000. Op. cit., p. 90. ** See table above, p. 140. > Cannon , I, p. 94. 148 CLEARING AND COLLECTION OF CHECKS the farmers and the railways to buying with freedom which was the beginning of a general stimulation in almost all lines of busi ness . In 1892 the situation was different. Crops were poor, prices low and gold exports heavy. These facts, combined with the lowering of the tariff which reduced the revenues of the Treas ury, the increased appropriations of Congress, the drainage of the gold reserve to meet not only foreign obligations but to redeem the United States and Sherman notes — the " endless chain " —the collapse of banks in Australia, the failure of the Philadelphia & Reading Railway and the National Cordage Company, destroyed confidence and plunged the country headlong into a panic .30 By May, bank deposits began to shrink rapidly, by June and July, the mortality among banks was alarming, and by August, a panic of great severity held the country in its grip . There was no way in which banks could expand their currency. The situation in the reserve and central reserve cities was aggra vated by the call of interior banks for their reserves which had been deposited in those cities. The interior banks got into trouble first and sporadic failures, multiplying here and there, gradually forced other banks, and finally the New York banks, to a tempo rary restriction of payments.81 Thus was manifested one of the outstanding defects of the old National Banking System, the pyramiding of reserves. Clearing house loan certificates were again resorted to as the best means of staying the force of the panic. Eight cities were reported to have employed loan cer tificates of large denominations for use in settling clearing house balances,32 New York began to issue the certificates June 21 , 1893 ; the last issue was September 6 ; the date of final cancellation, Novem ber 1 ; and the aggregate issue, $41,490,000, an issue of unprece dented size. New Orleans followed New York on June 22, under joint agreement and responsibility as contrasted with the usual individual responsibility. The largest amount outstanding at any one time was $998,000. Boston began to issue loan certificates June 27, bearing 7.3 per cent. interest. The aggregate issue was $11,645,000 and the maximum at any time $11,445,000. They were cancelled by October 21. Philadelphia issued an aggregate amount of $11,470,000, the largest amount outstanding at any so See W. C. Mitchell, Busine88 Cycles ( University of California, 1903) , pp . 51-58 . *A . P. Andrew, “ Substitutes for Cash in the Panic of 1907,” Quarterly Journal of Economics, Vol. XXII ( 1908 ) , p. 513. 87See Table XV above, p. 141 . 9 CLEARING HOUSES PRIOR TO 1914 149 time being $10,965,000. The maximum amount outstanding at any time in Baltimore was $1,475,000. Buffalo banks issued an aggregate of $ 985,000. Pittsburgh issued $987,000 in the aggre gate. The first was issued on August 11 , and the last retired on September 15. Detroit had a maximum outstanding of $ 360,000 ; Atlanta a maximum of $127,000. Atlanta's certificates were dis tinguished from those mentioned above in the fact that they cir culated outside of the banks and were received on deposit or in payment of debts due any bank in the clearing house. This was the first time that clearing house loan certificates in currency denominations, to be used by banks in paying their customers, were ever issued.33 Birmingham also issued loan certificates for general circulation in denominations as small as $2, $1 , 50 cents, and 25 cents. No other association in the United States had pre viously made issues which compared with the one at Birmingham , in the comprehensiveness of its currency system and the extent to. which it was developed on this occasion. Cincinnati and Chatta nooga also resorted to loan certificates, but the amount issued is not known. In cities in which there were no clearing houses an emergency currency, under the name of " clearing -house certificates,” was issued by banks associated together. These certificates were tempo rary loans made by the banks associated together and pledged for their redemption. They were in small denominations and pecu liar to the Southeast. The denominations and cities were : Albany, Ga., $10, $5, and $1 ; Chester, S. C., $10, $5, and $1 ; Columbia, S. C. , $50, $20, $10, $5, $2, and $1 ; Newman, Ga., $ 10, $5, and $1 ; and Rock Hill, S. C., $5, $2, and $ 1 . They afforded relief to the public and accomplished results similar to those accomplished by actual clearing house loan certificates in larger cities.34 Loan certificates in 1895 and 1896 Certain localities experienced a depression in 1895. Boston felt such pressure that the clearing house association issued loan, certificates to the amount of $235,000, the last of which were re tired March 12, 1896. In a similar manner Philadelphia made an issuing aggregating $8,220,000.35 In 1896 , New Orleans issued clearing house loan certificates. The largest amount outstand * A . P. Andrew , op. cit . , p . 507 ; John DeWitt Warner, “ The Currency Famine of 1893 ,” Sound Currency, Vol . II, No.:6 ( New York, 1895 ), p. 6.. “ Cannon , I , p. 112. 38Ibid ., p. 113. 150 CLEARING AND COLLECTION OF CHECKS ing at any time being $ 399,000. Cannon says the excitement due to the presidential contest in that year was the disturbing factor which occasioned the issue. This seems to have been the last issue until the panic of 1907. Loan certificates and other currency substitutes issued during the panic of 1907 The panic of 1907 was a violent manifestation of an interna tional crisis which terminated the period of business expansion in Europe and America in 1905-1906 . The defective currency sys tem was undoubtedly the chief contributing factor. Business was being done by the modern system of bank credits with inadequate machinery for readily converting bank credits into cash. The crisis antedated the panic by several months. While the panic came in March with a second crash in August, 1907 , a recession in the prices of raw materials began in the spring and early sum mer of the preceding year. Unsold stocks accumulated and forced large industrial enterprises into the hands of receivers in June, August, and October. The investment market for loans became more and more stringent . Prices fell rapidly on the Stock Ex «change and acute trouble began when suspicion was directed against certain New York banks , controlled by a group of finan ciers who were believed to have suffered heavy losses through the decline in the prices of copper stocks. The run on the Knicker ibocker Trust Company , October 22, precipitated the panic which -carried down with it other financial houses with the usual attend ing phenomena . From New York as a center the panic spread rapidly over the country. The banks of the country, it seems, had never suspended payments with quite the same simultaneity as in 1907. Clearing house loan certificates were again resorted to, but, in addition, several other expedients were adopted.36 It had been hoped and expected in New York that the fact that the New York Clearing House had announced its intention to support the asso ciated banks, would be sufficient to tide the banks over the crisis. Several of the banks applied for and received assistance through the joint action of many of the banks, which advanced cash , re . ceiving therefor participating certificates, for which the clearing house held the collateral security. The drain upon all the banks was exceedingly severe, and it became apparent that aid would be solicited soon by other members of the association. For this rea 30For other remedies adopted, see Mitchell, Business Cycles, p. 78. CLEARING HOUSES PRIOR TO 1914 151 son the loan certificates were issued. The first issue was on Octo ber 26, 1907. Most of the clearing house associations of the country met about the same time and made provision for the issue of some form of instrument that would aid in relieving the exist ing conditions, and in the majority of cases certificates were issued varying in rates of interest from 5 to 10 per cent., and were issued for from 50 to 80 per cent. of the collateral deposited to secure them. Although Cannon thought it impossible to estimate the amount of these instruments outstanding at any one time, he thought it safe to assert that more than $250,000,000 were issued during the panic in addition to which some of the railroads and larger industrial concerns issued checks of various denominations to pay wages of employees, all of which, he concluded, served well the purpose for which they were issued.37 The variations in the types of issues almost defy classification. Table XVI below classifies the issues of 1907 under five main heads. However, there were other variations that should be men tioned and a more complete classification would be as follows : ( 1 ) Clearing house loan certificates in large denominations for the settlement of bank balances, (2 ) clearing house loan certificates in small denominations for general circulation, ( 3 ) clearing house checks in convenient denominations for general circulation, ( 4) cashiers' checks in convenient denominations payable only through the clearing house, ( 5 ) certificates of deposit in conven ient denominations, ( 6) drafts on reserve banks, and (7 ) pay checks payable to bearer. In addition, other expedients were re sorted to as ( 1 ) official encouragement of suspension, ( 2 ) limit ing the size of checks to be paid, ( 3 ) the practice of requiring the larger customers of the banks to mark their checks " payable only through the clearing house, " and ( 4 ) the plan of group No. 2 of the Ohio Bankers' Association. Clearing house loan certificates in large denominations It would be unprofitable to make a detailed study of the par ticular issues of clearing house loan certificates in large denomina . tions further than to mention briefly some of the most typical and outstanding cases. Mr. A. P. Andrew says that in 1900 there were 147 cities with populations of 25,000 or over and that out of 145 of these which reported to him in 1908, 42 issued clearing house loan certificates in large denominations to settle bank bal 37J. G. Cannon , Clearing Houses and the Currency ( Columbia University Press, 1908 ) , pp. 112-113. Hereafter cited as Cannon, Ii . 152 CLEARING AND COLLECTION OF CHECKS ances at the clearing houses ; 22 of the 145 issued loan certificates of small denominations for general circulation ; and 51 issued either or both.38 On October 26, the New York Clearing House Committee first issued $ 11,235,000 of loan certificates to take care of the partici pating receipts given for loans advanced the preceding week . The final issue was on January 30, 1908 ; while final cancellation was on March 28, 1908. The aggregate issue was $101,060,000 and the maximum amount outstanding at any one time was $88, 420,000. During this period $453,000,000 of collateral passed through the hands of the committee, of which $330,000,000, or 72.92 per cent., consisted of commercial paper,, and $ 123,000,000, or 27.08 per cent., of stocks, bonds, and short-time railroad and other similar notes . The smallest amount issued to any bank was $250,000 ; the largest amount, $17,000,000, an amount of certifi cates greater than the aggregate issue of any individual clearing house in the United States with the exception of Chicago.39 The issues of clearing house loan certificates in New York also pro vided credit with which the banks were enabled to buy and pay for large amounts of the Panama bonds and United States certifi cates of indebtedness which were issued by the government as a measure of relief. The bonds and certificates so purchased were then placed on deposit in Washington, as security for new na tional bank note circulation. In this manner the issue of clearing house loan certificates made it possible to secure more circulation. Aid was extended also to the trust companies of the city by permitting them to borrow from clearing house banks with which they did business, on their own notes secured by collateral which they permitted the clearing house banks to hypothecate with the New York Clearing House Association and for which they re ceived clearing house loan certificates in return. This relieved the trust companies of great embarrassment.40 Chicago followed New York on October 28 or 29 with its first issue of clearing house loan certificates. They differed from those issued by New York as the agreement under which Chicago's cer tificates were issued was amended on November 6, and again on . November 9, authorizing the substitution of checks in denomina tions of $ 1 , $2, $5, and $ 10, as desired . These were designed to circulate to the extent of $7,500,000 and were secured by clearing 38 A. P. Andrew , op cit., p. 501 . 3*See Table XVI below, pp. 156-157. "Cannon, II, pp. 112-113. CLEARING HOUSES PRIOR TO 1914 153 house loan certificates which, in turn, were secured by 133 per cent. of good collateral.41 Boston issued only long-time certifi cates. For the period beginning October 28 and ending January 24, she issued $ 12,595,000. According to Cannon, Philadelphia began to issue such certificates as early as September 24, and issued an aggregate amount of $13,695,000. Other types also ap peared there. The table should be consulted for a further list of the cities which made such issues. Clearing house loan certificates in small denominations for general circulation Mr. A. P. Andrew estimated that out of 145 cities with a pop ulation of 25,000 or over, at least 22 issued loan certificates in small denominations for general circulation. Table XVI, however, lists 26 cities with a population of 25,000 or over, and Table XVII lists 34 more with a population of less than 25,000 that made such issues. It is obvious that this information must be very uncer tain and incomplete . The Los Angeles Association issued not only clearing house loan certificates in large denominations, but also a peculiar issue designed for general circulation and called “ clearing house circu lating certificates or scrip.” Their purpose was identical with that of the clearing house checks issued by other associations and closely resembled them except that they were more elaborate in form. Both types of issues were directly secured by collateral, the former to the extent of 133 per cent. , and the latter by securities valued at 200 per cent. of the amount issued. This was unlike the practice followed by most clearing house associations which issued both types. The usual practice was to secure the checks by the deposit of loan certificates, which were secured by collat eral. The Kansas City, Missouri, Association, like that of Los Angeles, issued both types, each directly secured by collateral. The Fargo, North Dakota, Clearing House Association issued loan certificates in denominations of $5, $10, $20, $100, and $500, payable on or before three months after date and only up to 50 per cent. of the deposited collateral . The Harrisburg, Pennsylvania, Association issued what it called “Certificates of Indebtedness” stating that the association was indebted to the bearer to the sum of $1 , the payment being guaranteed by mem bers of the Harrisburg and Steelton Associations, but payable only through the Harrisburg Clearing House. On the reverse "Cannon, I, pp. 121-123. Cannon's data do not harmonize with Table XVI . 154 CLEARING AND COLLECTION OF CHECKS side were found the following words printed in English , Polish, Hungarian, and Italian : “ This check may be deposited but will not be paid in cash .” 42 Examples will not be multiplied. Regard ing both types of loan certificates, Mr. Andrew pointed out that upon no previous occasion had banks of so many cities resorted to clearing house loan certificates for the settlement of their mutual obligations ; never before had they issued them in such large amounts, nor for such long periods of time, and never had these certificates been so extensively issued in small denominations 43 to meet ordinary bank obligations in lieu of cash.* Clearing house checks in convenient denominations for general circulation Like the loan certificates of general circulation, clearing house checks were issued by the associations to member banks upon the deposit of approved securities and were accepted for deposit in any of the banks, but were payable only through the clearing house. They were in currency denominations and were often very elaborately engraved in order to resemble currency. However, they were unlike the loan certificates in the fact that instead of merely certifying indebtedness on the part of the clearing house association, they took the form of checks drawn upon particular banks, and were signed by the manager of the clearing house. In Chicago a bank desiring such checks, deposited with the clearing house a corresponding amount of the ordinary loan certificates of large denominations, and received the checks in currency denomi nations in exchange.. They were also issued in Cleveland,, Mil waukee, and some smaller cities.44 Cashiers ' checks issued in convenient denominations and payable only through the clearing house National banks and State banks, despite the 10 per cent. tax law, issued these checks in convenient denominations, which circu lated virtually as bank notes. Such checks usually purported to be “ payable to bearer, ” but they were “ payable only through the clearing house,” or in " clearing house funds” . Sometimes they were secured by the deposit of approved collateral with a com mittee of the clearing house, but in the small towns of the middle “ Cannon , Clearing House Loan Certificates and Substitutes for Money Used During the Panic of 1907. Address delivered before the Finance Forum , New York City ( March 30, 1910 ) , p. 13. "A. P. Andrew , op. cit., p. 501 . “ Ibid ., p. 510. CLEARING HOUSES PRIOR TO 1914 155 West they were commonly issued directly by the individual banks. Occasionally an apparent effort was made to circumvent their illegality by making them payable to a supposed person. In St. Louis, Mo., and Muskogee, Okla., they were payable to “ John Smith, or bearer” ; in Memphis, Tenn., to “ Richard Roe, or bearer. " 45 The Cincinnati Clearing House issued similar checks begin ning October 28, 1907, to the extent of about $ 2,000,000. They were in denominations of $2, $5, $10, and $20 and were issued to each of the fourteen clearing house banks on the security of high class collateral which exceeded the amount of the checks issued by more than 20 per cent. Over three hundred merchants whose names were published in the papers indicated their willingness to cash such checks and in some instances a premium as high as 5 per cent. was allowed for cash purchases made and settled by these checks. As soon as the currency situation became normal again they practically retired themselves.46 At Canton, Ohio, a manufacturing center, which required large amounts of cash for payrolls, an agreement was made be tween the bankers and their manufacturing clients by which pay checks were to be used. The banks supplied their customers with these in a general form in denominations of $5, $10, and $20, made payable to the bearer through the clearing house. In using them for purchases with the trades people, they were found to be an easy means of exhausting the supply of cash which the stores were obliged to give in change when small purchases were made. As a result, clearing house checks, or cashier's checks payable to bearer through the clearing house only, were issued to the extent of about $200,000 in denominations of $1 , $2, $5, and $10. These checks had no collateral security back of them and were accepted purely on the responsibility of the issuing bank. Similar checks were issued by Council Bluffs, Ia., Denver, Colo., and other cities, as indicated in Table XVI. Certificates of deposit In a few instances the banks issued currency in the form of negotiable certificates of deposit in convenient denominations. Sometimes the certificates asserted that a particular person or company had a deposit and sometimes the assertion was in general terms, as “ This is to certify that there has been deposited with the "A. P. Andrew , p. 510. " Cannon , I , p. 127. 156 CLEARING AND COLLECTION OF CHECKS First National Bank of Berkeley, Cal., 5 dollars ” .47 In some cases they were interest bearing and payable after the expiration of a certain period ; in others they were immediately acceptable by the issuing bank through the clearing house and bore no interest. They seem to have been found only in a few cities and those with population of 25,000 or less.48 Drafts on reserve banks The banks of Birmingham , Ala ., issued drafts on New York City in denominations of $1 and upward, which were used for pay rolls and general circulation in that locality. They were drawn against actual balances held by particular New York corre spondents and were payable through the New York Clearing House. Such a practice seems to have been peculiar to Birming ham. They were not unlike cashiers' checks "payable in ex change" .49 Pay checks payable to bearer These checks were drawn by such bank customers as railways, mining companies, manufacturers, storekeepers, etc., upon their banks in currency denominations and used in all parts of the coun tries in payment of wages and in settlement of other commercial obligations. They were generally “ Payable only through the Clearing House," but differed from cashiers' checks and clearing house checks in the fact that, unlike the latter, they were not a liability of the clearing house association but of the firm or corpo ration for whose benefit they were drawn. The pay check reached its largest development in Pittsburgh, $ 47,000,000.being issued there during the panic of 1907. Many of them were in denominations of $1 and $2. Their issue involved much labor to the clearing house, to the banks, and to corpora tions using them. They came to banks by the basketfuls, requir ing many extra clerks working far into the night to assort them. Where concerns issued them it was found that clerks could not sign over 400 to 500 checks in eight hours ; since 30,000 to 40,000 checks were issued semi-monthly, the tremendous amount of labor can be appreciated. It is surprising that such checks were so readily accepted in lieu of cash by shops, stores, places of amuse "Andrew, p. 511. ** See Table XVII. “Andrew, p . 511 . { D B А A B D SA D B I B SA A B B ,A .*Circulation DWil ,. el mingtonD A ( OYou , hiongstow Bn K ,. an ita Wich .Top K, aneka .W, . eling Va Whe W ,. ash oma Tac .M , ass nton Tau W,. is rior Supe WSpo ,. ash kane I,. nd dh Ben Sout .., a x ISiou City IB D A .San al isco C ,Franc B .. T , ex io Anton San .G , a nnah Sava .W , ashle Seatt Total 17UT an ',807 ,000 Nov. 1,150 07 ',29 Oct. 00 12,339,0 07 ',4Nov. 0 7,390,00 '265,0 ,407 00 Nov. '1,700 ,407 ,000 Nov. '344,000 1, 07 Nov. obtai not nable nt Amou 07 ',264,500 20 Nov. . omic Econ of al s Journ erly Quart The 3$30,066,223 276,500 43,000 07 000 ',28 Oct. 245, inable obta not Amount 07 ',10 Nov. 120,000 07 .000 ',1Nov 669, 1,407,000 inable obta not unt Amo 0 7, 7 00 Nov. 500,0 obtai not nable nt Amou 07 ',14 Nov. 40,000 07 'Nov. ,8 195,000 ',8 07 Nov. 173,000 251,500 453,650 h,thro -. ouse the ugh only nd ing aclear rle beare to payab inations denom 08 ',23 Jan. 08 '31 ,Dec. 08 ',3Jan. '21 , 08 Jan. ',1 08 Jan. '7,08 Jan. ', 08 10 Jan. 08 ',13 Jan. ',1308 Jan. ', 08 10 Jan. '1, 08 Mar. ,'1508 Jan. -10,000 07 ',12 538,000 Dec. 07 Nov. 45,000 ',29 07 ',Nov. 211,000 28 22,500 490,000 '1, 07 2,076,000Nov. 120,000 ', 07 . Nov 245,000 20 '1, 07 321,000 Dec. 07 Nov. 172,963 ',20 07 ',Dec. 24 12,339,000 07 6 7,390,000,'1Dec , 07 Nov. 265,000 '15 1ec 122 .-D Nov. 2savings ,$5 accounts Only Discretionary custo per $50 mer Discretionary cust per 1$00 omer per 00 omer 1$cust cust per 1$ 00 omer 0 $ 5hen ,10 Dec. to 2t5 $ unts acco savi Onlyngs custo 1per $00 mer discr with 1$00 etion Discretionary day per $50 esy Court 908 ug. XIIomic XA1of .V,(,5p.) 02. ol al s Journ erly Quart he TEcon ,S”of 1907 of Panic the in Cash for tutes ubsti . ews P“,Andr .*A de small in certificates ouseen hof ng leari Cloan -B.balan ces bank conv ement settl hecks the cgener 'C-for for rs ashie ons D.in inati denom latio large in circu al icates certif loan York ouse h inati ew ng n ons N denom E leari C . nient A house conve in ing steral clear the ouse with g arin _Cle colla Ccheck of .-hdepos it n latio circu the al by nient gener ed for conve secur ly in s usual ation hecks nd c aclear nomin PG. ay ble ,house ing on inatisons the denom gh nient throu conve only it paya depos of inati icate denom Cfor ient -Fin .ertif n latio circu gener inati denom nient conve in al nge on excha 157 CLEARING HOUSES PRIOR TO 1914 But this was done despite their variety, liability to counterfeit, and their general lack of security.50 The Philadelphia Clearing House Association, in addition to ment , etc. issuing the loan certificates, also made special arrangements to care for checks which were being used by employers in making payments to employees. On account of the temporary scarcity of currency, employers found it necessary to make payments of wages in pay checks, payable through the clearing house rather than in cash. The clearing house association thought such checks should be rendered as readily available as possible, and conse quently, by a resolution on November 16, recommended that such payroll checks made payable through the clearing house should be certified before issue by the banks upon which they might be drawn ; that no such checks should be certified by any member of the association unless furnished by the American Banknote Com pany in the form approved by the clearing house association ; that they should be furnished only to members of the association upon application to the clearing house association ; that members of the association, before certifying such checks, should open a payroll account for the depositor to whom such checks were to be issued and to which account the checks were to be charged when paid ; and finally, that returns of the amount of checks issued and out standing, as shown by the balance to the credit of payroll account, should be made daily to the clearing house committee by the banks which had accepted and certified them.51 The amount issued in Philadelphia is not known. Duluth and New York seem to have been the only other cities in which they were issued . TABLE XVII Currency Substitutes in Cities of Less than 25,000 Inhabitants, 1907 Total Cities Atchison , Kan. Kind of Amount Device D Issued Bainbridge, Ga. Berlin, N. H.. Berkeley, Cal. Bishop , Ga . Blakely, Ga. Brunswick, Ga. Columbia, S. C. .B D F В B B B 40.000 125,000 Date of First Issue Date of Retirement Nov. 1, '07 Nov. 6, '07 Jan. 1 , '08 Mar. 1 , '08 Amount not obtainable. 34,000 Nov. 5, '07 Amount not obtainable. Amount not obtainable . 109,000 250,000 Nov. Oct. Nov. Oct. 6, 24, 1, 30, '07 '07 '07 '07 B 320,000 617,200 45,000 B 50,000 Nov. 1 , '07 B 33,500 Oct. 29, '07 Columbus, Ga. B Danville, Va. Dawson, Ga. Douglas, Ga. B Fargo, N. D .. BO Andrew , pp. 512-513. " Cannon , I, pp. 124–125. Jan. 10, '08 Mar. Mar. Jan. Jan. 28 , 1, 22, 9, '08 '08 '08 '08 Mar. 1 , '08 Jan. 18, '08 158 CLEARING AND COLLECTION OF CHECKS TABLE XVII- (Continued ) Kind of Device B Cities Gadsden, Ala . Gaffney, S. C. B Greensboro, N. C ... B B F SB Greenwood, s . C .. Guthrie, Okla. Hastings, Neb . Hattiesburg, Miss. F D с .D Henderson, Ky. Iron River, Mich . B B Jackson, Ga. Key West, Fla .. Kalamazoo, Mich . Total Amount Issued 8,000 20,000 39,100 Date of Retirement Jan. 1, '08 Jan. 1 , '08 Jan. 25, '08 Date of First Issue Nov. 15, '07 Nov. 11 , '07 Nov. 4 , '07 Amount not obtainable . Amount not obtainable . Oct. 28, '07 7,713 Dec. 20 , '07 Amount not obtainable. 40,000 Oct. 1 , '07 89,000 Oct. 30 , '07 24,000 Nov. 12, '07 Amount not obtainable . Amount not obtainable. Dec. 15, '07 Jan. 9, '08 Dec. 24 , '07 Customers asked to make checks payable in exchange. B B B B Las Vegas, N. M. Lynchburg, Va. Macon, Ga. Milledgeville, Ga. Muskogee, Okla . Newman, Ga. New Carlisle, Ind . Oklahoma, Okla.. Ogden , Utah Rome, Ga. Sedalia, Mo. South Boston, Va . 30,000 381,000 325,000 Amount not obtainable. Amount not obtainable. D Amount not obtainable . .A, B 200,000 .D circ. 275,000 .B 120,000 D 100,000 100,000 .B Thomaston , Ga. Thomasville, Ga. Tifton, Ga. Valdosta, Ga. 1, 1, 1, 15, 5, B Amount not obtainable . Nov. 22, Oct. 28, Nov. 1 , Nov. 6, Nov. 1 , Nov. 23, 200,000 Nov. 10, Amount not obtainable. B B D B Willacoochee , Ga. Winston-Salem, N. C .. B F Total .... Nov. Nov. Nov. Nov. Nov. .B .B .B .B Vicksburg, Miss. Virginia, Minn . Waycross, Ga. Dec. 31 , '07 Jan. 13, '08 Jan. 31, '08 Amount not obtainable . .B .D Sylvester, Ga. Tampa, Fla . Nov. 1 , '07 Nov. 18, '07 Nov. 4, '07 125,000 10,000 40,000 50,000 100,000 170,000 '07 '07 '07 '07 '07 Jan. Dec. Jan. Jan. 1, 31 , 10, 15, '08 '08 '08 '08 '07 '07 '07 '07 '07 '07 '07 Feb. Mar. Jan. Feb. circ.Feb. 1, 1, 1, 15, 1, '08 '08 '08 '08 '08 Apr. 25, '08 Dec. 20, '07 Amount not obtainable . 350,000 Nov. 1, '07 circ.Jan. 1, '08 4,420,513 A - Clearing - house loan certificates in large denominations ment of bank balances. B-Clearing-house loan certificates in nations for general circulatoin. C - Clearing -house checks denominations for general circulation. D - Cashiers' checks in for the settle small denomi in convenient convenient de nominations payable only through the clearing house, and usually secured by the deposit of collateral with the clearing house. F - Certificates of deposit in convenient denominations. 'A. P. Andrew , op. cit., p. 505. Courtesy of The Quarterly Journal of Economics. This information is known to be very fragmentary. Some towns were known to have issued emergency currency from which no information could be elicited and many more undoubtedly employed emergency currency. As a result this table probably represents but a small fraction of what actually existed in the smaller localities of the country during the panic. Official encouragement of suspension Official encouragement of suspension was an expedient re sorted to in several States in order to meet the panic conditions. CLEARING HOUSES PRIOR TO 1914 159 Legal holidays were declared by governors, especially in the west ern States, which were intended to authorize banks, as well as other firms and individuals, to decline payment when unduly pressed or whenever they saw fit. The governor of Nevada was the first to resort to this measure on October 24, and he was fol lowed quickly by the governors of Oregon and California . Limiting the size of checks to be paid In some States, banks limited the size of the checks to be paid at any particular time. The limitations varied from $10 to $300. This practice was common in Indiana where only partial payments were made to depositors. The attorney-general ruled that the practice was not a violation of the law. Banks in Iowa, Okla homa, and Wisconsin did likewise. In 53 cities, with a population of 25,000 or over, depositors were not subjected to restrictions of payments and no resort was made to emergency devices.52 The practice of requiring the larger customers to mark their checks “ Payable only through the Clearing House” This was another expedient resorted to by banks in several cities in order to protect themselves from loss of cash especially where the checks were sent out of town and might be presentd for collection through the agency of express companies. In the following cities of 25,000 or more inhabitants such re strictions were practiced : Allentown, Pa. Mobile, Ala. Bay City, Mich. Binghamton , N. Y.S Dayton, Ohio ( one trust company ) Oshkosh, Wis. Pawtucket, R. I. Erie, Pa . Evansville, Ind ." Fall River, Mass.53 Gloucester, Mass. Hartford, Conn. McKeesport, Pa . New Haven, Conn. Reading, Pa. Saginaw, Mich. Springfield , Mass . Syracuse, N. Y.53 Woonsocket, R. I. York, Pa. The plan of Group No. 2 of the Ohio Bankers ' Association In an effort to overcome the disastrous consequences resulting from false rumors in times of stress and to prevent runs on banks “ Andrew , p. 503. Andrew also states that there were only six States in which there were no restrictions or substitutes for cash, but his own tables disprove the statement as some of the States named as being immune were in cluded in his tables. The fact that so few escaped, however, shows how wide spread was the panic. In these cities customers sending checks out of town were asked to make their checks payable only through the clearing house in order to prevent their collection by express. Andrew, p . 502. CLEARING AND COLLECTION OF CHECKS 160 worthy of assistance, a plan was adopted for the mutual protec tion of the associated banks of Group No. 2 of the Ohio Bankers' Association . This group included the banks in the following Ohio counties : Allen, Anglaize, Darke, Hancock, Harden, Logan, Mercer, Miami , Paulding, Putnam, Shelby, and Van Wert. This plan is worthy of notice since it offers the first concrete example of banks uniting in any particular section of any State in an effort to overcome panic conditions. The agreement provided for three trustees who were to enforce the provisions. This board of trustees was given authority to grant relief to any member bank or banker if satisfactory assets were turned over to the board. The amount to be advanced could not exceed 60 per cent. of the cash value of the assets ; all ad vances were to be repaid within sixty -five days, and were to bear 8 per cent. interest. Such advances could take the form of gold, silver, currency, or checks, if so determined by the executive com mittee of the group. When relief was granted to any bank the burden was to be apportioned among the member banks according to resources. Failure to assume its share of burden resulted in the forefeiture of the member bank's rights under the agreement ; failure to repay the amount received by the relieved bank made it liable to suit by the board of trustees. No bank securing such relief could make any loans or discounts until the relief had been repaid.54 A general summary Surveying the record as a whole, Mr. Andrew offers the follow ing definite data for $334,000,000 of emergency currency issued during the panic of 1907, classified as follows : Clearing house certificates ( large ) Clearing house certificates (small ) Clearing house checks Cashiers' checks Manufacturers' pay checks Total $ 238,000,000 23,000,000 12,000,000 14,000,000 47,000,000 $ 334,000,000 He thinks the estimate of the total issue of substitutes for cash issued during the panic may be placed safely above $ 500 , 000,000.55 " Cannon, I , pp. 131-135. 55Andrew , op . cit., p. 515. CLEARING HOUSES PRIOR TO 1914 161 Did the currency substitutes violate the 10 per cent. tax provision of the Act of 1865 ? Clearing house loan certificates have been criticized on the ground that they were issued in violation of the 10 per cent. tax on banknote currency other than national banknote currency, and the provision of the National Bank Act which states that no national banking association shall issue “ any other note to circu late as money than such as are authorized by the provisions of this title. ” 56 This criticism becomes pertinent when such loan cer tificates find their way into general circulation as was the case in the southeastern part of the United States in 1893, and in other parts of the United States in 1907. But since they were looked upon as strictly emergency currency and retired as soon as pos sible they escaped taxation, although technically subject to the tax. Most of the substitutes for cash which were issued during the panic of 1907 and which for two months or more furnished the principal means of payment for the greater part of the country, were illegal and subject to the 10 per cent. tax. But no one thought of prosecuting or collecting the tax. As most of it bore the words “ Payable only through the Clearing House,” its holders could not demand payment for it in cash. In nature it was incon vertible paper issued without the sanction of law. Where the certificates did not circulate outside the clearing house associations, they were essentially loans made by the banks, banded together as a clearing house association, to members of the association, for the purpose of settling balances due to each other. In nature they were due-bills. Clearing house loan certificates in 1914 With the outbreak of the War in 1914, this country experi enced another strain on its financial machinery which called forth loan certificates once more. The Federal Reserve System was too young and unorganized to meet the sudden stress. Nor did the emergency currency under the Aldrich - Vreeland Act meet the im mediate needs of the banks . Inquiries were sent to one hundred clearing houses by the Comptroller of the Currency and as a result he learned that cer tificates were issued by the twelve clearing houses listed in the following table : Section 5183 as amended 1875 ; Act, June 3, 1864, c. 106, sec. 23 ; 13 Stat. L., 106 ; Act, Feb. 18, 1875, c. 80 ; 18 Stat . L. 320. Total Moines Des Detroit Louisville Minneapolis Boston Louis St. Baltimore Orleans New Paul St. Philadelphia Chicago York New Houses Clearing 8 Sept. 2Sept. 15 Sept. 5Aug. 18 Aug. 29 Aug. 13 Aug. 5 Aug. 15 Aug. 5 Aug. 5Aug. 6Aug. 4Aug. 5 Aug. 6 Aug. 7 Oct. 5 Oct. 7 Nov. 15 Aug. 1Currency .),pI(Vof 02-103 p ol Comptroller the 'R915 eport 9Nov. 1 Dec. 7Nov. Nov. 5 28 Nov. 14 Dec. 28 Nov. 16 Oct. 24 Nov. Dec. 10 9 Dec. 23 Oct. cancellation Final Oct. 8 1 Dec. 29 Aug. 30 Sept. 23 g. Au 13 Aug. 2 Oct. 4 Aug. 5 Aug. 4 Aug. 26 Aug. First Oct. 15 14 Oct. 2 Oct. issue Last 3 Aug. 4 Aug. 3 Aug. First issue XVIII TABLE 1,200,000 159,000 $195,754,000 1,200,000 $211,778,000 168,000 15 Aug. 1,350,000 1,350,000 1,915,000 2,040,000 2,150,000 11,385,000 10,805,000 2,350,000 11,530,000 7.- ct O 13 Aug. .15-Dec Aug. S29 -.29ept Aug. 25 1$09,185,000 Sept. 41,890,000 Oct. 14 2-16 11,530,000 Oct. 11,385,000 Oct. 5-6 10,725,000 2-7 Sept. Aug. 2,225,000 15-26 5-23 2,150,000 Aug. 2,040,000 18-29 Aug. 1,915,000 issue 1$ 24,695,000 42,190,000 of Date . amt maximum outstanding . amt Maximum CLEARING AND COLLECTION OF CHECKS outstanding Aggregate 162 CLEARING HOUSES PRIOR TO 1914 163 In New York City the certificates were first issued August 3, 1914 ; the last issue was October 15 ; and the aggregate amount authorized was $124,695,000. The last cancellation was Novem ber 28, 1914 ; the largest amount outstanding at any one time was $109,185,000 which was on September 25. Certificates were issued to 44 of the 61 members of the association, who paid 6 per cent. interest, amounting to $1,497,534.16, which was disbursed to the members holding the certificates.57 The issue of loan certificates in 1914 marks the last issue up to date. It is expected that the necessity for them has been re moved since the Federal Reserve System is able to supply a more elastic deposit and note currency due to the fact that it has con centrated and rendered mobile a large proportion of the banking reserves of the country, provided rediscount facilities for member banks, created a more effective clearing and collection system, and introduced a new form of note currency. If enough elasticity has been secured to obviate the necessity of any future issues of clear ing house loan certificates, then one of the important functions exercised by the clearing house associations in the past will have passed away. Elasticity is one of the most desirable attributes of a currency system, and while our currency prior to the inaugu ration of the Federal Reserve System was notoriously inelastic, conditions would have been much worse had it not been for clear ing house loan certificates. With the exception of the provision for the Aldrich - Vreeland notes ( 1908-1915 ) , these clearing house loan certificates provided the only means of injecting any elas ticity into the old currency system. 57For additional data on the issue in New York City, see the Report of the Comptroller of the Currency, Vol. I ( 1915 ) , p. 103. CHAPTER VI HISTORY OF THE FEDERAL RESERVE CLEARING AND COLLECTION SYSTEM Legal provisions Incorporated in the Federal Reserve Act were provisions, which when put into effect, would create a new system for clearing and collection of checks. These provisions were found in Sections 13 and 16 of the Act. Both Sections were originally distinguished for their want of clearness which was partially responsible for the difficulties experienced in inaugurating the system . Section 13 seemed to be permissive while Section 16 was both permissive and mandatory. Section 16 provided for two types of clearing : ( 1 ) An intra district clearing system among member banks by authorizing the Federal Reserve Board to require each Federal reserve bank to act as a clearing house for its member banks, and (2) an inter district clearing system by authorizing the Federal Reserve Board itself to act as a clearing house for the Federal reserve banks or to designate one of the Federal reserve banks to exercise such functions. This Section as affecting clearings and collections read as follows: “ Every Federal reserve bank shall receive on de posit at par from member banks or from Federal reserve banks checks and drafts drawn upon any of its depositors, and when remitted by a Federal reserve bank, checks and drafts drawn by any depositor in any other Federal reserve bank or member bank upon funds to the credit of said depositor in said reserve bank or member bank. Nothing herein contained shall be construed as prohibiting a member bank from charging its actual expense in curred in collecting and remitting funds or for exchange sold to its patrons. The Federal Reserve Board shall , by rule, fix the charges to be collected by the member banks from its patrons whose checks are cleared through the Federal reserve bank and the charge which may be imposed for the service of clearing or col lection rendered by the Federal reserve bank. “ The Federal Reserve Board shall make and promulgate from 164 ! FEDERAL RESERVE CLEARING AND COLLECTION 165 time to time regulations governing the transfer of funds and charges therefor among Federal reserve banks and their branches, and mayat its discretion exercise the functions of a clearing house for such Federal reserve banks or may designate a Federal reserve bank to exercise such functions, and may also require each such bank to exercise the functions of a clearing house for its member banks.") 1 It will be noted that in this Section member banks were per mitted to charge for their actual expenses in collecting and re mitting and also that charges might be imposed for the service of clearing or collection rendered by the Federal reserve bank, the Federal Reserve Board to fix the charges by rule. Section 13 prescribed in a general way the character of the items that might be received on deposit by Federal reserve banks and seemed to contemplate the performance of a certain clearing, function by such banks for their members . The portion applying to clearings and collections read : “ Any Federal reserve bank may receive from any of its member banks, and from the United States, deposits of current funds in lawful money, national bank notes, Federal reserve notes, or checks and drafts upon solvent member banks, payable upon presentation ; or, solely for exchange pur poses, may receive from other Federal reserve banks deposits of current funds in lawful money, national bank notes, or checks and drafts upon solvent member or other Federal reserve banks, pay able upon presentation .” The institution of the system From the beginning, the Federal Reserve Board looked upon the organization and institution of a new clearing and collection system as one of the most novel as well as one of the most difficult and intricate problems with which it was faced under the Act.. Despite the fact that it believed substantial benefits would accrue from a well organized system of clearings national in scope, the Board considered it the better part of wisdom to proceed cau tiously lest the innovations dislocate to too great an extent the established commercial and banking practices. As a result of this belief on the part of the Board, the history of the Federal reserve clearing and collection system naturally divides itself into two parts : ( 1 ) The voluntary system which obtained from June, 1915 , to July, 1916, and ( 2 ) the compulsory system which has existed since that time. However, before beginning a study of these sys ' See First Annual Report of the Federal Reserve Board ( 1914 ) , p. 38. 166 CLEARING AND COLLECTION OF CHECKS tems it will be well to review briefly the nature of the system of reserves which existed at this time, since a vital connection exists between the type of reserve structure which happens to obtain at any particular time and the clearing and collection system also existing at the same time. Relation of the voluntary system to decentralized reserves The necessity for attempting a voluntary rather than a com pulsory system at the beginning can be understood better in the light of the system of reserves which existed during the first three years of the Federal Reserve System . Section 19 of the original Act fixed a period of three years after the establishment of the system by official announcement, within which there was to be a gradual transfer of a part of the required reserves from approved reserve agents to the Federal reserve banks. Member banks in central reserve cities were required to keep reserves of 18 per cent. against demand deposits and 5 per cent. against time de posits ; 6/18 of the required reserve was to be kept in their own vaults, 7/18 in the Federal reserve bank, and 5/18 could be held in either place. The 7/18 was to be transferred to the Federal reserve bank at once . T Member banks in reserve cities were required to maintain re serves of 15 per cent. against demand deposits and 5 per cent. against time deposits . Of this amount, 6/15 was to be held in their own vaults for three years after which time 5/15 was required ; 3/15 was to be deposited at once in the Federal reserve bank for the first year and for each additional six months an additional 1/15 was to be added until 6/15 was deposited in the Federal re serve bank. For the three- year period the balance could be held in either place, or in national banks in reserve or central reserve cities?, but after the three years the balance was to be held either in the member banks' vaults or in the vaults of the Federal reserve bank . Country banks were required to hold reserves of 12 per cent. against demand deposits and 5 per cent. against time deposits. For the first three years they were to hold 5/12 of the reserve, and thereafter 4/12. In the Federal reserve bank they were to hold 2/12 for the first year, and for each succeeding six months an ad ditional 1/12, until 5/12 was deposited, which was to be required permanently thereafter . For the first three years the balance could be held in their own vaults, with Federal reserve banks, or in ' Italics are the author's. FEDERAL RESERVE CLEARING AND COLLECTION 167 national banks in reserve or central reserve cities ", after which time the balance was to be held in their own vaults or those of the Federal reserve banks, or both4. It will be seen from the above that the reserves would be scat-7 tered widely for three years. To force a compulsory clearing and collection system upon the member banks under such circum stances especially since the reserve and clearing systems are so in extricably bound up with each other, seemed highly unwise to the Federal Reserve Board which hoped to bring the member banks to recognize of their own free will the advantages of a general and nation-wide clearing system-"advantages which would inure not only to the direct benefit of the public at large, but ultimately to the direct benefit of "the member banks themselves from the purely 5 business standpoint." Initial steps preceding the voluntary system Before the formal institution of the voluntary system in June, 1915 , a few halting steps were taken towards the establishment of clearing and collection machinery in certain sections of the United States in conformity with tentative suggestions made by the Fed eral Reserve Board. On October 17, 1914, the Board issued a circular to the Federal reserve banks with tentative suggestions for organization in order to promote a desirable uniformity. Included in the suggestions for organization were two plans for a uniform clearing system, the regulations defining ( 1 ) the relations between the Federal reserve banks and the member banks in the same city, ( 2 ) the relations between the Federal reserve banks and their members outside the city, and (3 ) the relations between the Federal reserve banks themselves . This circular laid down regu lations applying to procedure, forms, advices, accounting systems, and organization of departments conforming to the rules applied by all well-known clearing house associations. It was suggested that every Federal reserve bank should inaugurate the clearing system at the earliest possible moment consistent with success, beginning with a partial system and subsequently extending it as rapidly as they found themselves able to do so. Inasmuch as the plans suggested were tentative and, in fact, not approved finally 'Italics are the author's. * Federal Reserve Act , Section 19. First Annual Report of the Federal Re serve Board ( 1914 ) , p. 40 . Second Annual Report of the Federal Reserve Board ( 1915 ) , p. 15. • Circular No. 8, Exhibit E, First Annual Report of the Federal Reseroe Board ( 1914 ) , p . 119ff. 168 CLEARING AND COLLECTION OF CHECKS by the Federal Reserve Board, no effort will be made to analyze at this point the clearing organizations which were suggested. Three Federal reserve banks, however, made a beginning before the inauguration of the voluntary system in June, 1915. Early in December , 1914, two districts, No. 8 ( St. Louis ) and No. 10 ( Kansas City ) , obtained permission to apply to their members a complete system of compulsory clearing, which worked with such success that, when, upon inauguration by the Federal Reserve Board of the voluntary clearing system, St. Louis offered to her member banks the option of withdrawing, comparatively few retired , about 80 per cent . of all continuing their membership.7 The Federal Reserve Bank of Kansas City continued its compul sory system after the introduction of the voluntary system with out giving its member banks the option of withdrawing. With the country clearing system of New England as a basis 8 on which to build , the Federal Reserve Bank of Boston took early steps to establish a clearing and collection system. It announced that it would receive on deposit for immediate credit checks drawn on any Federal reserve bank and checks drawn by member banks on member banks in Boston only. On November 13, 1914, the Federal Reserve Bank of Boston was elected a limited member of the Boston Clearing House Association, and on November 18 began to clear Boston checks. Beginning with that date the Boston banks made clearing house settlements by checks drawn on the Federal reserve bank, a policy which still continues, and which has done away with the payment of money in clearing house transactions and the necessity of carrying large sums of money through the streets to and from the clearing house. Under the new plan, Boston banks having debit balances against the clearing house each day drew their check in favor of the clearing house manager, who, in turn , opened a temporary account in the Fed eral reserve bank. He deposited these checks each day and drew his checks in favor of banks having a credit balance. This system continued , in general , until the institution of the voluntary system by the Federal Reserve Board, at which time the Boston bank also established the system which was adopted generally by the Fed eral reserve banks. ' On July 15, 1916, with the institution of the compulsory sys tem, the Federal Reserve Bank of Boston took over the Clearing House of Boston and assumed the task of collecting all the checks 'Second Annual Report of the Federal Reserve Board ( 1915 ) , p. 16. *See above, pp . 126-128. Second Annual Report of the Federal Reserve Board ( 1915 ) , p. 132. FEDERAL RESERVE CLEARING AND COLLECTION 169 on New England. The old Boston Clearing House became a part of the Federal reserve bank, but as a department in the bank, in which capacity it continued to clear Boston checks.10 In line with the usual progressive banking ideas for which New England has been distinguished, the Federal Reserve Bank of Boston was soon able to collect checks at par on all the banks in New England. It was the first Federal reserve bank to bring all the banks of its dis trict into the system.11 Inter -district clearing system precedes voluntary intra -district sys tem ; the Gold Settlement Fund Before beginning our study of the voluntary intra -district clearing and collection system it is necessary, in the interest of good chronology, to point out briefly that the Federal Reserve Board was able to establish the mechanism for inter-district clear- ings and collections about a month before it was able to install the voluntary intra-district system. This inter-district mechanism took the form of the well-known Gold Settlement Fund, described briefly elsewhere in this chapter and more fully in a separate chapter. It is analogous toa clearing house and stands at the 7 peak of the system. While the Federal reserve banks serve as clearing houses for their respective districts, the Federal Reserve Board, through the Gold Settlement Fund, serves as a clearing center for the Federal reserve banks and their direct-settling branches.12 This Fund, which is controlled by the Federal Re serve Board and to which each Federal reserve bank was compelled to contribute funds, provides the mechanism by which all cash items throughout the country may be cleared by means of book transfers. The ideal clearing system is one of complete offsets , but to attain this perfection all banks must enter the system . Only then can all debits and credits balance and be liquidated by book transfers rather than by the actual transfer of funds. To the extent that banks do not enter the system, the mechanism must function imperfectly. Theoretically then, the Gold Settlement Fund is virtually perfect in conception . It makes possible the maximum use of credit with the minimum of friction and expense . It makes the medium of exchange the most efficient and economical ever conceived . Federal Reserve Bulletin, Vol. II ( 1916 ) , p. 317. uSee Federal Reserve Bulletin , Vol. III ( 1917 ) , pp. 162-164. " For a discussion of the two types of Federal reserve bank branches see pp . 186-187, 216 , 547-550 below. 170 CLEARING AND COLLECTION OF CHECKS The Gold Settlement Fund was established in May, 1915, in order to meet pressing demands for some means of clearing and collecting inter-district checks which were multiplying rapidly in numbers as a result of the organization and rapid development of the Federal reserve banks. The only mechanism in existence for the clearing and collection of such items prior to this time was re ciprocal accounts carried by the Federal reserve banks with each other. This method was too cumbersome and the Gold Settlement Fund was devised as an effective medium for the expeditious and economical transfer of credits from one section of the country to another. 13 According to the plan as originally instituted, each Federal reserve bank was required to contribute at least $1,000,000 in gold or its equivalent plus what it owed to all other Federal reserve banks at that time. Each Federal reserve bank by May 27, 1915, had deposited the required amount with the nearest sub-treasury, the amount being determined by means of аa preliminary settlement made on May 20. The Assistant Treasurers forwarded tele graphic advices of the deposits to the Treasurer of the United States, who, in turn, issued gold order certificates of $ 10,000 denominations payable to the Federal Reserve Board. This Fund was kept in a safe in the Treasury vaults set aside for the exclu sive use of the Board. A settling agent and a deputy settling agent were appointed by the Board to keep all necessary records and accounts. The equity of each Federal reserve bank in the Fund counts as part of its legal reserve. It must keep at all times at least $1,000,000 in the Fund, but may draw out the surplus at will. The first regular inter-district settlement was made on May 27, 1915, with approximately $18,450,000 in the Fund, below which amount it has never fallen. Settlements through the Fund were originally made at the close of business each Wednesday, but since July 1 , 1918, they have been made each day. Other changes in the method of operating the Fund are described briefly else where in this chapter and at greater length in Chapter VIII . The establishment of the Federal Reserve Agents ' Fund After the establishment of the Gold Settlement Fund it seemed advantageous to apply the same principle to the reserve funds which Federal reserve agents were required to maintain as secu 1 * See Collection of Checks, Letter No. 5, Federal Reserve Bank of Rich mond (March, 1922). Hereafter cited as Letter No. 5. FEDERAL RESERVE CLEARING AND COLLECTION 171 rity against Federal reserve notes. These reserves, which the agents held apart from the reserves of the Federal reserve banks against other obligations, had been increasing steadily. The increasing issues and retirements of the notes rendered more fre quent the payment of large sums from banks to their agents and vice versa. This necessitated much counting and recounting on the part of the banks and the representatives of the Federal reserve agents which it was desirable to eliminate. On September 8, 1915 , the settling agent and deputy settling agent of the Federal Reserve Board opened on their books a dis tinct and separate account for each Federal reserve agent and re ceived from them deposits of gold certificates held subject to the agents' order. As in the case of the Gold Settlement Fund, the Federal Reserve Agents' Fund was evidenced by gold order certifi cates in denominations of $ 10,000. These were held in the vaults of the United States Treasury, but separated from those certifi cates representing the Gold Settlement Fund. Their removal, or transfer upon the order of the agents, was governed by the same regulations applying to the Gold Settlement Fund. The first transfer under this system was made by the Federal Reserve Bank of Atlanta, September 8, 1915, when it transferred part of its holdings in the Gold Settlement Fund to the credit of the Federal reserve agent at Atlanta . 14 Changes in the method of operating this Fund parallel those affecting the operation of the Gold Settlement Fund and will be noted in that connection. For example, the Federal Reserve Agents’ Fund was affected in the same manner as was the Gold Settlement Fund by the abolition of the gold order certificates, June 21 , 1917 ; the introduction of the leased wire system, June 4, 1918 ; the introduction of telegraphic transfers, June 10, 1918 ; the introduction of the system of daily settlements, July 1 , 1918 ; and other changes that will be mentioned more at length elsewhere, especially in Chapter VIII, devoted to the Gold Settlement Fund. The voluntary intra -district system , June, 1915-July, 1916 On March 4, 1915, the Federal Reserve Board announced that it had determined to direct the introduction of a voluntary recip rocal plan for clearance at all Federal reserve banks where a clearing plan was not already in operation. The Board did not attempt to prescribe details, since it had been found that in dis See Second Annual Report of the Federal Reserve Board ( 1915 ) , p. 82. CLEARING AND COLLECTION OF CHECKS 172 tricts where clearing was being practiced the best results were ob tained by leaving the control with the bank officers. It merely re quired that the Federal reserve banks make such a system effective by June, 1915. Letters were sent to Federal reserve agents direct ing that they take up this question with their boards of directors at once . Circulars were issued by the Federal reserve banks to their member banks outlining plans and inviting them to partici pate. Using the plan adopted by the Federal Reserve Bank of Chi cago as a typical illustration, we find that these first efforts to establish a voluntary intra-district clearing and collection system provided, in general , for the following arrangements: Membership in the system was voluntary and items were received at par by the Federal reserve bank only from and upon those banks of its dis trict which joined. The items were to be immediately credited and debited to the accounts of the sending and paying banks, subject to final payment ; a practice, it will be noticed , which did not rec ognize the factor of time in the collection of checks . This system of immediate debit and credit resulted in the Federal reserve banks carrying a float which has been estimated to equal half of the deposits. The practice resulted in many overdrafts and meant a great and unreasonable burden on the Federal reserve banks, especially in case of any financial stringency when some of these banks might have become bankrupt.15 Fortunately this practice was abandoned with the introduction of the compulsory system in July, 1916. There was no intention of superseding or supplant ing local clearing houses or the exchange of checks between near by towns or cities, or of handling checks drawn on banks in other districts. Each member bank was required to keep sufficient funds with the Federal reserve bank to offset the items charged against its account without impairing the reserve required to be kept in the Federal reserve bank. The Federal reserve bank acted only as the collecting agent of the member banks and received authority from them to send items direct to the banks on which drawn if it so desired. Member banks under the Chicago plan could come in at any subsequent time or withdraw after thirty days' notice, while the Federal reserve bank could withdraw the privilege of membership from any member not observing the rules. The Federal reserve bank was to make no charge nor pay any charge in operating the system, although the Federal Reserve 18 E. W. Kemmerer, Six Lectures on the Federal Reserve System, given at the Federal Reserve Bank of Philadelphia ( 1920 ) , pp. 52-53. FEDERAL RESERVE CLEARING AND COLLECTION 173 Act permitted it to levy charges on the member banks to cover 18 cost. Similar plans were inaugurated in the other Federal reserve districts with varying degrees of success, but it was felt that all these plans were largely experimental and that no satisfactory basis of clearing could be reached until some plan was evolved by which all member banks, and possibly a considerable number of non -member banks, could be induced or required to co -operate. The voluntary system a failure It was hoped that a large number of the member banks would promptly affiliate themselves with the new system of clearing and that the natural force of economic competition would attract ulti mately to it those who at first might hesitate. But the results were disappointing. At the end of the year 1915, less than 25 per cent. of the institutions eligible for membership had joined the system. In addition to the 950 banks which were compelled to join in the Kansas City district and the 365 in the St. Louis dis trict which remained in the system , only about 1,150 banks of their own free will assented to the voluntary clearing plan, making a total of 2,465 which had joined in 1915.18 This small proportion of membership proved a severe disap pointment to those who had confidently expected that the fore sight and enlightened self-interest of the member banks would speedily accomplish the desired result. Some progress was made through the action of the banks, both member and non-member, in improving exchange conditions and in providing for the clear ance of country checks at points where this practice had never pre vailed before, but in the main, comparatively small advance was made in rendering effective the provisions of the law which pro vided for the standardization of exchange and clearance prac tices.19 The following table will present a summarized view of the growth , or rather lack of growth, of the voluntary system : 19Federal Reserve Bulletin , Vol. I ( 1915 ) , pp. 6-9. 11Dallas, in December, 1915, established a system somewhat different from the others when she established the Reserve City Clearing House Association of Texas. It was operated for the convenience of the reserve city banks and at their expense. With the inauguration of the compulsory system it was carried on as an adjunct to the new system . In 1916, its operations extended to twenty -seven banks in the cities of Fort Worth, Waco, Houston, Galveston , San Antonio and Dallas. See Third Annual Report of the Federal Reserve Board ( 1916) , pp. 432-435. Fourth Annual Report of the Federal Reseroo Broad ( 1917 ), p. 552. See especially p. 188 below. " Second Annual Report of the Federal Reserve Board ( 1915 ) , p. 16. 9 " Ibid . CLEARING AND COLLECTION OF CHECKS 174 TABLE XIX GROWTH OF THE VOLUNTARY INTRA -DISTRICT CLEARING 50 Boston New York 115 Philadelphia 125 126 89 Cleveland Richmond 49 116 49 124 125 120 127 126 89 Atlanta 71 88 81 Chicago 111 366 121 368 83 121 364 166 951 93 182 951. 186 951 92 209 105 217 St. Louis Minneapolis Kansas City .. Dallas San Francisco . 110 Totals 50 126 120 123 91 74 116 365 184 951 96 160 50 129 119 118 50 50 50 129 117 118 129 130 115 90 74 90 114 116 90 74 74 71 114 114 362 113 363 113 362 187 187 951 362 187 951 83 161 79 162 951 72 161 951 70 157 50 128 119 123 90 74 116 363 184 187 951 162 110 87 47 134 109 114 82 72 113 359 187 951 67 157 June May April March February ,1916 January December November October ug A.,1July - 915 September SYSTEM 47 134 109 114 81 71 115 359 187 951 67 157 ... 2,373 2,508 2,536 2,456 2,442 2,436 2,428 2,420 2,403 2,392 2,393 ‘Compiled from the Federal Reserve Bulletins. At this point it will be worth while to inquire into the reasons why eligible banks did not join the system . Objections to the voluntary system The common grounds for opposition to the system were : ( 1 ) Loss of exchange charges. Under the old system it was the gen eral practice of banks to charge in remitting for items sent for collection. Under the new system, although the Act authorized them to make charges for remittance and collection, they were not given the opportunity to exact remittance charges, since the items were charged directly against the accounts of the paying banks. Consequently, only those banks joined which were ready to forego this charge. Usually the city banks which had been bearing the brunt of the exchange charges entered ; the smaller exchange charging banks held aloof.20 ( 2 ) Membership obliged many banks to carry larger reserves. It had been the practice of the Comptroller's office to permit banks to compute the reserves from their own books, that is, as soon as checks were mailed out by banks they were counted as reserves, and checks sent to them by collecting banks were not deducted * G . B. Anderson, " Some Phases of the New Check Collection System , ” Annals of the American Academy of Political and Social Science, Vol. LXVIII ( 1916 ) , pp. 122-131. FEDERAL RESERVE CLEARING AND COLLECTION 175 until received , leaving the correspondent reserve banks to carry the float. Under the new system the reserves were to be computed from the books of the Federal reserve bank, which would require larger and real reserves from the member banks. ( 3 ) The fact that the system was voluntary and not all the banks, indeed but few of them, were coming in, was considered a hardship on those that did enter. The Federal reserve bank would receive at par all checks on the members of its collecting system whereas it could send as an offset only checks on the few banks in the district which had joined. ( 4 ) Some banks maintained that there was no power to com pel aа member bank not located in a Federal reserve city to pay or have charged to its account at the Federal reserve bank of its dis trict a check which it had not seen and approved prior to the time of presentation at its own counter. This principle of immediate debit and credit was one of the most distinguishing characteristics of the voluntary system , but was destined to give way to the de ferred debit and credit principle, as it did not stand the tests of practical banking experience. While it is a sound principle, in general, to substitute clearing for collection so far as possible, practical limits to the application of this principle are sometimes reached in banking. The practice of making immediate debits and credits represents an offsetting or clearing principle and may be supposed to be desirable, but any gains that may have resulted under the voluntary system were more than overbalanced by the following disadvantages: ( a ) Charging items to the accounts of the member banks before they could be advised of the amounts charged or see the items, not only constantly impaired their re serve balance, but almost daily created overdrafts in the accounts of the several banks. ( b ) The member banks could not control their reserves and the Federal reserve banks not only had less in deposits than the law contemplated but daily had to assume either the responsibility of permitting the overdraft of accounts or de cline to accept checks drawn upon them . ( c ) The system gave the member banks no chance to maintain their reserves by remitting or rediscounting. A system which defers both debit and credit gives the banks time to do this.21 For these reasons, therefore, it has not seemed desirable to carry the clearing principle so far as to include out-of-town banks, as considerable time must elapse before the items can be converted into reserve funds . The prin * Pierre Jay, The Country Banker and the Federal Reserve System, 64th Cong ., 1st Sess ., Sen. Doc. No. 458 (April 17, 1916 ) . 176 CLEARING AND COLLECTION OF CHECKS ciple of immediate debits and credits forced the Federal reserva banks to absorb a very heavy float, made a large proportion of the member banks' reserves mere paper rather than collected funds, and thus continued one of the worst evils that characterized the clearing and collection system under the old National Banking System.22 Another difficulty facing the Board was the fact that the Federal Reserve Act granted a period of three years to all banks, except those within central reserve cities, within which to effect the final transfer of reserves to the Federal reserve banks, balances with correspondents counting as reserves in the meantime. The fact that these reserve balances in some reserve cities were used for the purpose of providing for exchange and collection opera tions together with the fact that they would continue, in all prob ability, the functions for some time in the future, pending the time when State banks would enter the system in large numbers, seemed to indicate that it might be necessary for some member banks to collect and clear through their correspondents in reserve cities. In the last analysis, the question of reserves was vital. To this problem the Board turned its attention. But the fact that re serves were yet decentralized was one of the principal conditions that caused the Board to ease the difficulties of the banks by in stituting first the voluntary system. The voluntary system had demonstrated that the plan was not sufficiently comprehensive, the number of members had not in creased appreciably, the objections raised indicated that the sys tem in that form worked a hardship on certain classes of banks, and it seemed most unlikely that the system could ever attain any great degree of efficiency for the entire country. Consequently, in April, 1916, the Board decided to establish a more comprehensive system which became operative on July 15, 1916, as a compulsory system . The history of the compulsory system may be divided into two periods. The first period, extending from July, 1916, to June 21 , 1917, was one in which the reserves were decentralized, a situation which gave rise to consequences different from what might have been expected had the reserves been concentrated . 12When banks, such as the Federal reserve banks, give immediate credit for uncollected items, they are virtually making an investment in uncollected checks. There is a theory that if such investments are practically equal throughout the country no harm is done through giving immediate credit. But at least two objections to this theory present themselves: First, that such in vestments are not equal at all times and may result in adverse currents of ex change involving even actual transfers of funds ; second , a considerable float is almost certain to be present and this, of course, means paper reserves. In times of extreme expansion fictitious reserves are dangerous. FEDERAL RESERVE CLEARING AND COLLECTION 177 The second period is one in which the reserves are concentrated in the Federal reserve banks and covers the period since June 21 , 1917. It will be convenient to survey the development of the clearing and collection system under these two heads. The compulsory system under decentralized reserves, July, 1916 June 21, 1917 All member banks were automatically brought into this system under the conditions laid down by the Federal Reserve Board in Regulation J, Series of 1916, which required all Federal reserve banks to exercise the functions of a clearing house for their mem ber banks . The detailed working out of the system was left, how ever, to each Federal reserve bank. Consequently , there were some variations as to details although, in the main, the banks followed rather uniform practices . 23 Each Federal reserve bank was required to receive at par from its member banks, checks drawn on all member banks, whether in its own district or other districts, and checks drawn upon non-member banks when such checks could be collected by the Federal reserve banks at par. Each Federal reserve bank was required to receive at par from other Federal reserve banks all checks drawn upon all member banks of its district and upon all non-member banks of its district whose checks could be collected at par by the Fed eral reserve bank . According to the requirements the Federal reserve banks prepared par lists of all non -member banks which were revised from time to time and furnished all member banks. In selecting collecting agents for handling checks on non-member banks, member banks were to be given preference. The new system did not mean that member banks were not free to continue to carry accounts with their correspondents and with other banks to which they might send items for collection and from which they might receive for similar purposes checks drawn upon themselves or upon other banks. A member bank could send items for collection through the Federal reserve bank regularly, occasionally, or not at all ; or it might collect them through its regular correspondents or in any other manner considered advan tageous.24 It did mean , however , that all Federal reserve banks were to install the system and that all member banks were required to pay without deduction checks drawn upon themselves and pre sented by their Federal reserve banks at their own counters. See Federal Reserve Bulletin , Vol . II ( 1916 ) , pp. 312-315. 2 * Ibid . 178 CLEARING AND COLLECTION OF CHECKS Herein lay the compulsion in the system. Remittance of such checks by the Federal reserve bank of their own district through themail was construed as presentation at their own counters and bankers were required to settle with the Federal reserve bank for such checks in acceptable funds. Remittance of lawful money or Federal reserve notes could be made at the expense of the Federal reserve bank in case they were unable to send in offsetting checks on other banks. In this manner the most severe aspects of the compulsion were mitigated. It also indicated a recognition of the fact that checks are not payable at par except at the counter of the drawee bank . In making payment elsewhere banks had become accustomed to charging exchange in making remittances on the ground that an expense was involved , especially since they might be called upon to ship currency . The charges were always pred icated on the fact that they might be compelled to ship currency even though they did not do so. Now the expense was to be as sumed by the Federal reserve banks and these banks were deprived of their chief reason for exacting charges in making remittances. Any impairment of reserves was to be subjected to a penalty of 2 per cent. per annum on the amount of the deficiency above the ninety-day discount rate of the Federal reserve bank of the dis trict in which the member bank was located. A progressive pen alty also became effective under certain conditions.25 The Board reserved the right to increase the penalty whenever condi tions required . Checks sent direct by a Federal reserve bank to its drawee mem ber banks for collection In handling items for member banks a Federal reserve bank acted as agent only. The Board required each member bank to authorize its Federal reserve bank to send checks for collection direct to the banks on which they were drawn, and, except for negligence, the Federal reserve banks were to assume no liability. This was a practice which was considered illegal under the old National Banking System , although it was indulged in frequently. A bank was not considered a good agent , in the eyes of the law. to collect on itself. In some instances, however, there would be but one bank in a town ; in other instances, it would be necessary to use a weak or otherwise undesirable bank as a collecting agent if an effort were made to conform to the letter of the law. Prior to the time under consideration many banks had learned that it was 25See pp . 330-331, 366-367. FEDERAL RESERVE CLEARING AND COLLECTION 179 better to send their checks direct to the bank on which they were drawn in case they were compelled to use an undesirable bank as a collecting agent, or some other agent in cases where but one bank existed in the town. Although legally unsound the practice soon became rather widespread. Consequently, the Federal reserve banks introduced no innovation in this respect.26 The deferred availability principle ; the zone system It will be recalled that the Federal reserve banks under the voluntary system did not recognize the time factor in collecting checks but resorted to the practice of making immediate debits and giving immediate credits for checks sent to them for collec tion. Under the compulsory system the time factor was recog nized. The system of immediate debits and credits, as pointed out above, had been unsatisfactory to both the member banks and the Federal reserve banks. The member banks, having items charged to their accounts before the items could reach them, were always uncertain how their reserve accounts with the Federal reserve bank stood until some time later. This uncertainty required them either to keep large excess balances with the Federal reserve bank or expose their reserve accounts to impairment, even to being over drawn. Usually a large percentage of the accounts of the coun try members of the collection system was impaired , many of them to such an extent that they were actually overdrawn. The Fed eral reserve banks would find their resources reduced by the im pairment of these reserve balances and themselves compelled, against their express determination to the contrary, to purchase from their member banks their out- of- town checks, commonly called " float." 27 Under the new regulation it was provided that checks received by a Federal reserve bank on its member banks were to be for warded direct to the member banks but were not to be charged to their accounts until advice of payment had been received or until sufficient time had elapsed within which to receive advice of pay ment. Upon receipt of items from its member banks for collec tion immediate credit entry upon the books of the Federal re serve bank at full face value was to be made subject to final pay ment but the proceeds were not to be counted as part of the minimum reserve nor become available to meet checks drawn until For a discussion of this question, see Proceedings of Departmental Con ferences held at Baltimore Convention of the American Institute of Banking (July, 1924 ) , pp. 323-341 . * Third Annual Report of the Federal Reserve Board ( 1916 ) , p. 231 . 180 CLEARING AND COLLECTION OF CHECKS actually collected. Under this system each Federal reserve bank determines by analysis the amount of uncollected funds appear ing on its books to the credit of each member bank and furnishes to each member bank a schedule of the time required within which to collect checks, in order to enable it to determine the time at which any item sent to its Federal reserve bank may be counted as reserve and become available to meet any checks drawn. The nature of the time schedules Each Federal reserve bank developed its own time schedule showing the number of days which must elapse before the proceeds of items deposited with it would become available as reserve to be drawn against . Each of these schedules covers the entire country and is based upon the average time required for the Federal re serve bank to send items to its member banks and receive remit tances from them plus the one-way mail time between Federal re serve banks and their branches. For certain items received from 3 member banks immediate credit is given ; for others, deferred credit, as, for example, for one day, two days, three days, or any number of days up to nine days.28 Supplementing, or rather serving as a common basis for the schedules of the Federal re serve banks, is an inter-district time schedule, approved by the Federal Reserve Board in 1920, which shows the collection time for cash items between all Federal reserve banks and branch banks.29 This schedule is based upon the one-way mail time between the Federal reserve banks and their branches and con stitutes the common frame-work on which each Federal reserve bank builds its schedule, adding to this time the average time re quired for each Federal reserve bank to send items to its mem ber banks and receive remittances from them . Average time has been used since it is impossible to calculate the exact time with respect to each point. As a result of the average time basis, the Federal reserve banks are carrying, without doubt , a “ float ” to some extent, although perhaps inconsiderable under the system of daily settlements, as compared with the weekly settlements through the Gold Settlement Fund . As an example of the manner in which the time is computed on an inter-district check by using the inter-district time schedule 28 See the Time Schedule of the Federal Reserve Bank of New York, p. 184 . From the Portland and Seattle branches of the Federal Reserve Bank of San Francisco to some of the eastern States, such as Alabama or Florida, the time is nine days. 2" See Inter-district Time Schedule, pp. 182-183. FEDERAL RESERVE CLEARING AND COLLECTION 181 as a basis and adding to it the collection time indicated by the time schedule of another Federal reserve district, let us suppose that a check drawn on a bank in Rochester, New York , is sent to the Federal Reserve Bank of Richmond by one of its member banks. Credit would be given three days after receipt. One of the days would be consumed in sending the item from Richmond to the Federal Reserve Bank of New York, one in forwarding the item from the Federal Reserve Bank of New York to the bank in Rochester, and the third day in the sending of returns by the Rochester bank to the Federal Reserve Bank of New York. Upon receipt of the returns settlement would be made between the Federal Reserve Bank of New York and the Federal Reserve Bank of Richmond without further delay, that is, through the Gold Settlement Fund . It is to be observed that the time schedule just described is a published time schedule for the benefit of collecting banks, and indicates when the items sent to the Federal reserve bank or branch will be available as reserve deposits. In other words, it is the basis by which the payee banks determine the amount of their deferred credits which become available on certain days. Theo retically all deferred credits (uncollected items ) , should equal all deferred debits ( the same uncollected items ) . As a matter of fact all deferred credits do not equal, necessarily, all deferred debits. This is due partly to the fact that drawee banks do not have their accounts debited until sufficient time has elapsed for the collecting Federal reserve bank or branch to have heard from them, regardless of the published time schedule. There is thus an unpublished time schedule for the drawee banks based upon actual collection time, rather than upon the average time as indicated in the published schedule. The latter schedule was devised in the interest of simplicity ; consequently, some banks may be placed in a two-day zone which cannot be reached and heard from in less than three days, others in the same zone may be heard from in two. days or perhaps in one day. The average time is two days, how ever , and checks sent to the three-day banks in the two-day average zone, become available funds to the payee banks in two days, but the drawee banks will not have their accounts debited until three days have elapsed . The Federal reserve bank, in this instance carries a float.30 The combined statement of all Federal reserve banks for June 11 , 1924, showed that the amount of float * For a further treatment of the nature of the time schedule, see pp. 539– 541 , 551 , below. CO CO CO CO DOO From w OT CO CO CO OWOCO CO CO CO CO No 0000 4. 100 లు 10101010101010010.1010- OOOOO Boston New York Buffalo Philadelphia COOCOOOOOOOOOOOOOOO ! Cleveland Pittsburgh QUOUIQOT QYQP QUE 00 Cincinnati OPQUTQQ OYOY I 1 - O QU QU OP OVQ OOOO do + 0 0 ৩ O W 0201 ৩৩৩৩৩৩৩৩৩০৩৩ । ৩০৩–৩ Richmond Baltimore 1 O QUQPQPOR CU O QUE QU QUO New Orleans ০০ ০৩ ৩৩ ৩৩ ৩ ৩ ৩ ৩। ৩৩৩৩ Atlanta ৪ ৫ ৩ ৩ ৩ ৩ ৩ ৩ ৩ --- ৩। ৩ ৩ ৩ ৩ ৩ ৩ ৩ ০ ০৩ - Birmingham Co to OP CYCP QUO 1 QUOQQUOQOOP 100 WOWOCO O COCO Co er CO WOOCO CO CO 101 100 O O O O O O OU O O OUT 00 Chicago Detroit ৩০৩৩৩৩৩০৩৩৩ ৩ ৩ St. Louis Louisville – ৩ -- ৩ ৩ ৩ ৩ ৩ ৩ ৩ ৩ Memphis 10 10 1000 POLOTOOOOO ৩ - ৩। Jacksonville Nashville O 000 0 O O no 0 0 0 1 O O O O O O Op O ৩– O O GP GP GP Q ৩ ৩৩৩৩৩৩৩৩ ৩৩৩৩৩০৩ Little Rock Minneapolis ORQUO QUO O O O O O O O O O O O O O OY O I Helena Kansas City --- 1010101010-0లలలలలలు 9 10 100 1000 O O O O O O O O QUOI 10 10 190 లలు నిలు 100 O O లలలు , Omaha Denver Oklahoma City O O O O O O O O O Dallas to v CO CO CO CO COCO Go to co GO El Paso Houston O O O GOVOR O O San Francisco O O O O O O O O O O OT O O O Spokane or Or Or Or or Portland or or on o en Or Or Or Or a or Seattle O O O O O O O ON Salt Lake City Los Angeles OP 12 3 4 3542 5432 3°:01*250~*^0 4059,23 63 SCHEDULE TIME -D INTER APPROVED THE RESERVE FEDERAL S ,BY BOARD HOWING : ISTRICT COLLEC FOR TIME TION BETWEEN ITEMS CASH FEDERAL R ESERVE 'ALL BRANCH AND BANKS &ğ$į*.§& 87+95a§1[ ğő &Š7ğ$ő⢧&i El IOo798%5y.!3& III Or Or Or Oro 182 CLEARING AND COLLECTION OF CHECKS Oklahoma City 2 3 3 4 4 4 Salt Lake City Los Angeles Seattle Portland Spokane Dallas Paso El Houston Francisco San Omaha Denver From Louisville .eschedules constructed were time the which on principles general 87 .9),p 920 1V I (.,two ol Bulletin Reserve Federal ee Sdays Detroit St. Louis -Το 34 Denver - - Portland Seattle San Francisco Spokane Houston Dallas El Paso Oklahoma City Omaha Kansas City Helena Little Rock COLLEC HOWING S ,BOARD RESERVE FEDERAL THE BY APPROVED SCHEDULE TIME - ISTRICT D INTER 3 2 4 15 6 4 Salt Lake City Los Angeles the showing from aside value little has nd ,aibeen today accurate not she revised schedule TYork above .New nd ,aFortland PS.example pokane above or given one the and banks reserve Federal of schedules time individual the of Bank Reserve Federal the zone ay -din four the re now aFrancisco ,San of Bank Reserve Federal the branches Seattle in differences considerable to found be will tCBoard ,.of onsequently Reserve Federal consent the with so dohere may deposited items cash for bank ember m ais to given credit final before time elapsed the shows schedule TExplanation : his deposit ,am.F example or cities bank branch and Federal other upon drawn reserve itsember with a(upon shown Omaha rawn )dcolumn vertical the in Cleveland of Bank Reserve Federal in cin asheck ing of expiration at Cleveland of Bank Reserve Federal books the upon credit given be wcolumn ) ould horizontal schedule dthe -in given that below time collection reduce can it finds bank Reserve ederal F,iinter ,aIf owever htistrict 34 2 4 2 13 2 3 2 2 3 4 4 3 4 2 13 3 4 2 13 2 5 4 4 1 32 4 3 4 2 2 3 4 45 14 4 5 6 4 3 2 1 2 4 3 3 4 5 612 5 5 2 3 6 5 14 15 5 5 4 3 12 4 6 5 56 4 15 3 6 5 2 5 5 6 BANKS BRANCH AND RESERVE FEDERAL ALL BETWEEN ITEMS CASH FOR TIME TION FEDERAL RESERVE CLEARING AND COLLECTION 183 CLEARING AND COLLECTION OF CHECKS 184 was about 10 per cent. of the amount of uncollected items on hand. Much of this is due, so it is alleged , to the fact that New York and Philadelphia have placed their most remote banks on a two -day basis although the items on many of these banks cannot be collected in less than three days.31 FEDERAL RESERVE BANK OF NEW YORK Schedule Showing When the Proceeds of Items Will Become Available 1 Effective January 2, 1923 ( Superseding Schedule Issued August 1, 1922) IMMEDIATE CREDIT When received by 9 a. m. New York Clearing House banks ( Reference to List A, page 4) Other New York City banks ( Reference to List B, page 6) Northern New Jersey Clearing House banks (Reference to List C , page 7 ) Checks and warrantson Treasurer of the United States, Washington, D. C. Brooklyn banks and bankers- Also Bank of Coney Island and Branch When received by 3 p . m . ( Saturdays 1 p. m. ) Checks on Federal Reserve Bank of New York and Buffalo Branch Officers' checks of other Federal Reserve Banks Federal Reserve Exchange Drafts Federal Reserve Transfer Drafts ONE DAY AFTER RECEIPT New York City – Balance of Manhattan, when received by 9 a. m. No. Boston Richmond Baltimore District District 3 District 5 Branch of 5 Pittsburgh Branch of 4 Buffalo Branch of 2 Philadelphia TWO DAYS AFTER RECEIPT District 4 Cleveland Banks in Connecticut ** New Jersey 4 Delaware Chicago Branch of District 7 Dist. of Columbia * Pennsylvania Detroit Branch of 7 Atlanta District 6 Branch of 6 Branch of 6 Cincinnati Birmingham Jacksonville Nashville Branch of 6 Minneapolis District 9 St. Paul In District 9 8 District Branch of 8 St. Louis Louisville Maine * Maryland * Massachusetts * New York Rhode Island Vermont * Virginia New Hampshire THREE DAYS AFTER RECEIPT New Orleans Memphis Branch of Branch of Little Rock Branch of 8 Kansas City, Mo. Kansas City, Kans. District Omaha 6 8 10 In District 10 Branch of 10 Branch of 10 District 11 Oklahoma City Dallas The time schedule also includes instructions to member banks for the sorting and forwarding of items. See below, p. 471 . *Proceedings of Departmental Conferences held at Baltimore Convention of the American Institute of Banking ( July, 1924 ), p. 379. FEDERAL RESERVE CLEARING AND COLLECTION 185 FOUR DAYS AFTER RECEIPT Helena El Paso Houston Denver No. Branch of 9 Branch of 11 Branch of 11 Branch of 10 Branch of 12 Banks in * Alabama * Arkansas *Minnesota * Florida * Missouri Mississippi *Georgia North Carolina * Ohio South Carolina * Tennessee Portland, Ore. Branch of 12 Branch of 12 * Illinois Indiana Iowa Seattle Branch of 12 * Kansas West Virginia * Kentucky *Michigan Wisconsin Spokane Salt Lake City FIVE DAYS AFTER RECEIPT San Francisco Los Angeles No. District 12 Branch of 12 EIGHT DAYS AFTER RECEIPT Arizona Banks in North Dakota * California * Colorado Idaho * Louisiana *Montana * Nebraska Nevada New Mexico * Oklahoma * Oregon South Dakota * Texas * Utah * Washington Wyoming * Except banks in cities referred to in the first column. **Except banks in Northern New Jersey Clearing House Association referred to on Page 7. [ Page 7 omitted here) The deferred availability principle and the collection of intra district cash items It must not be inferred that a member bank will send all of its intra -district transit items through its Federal reserve bank for collection. Quite often much time can be saved by sending such items by more direct routes. It has been pointed out else where that cash items may be collected either through the mechan ism provided by the Federal Reserve System or in any other manner that a bank sees fit to use. If the Federal reserve mechan ism is used intra -district cash items may be collected in three ways : ( 1 ) By sending the items to the Federal reserve bank as agent for collection, ( 2) by sending them direct to a branch of the Federal reserve bank when the branch is nearer the drawee bank, and (3) by sending the items direct to the drawee bank. 1. Collecting intra - district cash items through the Federal reserve bank The method of collecting intra-district cash items through the parent Federal reserve bank has been explained sufficiently in the discussion of the nature of the time schedules and the deferred availability principle immediately above and need not be ampli 186 CLEARING AND COLLECTION OF CHECKS fied here.32 Our attention will be confined to the second and third possibilities which offer more speedy results. It is obvious that it would require more time in many instances to send items through the parent Federal reserve bank than to send them by more direct routes which may be through branches of the Federal re serve bank or in some cases direct to the drawee banks. 2. Collecting intra - district cash items through Federal reserve bank branches A Federal reserve district may be so large that it is advisable to establish branches of the Federal reserve bank. These branches, of which there are now twenty-three, are of two types. One type, which we will designate for convenience as Class I, has its capital, territory, member banks and reserves allotted to it , and performs most of the functions performed by a Federal reserve bank. Intra district clearings and collections in its district are handled through it just as they would be handled through a Federal re serve bank . It has its own time schedule for the banks in its district and for inter-district collections worked out on exactly the same principles as that of the parent Federal reserve bank. It settles directly through the Gold Settlement Fund for its inter district items in a manner quite similar to that of the parent bank . For this reason this type of branch , of which there are sixteen, is known as a direct- settling branch . If a bank in the northern part of the district occupied by the Federal Reserve Bank of San Francisco has a check on a member bank near the Portland branch of the Federal Reserve Bank of San Francisco, it obviously would involve a loss of time to send the item to San Francisco for collection from which place it would then be sent to the Portland branch to be forwarded to the drawee bank. Instead, the payee bank would send the item to the Port land branch for collection, using the time schedule of the Port land branch . All banks in the twelfth district are provided with the schedules of33 these branches and may remit their items direct in this manner. When intra - district items are sent direct to the branches, settlements are made by telegraph between the parent bank and the branches. The Federal Reserve Bank of San Fran cisco maintains a Branch Clearing Settlement to facilitate the daily settlement of balances resulting from transactions between **A thorough discussion of clearing and collecting intra -district items through the Federal Reserve bank will also be found below, pp. 537-554. 33 All branches in the twelfth district are Class I or direct-settling branches. They are Spokane, Seattle, Portland, Salt Lake City, and Los Angeles. FEDERAL RESERVE CLEARING AND COLLECTION 187 the head office and its branches . Unlike the Gold Settlement Fund, which is not used to make settlements between a parent Federal reserve bank and its branches, there is no actual money carried in the Branch Clearing. The entire process is carried out through a system of bookkeeping at the head office and amounts due to and due by the head office and branches are accounted for over the leased wire maintained between the head office and the branches.34 The second type of branch, which we will designate as Class II, and of which there are seven, does not have any definite capital, territory, member banks, or reserves allotted to it, nor does such a branch settle through the Gold Settlement Fund for its inter district items. One of its main functions is to act as a clearing and collection agent and, as a result, has a collection zone as signed to it. All member and properly qualified non -member clearing banks and trust companies within this zone may be col lected upon through this branch. The resulting credit, inter district as well as intra -district, is reported by this branch daily to the Federal reserve bank of that district. 3. Sending intra -district items direct to drawee banks for col lection Member banks, ordinarily, may not send items direct to drawee banks for remittance to the Federal reserve bank or branch for credit to the account of the payee bank . There are two important exceptions to the general principle, however, when intra -district items are involved . One is the system of county collections found in the second and third Federal reserve districts ; the other is the so - called Reserve City Clearing House Association in Texas, in which direct sendings go beyond county lines. (a) County clearing of checks. In the second , and to a less degree in the third, Federal reserve districts , banks in certain counties, whose business is essentially local , are permitted to send checks direct to drawee banks in the same county. This system as used in the second district has been described as follows : “ A bank in Newark has $ 10,000 worth of checks drawn on a bank in Orange which it receives in the ordinary course of business . The bank in Newark will send such checks direct to the bank in Orange and at the same time mail an advice to the Federal Reserve Bank of New York, showing the total of such checks sent. The advice A more detailed treatment of the two types of branches, the nature of their time schedules, and the methods of clearing and collecting intra- and inter district items is given below, pp. 547-553 . CLEARING AND COLLECTION OF CHECKS 188 will be received by the Federal Reserve Bank at the same time that On receipt the checks are received by the bank in Orange. of the advice, the Federal reserve bank will credit the account of the bank in Newark with the total amount of such checks which it sent to the bank in Orange and charge the account of the bank in Orange on its books ; thus, instead of the usual three days for the collection of such checks, the bank in Newark will receive credit in its reserve account in one day, saving the two days' time. ” 35 When banks wish to send items direct to drawee banks in order to save time they must make suitable arrangements not only with the Federal reserve bank but with the member banks on which they wish to collect direct. Otherwise they make themselves liable for remittance charges . In April, 1920, the question was asked the Federal Reserve Board whether a member bank , either State or national, could be required under the terms of the Federal Re serve Act, to remit at par for checks drawn upon it and received from another bank, other than a Federal reserve bank, with direc tions to remit in payment direct to the Federal reserve bank for the account of the bank owning the items. The Board ruled that the remitting banks could not be required to remit at par as Sec tion 13 of the Federal Reserve Act prohibited member banks from charging the Federal reserve banks only , when remitting, and did not prohibit one member bank from charging another. In a case like the one submitted to the Board in this instance, the Board held that the charge is made against the bank for whose account remission is made and not against the Federal reserve bank which, in the circumstances, is merely a depository of the proceeds of the checks, less the amount of the exchange charge.36 Consequently, for direct sendings to be successful, suitable arrangements must be made in advance. (b) The Reserve City Clearing House Association of Texas. The so-called Reserve City Clearing House Association of Texas includes the following six principal cities in Texas : San Antonio, Dallas, Houston, Ft. Worth , Galveston, and Waco. One of the purposes of the association is to enable its members to obtain set tlement on the books of the Federal Reserve Bank of Dallas in one 35A . J. Lins, “ County Clearing of Checks, ” Bulletin of New Jersey Bank ers Association (December, 1922 ), pp. 8-9 . See also Eighth Annual Report of the Federal Reserve Board ( 1922 ), p. 512. Among the counties in New York and New Jersey in which this system is operating successfully, are to be mentioned the following: (1 ) In New York—Broome, Tioga, Tompkins, Chemung, Delaware, Herkimer, Nassau, Otsego, Saratoga, Warren, Washing ton, Steuben, Sullivan, and Westchester ; (2 ) in New Jersey - Bergen, Middle sex, and Monmouth counties. 30Federal Reserve Bulletin , Vol. VI ( 1920 ) , p. 494 . FEDERAL RESERVE CLEARING AND COLLECTION 189 day for checks and drafts drawn on each other. For example, Ft. Worth will send all of its Waco checks and drafts to a par ticular bank in Waco, drew a draft on this bank for the amount and send it to the Federal Reserve Bank of Dallas which effects a clearing of all those reserve city items in its own office by charging the reserve account of the Waco bank and crediting the account of the Ft . Worth bank . Considerable time is saved in this manner.37 Another purpose of the association is to enable country bank correspondents of members of the association to make their drafts on reserve city clearing house banks immediately available for credit upon receipt by the Federal Reserve Bank of Dallas, which arrangement places the banks that are members of the Reser City Clearing House Association on an equal footing with banks located in Dallas in so far as concerns the exchange facilities that 38 they can offer to their country correspondents. The collection of and settlement for inter -district cash items Inasmuch as a complete and detailed discussion of the present methods used in making inter -district collections of cash items is given below in Chapter VIII which deals with the nature and operation of the Gold Settlement Fund and especially on pp. 558-569, no attempt will be made at this time to give more than a general outline of the mechanism used. This will suffice to give the reader enough knowledge of the system to understand the significance of the later topics treated in this chapter. Inter -district cash items , like intra-district cash items, may be collected through the Federal reserve clearing and collection sys tem or in any other manner that the member or non-member clearing banks may choose. If they use the Federal reserve mechanism these items may be collected in any one of three ways. ( 1 ) A member or non-member clearing bank may send its items to its own Federal reserve bank or branch of the Federal reserve bank ( if it is assigned to that branch ) which will send them to the Federal reserve bank or branch to which the drawee bank belongs ; ( 2 ) a member or non -member clearing bank in one district may send the items direct to the Federal reserve bank or branch in the district to which the drawee banks belong ; and ( 3 ) in certain *Proceedings of Departmental Conference held at Baltimore Convention of the American Institute of Banking (July, 1924) , p. 378. Letter from Mr. W. 0. Ford , Assistant Cashier, Federal Reserve Bank of Dallas, March 5, 1925. 190 CLEARING AND COLLECTION OF CHECKS instances items may be sent direct to the drawee member and non member clearing banks in another district. 1. Collecting inter - district cash items through a bank's own Federal reserve bank or branch Banks using this medium of collection are required to sort their items into classes according to their availability as shown in the published time schedules . The cash letters including these items are then sent to the Federal reserve or branch banks which give the payee banks a deferred credit and send the items on to the proper Federal reserve banks or branches, which in turn send them to the drawee banks . After sufficient time has elapsed for the Federal reserve banks or branches, to which the drawee banks be long, to hear from the drawee banks, settlement is made through the Gold Settlement Fund. The Class I branches settle directly through the Fund in the same manner as do the parent Federal reserve banks except that the final debit and credit adjustments are made on the books of the Federal reserve banks since the Class I branches do not carry funds in the Gold Settlement Fund. Class II branches telegraph to their parent Federal reserve banks the amounts due to other Federal reserve banks and branches which are then included in the telegram sent by the parent bank to the Gold Settlement Fund. Adjustments between the Class II branches and their parent Federal reserve banks are then made on their books . 2. Member and non -member clearing banks may send inter district cash items direct to Federal reserve banks and branches in other districts Banks are encouraged to send inter-district cash items direct to the Federal reserve banks or branches to which the drawee banks belong if time can be saved through such procedure. In order to do this the sending bank must secure the permission of its Federal reserve bank or branch which will give it a new time schedule for these direct sendings. Ordinarily the sending bank will save at least the time required to send the items to its own Federal reserve bank or branch . When the payee banks send out these items they notify their own Federal reserve bank or branch of the amount of the items sent and indicate when each batch should become funds. This is done on forms which are provided and which show the totals avail able in one, two, three, four, or more days. ( See Forms 19, FEDERAL RESERVE CLEARING AND COLLECTION 191 20 and 21 on pp. 456, 457 and 563 , respectively . ) These items,, properly sorted , are sent direct to the other Federal reserve banks or branches for the credit of the Federal reserve banks or branches to which the payee banks belong. After the expiration of the proper amount of time the Federal reserve banks, direct settling branches, and the Class II branches through their parent Federal reserve banks, make the proper settlements through the Gold Settlement Fund and then the Federal reserve banks or branches receiving the credits check them against the advices of direct sendings. The Federal Reserve Banks of Boston and San Francisco led the way in 1916 by permitting their member banks to make ar rangements to send items direct to other Federal reserve banks or branches for the credit, respectively, of the Federal Reserve Banks of San Francisco and Boston.39 By 1919 the volume of such checks had increased to such an extent that the practice of direct routing had become common . In 1916 the Federal Reserve Bank of New York took a step, later followed by other Federal reserve banks, which was destined to insure the presentation of checks by direct routing to the proper banks. In that year the Federal Reserve Bank of New York announced that it would not accept any item drawn on a bank located outside its district when such item bore the endorse ment of a bank located outside of its district . This restriction prevented banks outside of the second district from sending items drawn upon banks in other districts to New York City for the 40 purpose of making New York exchange.10 3. Sending items direct to member and non -member clearing banks in other districts Theoretically member and non-member clearing banks in one district may not send inter-district cash items direct to the drawee banks in another district if they wish to use the Federal reserve clearing and collection mechanism . As a matter of fact member and non -member clearing banks do send items direct to drawee banks in other districts and request them to deposit the proceeds with their Federal reserve bank or branch for the credit of the payee banks. Thus, while it may be said that the Federal re serve clearing and collection system is not being used, the payee banks can build up their reserve balances in this manner just as **Third Annual Report of the Federal Reserve Board ( 1916 ) , pp. 207, 459. **Loc. cit . , p. 232. 192 CLEARING AND COLLECTION OF CHECKS though they had used the Federal reserve clearing and collection system. Banks often are able to save time by doing this. But it should be noticed that the Federal reserve banks have no control over such transactions. Another type of direct sendings is authorized in exceptional cases, however, which does involve the use of the Federal reserve mechanism. Certain important centers may be in different Fed eral districts but very near to each other as in the case of Detroit, Michigan, in the Chicago district , and Toledo, Ohio, in the Cleve land district . Ordinarily, if the regular collection procedure were followed , checks on Toledo which are deposited in Detroit banks would be sent to the Federal Reserve Bank of Cleveland, thence to Toledo for collection which would involve a great waste of time. By special arrangement the Detroit branch of the Federal Re serve Bank of Chicago forwards checks on Toledo banks direct to the drawee banks which in turn remit for them to the Federal Reserve Bank of Cleveland for the Detroit branch of the Federal Reserve Bank of Chicago. The same arrangement is made for Indianapolis , Indiana, and Cincinnati, Ohio . Checks on Indian apolis are forwarded by the Cincinnati branch to Indianapolis and remitted for by the Indianapolis banks to the Federal Reserve Bank of Chicago for the credit of the Federal Reserve Bank of Cleveland.41 The amount of items sent direct to drawee banks in this manner is relatively small. In 1923, only 190,000 items amounting to $ 85,996,000 were sent in this manner.42 Service charges At the time the compulsory system was introduced it was de cided that the cost of collecting and clearing checks should be borne by the banks receiving the benefit and in proportion to the service rendered . The Federal Reserve System was comparatively young and few , if any, of the Federal reserve banks were earning their required dividends and current expenses. The compulsory plan provided that a charge not exceeding 2 cents per item might be made at stated intervals against such banks as sent to the Federal reserve banks checks or drafts on other banks for collec tion and credit , such a charge, of course, not applying to banks which had not availed themselves of the privileges offered . Mem ber banks were not deprived of any income which they had been 4 The writer is indebted to : Mr. H. F. Strater, Assistant Cashier , Federal Reserve Bank of Cleveland, for this information. "Tenth Annual Report of the Federal Reserve Board ( 1923 ) , p. 161 . FEDERAL RESERVE CLEARING AND COLLECTION 193 receiving from the collection of drafts43 or from the purchase or discount of commercial bills of exchange. The Federal Reserve Board ruled that an account should be kept by each Federal re serve bank of the cost of performing this service and the Board then, by rule, was to fix the charge, at so much per item which was to be imposed . For the period of July 15 to December 31 , 1916, the service charge per item ranged from .9 of one cent for Boston to 2.0 cents for San Francisco, 1.5 cents being the most commor charge. The cost of transporting currency, however, was to be borne by each Federal reserve bank.44 As pointed out below, service charges were gradually lowered and finally abolished on July 1 , 1918 . The meaning of par collection under this system 45 The expression "collectible at par through the Federal re serve bank” as used by the Board in Circular No. 1 and Regula tion J, Series of 1916, merely meant that checks were collectible at full face value through the Federal reserve bank , that is, that remitting banks would remit without deductions when remitting to Federal reserve banks . It did not mean that banks sending checks for collection to their Federal reserve banks could not charge their customers for the expense involved. Indeed, the Federal Reserve Board expected the collecting banks to charge enough to cover costs . Items sent through the Federal reserve banks for collection by member banks were not available until actually collected which meant that the funds would not be avail able for the depositors of the member banks until actually col lected . Consequently, if member banks gave their customers im mediate credit for checks deposited they were carrying the float for their depositors and were entitled to interest on the funds ad vanced in this manner. The Federal Reserve Board specifically stated that it did not expect member banks to collect checks at a loss, but on the contrary, expected them to charge not only enough to cover the charges levied on them by the Federal re serve bank, but enough to cover interest on the advances made by giving immediate credit.46 On the other hand, the Federal Re Other than bank drafts. “Third Annual Report of the Federal Reserve Board ( 1916 ) , pp. 9-11 . At no time did the Federal Reserve Board fix the charges to be levied by member banks. See below pp. 211-213. *A fuller explanation of the meaning of this term will be found on p. 232, note 1 . *Federal Reserve Bulletin , Vol. II ( 1916 ) , pp . 263-264, 310-311 . 194 CLEARING AND COLLECTION OF CHECKS serve Board thought that if they could reduce the charges by having a well organized system, these benefits should be passed on by the member banks to their depositors. Some banks charged, while others accepted items at par for collection, bearing the ex pense themselves. In other instances clearing houses required their member banks to make uniform charges. Thus, it will be seen, that no uniformity of practice relative to charges for col lection, existed among the various banks. Where clearing houses established uniform collection charges on items received from de positors, there was not, ordinarily, a proper differential es tablished between items on member banks of the Federal Reserve System which cleared at par, and items on State banks which de clined to remit at par. In such cases the depositor was not get ting the benefit of the Federal reserve par system.47 In addition to these charges it will be recalled that the Federal Reserve Act permitted members to charge for making remittances also, pro vided the charges were not levied against a Federal reserve bank . As a result, it was to the interest of the member banks to have their checks collected through the Federal reserve banks in order to avoid being charged by remitting banks. The question of reserves ; the Board's proposal to concentrate It was estimated by the Board that as soon as the new clearing system could be put into operation checks upon about 15,000 national banks, State banks, and trust companies could be col lected by the Federal reserve banks at par, subject to the small service charge referred to above. As any bank would be likely to lose desirable business when checks drawn upon it were at a dis count, while checks drawn upon a nearby competitor circulated at par, it was believed that in a short time checks upon practically all banks in the United States could be collected at par by Federal reserve banks . On the other hand , many banks had found it necessary to maintain balances with a number of correspondent banks for exchange purposes thus compelling them to keep an undue proportion of the funds away from home. This was a defect that required correction. Despite this burden, the number of banks upon which par collections were made under this new plan had exceeded 15,000 by December 15, 1916, and the total daily clearance at all Federal reserve banks aggregated at that date over $125,000,000.48 “ Third Annual Report of the Federal Reserve Board ( 1916 ) , p. 305. *Ibid., pp. 10-11 . FEDERAL RESERVE CLEARING AND COLLECTION 195 In order to make the system effective, the Board found it necessary to solve the question of reserves, that is, to permit no bank balances to be available as reserves for national banks, except balances in Federal reserve banks. This would check the carry ing of balances with correspondents, as the maintenance of such non - reserve balances would then mean a real hardship to banks: practicing it. Such a concentration of reserves would naturally carry with it the clearing and collection functions which the Board was anxious to accomplish. The desire to solve this problem, combined with the desire to meet the war emergency, caused the Board to propose an amend ment to Section 19, which provided that all reserves of member banks should be maintained with Federal reserve banks on the basis of 7, 10, and 13 per cent, against demand deposits, plus 3 per cent. against time deposits, for country banks, reserve city and central reserve city banks, respectively. The Board pro posed an amendment, also, to the Act to permit non-member State banks and trust companies, even though too small to be eligible for membership in the Federal reserve banks, to avail themselves of the clearing and collection facilities of the Federal reserve banks, provided they would cover at par checks on them selves sent for collection by the Federal reserve bank and pro vided further that they keep compensating balances with the Federal reserve bank in amounts to be prescribed by the Federal Reserve Board.49 The purpose was to make the plan compre hensive enough to include all checks. At the time this amend ment was proposed, the par lists of the Federal reserve banks included the names of banks, checks on which could be collected in any circumstances at a minimum of time and expense, but did not embrace a large number of towns in every State where there were no member banks ; and in order to make collections on such points many banks were obliged to maintain accounts in addition to their reserve accounts with the Federal reserve banks. A neces sary factor in any successful clearing plan is the offset whereby only balances, instead of the total volume of transactions, require settlement. So long as the clearing system does not embrace all of the banks this offset is lost in a corresponding degree and the value of the system diminished in proportion. Hence the justification of the proposals of the Federal Reserve Board. " Ibid ., pp . 11 , 28. CLEARING AND COLLECTION OF CHECKS 196 The question of non -member banks; amendment of September 7, 1916 Section 13 as originally passed did not specifically allow Federal reserve banks to receive from their member banks, or from other Federal reserve banks, checks drawn upon non-member banks although many were remitting at par. In order to develop the par collection plan this Section was amended September 7, 1916, to make this possible . The significant part of Section 13 as originally enacted read : “ Any Federal reserve bank may receive from any of its mem ber banks . . . checks and drafts upon solvent member banks, payable upon presentation ; or solely for exchange purposes, may . . receive from other Federal reserve banks ... checks and drafts » This upon solvent member or other Federal reserve banks. . clause as amended read : “ Any Federal reserve bank may receive from any of itsmember banks ... checks, and drafts , payable upon presentation ... ; or solely for purposes of exchange or of collection , may receive from other Federal reserve banks .. checks upon other Federal reserve banks, and checks and drafts payable upon presentation within its district. . . .9950 The natural inference flowing from this amendment was that the Federal reserve banks were not only to accept checks on non -member banks from their member banks and other Federal reserve banks, but were to exercise the power necessary to collect them.51 The concentration of reserves, June-July, 1917 In harmony with the recommendations made by the Federal Reserve Board in 1916 , Section 19 of the Federal Reserve Act was amended June 21 , 1917 , repealing the original reserve re quirements and substituting new requirements which reduced the amounts required and concentrated them entirely in the Federal reserve banks. Against demand deposits, member banks in cen tral reserve cities were required to keep 13 per cent . ; those in re serve cities 10 per cent . ; and those members designated as country banks, 7 per cent . Against time deposits all member banks were required to keep 3 per cent . reserve. Member banks in central reserve cities were required to move the remainder of their reserves by June 27 ; other member banks were given to July, 1917, to make the change.52 50Ibid ., p . 134. 5 Letter No. 5, p . 8. 32 52Federal Reserve Bulletin, Vol. III ( 1917 ) , p. 508 . FEDERAL RESERVE CLEARING AND COLLECTION 197 This amendment effected a concentration of reserves which, doubtless, did more than anything else to make effective a central ized clearing and collection system, as banks were now deprived of one of their chief incentives for having their checks collected through other channels. The concentration combined with the slight reduction, also contributed substantially to the elasticity of deposit currency. While the reserve requirements were decreased the real decrease was not as great as might appear, since all member banks must necessarily carry a certain amount of cash in their own vaults to meet current needs. These reserves, more over, with the Federal reserve banks had to consist of realized balances made real through the operation of the zoning system. With the concentration of all reserves in the member banks, the next important problem facing the Board in its efforts to develop a centralized clearing and collection system was the bringing of non-member banks into the system. Non -member banks admitted to the privileges of the system , June 21 , 1917 From the beginning of the collection system non -member banks could obtain the benefits of the system through their mem ber bank correspondents since Federal reserve banks, under the law, were required to receive certain items sent to them by their member banks and no discrimination could be made in the case of items bearing the endorsement of a non- member bank ahead of the endorsement of the member bank by which they were offered . By the amendment of September 7 , 1916, express permission had been given the Federal reserve banks to accept from their member banks and other Federal reserve banks checks drawn upon certain non -member banks. Non -member banks could be collected upon by Federal reserve banks but could not use the Federal reserve banks directly as collecting agents. It was felt that justice required that the non-member banks co-operating in the collection system should be safeguarded in their right to use the system and not be left wholly at the mercy of the member banks. Conse quently , the Federal Reserve Board proposed that Section 13 be amended so that non -member banks could be admitted to the privileges of the system and use the Federal reserve banks as collecting agents. Acting upon the suggestion of the Federal Reserve Board , Congress amended Section 13 in order to permit non -member banks and trust companies to become clearing mem bers in the system. This amendment permitted Federal reserve CLEARING AND COLLECTION OF CHECKS 198 banks to receive accounts for collection and exchange purposes from such non -member banks and trust companies as might agree to remit to the Federal reserve banks at par for checks drawn upon themselves and which, in addition, would maintain balances with the Federal reserve bank sufficient to offset items in transit held for their account by the Federal reserve bank.53 At the outset several large non-member banks opened clear ing accounts, but as most of these later became members of the Federal Reserve System, the number of non-member clearing ac counts did not become large.54 Non -member banks found it more convenient to use the Federal reserve collection system through their member bank correspondents. Free use of the system was made through member bank correspondents not only by all the non-member banks that from time to time agreed to co-operate by remitting at par for checks drawn upon themselves, but also by the non -member banks that maintained what they called their “ right to charge exchange.” Even during the time they were seeking by means of injunctions and suits, to prevent the Federal reserve banks from presenting and collecting at par checks drawn upon them, they unhesitatingly made free use of the Federal reserve collection system through member bank correspondents for the collection of checks deposited with them and drawn upon member banks or non-member banks whose names appeared upon the par list of the Federal Reserve System . This amendment consequently was rather unsuccessful and the Federal reserve banks found themselves unable to collect checks drawn on many non -member banks except at heavy expense. Problem of collecting checks on non -member banks The Federal Reserve Board had interpreted Sections 13 and 16 to mean that the Federal reserve banks were required to accept at par all checks payable upon presentation when deposited with them by member banks . It is evident, that aa Federal reserve bank receiving checks on non-member banks for deposit would proceed to collect those checks, and that if the banks upon which they were drawn would not remit at par the Federal reserve bank was obliged to provide itself with some other means of making the collection. Various means were resorted to where there were no * Fourth Annual Report of the Federal Reserve Board ( 1917 ) , pp. 12-13, 23-24. 5*Governor W. P. G. Harding's Report to the Senate, 66th Cong., Ad Sess., Sen. Doc. No. 184 , p. 3. 65Letter No. 5, p. 10. FEDERAL RESERVE CLEARING AND COLLECTION 199 member banks in the same town through which the collections could be made over the counter. Express companies and other agencies were used , depending upon the circumstances. But in order to simplify the problem the Federal reserve banks called the attention of the non-member banks to the provisions of the law and stated that stamped envelopes would be sent in each case to the remitting bank, in order that there might be no actual expense incurred by the drawee bank in making the remittance and that if it were more convenient, remittance might be made in currency at the expense of the Federal reserve bank. As the opposition to the provisions of the Act increased on the part of the non -member banks which were anxious to maintain this old source of profit due to charging exchange for remittance, the issue was raised as to whether Congress had a right to legis late in any way that would diminish the profits of the non-member banks . The Board, in answer to this issue, pointed out that Congress clearly has the power to legislate in matters relating to the manner in which the Federal reserve banks should operate. The Board further pointed out that it was its view that Congress ( 1 ) had directed all banks, non-members as well as members, not to make exchange charges against Federal reserve banks ; ( 2 ) had directed the Federal reserve banks to receive on deposit at par any checks and drafts which were payable on presentation ; and (3 ) had directed the Federal reserve banks not to pay any ex change charges to banks in making these collections. The Federal Reserve Board then suggested that if it were desired to question the constitutional right of Congress to enact a law prohibiting a Federal reserve bank from paying exchange to a non-member bank on checks drawn upon a non-member bank by its own depositors, the banks which questioned its validity should initiate the proceedings rather than the Federal Reserve Board ; that should they concede the right but believe the law oppressive, unjust or unwise, they should appeal to Congress with the view of having the objectionable features stricken out or modified ; that if banks doubting the validity of the law felt that the length of time necessarily involved in obtaining a judicial and final interpretation made it undesirable to litigate they should appeal directly to Congress ; that the banks should not obstruct the law as it then stood pending a final determination of policy by Congress ; and finally, that if non -member banks should be required to remit at par no longer, member banks should also be relieved from such an obligation, for the member banks were 200 CLEARING AND COLLECTION OF CHECKS supporting the Federal Reserve System and it would be unfair to deprive them of opportunities for profit given to non -members.56 The Hardwick Amendment, June 21, 1917 During 1917 a determined effort was made by some of the exchange-charging member and non -member banks to amend the Federal Reserve Act in order to provide for a standardized exchange charge not to exceed 1/10 of 1 per cent. to be made by member banks against the Federal reserve banks for checks sent for collection . The fight resulted in the so -called Hardwick Amendment which provided “ that nothing in this or any other section of this act shall be construed as prohibiting a member or non-member bank from making reasonable charges, to be deter mined and regulated by the Federal Reserve Board, but in no case to exceed 10 cents per $100 or fraction thereof, based on the total of checks and drafts presented at any one time, for collection or payment of checks and drafts and remission therefor by exchange or otherwise ; but no such charges shall be made against the Federal Reserve Banks. " 57 The Attorney General • was requested to give his opinion as to whether this proviso applied to non-member banks. He held that it did not apply to State banks not connected with the Federal Reserve System and that the provisions prohibited the Federal reserve banks from paying exchange charges to member or non -member banks.58 It was thought that had he given an affirmative opinion it would have made much easier the establishment of a universal par collection system. The adverse opinion holding that the proviso applied to member banks only, meant that the further development of the collection system would necessarily be re tarded and in the absence of further legislation would depend upon voluntary action of many small banks.59 Other attempts to develop the system In addition to the attempts already made by the Federal Reserve Board to enlarge the scope of the clearing and collec 09Federal Reserve Bulletin, Vol. VI ( 1920 ) , p . 489 . "Italics are the author's ; Fourth Annual Report of the Federal Reserve Board ( 1917 ) , p . 23 ; Seventh Annual Report of the Federal Reserve Board ( 1920 ), p. 64. 88For this opinion see Federal Reserve Bulletin, Vol. IV ( 1918 ) , pp . 367 371. See also Fourth Annual Report of the Federal Reserve Board ( 1917 ) , pp. 23-24 ; Seventh Annual Report of the Federal Reserve Board ( 1920) , p. 64. « Fifth Annual Report of the Federal Reserve Board ( 1918 ) , p. 76 ; Seventh Annual Report of the Federal Reserve Board ( 1920 ) , p. 64. FEDERAL RESERVE CLEARING AND COLLECTION 201 tion system , the Board consciously and persistently made ar rangements and innovations that were designed to make the system more advantageous and attractive to the non -member banks. The scope of the system was enlarged through ( 1 ) pro visions for the collection of notes, drafts, and other items, ( 2 ) provision for exchange and transfer drafts, ( 3 ) the development of the telegraphic transfer system, and ( 4 ) the elimination of service charges and the absorption of other costs by the Federal reserve banks . The collection of notes, drafts, and other items The Federal Reserve Act as originally passed did not include provisions for the collection of notes, drafts and other maturing items. By an amendment to Section 13, approved September 7, 1916, the Federal reserve banks were given authority to " receive from any of [ their] member banks, and from the United States ... for collection, maturing bills ; or solely for purposes . . . of collection, may receive from other Federal reserve banks maturing bills payable within [ their districts.” ]" This Section was further amended on June 21 , 1917, so as to make it possible . . > for Federal reserve banks to receive for collection such maturing notes and bills from any non -member bank or trust company, provided such banks, or trust companies maintained with their Federal reserve bank a balance sufficient to offset the items. The Act does not authorize аa Federal reserve bank to collect maturing notes and bills payable within its own district which are for warded to it for collection by any member bank located outside of its own district. Section 16, however, authorizes a Federal reserve bank to receive from any member bank, regardless of its location, checks and drafts drawn upon a member bank of its district . This, it will be noted , is the only collection service which a Federal reserve bank may perform directly according to the provisions of the Federal Reserve Act for any member bank located outside of its own district . Until 1920 the collec tion service of maturing notes and bills was limited to items sent to a Federal reserve bank by its own member banks or by In that year, however, an ar 61 other Federal reserve banks. rangement was made by the Board whereby a member bank might send maturing notes and bills direct to a Federal reserve bank of another district for collection and credit to the account of *Third Annual Report of the Federal Reserve Board ( 1916 ) , p. 134. Federal Reserve Bulletin , Vol. V ( 1919 ) , p . 467. 202 CLEARING AND COLLECTION OF CHECKS the Federal reserve bank of the district in which the sending bank was located , although there was no provision of law which au thorized a Federal reserve bank to receive such items from a 62 member bank located outside of its own district. On August 11 , 1917, the Board requested the Federal reserve banks to establish general collection departments in order to receive such maturing paper for collection. The paper was to consist of maturing notes, bills and miscellaneous drafts made by or drawn upon individuals, firms, or corporations other than banks, and was to be subject to a moderate collection charge.63 As a result, member banks which were obliged to rely upon other banks for service of this sort could now obtain it from the Federal reserve banks . Such a move on the part of the Board and banks seemed necessary, since reserves were now concentrated, if banks were not to experience the hardships of being compelled to carry additional deposits with banks other than the Federal reserve banks for purposes of collecting such items.64 The handling of items of this kind presented problems quite different from those involved in the handling of checks . The Federal Reserve Board clearly distinguished between checks and drafts on banks and maturing notes and bills of exchange sent through the banks for collection. There were no provisions in the law requiring Federal reserve banks to receive bills and notes at par as in the case of checks and drafts on banks. Obviously, such items could not be received at par for the reason that no bank could properly be forced to credit at par an unmatured or uncollected note or bill . Neither did the Hardwick Amendment to Section 13 prohibit member banks charging the Federal re serve banks for collecting such items nor give the Board any authority to regulate such charges.65 In 1917, the Federal Reserve Bank of New York, for example, made a service charge of 10 cents per item , in addition to such collection charges as might be imposed by the collecting bank, and in case a collection item was returned unpaid , a charge of 10 cents was imposed, to be paid by the bank presenting the item for payment. No charge was made, however, for the collection of coupons other than the charge made by the collecting bank plus mail or ex 02 o Federal Reserve Bulletin , Vol. VI ( 1920 ) pp. 276, 949. 62 As early as October, 1915, the Board had ruled that the Federal reserve banks might and should make such collections but the matter did not become urgent until 1917 . “ Fourth Annual Report of the Federal Reserve Board ( 1917 ) , pp. 12, 23, 9 181 ; Federal Reserve Bulletin, Vol. III ( 1917 ) , p . 656. esFederal Reserve Bulletin, Vol. III ( 1917 ) , pp. 662-663. FEDERAL RESERVE CLEARING AND COLLECTION 203 press charges . So far as possible, items were sent direct to their place of payment and when payable outside of the district, the collecting bank was permitted to make remittance either direct to the Federal Reserve Bank of New York in New York exchange, or, if more convenient, in available exchange to any other nearby Federal reserve bank for the credit of the Federal Reserve Bank of New York.66 In April, 1918, the Board ap proved certain recommendations that the 10 cents charge on collection items between Federal reserve banks and their member banks be eliminated until further notice, but that a charge of 15 cents per item be made on all such items returned unpaid in order to prevent the sending of dunning items through the Federal reserve banks. This rule became effective June 15, 1918.67 At the same time the Federal Reserve Board recommended that while trade acceptances should be treated as collection items, bankers' acceptances should be treated as cash items. Early in 1920, the question was presented to the Federal Reserve Board as to whether a member bank might make an exchange charge lawfully on one of its own acceptances presented to it for collection by the Federal reserve bank of its district. The Board ruled that a banker's acceptance was a draft within the meaning of that part of Section 13 which prohibited member banks making any charge against the Federal reserve banks for collection or pay ment of checks and drafts presented to them by the Federal reserve banks.68 It was pointed out, however, that Section 13 did not prohibit a member bank from charging the Federal reserve bank for the service of collecting maturing notes and bills of exchange drawn upon individuals, firms or corporations other than banks . The fact that such a note or bill of exchange not drawn on a bank might be made payable at that bank did not bring it within the restrictions of Section 13 and did not pre clude the member bank from making a charge against the Fed eral reserve bank for effecting its collection and remitting there for by exchange or otherwise . In April, 1918, the Board ruled , also, that bill -of-lading drafts could be received by the Federal reserve banks only as collection items, and not as cash items for which immediate credit could be given even though drawn pay able at sight.70 * Fourth Annual Report of the Federal Reserve Board ( 1917 ) , p. 269 ; Fed eral Reserve Bulletin , Vol. III ( 1917 ), pp. 743-744 . " Federal Reserve Bulletin , Vol. IV ( 1918 ), p. 371 . € Federal Reserve Bulletin , Vol. VI ( 1920 ), p . 162. Ibid. , p. 699. **Ibid., pp. 372, 436 . 204 CLEARING AND COLLECTION OF CHECKS In August, 1918, the New York City Clearing House took a forward step with reference to the collection of acceptances through the clearing house which did much to eliminate at least one day's float. The clearing house agreed to pass acceptances through the clearings and charge them to the accounts of their acceptors at the banks at which they were payable upon the date of their maturity precisely as if they were checks, and established regular methods for the reimbursement of accept ances by those in whose favor they were made. This practice supplanted the long established custom of presenting such items at maturity and receiving either certification thereof or checks, final payment thus being delayed for one day after maturity.71 In 1920 the question was raised as to whether a non-member bank which was not even a clearing member, but a correspondent of a member bank, could send bill-of-lading drafts direct to the Federal reserve bank for collection and credit to the member bank's account when so authorized by the member bank. The Federal Reserve Board ruled that this could be done if the Federal reserve bank had received specific notice from the mem ber bank that it had authorized the sending bank to act as agent of the member bank in forwarding the items for the member bank's account. The Federal Reserve Board, however, reserved to each Federal reserve bank the right to decline to receive such items at its discretion.72 The question was raised , also, as to whether a Federal reserve bank might collect maturing notes and bills drawn upon firms, individuals, or corporations which were located within its district but which were not member banks, when such notes and bills were forwarded to it for collection by a member bank of another district for the account of the Federal reserve bank of that other district . On this point the Board ruled that such a service might be performed by a Federal reserve bank at its own option when ever it had received satisfactory advice that the Federal reserve bank for whose account the collection was being made had au thorized its member bank to act as its agent in forwarding maturing items of this character for collection and credit to its account. It was considered , by the Board , to be immaterial whether the authority to act as agent was specific as to the particular member bank or whether it was general as to all 71See Federal Reserve Bulletin , Vol. IV ( 1918 ) , pp . 806, 819-821 . 7 FederalReserve Bulletin, Vol. VI ( 1920) , pp. 918-919. FEDERAL RESERVE CLEARING AND COLLECTION 205 member banks of the Federal reserve bank for whose account the collection was being made.T3 Schedule for availability of proceeds of bankers' acceptances The following schedule became effective on and after March 1 , 1919, indicating when the proceeds of bankers' acceptances received by Federal reserve banks for collection from or for the account of other Federal reserve banks, and subject to final payment, would be available : SCHEDULE FOR AVAILABILITY OF PROCEEDS OF BANKERS' ACCEPTANCES Credit for items payable Credit available at maturity for items elsewhere in district avail District payable in Boston ... New York . Philadelphia . Cleveland ...... .Boston, Mass ... New York , N. Y .. Buffalo, N. Y. able . 1 day after maturity Do Do Do Do Do Do Philadelphia, Pa . . Cleveland, O .. Cincinnati, O. Richmond .... Pittsburgh, Pa .... .Richmond, Va.. .2 days after maturity for Mary land , District of Columbia , and Virginia ; 3 days after maturity for West Virginia, North Carolina and South Carolina Atlanta ..... Baltimore, Md ..... .Atlanta, Ga ..... Do .1 day after maturity for ac ceptances of member banks only ; acceptances of non member banks when collected New Orleans, La ... Chicago ... St. Louis .... Jacksonville , Fla . Birmingham, Ala ... Chicago, ni.. Detroit, Mich . St. Louis, Mo. Louisville, Ky .. Memphis, Tenn .. Do Do Do 1 day after maturity Do Do Do Do Little Rock , Ark .. Do Minneapolis .... .Minneapolis, Minn .. Kansas City ... ... Kansas City, Mo ... Do Do Do Do Do St. Paul , Minn .. Dallas... San Francisco .. Omaha, Neb . Denver, Colo . .Dallas, Tex . El Paso , Tex . .San Francisco, Cal. Spokane, Wash . Portland, Ore . ... Seattle, Wash ... Do Do Do Do Do Do Do Salt Lake City, Utah .... From Federal Reserve Bulletin , Vol. V ( 1919 ) , pp . 245-246 . * Ibid ., pp. 276, 949 . 206 CLEARING AND COLLECTION OF CHECKS Anto Introduction of Federal reserve exchange and transfer drafts With the concentration of reserves it was felt that some ma chinery should be provided for the transfer of funds for banks which had been in the habit of using drafts on central reserve city banks. The provision for such a mechanism would serve as an additional inducement to non -member banks to enter the system. While it is true that member banks could draw drafts upon their own Federal reserve banks, and indeed , did so from the beginning of the Federal Reserve System, such drafts , after July 15, 1916, were acceptable for immediate credit only at the Federal reserve bank of the district in which the drafts originated . This ordinary type of bank draft, when sent into other Federal reserve districts, was acceptable only on a deferred credit basis, that is, in accordance with the published time schedules . To meet the needs of the large number of banks which had obligations to meet outside their own district, two types of Fed eral reserve drafts were created, the Federal reserve exchange draft and the Federal reserve transfer draft. These drafts, which were officially introduced on June 1 , 1917, provided all member banks in the several districts with a means of remittance which was acceptable for immediate credit at any one of the Federal reserve banks or branches. They were designed to supplement not only the ordinary bank draft , but also telegraphic transfers, and to facilitate payments that did not need to be made by tele graph, thus giving bank exchange a wider currency and usefulness. A Federal reserve exchange draft is one drawn by a member bank upon its own Federal reserve bank and made receivable at pa for immediate availability at any Federal reserve bank, although actually payable only at the drawee Federal reserve bank . Such drafts were originally drawn in amounts not to ex ceed $250, but on September 3, 1918, the maximum was increased to $5,000. The bank drawing such drafts is required to give advice by mail to its Federal reserve bank of the total amount of drafts drawn each day. This amount is charged to the member bank's account and the funds placed in a special account against which the drafts will be charged when presented for payment. Special forms for the drafts and advices are provided.74 **Federal Reserve Bulletin , Vol. III ( 1917), pp . 348-319; Fourth Annual Report of the Federal Reserve Board (1917 ), pp. 23-24 ; Federal Reserve Bulletin , Vol. IV ( 1918 ) , p . 819. When member banks' reserve accounts are kept with Federal reserve bank branches, such drafts are drawn on and payable at the branch. branches. In such cases the daily advices are mailed to the FEDERAL RESERVE CLEARING AND COLLECTION 207 Each member bank must apply for and receive permission from its Federal reserve bank before drawing Federal reserve ex change drafts, and the Federal reserve bank reserves the right to withdraw this privilege from the member bank should it violate the prescribed regulations. No draft can be drawn except against an available balance in excess of the required reserve of the bank. It is to be observed that although the Federal reserve bank, to which such exchange drafts are sent by one of its own member banks, gives immediate credit for the draft ( subject to final pay ment ) , it really advances no funds of its own, due to the fact that it is permitted to deduct the total amount of these drafts from what it owes the drawee Federal reserve bank when it makes its daily settlement through the Gold Settlement Fund. Nor is the drawee Federal reserve bank out of the funds, since it imme diately charges the account of the member bank drawing the draft upon receipt of the daily advices. Up to the present time comparatively little use has been mada of the Federal reserve exchange draft. This has been due to in ertia in adopting new methods, to the fact that many banks for various reasons cling to their old correspondents, to the fact that many banks have found that the ordinary bank draft drawn on their own Federal reserve banks has met most of their demands, to the increased efficiency in the check clearing and collection system which lessens the demand for drafts, and to the fact that banks can transfer balances between their correspondents without expense and without loss of time by using the telegraphic transfer system. These drafts did not attain any importance whatever until their maximum was raised from $250 to $5,000.75 The Federal reserve transfer draft is a draft drawn by a member bank upon its own Federal reserve bank and made payable at any Federal reserve bank specified in the draft . The minimum for these drafts was fixed at $250, the maximum originally placed on the Federal reserve exchange drafts . While this minimum re quirement has never been changed, it is generally understood that no transfer drafts will be drawn for amounts under $5,000, since that amount now constitutes the maximum for the exchange drafts. The drawing bank is required to give advice by mail to its Federal reserve bank of the numbers, amounts, and total made payable at each Federal reserve bank of drafts drawn each day . It also sends a duplicate of this advice to the specified Federal * Federal Reserve Exchange, Letter No. 17, Federal Reserve Bank of Rich mond ( September, 1924 ) , pp. 9-10. Hereafter cited as Letter No. 17. 208 CLEARING AND COLLECTION OF CHECKS reserve bank at which the drafts are made payable. The drawee Federal reserve bank, upon receipt of this advice, charges the total amount of the drafts to the account of the member bank and makes provision for payment at the Federal reserve bank or branches specified. At the same time it telegraphs the Federal reserve banks at which the drafts are payable, confirming the advice sent by the drawing bank. These drafts will not be paid unless the paying Federal reserve bank has the duplicate advice of the drawing bank and the confirmation of the drawee Federal re serve bank . Due to the cumbersome nature of the transfer drafts, their use has not become common.76 JThe telegraphic transfer system Soon after the establishment of the Gold Settlement Fund a system of telegraphic transfers was established . The Federal Reserve Bank of New York inaugurated a transfer system as early as May 26, 1915, by which it undertook to transfer funds for any member bank to any other member bank in that district and to any other Federal reserve bank for account of any of its member banks . When the transfers were advised by mail no charge was made ; when advised by telegram a slight charge was made, but after December 30, 1916, the bank reduced the charges for telegraphic transfers to the cost of the telegram .77 Appar ently these transfers were largely, if not entirely, among member banks within the Federal reserve bank's own district, for when the question came before the Federal Reserve Board in March, 1917, as to the wisdom of permitting the use of the Gold Settlement Fund for the purpose of making transfers between distant member banks, the Board declined to sanction such practice.78 During the last six months of 1917, however, the Federal Reserve Bank of New York made many transfers, probably mostly intra-district, and at the close of that year reported that telegraphic transfers had been made for member banks without limit as to amount and without charge other than the cost of the telegram.79 The Fed eral Reserve Bank of San Francisco reported in 1917, however, that it performed for its member banks a service that involved 76Letter No. 17, pp . 4-5. * Third Annual Report of the Federal Reserve Board ( 1916 ) , pp. 234-235 . 78Federal Reserve Bulletin , Vol. III ( 1917 ) , p . 238 ; The Gold Settlement Fund , Letter No. 7, Federal Reserve Bank of Richmond ( September, 1922) , p . 1. Hereafter cited as Letter No. %. "Fourth Annual Report of the Federal Reserve Board ( 1917 ) , p. 270. FEDERAL RESERVE CLEARING AND COLLECTION 209 inter-district transfers for member banks through the Gold Settle ment Fund.80 Nevertheless, it was not until after the installation of the leased wire system in June, 1918, that the present highly developed system of telegraphic transfers had its most rapid growth , that is, a system by means of which a Federal reserve bank could make through the Gold Settlement Fund telegraphic transfers of funds for member banks, or for individuals and non- member banks through the medium of the member banks. On June 10, 1918, the Federal Reserve Bank of Richmond announced to its member banks that it was ready to make such transfers for them without charge. Similar announcements were made by all other Federal reserve banks to members in their respective districts.81 Prior to the introduction of the Federal reserve clearing and collection system and of wire transfers, distant payments were made by check or draft, which naturally consumed much time in effecting a settlement . For example, suppose a merchant in New York deposited in his bank a check for $50,000, drawn upon a bank in San Francisco. The check would travel to San Fran cisco, where on arrival it would be charged to the account of the man who drew it, and his bank would mail the New York bank a New York check in payment. The $50,000 would not be avail able to the merchant at his New York bank until the check arrived, at least ten and probably twelve days after the merchant depos ited the original check.82 The new Federal reserve clearing and collection system cut the time at least in half through the use of the Gold Settlement Fund. Instead of mail remittance, the San Francisco bank upon which the check is drawn makes payment at the Federal Reserve Bank of San Francisco. The same day the funds are transferred through the Gold Settlement Fund to the Federal Reserve Bank of New York which , in turn , settles imme diately with the bank that had presented the check for collection. But the system of transfers by wire virtually eliminates the time element. Suppose that the $ 50,000 payment due from the man in San Francisco to the New York merchant could not wait for a check to be transmitted through the mail. The payer's bank would charge his account, and at the same time instruct the Federal Reserve Bank of San Francisco to telegraph the Federal Reserve Bank of New York, asking it to place $ 50,000 to the 80 Ibid ., p. 598. * Letter No.7, p. 11 . *2Some banks give immediate credit but deduct interest. 210 CLEARING AND COLLECTION OF CHECKS credit of the New York merchant in his own bank. The San Francisco member bank is charged $50,000 on the books of the Federal reserve bank, and $50,000 in the Gold Settlement Fund passes from the ownership of the Federal Reserve Bank of San Francisco to that of New York. Since the introduction of daily settlements these transactions are settled daily through the Gold Settlement Fund as are those growing out of the clearing and collection of checks . Such transfers are usually for large sums ; to make a large number of small transfers which might have been made by check equally well would clog unduly the private wire system of the Federal reserve banks and hamper the efficiency of the service.83 When the Federal reserve banks first undertook to make transfers of funds for their member banks, there were numerous instances in which member banks, with the best of intentions, started to make use of the facilities for practically all transfer operations for their customers, both small and large. The transfer facilities are intended primarily for the adjustment of balances between banks, and it was soon found necessary to set limits as to the size of transfers that would be accepted in order to avoid congestion of the wires with a multitude of small and relatively unimportant transactions which would tend to lessen the efficiency of the trans fer system. As soon as the member banks understood the situa tion, they responded willingly and gave their full measure of co-operation toward making the transfer facilities effective. Originally there were no limits set on the size of the transfers which would be accepted from member banks, the matter being left entirely to the member banks. If a member bank appeared to be making use of the transfer facilities for unimportant items to such an extent that the service was retarded, the fact was pointed out to that bank that while the Federal reserve transfer system was open to them for such use they might desire to make of it, yet a situation might arise in which a very important large transfer would be seriously delayed by reason of a multitude of smaller and less important transactions taking precedence over it. By this method a most effective co -operation between the Federal reserve banks on the one hand, and their member banks on the other, was secured.84 82“ Transferring Funds Under the Federal Reserve System ,” Monthly Re view, Federal Reserve Bank of New York ( June 1 , 1921 ) . $*Frederick Greenwood, “Relations Between · Federal Reserve Banks and Member Banks, ” Bulletin of the American Institute of Banking, Vol . V, No. 1 ( January , 1923 ) , pp . 36-37. Federal reserve banks now make transfers over FEDERAL RESERVE CLEARING AND COLLECTION 211 With the installation of the leased wire system no charges whatever were made for these transfers, which included not only transactions between banks but also payments through member banks to individuals. This was in harmony with recommenda tions made by the Federal Reserve Board in May, 1918, that tele graphic transfers be bought and sold at par, each Federal reserve bank absorbing the telegraphic expense.86 With such facilities available, mail transfers were greatly reduced , as was the buying and selling of domestic exchange, since funds actually available could be transferred at par by telegraph. With reference to mail transfers, the Board recommended in 1918 that the discount rate on mail transfers be based upon the fifteen day rate, but, because it was thought desirable that the rate for such transfers should remain as nearly uniform as possible and not vary too frequently, it suggested that for the time being and until further notice a charge of 10 cents per day per thousand dollars, or, at the rate of 3.65 per cent., be fixed as the rate for all transfers.86 Rates seemed to have varied from this recommended rate, however. In 1919 the Federal Reserve Bank of Chicago, for example, reported that their policy of promoting mail trans fers as well as telegraphic transfers was being continued and that uniform charges were maintained " of 15 cents discount per day per thousand—say 512 per cent. per annum—for mail purchases » 87 and 71/2 cents discount per thousand for mail sales." Service charges lowered and finally abolished July 1, 1918 It has been pointed out already that with the inauguration of the compulsory clearing system on July 15, 1916, service charges were exacted by the Federal reserve banks to cover costs of col lection. These charges during the remainder of the year 1916 . ranged from .9 of 1 cent to 2.0 cents per item. After 1916 they ranged from .9 of 1 cent to 1.5 cents per item, although some of the Federal reserve banks in 1917, with the authority of the Fed eral Reserve Board, began exempting a certain number of items, usually five hundred per month, for each member bank. This was a part of the general movement on the part of the Federal reserve banks designed to encourage the use of the par collection facilities the Federal reserve private wire system free of charge only when such transfers are accepted from and payable to member banks, are limited to bank balances, and are in multiples of $ 100. 88Federal Reserve Bulletin , Vol. 1V ( 1918 ) , p. 371 . 86 Ibid . 57 Sixth Annual Report of the Federal Reserve Board ( 1919 ) , p. 412. 212 CLEARING AND COLLECTION OF CHECKS of the system. For example, in September, 1917, the Federal Reserve Bank of Atlanta put into effect a rule whereby member banks were permitted to clear through the Federal reserve bank without any charge whatever checks to the number of five hundred per month, the number above five hundred being charged at the rate of 11/2 cents per item . It also permitted State banks to remit to it in eastern exchange, since some of the banks which agreed to remit to it at par had no Atlanta account.88 The Federal Reserve Bank of Kansas City in the same year exempted from the service charge a maximum of five hundred items per month received from any one bank, besides making provisions for the reduction of the service charges on items exceeding the five hundred limit. The Federal Reserve Banks of San Francisco and Kansas City also provision to supply banks which remitted at par with return postage. 89 On July 1 , 1918, the service charge was abrogated made entirely and the Federal reserve banks began to collect without charge all checks and drafts on member and other banks on the par list.9: This move was justified because of the increased earn ings of the Federal Reserve System and the desire of the Board to extend the benefits of the system in every way possible. As an illustration of the extent to which business was relieved of the burden of exchange charges the situation as reported by the Board for the year 1919 is interesting and instructive. The total volume of transactions through the Gold Settlement Fund in the year 1919 was approximately $74,000,000,000 and the total cost, including the expense of the leased wires, was about $250,000. This cost was borne by the Federal reserve banks and did not rep resent any expense whatever to the member banks or their cus tomers. The basic cost of making domestic exchange in that year was 0.3 of a cent for each $1,000 transferred. A charge of 10 cents per $100 on the amount cleared through the Gold Settlement Fund would have involved an expense of $1 for each $1,000 transferred, or about $74,000,000 for the entire amount. The intra - district clearings made by Federal reserve banks in 1919, eliminating duplications, amounted to about $ 135,000, 000,000 and the total expense of these transfers was borne by the Federal reserve banks. Had the Federal reserve banks been obliged to pay for these transfers at the rate of 10 cents per $100 the total expense would have been $ 135,000,000, which amount 88Fourth Annual Report of the Federal Reserve Board ( 1917 ) , p. 418. 8ºIbid ., pp . 520, 597. soFifth Annual Report of the Federal Reserve Board ( 1918) , pp. 76-77. FEDERAL RESERVE CLEARING AND COLLECTION 213 was far in excess of the total earnings of the Federal reserve banks and, therefore, could not have been absorbed by them. If not absorbed, it would have been necessary to transfer the charge to the depositors of the checks, so that a charge of 10 cents per $100 upon the business handled by the Federal reserve banks would have involved a cost to commerce and industry of this country of at least $135,000,000.91 Absorption of other costs by Federal reserve banks In October, 1918, new inducements were extended, in the form of additional facilities , to member banks and their customers through the absorption by the Federal reserve banks of all cost of postage, expressage, insurance, etc. , incident to shipments of cur. rency to and from member banks, not including silver and silver coin, also of the cost of telegrams between the Federal reserve banks and member banks in connection with currency, exchange transfers and deposit transactions. Under a similar arrangement for non-member banks maintaining clearing accounts, the Federal reserve banks absorbed the cost of postage, insurance and ex pressage in connection with shipments of currency in settlement of clearing balances, and a further saving of expense to non-member banks on the par list was provided by inclosing stamped envelopes with collection letters for return remittances. All expenses inci dent to shipments of currency made in payment of items sent for collection were to be borne by the Federal reserve banks.92 This step removed one of the strongest arguments against the Federal reserve clearing and collection system presented by the non member banks, especially those country banks which came in direct contact with the farmers and furnished them with the necessary financial resources during crop moving seasons. The cost of securing the necessary funds with all the attending risks involved had been borne by these outlying banks and for the assumption of these heavy burdens these banks had been justified in exacting payment.93 These inducements combined with those made in 1917 in the inauguration of the system of transfer drafts and the collection of maturing notes, bills, etc., impresses one as being sufficient to bring most of the non - clearing banks into the system. But they " Seventh Annual Report of the Federal Reserve Board ( 1920 ) , pp. 67-68. " Fifth Annual Report of the Federal Reserve Board ( 1918 ) , p. 77. * The problem of these banks is set forth well by Mr. Joseph T. Talbert, Proceedings of the Academy of Political Science, Vol. IV ( 1913-1914 ), pp. 197-198. 214 CLEARING AND COLLECTION OF CHECKS failed to accomplish the desired result and opposition became more pronounced. The nature and growth of this opposition will be reviewed briefly after mentioning some of the more important changes made in the operation of the Gold Settlement Fund. Changes in the operation of the Gold Settlement and Federal Re serve Agents' Funds Since Chapter VIII gives a full account of the history and nature of the Gold Settlement Fund, it will be necessary to survey but briefly the principal changes that were made relative to its operation. Details relative to the increased use of the Fund can be found in Table XXVII , p. 318. The first important change affecting the Gold Settlement Fund after its creation on May 24, 1915, was the result of the amendment of June 21 , 1917. Regulations in harmony with this amendment, which applied to the Federal Reserve Agents' Fund also, abolished the use of gold certificates as evidences of deposits made by the Federal reserve banks with the United States Treas ury, as they had grown in such amounts as to be aа burden. Under the old system these certificates in denominations of $10,000 were constantly being transferred from the Treasury to the Federal Reserve Board and back again, according to whether Federal re serve banks were building up their deposits with the Board or withdrawing them. This amendment reduced the transactions to merely bookkeeping operations. The Treasurer of the United States simply opened an account with the Federal Reserve Board, giving credit to the Board for the sum of the deposits of the Fed eral reserve banks, the individual accounts being kept as before by the Federal reserve banks. When a Federal reserve bank wished to build up its deposit in the Gold Settlement Fund it de posited gold with the nearest sub-treasury. The Assistant Treas urer gave a receipt to the Federal reserve bank , wired the Treas urer of the United States, who issued a duplicate receipt to the Federal Reserve Board, and credit was given to the Federal re serve bank upon the books of the Gold Settlement Fund. Pay ment out of the fund was made by the Federal Reserve Board drawing a check upon the Treasurer of the United States, who now held the gold ."94 The leased wire system , June 4, 1918 On June 4, 1918, the Federal reserve banks began operating a special leased wire system by which all Federal reserve banks and "Federal Reserve Bulletin , Vol. III ( 1917 ) , p. 521 . FEDERAL RESERVE CLEARING AND COLLECTION 215 branches, the Federal Reserve Board, and the Treasury Depart ment at Washington, were kept in communication with each other. Prior to this time the Federal reserve banks had used the commer cial wires. Good service had been given, but the volume of busi ness was increasing to such an extent that it seemed the better part of wisdom for the Federal reserve banks to control their own wires. The installment and operation of this system, which has been used continuously since, has facilitated not only settlements through the Gold Settlement Fund but has greatly facilitated many other operations of the Federal reserve banks and rendered possible services to member banks which could not have been under taken without this facility. Under this system Washington and Chicago were made relay points for the East and West, respec tively. The Federal Reserve Bank of Chicago was given charge of the operations of the system, and the chief telegraph operator is stationed at the Chicago office, with a supervising operator at Washington as an assistant. In 1918 there were twenty-nine operators, including the chief, employed in the main line offices, and about 20,000 messages carried monthly over the system, while 65 per cent. of this number were relay.95 The leased wire system made possible the daily settlements which were provided for about one month later. Daily gold settlement plan , July 1, 1918 Daily settlements through the Gold Settlement Fund were substituted for the weekly settlements on July 1 , 1918. This ren dered the transfers and clearings through the Fund much more effective and much better organized. It brought about the proper adjustments in the holdings of gold to the credit of each Federal reserve bank in 'the Gold Settlement Fund in as nearly automatic a manner as possible. Under the weekly settlement system many credit transfers were being made by the Federal reserve banks between settlement periods and the practice was on the increase, although it covered but a small proportion of the credits. Daily settlements meant a better organized and a more effective system in every respect.96 Under the system of daily settlements as originally devised, the settling agent made his settlements on the morning following the wiring of the credits by the Federal reserve banks to the Fed eral Reserve Board . The Federal reserve banks, upon receipt of * Fifth Annual Report of the Federal Reserve Board ( 1918 ) , pp. 558-559 . * Federal Reserve Bulletin, Vol. IV ( 1918 ) , p. 591 . CLEARING AND COLLECTION OF CHECKS 216 these advices would make the appropriate entries as of the day on which they received the advices. Thus, the payments through the Gold Settlement Fund were always at least one day late. In order to eliminate any inter-Federal reserve bank float that might be carried by the Federal reserve banks, a system of evening settle ments was provided for on March 1 , 1920. According to this plan each Federal reserve bank and direct - settling branch tele graphs the Board its credits before the final closing of its books for the day . The settling agent makes settlements the same day and telegraphs to the Federal reserve banks and settling branches in time for the telegram to reach them before the opening for business on the following day when the necessary entries are made and their books finally closed as for the preceding day . Certain branches of Federal reserve banks clear directly through the Gold Settlement Fund97 In order to eliminate unnecessary work between the Federal reserve banks and their branches and other Federal reserve banks, and delays in reconciling differences due to the distances between the parent bank and branches, a plan was instituted by which cer tain branches were authorized to make settlements through the Gold Settlement Fund in the same manner as the Federal reserve banks, except that the net debit or credit balance of each branch in the Fund is adjusted through the Gold Settlement Fund ac count of the parent Federal reserve bank, as the branches do not maintain accounts with the Fund. On December 2, 1918, the first move in this direction was made, when the four branches of the Federal Reserve Bank of San Francisco98 were authorized to make settlements directly through the Gold Settlement Fund. Relation of the Gold Settlement Fund to rediscounting between Federal reserve banks Rediscounting between Federal reserve banks was not resorted to until June, 1918, although rediscounting by Federal reserve banks for their own member banks began in November, 1914, soon after the Federal reserve banks opened for business. "See pp. 186-187 above. " Located at Seattle, Spokane, Portland, and Salt Lake City. Fifth Annual Report of the Federal Reserve Board ( 1918 ), pp. 32-35. Los Angeles now constitutes a fifth branch. Of the 23 branches of Federal reserve banks in existence today all but the following seven are direct -settling branches : Pitts burgh , Buffalo , Cincinnati, Birmingham , Jacksonville, Nashville, and Okla homa City FEDERAL RESERVE CLEARING AND COLLECTION 217 The process of rediscounting between Federal reserve banks and its relation to the Gold Settlement Fund may be described briefly as follows : The Federal reserve bank requiring the redis count for the purpose of increasing its reserve against deposits or Federal reserve notes wires the Federal Reserve Board, stating the amount needed99 and the character and maturities of the paper offered . The Board, which is at all times advised of the reserve position of each Federal reserve bank , designates the bank to which the rediscount is to be assigned.100 Upon receipt of this ad vice, the second Federal reserve bank transfers the gross amount to the other Federal reserve bank through the Gold Settlement Fund, although this transfer is not included in the regular settle ment growing out of the clearing and collection of checks. The discount is calculated by the bank requesting the discount and later is verified by the other Federal reserve bank, to be handled as an ordinary credit and cleared through the Gold Settlement Fund on the next settlement day. Maturing discounts are paid in like manner by means of transfers through the Gold Settlement Fund, made independently of the regular settlement.101 It should be observed that these rediscount transactions between the Fed eral reserve banks are not included in the settlements growing out of the clearing and collection of checks and drafts, which are effected daily, but are carried on independently.102 They are settled directly at any time and the transactions are consummated in a very few minutes, depending upon the details to be adjusted between the Federal reserve banks.103 Settlements growing out of the exchange of Federal reserve notes between Federal reserve banks, transfers from the Gold Settlement Fund of a Federal re serve bank to the gold fund of its Federal reserve agent, and vice versa, and transfers to the redemption funds, are also settled in dependently of the daily settlements which result from the clear ing and collection of checks. 104 " Usually $ 5,000,000 or some multiple thereof. 100 The transactions through the Fund have an important bearing upon the reserve position of the banks, and as all entries affecting the Fund are made on the books of the Board and all the banks simultaneously, the Board is informed at once as to the effect of the day's transactions upon the reserves of each bank. 101Letter No. 7, pp. 11-12. 102Practical Operation of the Gold Settlement Fund, Letter No. 8, Federal Reserve Bank of Richmond (October, 1922 ) , p. 4. Hereafter cited as Letter No. 8. 163Fifth Annual Report of the Federal Reserve Board ( 1918 ) , pp. 33-35 . 104See pp. 315-319 below. CLEARING AND COLLECTION OF CHECKS 218 The growth of membership in the Federal Reserve System Before reviewing the growth of membership in the clearing and collection system additional light will be thrown on that partic ular problem by reviewing first the growth of membership in the Federal Reserve System . Obviously, the growth of membership in the Federal Reserve System is to be separated from the question of the growth of membership in the clearing and collection system ; the latter includes the former and involves problems different from those connected with the former. The provision of the Federal Reserve Act, making membership compulsory for national banks, brought all of them at once into the system as the price of retaining their charters. By the end of 1914, ninety-three State banks and trust companies had been converted into national banks. During the same year nine State banks and four trust companies were admitted to the system as members. 105 The following table shows the growth of membership in the system : TABLE XX GROWTH OF MEMBERSHIP IN THE FEDERAL RESERVE SYSTEM, 1914-19241 Member banks End of year 1914 . 1915 . 1916 . 1917 . 1918 . 1919 . 1920 . 1921 . 1922 . 1923 . 1924 . Total 7,582 National Non national 8 9,066 9,606 7,574 7,600 7,577 7,657 7,762 7,885 8,125 9,779 8,165 9,859 8,220 1,614 1,639 9,774 9,587 8,179 1,595 8,043 1,544 7,631 7,614 7,907 8,692 31 37 250 930 1,181 1,481 Federal Reserve Bulletin, Vol. IX (1923 ), p . 1175 ; Tenth Annual Report of the Federal Reserve Board ( 1923 ) , p. 47 ; Federal Reserve Bulletin , Vol. XI ( 1925 ) , p. 219. State institutions entered slowly. The above table shows that there were but 31 non-national member banks at the close of the 105First Annual Report of the Federal Reserve Board ( 1914 ) , p. 20. Unfortu nately the data given here do not agree with those given in Table XX , which were taken from the Federal Reserve Bulletin, Vol. IX ( 1923 ), p . 1175. Nor do they agree with data given by Mr. Pierre Jay in " The Federal Reserve System , State Banks and Par Collections,” Annals of the American Academy of Politicaland Social Science, Vol. XCIX ( January, 1922), p. 79. He says: " The provision of the Act making membership compulsory for national banks, brought at once into the System about 7,600 national banks with capital and surplus of $ 1,788,000,000 and total resources of $ 11,492,000,000, thus giving a membership at the outset comprising 42.6 per cent of the total resources of the country .” He does not state whether any State institutions entered the system during the years 1914 or 1915. FEDERAL RESERVE CLEARING AND COLLECTION 219 year 1915, that is, that but 23 had entered during the year 1915.106 The year 1916 witnessed a slight decrease in the total membership of the system . The number of national banks declined from 7,600 to 7,577 and the number of non -national banks in creased from 31 to 27 if the data in the table given above may be taken as authoritative. Mr. Pierre Jay107 pointed out that most of the State institutions were either passive or opposed to the plan of the Federal Reserve System . The number of such members at the close of 1916 was 37, of which only seven had a capital and sur plus of over $1,000,000. Membership on the part of the State banks increased in 1917 as a result of two things : ( 1 ) The amend ment of the Act108 in that year which permitted State banks to carry on their banking business in substantially the same manner as they had done previously, with the right to withdraw from the system upon six months' notice. ( 2 ) The entrance of the United States into the World War gave a new and strong impetus toward membership. The necessity of strengthening the banking system of the country to the maximum degree possible, in order to meet the strain of war financing, led President Wilson in the autumn of 1917 to make a strong appeal to State banking institutions to join the Federal Reserve System. The officers of Federal reserve banks carried the appeal to the individual institutions. Many of the more important ones responded and during the fall of 1917 and the first half of 1918, a considerable number of State institutions throughout the country became members. The movement was particularly noteworthy with respect to the aggregate resources which thus augmented the strength of the system. The major portion of the large institutions in New York City entered the system promptly, and the close of the year 1917 found the system with a State bank and trust company membership of 250, having aggregate capital and surplus of $520,000,000 and aggregate resources of about $ 5,000,000,000. This represented 2.9 per cent . of the number and 37.3 per cent . of the resources of the State institutions eligible for membership.109 The Federal Reserve Board estimated that the total membership of the Federal Reserve 104Again one finds a lack of agreement in data presented by the Federal Re serve Board. The Second Annual Report of the Federal Reserve Board ( 1915 ) , p. 13, says: “ While the attitude of State banks and trust companies has been such that but 32 have been admitted to membership, 84 others have become members by conversion or by organization as national banks during 1915. ” 101 Op. cit. , pp. 79-80. 108Amendment to Section 9 of the Federal Reserve Act, approved June 21 , 1917 . 10®Fifth Annual Report of the Federal Reserve Board ( 1918 ) , p. 27. 220 CLEARING AND COLLECTION OF CHECKS System at the close of the year 1917 represented about 75 per cent. of the total commercial banking assets of the country.110 From the year 1917 to the end of the year 1922 there was a steady annual increase in both national and non-national banks. The year 1918 witnessed a large increase in the number of non national banks admitted to membership—930 as against 250 at the end of 1917.111 These 930 non-national banks had total re sources of over $7,000,000,000.112 The Federal Reserve Board estimated that the membership of the State banks and trust com panies represented at that time 54.5 per cent . of the total banking assets of all State banking institutions eligible for membership in the Federal Reserve System, although but 11 per cent. of the number eligible for membership. With the end of the War there came a slowing down of the efforts of the Federal reserve banks to convince institutions of the importance of becoming members of the Federal Reserve System, although there was a substantial movement of State institutions into the system. The laws of many States contained provisions concerning reserves, character of investments or other vita! matters which hindered or prevented institutions in those States from taking membership in the system . As these obstacles from time to time were removed, more and more State institutions took advantage of the opportunity to join. Many States, for example, have passed laws providing that a State institution, becoming a member of the Federal Reserve System , need keep only the legal reserves required by the Federal Reserve Act. The influence of this factor is strikingly illustrated in California where 61 institu tions with total resources of $1,110,000,000 became members in the eighteen months following the amendment of the State law in respect to reserves to be carried by member banks. 113 With the end of the War it was expected that some of the State banks would withdraw , as some of them had entered the system with that intention, but their experience as members was such that but few withdrew. In 1919 the membership of non-national banks in creased from 930 to 1,181 , representing a total capital and sur plus of over $891,200,000, and total resources of about $ 9,913 , 700,000. In 1920 the non-national bank membership increased 110Fourth Annual Report of the Federal Reserve Board ( 1917 ) , p. 14. 111At this time the American Bankers' Association was conducting an active campaign for membership . 112Pierre Jay, op. cit., p. 80. The Fifth Annual Report of the Federal Reserve Board ( 1918 ), pp . 25, 27 , says there were 936 such institutions on January 1, 1918, having aggregate resources of about $ 7,339,000,000 . 112Pierre Jay , op. cit. p . 80. FEDERAL RESERVE CLEARING AND COLLECTION 221 from 1,181 to 1,481 , representing capital and surplus of $ 1,035 , 023,000 and total resources of $9,826,794,000. In 1921 the number had increased to 1,614, with capital and surplus of $1,110,663,000 and total resources of $9,904,860,000.114 In 1922 the number reached 1,639 with an aggregate capital and surplus of approximately $ 1,175,000,000 and total resources of $ 11,917,000,000. According to the Annual Report of the Fed eral Reserve Board for that year,,115 there were, on June 30, 1922, 30,325 banks in the United States116 with an aggregate cap ital and surplus of $5,599,134,000 and resources of $ 50,147, 513,000. Of these institutions 9,892 were members of the Federal Reserve System, with a capital and surplus of $3,496,319,000 117 The resources of member and resources of $ 31,723,950,000.11 banks of the Federal Reserve System therefore constituted about 63 per cent . of the total banking resources of the country. There were 9,678 State banks and trust companies with capital stock sufficient to enable them to become members which were not mem bers at the end of June, 1922, their aggregate capital and surplus being $ 1,209,115,000 and their resources $8,983,580,000. If the mutual savings and private banks which are not eligible for mem bership are excluded, it is found that at the end of June, 1922, the national banks and State banks and trust company members rep resented about 78 per cent. of the banking power of all banks eligible for membership.118 On June 30, 1923, the total had dropped to 9,856, of which 8,236 were national banks and 1,620 State banks and trust com panies. Approximately 33 per cent . of all the banks, represent ing over 70 per cent . of the total banking resources of the coun try, were members of the system. By the end of the year 1923 the total had dropped to 9,774, of which 8,179 were national and 1,595 were non-national. The reduction of 85 in Federal reserve membership for the year 1923 was the net result of the addition of 210 member banks and the loss of 295. Of the banks added to the membership, two were banks previously closed which resumed 11*Eighth Annual Report of the Federal Reserve Board ( 1921 ), p . 60. On p . 59 of the Eighth Annual Report of the Federal Reserve Board , the number is given as 1,621 . Such repeated inconsistencies in data are unfortunate. 115Ninth Annual Report of the Federal Reserve Board ( 1922 ) , p. 29. 110Including national and State commercial banks, mutual and stock savings banks, private banks, and loan and trust companies. 117If this statement is correct it seems that the total membership in the Fed eral Reserve System reached its peak about June 30, 1922, since the total mem bership at the end of the year was but 9,859 and has declined since that time. 118 Vinth Annual Report of the Federal Reserve Board ( 1922 ) , p. 29. . Francisco San Total December .. 31 Dallas Kansas City Minneapolis . Louis St. Chicago Atlanta Cleveland Richmond Philadelphia Boston York New Reserve District Federal banks 802 9,774 9,856 849 1,122 940 624 803 857 1,145 989 1,427 8,236 602 658 1,106 868 497 1,062 8,179 659 607 1,086 831 497 1,058 561 385 561 389 627 525 629 530 1,434 621 759 764 877 660 680 835 30 June 390 722 Bulletin 'F19 ederal ol 923 X 176 3VReserve (1;I 924 .),pX 1,620 201 199 39 122 124 372 141 68 116 1,595 190 195 36 127 109 369 66 140 118 1,637 21,502 22,395 2,940 33,796 35,239 864 978 1,013 1,376 912 1,443 1,133 1,542 2,813 768 1,743 5,193 1,881 2,027 1,275 30 June National banks banks, and 121 were formerly non-members which joined the activities during the year, 89 were newly organized national 12,843 12,294 1,303 114 166 120 531 2,135 423 206 1,322 520 4,689 Non national banks 30 June 765 millions (In dollars )of Resources FEDERAL THE IN MEMBERSHIP J SYSTEM UNE 31 DECEMBER AND ,1RESERVE "30 923. 1,191 4,948 1,481 3,349 Non Non national AU National national banks banks banks banks June June 30 30 31 Dec. 31 Dec. 37 36 2,508 388 692 9,882 143 141 66 656 60 2,401 National 429 All banks 31 Dec. 880 720 All banks June 30 427 821 Number XXI TABLE 222 CLEARING AND COLLECTION OF CHECKS system. Of the losses in membership, mergers accounted for 87, of which the largest number were in the San Francisco district , FEDERAL RESERVE CLEARING AND COLLECTION 223 voluntary liquidation accounted for 31 , absorption by non-member banks for 48, voluntary withdrawal of State banks and trust 119 companies for 29, and insolvencies or suspensions for 102.1 A survey of the distribution of membership by Federal reserve districts shows that the largest number of member banks is in the four middle western districts, which have nearly half the member banks, while the larger proportion of member bank resources, as is to be expected, is in the eastern districts, nearly a third of the total resources being in the New York district alone. The non national banks, which constitute less than one- sixth of the number of member banks, represent more than one-third of the resources. This reflects the much larger average size of State bank and trust company members than of national banks. In fact, the total resources of the more than 8,000 national banks are about $ 22, 000,000,000, or an average of about $2,500,000, while the total for the 1,600 State bank and trust company members is about $ 12,000,000,000, or an average of about $7,500,000.120 Table XXI shows the situation. For the country as a whole, two-thirds of all the banks, both eligible and ineligible, are still outside the system, although they represent less than one-third of the total banking resources. The geographic distribution of non -member banks is far from uniform. The largest number of such banks is concentrated in the agricul tural districts, while in the eastern financial and industrial dis tricts the proportion of the non -membership is low . The follow ing table shows the percentages of non-member banks by dis tricts : 121 Boston New York Philadelphia Cleveland Richmond Atlanta Per cent. 35 30 41 55 71 74 Per cent. Chicago 75 St. Louis 81 Minneapolis Kansas City . 73 73 55 54 Dallas San Francisco .. The Agricultural Credits Act of 1923, passed on March 3 of that year, provided for a committee to inquire into the reasons that have actuated eligible non-member banks in remaining out side of the Federal Reserve System. This committee, consisting 11ºTenth Annual Report of the Federal Reserve Board ( 1923 ) , p. 48 ; for a discussion of the changes during the year 1924, see Federal Reserve Bulletin , Vol. XI ( 1925 ) , pp . 218-219. Although the total membership has declined since 1922, the resources of the members have increased from $33,883,000,000 at the end of 1922 to $ 38,987,000,000 at the end of 1924. 120Federal Reserve Bulletin, Vol. IX ( 1923 ) , p. 1176. 121 ]bid . 224 CLEARING AND COLLECTION OF CHECKS of three members of the Banking and Currency Committee of the Senate and five members of the corresponding committee of the House of Representatives, has been conducting hearings and has heard the views of the Governor of the Federal Reserve Board, the Comptroller of the Currency, other members of the Federal Re serve Board, members of the Federal Advisory Council, the Direc tor of the War Finance Corporation , members of the Farm Loan Board, and representatives of banking and farm organizations.122 This committee has learned that capital requirements have not been the chief impediment to increased membership. Since the Agricultural Credits Act of 1923 reduced the capital require ments, making about 4,200 more State banks and trust compa nies eligible for membership , but one application for membership from the new group made eligible was received up to the end of November, 1923. It appears that the reserve requirements of the Federal Reserve System can offer little, if any, inducement, although the total required balances that must be carried with the Federal reserve banks plus the till money now carried by member banks is somewhat less than the cash they formerly carried in their vaults. Many of the States subsequently enacted legisla tion reducing the reserve requirements, so that at present, although there is no uniformity in the State requirements, in gen eral the reserves required of non-member banks are lower than they were prior to the establishment of the Federal Reserve Sys tem . In 30 States member banks are controlled by the require ments of the Federal Reserve Act, while in 18 States banks must conform to both Federal and State law.123 The fact that the Federal reserve banks do not pay interest on deposits seems to act as a deterrent. The committee thinks that the addition to mem bership of the smaller rural banks would add little to the reserves of the system, while it would increase its responsibilities . The desirability of their admission rests not upon their contribution to the strength of the system , but upon the fact that through their admission the benefits of the reserve system would be more widely distributed, especially to the communities which these non Mr. Pierre Jay125 points out also that many of these banks have learned that they can enjoy many of member banks serve. 124 the advantages of the system, such as the avoidance of the old 122 1bid ., p. 1175. 123 Ibid ., p . 1178. 124Ibid ., pp . 1178-1179. 1250p. cit., p. 81 . FEDERAL RESERVE CLEARING AND COLLECTION 225 fashioned money panic and the stabilization of banking conditions, without assuming any burdens of membership. Finally, and above all, there is the opposition to the plan of par check collec tion, the subject with which we are primarily interested, and to which we now will turn our attention, although a separate chap ter is devoted to this problem . The growth of the clearing and collection system Since a detailed account of the growth and opposition to the Federal reserve clearing and collection system is given in Chapter VII, a brief resume will suffice at this time. Although the original provisions of the Federal Reserve Act did not authorize Federal reserve banks to collect checks on non TABLE XXII MEMBERSHIP IN THE FEDERAL RESERVE CLEARING AND COLLECTION SYSTEM Total non -member banks, Non- member computed banks Non -member Member banks on par list Date banks Aug. 15, 1916 7,624 7,622 7,9094 7,032 8,130 8,692 9,089 Jan. 15, 1917 Jan. 15, 1918 9,268 Jan. 15, 1924 9,875 10,595 16,9864 19,101 18,066 17,777 16,484 May 31 , 1924 9,785 15,981 Jan. 15, 1919 Jan. Jan. Jan. Jan. 15, 15, 15, 15, 1920 1921 1922 1923 9,637 9,847 9,911 Total on not on par list par list 14,656 15,752 17,177 19,287 10,336 9,923 26,075 28,738 27,913 27,688 26,359 25,766 from columns 3 and 5 3,566 1,7056 20,604 20,518 20,552 20,806 2,350 2,289 3,013 3,240 20,416 20,066 19,497 19,221 "Compiled from Federal Reserve Bulletins and Annual Reports of the Fed eral Reserve Board. " This item as given in the Federal Reserve Bulletin , Vol. V (1919 ) , p. 775, does not harmonize with data given on p. 181 of the same volume. ' In some places this item is given as 16,985 , in others as 16,986. * This month also marks the peak for the number of non -member banks on the par list. member banks, as many as 7,032 such banks had agreed to remit at par by August 15, 1916, making a total of 14,656 member and non-member banks on which the Federal reserve banks could col lect checks at par on that date. On September 7, 1916, Section 13 was amended so as to authorize the Federal reserve banks to receive for collection from any member bank or other Federal re serve banks checks drawn upon non-member banks and trust com panies within their respective districts and payable upon pres 226 CLEARING AND COLLECTION OF CHECKS entation.126 By December 15, 1916, only 37 of approximately 20,000 State banks had become members of the Federal Reserve System and about 8,065 of the non -member State banks had agreed to remit at par.127 An amendment of June 21 , 1917, made it possible for the Federal reserve banks to act as collecting agents for non -member banks provided they carried sufficient deposits with the Federal reserve banks to offset the cash items being col lected. The concentration of reserves, the development of a col lection system for maturing notes, bills and drafts, the introduc tion of a system of transfer and exchange drafts and of wire transfers, the assumption by the Federal reserve banks of the expenses of currency shipments and remittances, combined with campaigns for increased membership, resulted in a steady increase in membership until January, 1921 , after which time there came a gradual decrease . The table on page 225 will give a summarized picture of the situation. Opposition to the clearing and collection system Strenuous opposition to the clearing and collection system developed from member as well as non-member banks, the princi pal opposition coming, however, from the non -member exchange charging banks. These banks opposed the extension of the par clearing and collection system on the ground that they were de prived unjustly of a source of income since there was a real expense involved in paying checks at places other than at their own counters . This objection, which was the chief one, was bolstered up by various minor ones, such as their contentions that Congress had never intended that they should not charge for remitting, that holders of checks have no unlimited right to collect them in cash or in unlimited amounts, that the methods used by the Fed eral reserve banks to collect checks on them were oppressive and consequently illegal , that the principle of par remittance cannot be justified on any ground other than that remission by the bank is a service to the drawer of the check which these banks con tended it was not, and finally, that the holder of a check has no right to demand payment of a check except at the bank on which drawn. Opposition on the part of these banks assumed various forms. They resorted to dilatory tactics in tendering payments ; they stamped various kinds of legends on their checks in order to pre 120 Third Annual Report of the Federal Reserve Board ( 1916 ) , p. 134. 17 Federal Reserve Bulletin , Vol. IX ( 1923 ) , p. 790. FEDERAL RESERVE CLEARING AND COLLECTION 227 vent the Federal reserve banks from presenting them for pay ment ; they organized the National and State Bankers' Protec tive Association in order to present a unified front in opposing the system ; they succeeded in persuading various State legisla tures to pass acts designed to protect them in the practice of charging exchange ; they petitioned Congress for hearings and amendatory legislation ; and finally, they resorted to suits and injunctions in an effort to protect themselves in what they con ceived to be their rights. A more complete treatment of this op position is deferred until Chapter VII is reached. At this time it , will be sufficient to point out the consequences that have resulted from the opposition. Certain important principles have been, established as a result of various court decisions, which on the whole, have been favorable to the opposing banks. The most outstanding principles of the clearing and collection system which may be said to obtain today as a result of the court decisions may be summarized as follows : The Federal reserve banks, as collecting agents, have the right to present checks directly to the drawee banks for payment with out deduction ( assuming there are no State laws to the contrary ) , even though such a procedure may inconvenience the drawee banks somewhat, provided the Federal reserve banks do not abuse their power by accumulating checks with the intention of embarrassing and coercing banks.128 In the same case the United States Supreme Court upheld the lower courts which had ruled that the Federal reserve banks, in publishing the names of the banks on their par lists, that is, the names of the banks on which they would attempt to collect checks at par, could not include the names of banks which had not given their consent. It had been the practice of the Federal reserve banks in making up their par lists to include any banks on which they would undertake to collect checks at par by direct presentation over the counter regardless of whether the banks consented or were aware that their names were to be pub lished . The so-called San Francisco par collection case defi nitely established the principle that a Federal reserve bank cannot. use the check collection system to coerce non -member banks to 128 A merican Bank and Trust Company et al. v. Federal Reserve Bank of At lanta et al., 284 Fed . 424 ( 1922 ) . An appeal was taken from this decision , which was rendered in the United States Circuit Court of Appeals, to the United States Supreme Court, which upheld the lower court . See American Bank and Trust Co. et al. v. Federal Reserve Bank of Atlanta et al., 262 U. S. 643 ( 1923 ). . These cases are discussed at some length in Chapter VII; see es pecially pp . 260-263 below . CLEARING AND COLLECTION OF CHECKS 228 remit at par.129 The same principle was declared in the Cleveland In the Richmond . par collection case decided in the same year 130 par collection case the United States Supreme Court upheld an act passed by the legislature of North Carolina which had for its purpose the protection of the non -member State banks in their attempts to make exchange charges for remittances.131 In this case the United States Supreme Court held that non-member banks could discharge their obligations lawfully by means of a draft when checks were presented for payment unless the bank's depositors, that is, the drawers of the checks, stipulated other wise, as the bank's obligation, according to the Court, is to the depositor and not to the holder of the check ; that the payment of the Federal reserve bank by drafts on reserve deposits did not deprive the Federal reserve bank of any legal right protected by due process of law132 ; that the State had a right to direct such an act against the Federal reserve bank if it considered it an instru ment oppressing State banks ; that the Federal Reserve Act is permissive only and does not place any obligation upon the Fed eral reserve banks to collect on non -member banks which do not wish to remit at par ; and finally, that Congress did not confer upon the Federal Reserve Board or Federal reserve banks a duty to establish universal par clearance and collection of checks. As aa result of and in conformity with the rulings of the courts, the Federal Reserve Board made new rulings to the effect ( 1 ) that no Federal reserve bank shall receive on deposit or for collection any check drawn on a non -member bank which refuses to remit at par in acceptable funds, and ( 2 ) whenever a Federal reserve bank receives on deposit for collection a check drawn by, en dorsed by, or emanating from any non -member bank which re fuses to remit at par in acceptable funds, it shall make a charge for the service of collecting such check of 1/10 of 1 per cent. , the 120Brookings State Bank v . Federal Reserve Bank of San Francisco, 281 Fed. 222 ( 1922 ) . See pp . 263-266 below. 150Farmers and Merchants Bank of Catlettsburg, Ky . v. Federal Reserve Bank of Cleveland, Ohio, and Mary B. McCall, 286 Fed. 610 ( 1922 ) . See pp. 266-269 below. 131Farmers and Merchants Bank of Monroe, North Carolina, et al. v. Federal Reserve Bank of Richmond, Virginia , 262 U. S. 649 ( 1923 ) . See pp. 269-276 below . 152 In the case of Federal Reserve Bank of Richmond v. Malloy et al., Trad ing as Malloy Brothers, 44 Sup . Ct. 296 ( 1924 ) , the same Court held that that the Federal reserve banks acting as collecting agents could not accept such drafts without assuming liability to the payee banks for any losses that might result from the acceptance of drafts instead of cash. See pp. 284-286. FEDERAL RESERVE CLEARING AND COLLECTION 229 minimum charge to be 10 cents for each item.133 Regulation J, Series of 1923, which embodied these two rulings was to have been effective August 15, 1923, but was postponed and finally sus pended , Regulation J, Series of 1920, again becoming effective. In November, 1923, the Board also directed the Federal reserve banks to discontinue the use of agents other than banks for the purpose of making collections at par upon non -member banks in any district in which such practice still existed.134 On May 9, 1924, the Board issued Regulation J, Series of 1924, which super seded the regulation of 1920 and which includes the following ruling: “ No Federal reserve bank shall receive on deposit or for collection any check drawn on any non -member bank which can not be collected at par in funds acceptable to the Federal reserve bank of the district in which such non -member bank is located .” In addition, the Federal reserve banks, under authority of this regulation, require all banks which use them as collecting agents to enter into an agreement releasing them from any liability for losses incurred in accepting drafts in payment for items sent for collection. 135 Success of the Federal reserve clearing and collection system Despite the fact that the Federal reserve clearing and collec tion system is far from universal in its application, is bitterly opposed by certain interests, and is impeded somewhat by adverse State legislation and court decisions, it must be conceded that the system is highly successful in the main, and marks a distinct achievement in banking progress. It has reduced the time factor and facilitated the use of deposit currency, the most efficient, economical and elastic sort of currency ; it has reduced the cus tomary float to a negligible factor and thereby increased the solidity and reality of the reserves which support the superstruc ture of credit, a fact appreciated by bankers and economists, especially since witnessing the disastrous effects of the tremendous float that had been present prior to and had been one of the im portant factors contributing to the panic of 1907. It has relieved business of a burden in the form of exchange charges, reduced the charges to a small per cent . of what they were formerly and has distributed the expense which is now almost negligible in a more 133Regulation J, Series of 1923, Federal Reserve Bulletin, Vol. IX ( 1923 ) , pp . 903-904. 13*Federal Reserve Bulletin , Vol. IX ( 1923 ) , p . 1194. 120Federal Reserve Bulletin , Vol. X ( 1924 ), p. 489. A fuller discussion of this subject is given on pp . 282-288 below . 230 CLEARING AND COLLECTION OF CHECKS equitable manner. It has made it much easier to transfer funds and mobilize reserves where most needed with little, if any, physi cal movements of gold, and with little, if any, discrepancies in discount rates between different sections of the country.136 Cer TABLE XXIII AVERAGE DAILY NUMBER AND AMOUNT OF ITEMS HANDLED, 1916-1918 , INCLUSIVE ." Average Average Average Average daily daily daily number amount daily For month ending 15th of 1916 August September number amount of items of items of items handled drawn of items handled handled handled drawn drawn on banks on U. S. drawn on U. S. government government on banks 133,113 177,397 204,891 227,489 236,038 $ 59,301,696 78,559,704 March 241,933 220,421 234,475 April 231,777 May June 238,288 October November December 1917 January February 97,666,107 115,061,224 125,603,732 November 251,061 293,742 325,690 December 343,787 121,814,589 110,188,028 116,404,430 127,648,503 160,680,956 174,236,737 197,489,674 176,410,219 182,303,483 220,732,251 283,938,810 314,623,152 359,067 292,585,856 38,130 325,301 369,898 388,058 399,812 407,866 282,785,363 48,224 321,805,317 319,977,817 58,991 59,228 366,126,872 60,771 77,750 July August September October 250,241 255,039 243,625 12,582 15,925 16,344 19,100 19,533 23,492 $ 2,643,408 3,597,865 4,414,508 11,637,899 9,701,569 11,006,515 26,797 13,518,566 30,426 17,496,974 27,179,053 33,806 1918 January February March April May June July August September October November December 588,710 649,827 346,005,014 427,741,091 373,404,503 397,327,936 448,657,299 717,714 490,142,831 106,539 98,168 764,185 452,935,793 135,173 538,984 546,358 82,536 81,323 87,213 21,116,293 21,316,033 25,827,757 31,563,675 30,928,185 39,054,003 47,181,467 41,063,646 45,695,643 51,048,149 52,790,232 60,766,938 * Federal Reserve Bulletin , Vol. V ( 1919 ) , p. 775. tainly no one who has the interests of the country at heart could advocate a return to a system similar to the one that existed prior to the establishment of the present one. It seems equally certain that advocates of measures which hamper the further de velopment of the present system to its logical conclusion must 124See pp. 319-326 on inter-district gold movements. 1921 No. Year bank city Federal reserve branch cities Federal reserve .years method data reporting of in change the to due 1914-1918 cities in banks on drawn Items 1919-1923 TABLE XXIV districts reserve Other Items Federal outside District drawn on (Nmounts .A in umbers )thousands dollars of bear the burden of proof and must present grounds of justifica tion which cannot be understood now to be in the interest of the country at large or in the interest of sound banking. Reports Annual from .*Ctompiled Board Reserve Federal of Iis this develop impossible the cover to table 42,804 108,479,604 94,643 465,736 34,612,128 48,146,789 35,803 85,996 190 639,176 4,511,735 195,836,252 . 1923 17,320,887 39,54 87,698,642 162 40,082,121 413,670 48,641 5,014,383 33,980 584,873 150,164,674 . 1922 97,517 33,142 58,365,284 377,845 16,297,746 104 38,509,597 22,017 33,200 5,649,747 522,665 118,844,391 78,374 43 305,159 14,518,471 32,900 37,240 46,340,904 214,177 13,115,715 14,832 62,481,093 136,493,423 43,206 . 1919 23,593 75 57,083,187 337,628 20,228,821 23,447 72,494,620 6,679,043 27,367 156,509,264 452,116 61920 . 3,599 .N. o. Amt Tof ) reasurer bank drawee to duplications Total items Federal freserve branch and bank orwarded ehandled (direct States United xclusive AND YEARS FOR SYSTEM COLLECTION CLEARING RESERVE FEDERAL THE OF OPERATIONS FEDERAL RESERVE CLEARING AND COLLECTION 231 CHAPTER VII THE PAR COLLECTION CONTROVERSY Growth of opposition to the Federal reserve par collection system 1 In the development of the Federal Reserve System in general, opposition to some aspects of it has been in evidence almost con tinuously, but it is probably true that in no particular line of de velopment has there been more constant or bitter opposition than in the attempt to establish a uniform Federal clearing and collec tion system based upon the principle of par remittance. It has been pointed out elsewhere that the Federal Reserve Board in taking its first steps towards establishing a clearing and collection system in the United States instituted , first of all, a voluntary system which was in existence from June, 1915, to July, 1916. During this period the opposition on the part of the mem ber banks was so pronounced that the Federal Reserve Board found it necessary to make the system compulsory. The opposi tion during the voluntary period was due not only to the loss of exchange by the banks but also to the reserve situation, which involved additional burdens to the banks that were compelled to carry reserves not only with the Federal reserve banks, but with other banks for clearing and collection purposes. " The term " par collection ” as used in this chapter is synonymous with par remittance. The former term is used because it is the one in popular use . One frequently meets the expression “ par clearance” which also refers to par remittance, but the writer believes it is less common than " par collec tion.” The controversy is over the question of par remittance and regardless of what term is used the meaning should be clear from the context. Un fortunately , also the term "exchange charges” is used in a variety of senses. Sometimes it refers to remittance charges, sometimes to charges for drafts on distant centers, and sometimes to the charges made by banks for collecting out-of- town items. Again the context must be relied upon for clarity. When banks make charges for collecting out-of- town checks, the charges are properly called collection charges. Obviously, the par collection controversy does not refer to these charges. Bankers today prefer to call collection charges " in terest charges” because, in the main , they represent the loss of interest ex perienced by the bank as a result of giving the depositor immediate credit for out-of-town items deposited . The par collection controversy might be extended easily to include the question of interest charges for collection, thus raising the question of the advisability of forcing banks to absorb this expense as a part of the general expense incidental to the banking business. 232 THE PAR COLLECTION CONTROVERSY 233 The same opposition continued during the compulsory system which was instituted in July, 1916. The member banks chafed because all banks were not in the system ; they felt that this fact forced additional burdens on them . It will be recalled that the first step in the campaign of compulsion was taken in the summer of 1916, when the Federal Reserve Board issued a regulation re quiring every drawee bank which was a member of the Federal Reserve System to remit at par for all checks upon it presented through the mail by the Federal reserve bank of the district. The operation of this requirement was at first limited in scope by the provisions of Section 13 which, at that time, authorized the re serve banks to collect only those checks which were drawn on mem ber banks and which were deposited by a member bank or an other reserve bank. Under this system but few of the non -member banks chose to become members. On September 7, 1916, Section 13 was amended so as to authorize a Federal reserve bank to re ceive for collection from any member bank or other reserve bank checks drawn upon non-member banks and trust companies within its district. Regulation J then issued by the Board provided that the Federal reserve banks would receive from member banks at par, checks only on those of the non -member banks which would remit to the Federal reserve bank at par. It was recognized that non -member banks were left free to refuse assent to the par collection system , although it was hoped and expected that the Federal Reserve Board would be enabled , by this amendment , to extend par clearance to a large proportion of all checks issued in the United States . By December 15, 1916 , how ever , only 37 of approximately 20,000 State banks within the United States had become members of the Federal Reserve Sys tem , and only 8,065 of the non -member State banks had assented to par clearance.3 Federal reserve banks, according to the law as it then existed, could not make collections for non -member banks. It was be lieved that if Congress would grant the Federal reserve banks permission to make collections for non -members also, the Board could offer to all banks inducements adequate to secure their con sent to par clearance. Consequently a further amendment to Sec tion 13 on June 21 , 1917, provided that the Federal reserve banks might receive from non -member banks checks payable upon pres entation if the non -member banks maintained sufficient bal * Third Annual Report of the Federal Reserve Board ( 1916 ) , p . 131. Federal Reserve Bulletin , Vol. IX ( 1923 ), p. 790. 23+ CLEARING AND COLLECTION OF CHECKS ances with the Federal reserve banks to offset the items in transit . To this amendment, which had been recommended by the Board, was added a proviso, known as the Hardwick Amendment, which provided that nothing in the Act “ shall be construed as prohibit ing a member or non-member bank from making reasonable charges, to be determined and regulated by the Federal Reserve Board, but in no case to exceed 10 cents per $ 100 or fraction thereof ... but no such charges shall be made against the Federal reserve banks.” From this time on the Federal reserve banks considered it their duty to collect any check on any bank. Strenuous efforts were made to induce non-member banks to agree to remit at par, even though the law did not compel them to do so. Many refused and continued to make remittance charges. With the concentration of reserves in the Federal re serve banks, which was ordered by the Federal Reserve Board im mediately after the amendment of the law in June, 1917, which provided for concentration, one big barrier to the unified clearing and collection system was removed. Other steps taken by the Federal Reserve Board to encourage non-member banks to enter the system have been reviewed . Among other things, the Board developed a collection system for maturing notes, bills and drafts at a small charge, a system of transfer and exchange drafts, a system of wire transfers, and assumed the costs of currency ship ments and remittances. In fact, they left the opposing banks with little real ground on which to rest their opposition. On March 21 , 1918, Attorney-General Gregory ruled that “ the Federal Reserve Act, however, does not command or compel these State banks to forego any right they may have under the State laws to make charges in connection with the payment of checks drawn upon them. The Act merely offers the clearing and collection facilities of the Federal reserve banks upon specified conditions. If the State banks refuse to comply with the condi tions by insisting upon making charges against the Federal re serve banks, the result will simply be, so far as the Federal Reserve Act is concerned, that since the Federal reserve banks cannot pay these charges they cannot clear or collect checks on banks de manding such payment from them .” 4 This opinion restricted the operations of the Federal reserve banks to checks which could be collected without the payment of exchange to the bank as col lecting agent. *31 Opinions of the Attorneys General, pp. 245, 251 ; Federal Reserve Bulle tin, Vol. IX ( 1923 ), p. 790. THE PAR COLLECTION CONTROVERSY 235 In accordance with this ruling the Federal reserve banks were compelled either to refuse checks on banks which would not remit at par or make plans to collect on the opposing banks in such a manner as to give them no legal grounds for exacting a charge, that is, by presenting the checks over the counter. The Federal Reserve Board interpreted the Federal Reserve Act as imposing a duty upon it to establish a universal par clearance and collection system. This interpretation of the Act, combined with the fact that the legality of the Board's actions was well established by previous court decisions as well as by general practice, that is , that checks were demand obligations payable upon demand and without deduction when presented over the counter, placed the opposing banks in a weak position. Justification of the Board's position did not convert the non-par banks ; it merely established the basis for a prolonged fight. At this point it will be well to examine the grounds of opposition. The basis of opposition to par collection The grounds on which the opposing banks have attacked the par collection system which the Federal Reserve Board has en deavored to develop, have been set forth many times in various forms and places, and have occupied a predominant place in the literature circulated by Mr. L. R. Adams, General Secretary of the National and State Bankers' Protective Association. They may be summarized briefly as follows: 1. The nature of checks and the obligations of a bank toward its depositors and other persons are governed by the laws of the States, not by Federal enactment. Under State law a bank 5 becomes a debtor when it receives an ordinary deposit and the terms of the debt are that the bank will repay on demand at its place of business to the depositor or to his order. The bank con tracts with the depositor to pay at its place of business and no where else. It has not undertaken to pay in another city or coun try. Consequently, when a depositor sends his check to a person in another place and the recipient of the check accepts it in pay ment, the recipient becomes only the transferee of the depositor's right, that is, his right to have the money paid on demand over the bank's counter or the credit transferred to him upon the bank's books. But such recipients ordinarily do not wish to be " See especially L. R. Adams, The Case Against Enforced Par Clearance , a pamphlet issued by Mr. Adams as General Secretary for the National and State Bankers' Protective Association ( Atlanta, Ga ., no date ). 236 CLEARING AND COLLECTION OF CHECKS come depositors in the drawee banks, and ask for a transfer of the credit from the place where it exists to the place where they de sire it. This request is beyond the conditions of the credit as it was originally created by the bank . As a result, par clearance in reality amounts to a change in contract without the consent of one of the parties, and to making the check payable anywhere in the United States at the option of the holder, instead of at the one known place provided for in the original contract. To comply with such a request involves the bank in an expense for which it is entitled to make a charge. This charge is for a banking service over and above the service which the bank contracted with its depositor to render to him or to any person he might designate in . his check . This service would differ only in degree if the request were that the credit should be made available in another country. Banks have in general, it is alleged, but two sources of income -interest and exchange. State banks have the right to these sources of income by virtue of State authority, and the Federal Reserve Board has no right or power to deprive them of one of the sources. The Board has no rights not conferred upon it by act of Congress, and Congress has no power of jurisdiction over such Referendum No. 39 on the Report of the Committee on Par Remittance for Checks, Chamber of Commerce of the United States of America (Washing ton, D. C., Aug. 30, 1922 ), pp. 5, 7. Hereafter cited as Referendum No. 39. It is interesting and instructive to note that while the non -par banks have put forth the argument of expense as one of the chief justifications for mak ing remittance charges, they continued to fight the Federal reserve banks when the latter met that argument by presenting the checks at the counters of the drawee banks for payment without deduction. It becomes obvious that the non -par banks wish to exact tribute regardless of the soundness of any principle or the reality of the expense involved. They have even gone to the State legislatures and secured laws authorizing them to make payment, when such checks are presented over the counter , in drafts with the regular charge for remittance deducted from the face and forbidding notaries or others to protest checks for non - payment when such payment is refused. It is thus reasonable to conclude that the argument of expense so boldly urged by the non-par banks cannot be taken too seriously. These banks have placed them selves in the position of showing bad faith regarding the real merits of the controversy. That their sole purpose is to exact charges regardless of any justification is seen in the following statement made by one of their number: “ Even though the country perish, we must keep our collection charges.” See Hearings before the Committee on Banking and Currency, United States Senate, 63d Cong., 1st Sess., Vol. XV , pp . 192-196, 202, 206 ; Vol. XVI. pp. 1517, 1519, 1618 . 'It was pointed out in the hearings before the Senate Committee on Bank ing and Currency in 1913 that about 63 per cent of the national banks at that time operated with capital under $ 100,000 and over 2,000 with $ 25,000 capital, that a large part of their revenue was derived from exchange charges, and if deprived of the opportunity to make such charges they would not enter the Federal Reserve System . It was estimated that the profit from exchange charges in a southern bank with a capital of $ 75,000 was from 35 to 50 per cent. Heavier charges were made in the South than in the North and West. THE PAR COLLECTION CONTROVERSY 237 matters as relate to non-member State banks, a contention upheld by the Attorney-General of the United States. 2. The clearing function performed by a reserve bank for its member banks necessarily differs from the function of a clearing house organized by banks located in one community, by reason of the distance and time involved. In a clearing house the claims of the member banks are offset, each bank being credited with the checks it holds and debited with those drawn upon it, the debit and credit balances being paid or received at once. But the banks in the Federal reserve districts are not all in one place and the Federal reserve banks are not willing to undertake a system of in 8 stantaneous settlements. S At best the system is one of deferred clearance and, in fact, does not differ essentially from mere collec tion. There may be a question as to whether these activities amount to the function which the Federal Reserve Act contem plates. The Federal Reserve Board, according to the Act, may and does act as a clearing house for the Federal reserve banks through the Gold Settlement Fund. The law also says that each Federal reserve bank may be required by the Board to exercise the functions of a clearing house for its member banks, but the reserve banks are not really performing this function. Moreover, there may be a question as to whether the reserve banks are complying with the law requiring their acceptance at par of checks deposited by their member institutions when they defer the credit for a certain length of time.' With par clearance resulting from voluntary agreements among banks, the opposing banks have no quarrel, on the grounds that such banks are usually justified by circumstances and com pensated by benefits received. It is with enforced universal par clearance that they take issue, because of the fact that the Fed eral reserve banks will not give immediate credit for checks in process of collection if they are out-of-town checks. They insist that the Federal reserve banks should give immediate credit and absorb the float on items deposited with them , while they ( the non par banks ) absorb the float on items deposited with them as they do now and have always done. 10 This was practiced by the Federal reserve banks only during the period of the so -called voluntary system which prevailed from June, 1915 to July, 1916. ' Referendum No. 39, p. 7. 1 °It was estimated in 1916 that the float would probably equal or exceed the aggregate resources of the Federal reserve banks, that their reserves would be afloat constantly in the mails instead of in their vaults, and that their CLEARING AND COLLECTION OF CHECKS 238 3. Congress never intended that non-member banks should not charge exchange, and nothing in the Act gives the Federal Reserve Board authority to force State banks to remit at par. On the contrary, the Federal Reserve Act specifically recognizes exchange charges in the so-called Hardwick Amendment . Nothing in the Federal Reserve Act requires Federal reserve banks to re ceive and attempt to collect checks at par on the opposing banks. The Act clearly recognizes that the check may be presented through other banking channels which exist and that it is entirely proper for the drawee bank to withhold from its remittance such a charge as the law describes. Reserve banks, however, in many cases have ignored the fact that checks they receive are drawn upon banks which desire to assert their right to make remittance charges and, instead of returning such checks to depositing banks in order that they might be collected through other channels and the charges paid which are contemplated by law, have taken un usual and sometimes expensive courses in order to make collection without paying the drawee banks' charges. 4. Holders of checks have no unlimited right to present an accumulation of checks and demand payment in cash . The con ditions on which a bank holds the deposits of its customers and the conditions under which it is obligated to pay them out again are all contractual, for the most part the result of an implied contract, implied from the customs of trade, and in the absence of a specific contract to the contrary, this implied contract is that the deposit is to be received and is to be paid out on the order of the depositor in the regular course of business and according to the customs of banking. The obligation to observe these condi tions descends to all holders of checks. Custom is the contract, and where checks are presented in a manner contrary to custom, that is, in large quantities and for cash, it violates the contract between the bank and the drawer, and the bank should not be re quired to make payment in such a manner. The right to payment of checks in cash is a relative and not an absolute right. 5 . Acts lawful in themselves may be committed for unlawful and vicious purposes and are then unlawful . The methods em ployed by the Federal reserve banks to enforce par clearance, while " embarrassing, annoying and expensive" to the bank against which they are directed, may be legal in themselves when employed in the regular course of business for a usual and lawful purpose, value as reserve agents would be completely nullified . Pierre Jay, The Country Banker and the Federal Reserve System , 64th Cong., 1st Sess., Sen. Doc. No. 458, pp. 7-8. THE PAR COLLECTION CONTROVERSY 239 but are clearly illegal when used as oppressive and coercive measures . 6. Genuine par clearance does not exist in the Federal Re serve System. The rules of clearing houses even show that there are few par points on them and that most items are subject to deferred credit or straight-out collection charges. It is only on the theory that the remission for checks is a service to the drawer of a check, that the advocates of par clear ance can even attempt to justify it ; and this contention is not sound, since the act of remitting is done for the benefit of the holder of the check and at his request, which fact carries with it the obligation on the part of the holder to pay a reasonable compen sation for the service, which is a valuable service to him and which involves the bank in some expense. The advocates of remittance charges also reason that the telegraph companies charge for re mittance, the express company will not send funds for nothing, and the United States government makes the largest charge of all for its post office money orders.11 8. The country banker feels that he is an important element in the financial system of the nation, that he should not be legis lated out of business, and that the government should feel some obligation when making laws to so frame them as to give him equal service with the national banks of the country . There are approx imately 22,000 State banks as against approximately 8,000 na tional banks. The resources of the State banks exceed the re sources of the national banks, " and the country banker feels that no law affecting any banks of the country should be made which ignores the existence of the majority of the financial institutions of the country . » 12 9. Any intimation that because in many cases competition forces banks to omit their charges, all banks should remit at par, is not sound. No such principle is applied in any other field of business activity. If it is in the public interest that remittances should be made upon all checks at par, the public should pay the cost, either by direct appropriation from the public Treasury or by foregoing some of the earnings of the Federal reserve banks that now go into the United States Treasury.13 " Hearings before the Committee on Banking and Currency, United States . Senate, 63d Cong., 1st Sess., Vol. XVII , p. 2291 . " George H. Bell in Bulletin on Par Clearance, National and State Bankers' Protective Association ( Atlanta, Ga., Sept. 28, 1920 ) , p. 24. 1aThe non -par banks urge that if a charge were universally made for re mittance, the aggregate amount would not be as large as sometimes estimated, for several reasons. In the first place, almost half the total amount of checks. CLEARING AND COLLECTION OF CHECKS 240 10. Charges for remittance are not a toll levied upon commerce. They are compensation for a definite service, which is just as real, though different in degree, as compensation for the physical transportation of merchandise. Goods have to be ti ns ported at the buyer's cost from the place where they lie to the place the purchaser wishes them, and similarly, the seller who ac cepts payment in a credit at the buyer's bank should transfer it at his own cost to the place where he wants it. Arguments for par collection The important arguments for par collections may be sum marized as follows : 1. Par collection would tend to relieve trade generally, and individuals in particular, of the burden of paying for the use of credit which is a trade facility and a trade necessity. It is to the public's interest to reduce costs to the lowest levels and these costs should be borne by some central agency which would reduce them to the minimum. Under the Federal Reserve System the costs would fall upon the Federal reserve banks and reduce to that extent the earnings which go to the government . The cost in the end is borne by the public. 2. If some checks circulate at par, all should circulate at par. Banks have been in the habit of favoring large customers by collecting their checks at par. This discriminates against the smaller customer and places him in a position of even greater dis advantage as compared with his more powerful competitor.14 3. Checks, like bank notes, are a substitute for money and perform their function most perfectly when their circulation is as free as possible and their redemption is easily and promptly ac passing through the Federal reserve clearing system in 1920 and again in 1921 , represented checks drawn on banks in the same city as the main office of the reserve bank ; obviously, there would be no remittance charge on such checks. Something like twelve per cent. were drawn on banks in cities where the reserve bank had a branch , with which it was in telegraphic communica tion. Some billions of dollars in checks were drawn upon the United States Treasurer, and would under no circumstances be subject to charges. Only about one-third of the total, or $ 57,000,000,000 in 1920, were drawn on banks outside the cities of reserve banks and their branches. Referendum No. 39, p. 13 . **Various important associations have come out in favor of par remittance such as the National Association of Credit Men , certain manufacturers and jobbers associations, and the United States Chamber of Commerce. The latter conducted an investigation on the merits of the question in August , 1922, submitting the question to its members through a referendum known as Referendum No. 39. The vote of the members stood 1759. in favor of making par remittance in payment of checks universal throughout the United States, with but 72 } opposed . THE PAR COLLECTION CONTROVERSY 241 complished . Par remittance would benefit all those engaged in commerce by the elimination of the expense and unnecessary de lays which are due often to roundabout routing of checks.15 It would secure for business interests of the country a much prompter collection of checks than formerly , reducing the risk of loss through bad checks and the amount of credit that sellers of goods formerly had to extend involuntarily during the very sub stantial time required to collect checks. 4. Par collection under the Federal Reserve System accom plishes direct and speedy collection of checks, the reduction of the labor caused by handling checks many times oftener than necessary and eliminates false balances. 5. Although in their origin exchange charges were justified on account of the necessity for and the high cost of actually trans porting currency, under the Federal Reserve System such charges can be justified upon no scientific or economic principle. The cen tralization of reserves reduces to a minimum the actual shipment of cash and the payment of checks at places other than where the drawee banks are located involves little expense and that is borne by the Federal reserve banks.16 The movements of specie are fur ther reduced since the Federal Reserve System, through its leased wires connecting. all Federal reserve banks and branches, and through its Gold Settlement Fund at Washington, offers facili ties for the instantaneous transfer of available funds by mere book entry. The Federal Reserve System pays the entire cost of maintaining these leased wires and the Gold Settlement Fund, and the Federal reserve banks pay the cost of transporting currency from member and non-member banks in their districts if such banks wish to make remittances for their checks in this manner. Consequently the justification for exchange charges has ceased to exist. 6. Taking the country as a whole, checks and drafts offset one another to a large extent, and if a plan of general balancing can be developed , the result is to eliminate a large proportion of the cost of collection . As the number of banks which are members of the Federal reserve clearing system increases, the advantage and economy to those already included in the system will corre spondingly increase. 17 14See W. M. VanDeusen , “ The Clearing of Checks at Par," Proceedings of the Academy of Political Science, Vol. IV ( 1913-1914 ), pp. 184-186. 14Seventh Annual Report of the Federal Reserve Board ( 1920 ) , p. 67. 17H . P. Willis, The Federal Reserve ( New York , 1915 ) , p. 235 ; Seventh An nual Report of the Federal Reserve Board ( 1920 ) , pp. 67-68. CLEARING AND COLLECTION OF CHECKS 242 7. Many banks which decline to remit at par to the Federal reserve banks receive the benefits of the Federal reserve check clearing facilities by having the checks which they receive col lected through a correspondent bank which is a member of the Federal Reserve System, although they contribute nothing to the strength of the system. To the extent that the practice of charg ing exchange is continued under the operation of the Federal Re serve System, it is an anomaly to permit the charging banks to impose a charge upon commerce and industry after they have ceased to perform the service which in former times justified such a charge. For example, banks that will not remit at par throw a double burden upon the people of their community. In the first place, the expense of the Federal Reserve System is borne by the taxpayers and these communities bear their share. But their banks add to the burden and expense of the Federal Reserve Sys tem by not remitting at par, and that means an increased expense for these same people. Then, in the second place, they charge on their own checks and drafts, which is an additional expense to these communities. 8. Under a centralized clearing and collection system , like that which should obtain under the Federal Reserve System, banks would be called upon to do most of their remitting to a single center and this remittance would be made by means of a single draft in one letter. These remittances, which would be large in comparison with the usual amounts paid over the counter for the checks presented, would involve an effort and expense much less than that involved in paying a corresponding amount over the counter of the bank. Moreover, the actual expenses, like postage, stationery and cash shipments, are borne by the Federal Reserve System. Consequently the opposing banks have no real reason for making charges for remittance. 9 . If the non -member par banks would keep a deposit in the Federal reserve bank for clearing and collection purposes they could call home all the deposits scattered abroad for collection purposes, and the required centralized deposit for collection pur poses would be considerably smaller than the combined deposits scattered among other banks. To bring such funds home and to use them as a basis for building up loans at the prevailing rate of interest, would probably be as profitable, if not more profit able, than receiving 2 per cent . or 3 per cent . interest on the scat tered funds. In addition to this, the advertising value which comes to a bank as a result of being able to tell its customers, both present and prospective, that their checks will circulate at par THE PAR COLLECTION CONTROVERSY 243 anywhere must have in it an element of reality, if indeed it does not bring a marked increase in deposits and profits. 10 . Since such a large percentage of business , perhaps 90 per cent., is consummated by means of checks, there is all the more reason why checks as compared with bank notes should be made to circulate at par. It hardly seems logical to penalize about 90 per cent. of the business because of the use of checks, while the remaining 10 per cent . is not subjected to such a burden. The remainder of this chapter will show the relative validity of the arguments advanced by both the friends and the foes of par remittance. In the main, one is compelled to look to the court decisions for final judgment on the merits of the questions involved , but, in addition, there are certain theoretical and prac tical tests that also may be applied, not only to those questions not definitely settled in the courts, but to a less extent, to those that have been passed upon by the various courts. The growth of the par lists It will be recalled that the amendment of September 7, 1916, permitted the Federal reserve banks to receive from their member banks or from other Federal reserve banks checks drawn upon non-member banks.18 - The number of non-member banks which agreed to remit at par after this amendment increased but slowly. This was true also following the amendment of June 21 , 1917, in which non-member banks were given the privilege of becoming clearing members.19 Many reasoned as did the opposing member banks, that if they entered the system they would be obliged to assume additional burdens unless all non -member banks would enter. Many also refused to enter the system as clearing members because they were able to have their out-of-town checks credited at par by some city correspondent. The year 1918 saw banks avail themselves more and more of the clearing and collection facilities afforded by the Federal Re serve System. On December 15, 1918, the number of member banks was 8,612, and the number of non -inember banks on the par list was 10,409, a total of 19,021 , showing an increase for the twelve months of 1,985 in the number of banks remitting at par. There were something over 10,000 banks which were not remitting at par.20 18 See p. 196 above. " See p. 197 above. *Fifth Annual Report of the Federal Reserve Board ( 1918 ) , pp. 74-75. 244 CLEARING AND COLLECTION OF CHECKS Although checks on two-thirds of the banks, representing perhaps 90 per cent. of the bank resources of the country, could be collected at par, the number of banks which would not remit at par, including some of substantial size located in important cities, was sufficiently large to make many banks hesitate to use the Federal reserve collection system because of the large number of items which could not be handled by the Federal reserve banks. At a meeting of the Federal reserve agents in December, 1918, the conclusion was reached that every effort should be made to increase the number of banks on the par list, on the grounds that the banks and the public needed a system able to collect all items, and that it was not a local or selfish undertaking for the benefit of member banks but a national enterprise for the convenience of the public and the promotion of commerce. Continuous effort was to be made through correspondence and personal solicitation to add to the number of banks on the par list. The year 1919 witnessed rapid progress in the development of the clearing and collection system. Of the 29,586 banks and bankers in the country at the close of the year 1919, 25,571 were on the par list. Checks drawn on all banks and bankers situated in 31 States were collectible at par, as compared with 17 States a year previous. All banks in six Federal reserve districts were on the par list, which meant that items drawn on over 86 per cent . of the total number of banks and bankers throughout the country could be received for collection and credit by the Federal reserve banks. During that year 6,581 banks were added to the par list,, leaving only 4,015 , or 14 per cent. of the whole, whose checks could not be collected at par.21 Despite the increase of banks on the par list during 1919, pro nounced opposition began to manifest itself, especially in districts 6, 9, and 10.22 Prior to this time it had been the general policy of the Federal reserve banks to decline to receive from member banks, for credit or for collection, checks drawn upon non-member banks which had not agreed to remit for them at par. But many non member banks continued to avail themselves of the facilities of the system to collect their own items without expense through some correspondent bank, without showing any inclination to render a like service or give up exchange charges as a source of profit. Persistent efforts to induce these parasitical non -member banks to become clearing members resulted in little success. In 1919 * Sixth Annual Report of the Federal Reserve Board ( 1919 ) , p. 374. -32Atlanta , Minneapolis, and Kansas City. THE PAR COLLECTION CONTROVERSY 245 more active steps were taken ; the mere attempt to persuade was superseded by more effective measures. With the approval of the Federal Reserve Board, several of the Federal reserve banks early in 1919 undertook to collect at par on all banks in their respective districts. The Federal Re serve Bank of Boston had been collecting at par on all banks in its district for more than three years, and other Federal reserve banks felt that in justice to their member banks and to the pub lic no further discrimination should be made. Recourse was had in many cases to means of collection other than through banks, but, to use the words of the Federal Reserve Board, “ as a rule such steps were not necessary for any length of time," and of 29,561 banks in the country, 25,565 were remitting on December 31 to the Federal reserve banks at par, while 3,996 still declined to do so.23 These extraordinary means of collection resorted to by the Federal reserve banks, with the approval of the Federal Reserve Board, created a storm of protest and an organized op . position among these independent banks which resulted, among other things, in court proceedings. The nature of the par lists was now changed. Prior to this time the par lists included only the names of those banks which had agreed to remit at par ; now the par lists included not only those banks which had agreed to remit at par but also those on which the Federal reserve banks had decided to collect at par by direct presentation over the counter through some agent. Many banks thus had their names placed upon the par lists of the Fed eral reserve banks without their consent, and much to their indig nation, as it would give the impression that they had given their sanction to the system. It became the practice of the Federal reserve banks to add entire States or districts to the par lists. when a sufficient number of banks had agreed to remit at par tu make it possible to collect directly from the few who would not agree to remit at par without involving too much expense. In August, 1919, a special map of the United States was published and circulated, showing the progress of the campaign for par points. Several of these maps were issued from time to time, and on September 1 , 1919, the Federal Reserve Board began the regu lar publication of maps, one map appearing in each issue of the Federal Reserve Bulletin . This practice on the part of the Fed eral reserve banks contributed to the animosity of the exchange charging banks toward the Federal reserve banks. These maps *Sixth Annual Report of the Federal Reserve Board ( 1919 ) , pp. 40-44 . CLEARING AND COLLECTION OF CHECKS 246 were widely circulated by the Federal reserve banks, particularly in those districts in which the campaign for par collections was being actively carried on, that is to say, in the districts in which there were one or more States that were not all-par.24 The increased opposition to par collection Despite the opposition, the Federal Reserve Board announced in 1919 its intention to continue its efforts to establish a universal par remittance system until all banks were on the par list, and in answer to the protests of the opposing banks, made a formal reply defining its attitude on the question.25 It based its contention on the grounds, ( 1 ) that the Federal reserve banks have the right to receive on deposit from any of their member banks any checks or drafts upon whomsoever drawn, provided they are payable upon presentation, ( 2 ) that the whole purpose of the Act demands that in justice to member banks they should exercise that right, (3 ) that the Federal reserve banks, according to the opinion of the Attorney-General, cannot legally pay any fee to any member or non-member bank for collection and remittance, ( 4) if the Fed eral reserve banks are to give the service required of them under the provisions of Section 13 they must use some other means of collection, no matter how expensive, in cases where banks refuse to remit for their checks at par, and ( 5 ) it is the Board's duty to see that the law is administered fairly and without discrimination and that it applies to all sections alike, and the Board, therefore, should take any and all steps necessary to carry out the intent of the law as construed by the highest legal authority of the ad ministrative branch of the government.26 During the year 1920, eleven States were added to the number of States in which all banks were on the par lists of the Federal reserve banks. On January 1 , 1921 , checks on all but 1,755 of the 30,523 banks in the United States could be collected at par, as compared with 3,996 out of 29,557 on January 1 , 1920. These 1,755 banks were all located in the following seven States of the Southeast : Tennessee, South Carolina, Louisiana, Mississippi, Alabama, Georgia, and Florida . Consequently every bank in nine of the twelve Federal reserve districts was on the par lists, the three districts in which there remained any non - par banks were 2*TheDevelopment of Par Collections by Federal Reserve Banks, Letter No. 6, Federal Reserve Bank of Richmond (May, 1922 ) , p. 3. Hereafter cited as Letter No. 6. 25Sixth Annual Report of the Federal Reserve Board ( 1919 ) , pp. 40–44. 20Ibid . THE PAR COLLECTION CONTROVERSY 247 Richmond ( No. 5 ) , Atlanta ( No. 6 ) , and St. Louis (No. 8 ) . But this development in the check clearing and collection system was accomplished in the face of continuous opposition on the part of some member and non-member banks. While fewer banks were participating in the opposition, they were well organized and the opposition was none the less vigorous. But little or no systematic and concentrated action in opposition appeared until the latter part of 1920.27 Beginning with the year 1921 , however, the numbers of the opposing non-member banks began to increase rather than de crease. They became better organized and their resistance more effective. The following table will show the situation for the years 1916 to 1924 :28 TABLE XXV GROWTH OF MEMBERSHIP IN THE FEDERAL RESERVE CLEAR ING AND COLLECTION SYSTEM Non -member banks not Number of member banks Non Date in the member banks on 1916 system the par list Aug. 15 Sept. 15 7,524 Oct. 15 Nov. 15 Dec. 15 1917 Jan. 15 Feb. 15 Mar. 15 7,618 7,618 7,623 7,627 7,622 7,630 7,630 7,625 7,651 8,666 8,789 7,683 7,718 7,747 8,837 Aug. 15 Sept. 15 Oct. 15 Nov. 15 Dec. 15 19189 Jan. 15 Feb. 15 Mar. 15 Apr. 15 May 15 7,826 7,823 7,909 7,972 8,013 8,059 than mutual 8,805 8,934 9,052 9,210 9,321 9,268 9,319 9,425 9,450 8,113 9,475 9,710 July 15 8,165 8,212 Aug. 15 8,294 Sept. 15 8,428 10,206 10,549 June 15 savings banks ) 8,130 8,086 8,007 8,607 8,926 June 15 July 15 banks other 7,032 7,449 7,459 8,059 8,065 Apr. 15 May 15 7,634 on the par list (incorporated 11,336 9,761 *Seventh Annual Report of the Federal Reserve Board ( 1920 ) , pp. 63-69. 2*For an additional discussion of this subject, see Charles S. Tippetts, "State Bank Withdrawals from the Federal Reserve System ,” The American Economic Review , Vol. XIII , No. 3 ( September, 1923 ) , pp . 401-410 . CLEARING AND COLLECTION OF CHECKS 248 TABLE XXV— (Continued ) Non -member Number of Date 1918 Oct. 15 member banks in the system 8,510 Nov. 15 8,584 Dec. 15 1919 Jan. 15 Feb. 15 Mar. 15 8,612 Apr. 15 May 15 June 15 July 15 Aug. 15 . Sept. 15 Oct. 15 Nov. 15 Dec. 15 1920 Jan. 15 Feb. 15 Mar. 15 Apr. 15 May 15 June 15 July 15 Aug. 15 Sept. 15 Oct. 15 Nov. 15 Dec. 15 1921 Jan. 15 Feb. 15 Mar. 15 8,692 8,717 8,7298 8,765 8,788 8,820 8,848 8,894 8,920 8,955 9,008 9,055 9,089 9,140 9,196 9,246 9,303 9,366 9,421 9,472 9,506 9,544 9,574 9,612 9,637 9,668 9,696 Non member banks not on the par list (incorporated banks other banks on than mutual the par list 10,318 savings banks ) 10,219 10,409 10,392 10,595 10,622 10,885 11,060 11,261 9,923 9,726 11,801 12,071 12,578 12,962 13,852 14,860 15,851 16,987 17,429 18,308 18,492 18,502 18,614 18,605 18,605 18,620 18,675 19,188 19,172 19,101 19,023 18,804 Apr. 15 9,726 May 15 9,747 June 15 July 15 9,775 9,769 Aug. 15 Sept. 15 9,791 9,794 Oct. 15 Nov. 15 Dec. 15 9,803 9,805 18,599 18,551 18,504 18,388 18,319 9,827 18,217 9,847 18,066 9,853 18,053 9,873 9,904 9,909 9,925 9,930 17,976 17,943 17,918 17,889 18,792 18,781 18,716 10,198 9,543 9,003 8,762 8,309 8,167 7,621 7,178 6,457 5,515 4,609 3,566 3,148 2,274 2,157 2,180 2,119 2,136 2,138 2,160 2,180 1,727 1,732 1,705 1,744 1,893 1,932 1,837 1,965 2,040 2,078 2,121 2,200 2,218 2,263 1922 Jan. 15 Feb. 15 Mar. 31 Apr. 30 May 31 June 30 July 31 Aug. 31 Sept. 30 Oct. 31 Nov. 30 Dec. 31 9,919 9,917 9,918 9,916 9,913 17,884 17,865 17,863 17,851 17,836 17,822 2,350 2,327 2,301 2,293 2,279 2,275 2,285 2,281 2,276 2,281 2,286 2,288 THE PAR COLLECTION CONTROVERSY 249 TABLE XXV— (Continued ) Non -member banks not Date 1923 Jan. 31 Feb. 28 Mar. 31 Number of member banks in the system Non member than mutual the par list savings banks ) 9,911 17,777 17,724 17,692 17,663 17,643 July 31 Aug. 31 Sept. 30 9,916 17,565 Oct. 31 Nov. 30 Dec. 31 9,898 June 30 banks other banks on 9,917 9,922 9,923 9,927 9,933 Apr. 30 May 31 on the par list ( incorporated 9,905 9,906 9,869 9,896 2,289 2,282 2,285 2,280 17,255 17,114 16,919 16,725 2,279 2,310 2,324 2,489 2,580 2,672 2,791 2,896 16,484 16,337 16,246 16,119 15,981 3,013 3,084 3,142 3,185 3,240 • 17,589 17,381 1924 Jan. 31 Feb. 29 Mar. 31 Apr. 30 May 31 9,875 9,857 9,819 9,806 9,785 Complied from the Federal Reserve Bulletins. *The data for the year 1918 as compiled from the Federal Reserve Bulle tins differ from data given in the Fifth Annual Report of the Federal Re serve Board ( 1918 ) , p . 206 . *Given in Federal Reserve Bulletin, Vol. V (1919 ), p. 405, as 8,782 and 10,905 respectively. The above data were given on p. 511 of the same bulletin. There are so many variations similar to those indicated that no further effort will be made to point them ouf. The writer, in many cases, was compelled to choose arbitrarily ; in some instances he was able to choose those figures that appeared most frequently. 'With these data for May which are reported in the Federal Reserve Bulletin for July, 1924, the Federal Reserve Board discontinued further monthly re ports on the membership . Common and concrete forms of opposition The opposition on the part of these opposing State banks has manifested itself in various ways, the chief of which are, ( 1 ) dila tory practices in tendering payments, ( 2 ) stamping legends on their blank checks, ( 3 ) organization of the National and State Bankers' Protective Association , ( 4 ) State legislation hostile to the par collection system, ( 5 ) petitions to Congress for hearings and amendatory legislation, and ( 6 ) injunctions and suits in the courts . Obstructive and dilatory tactics in tendering payments have seriously embarrassed the Federal reserve banks at times. Since Federal reserve banks cannot pay exchange charges, they have no choice, if they are to collect the checks drawn on these non-member 250 CLEARING AND COLLECTION OF CHECKS banks which refuse to remit at par, but to make presentation of such checks at the counters through selected agents. These agents may be employees of the Federal reserve banks or may be banks, express companies, or any other suitable agents located in the town of the drawee bank. The employees and agents of the Federal reserve banks have encountered various obstacles in mak ing presentation of checks, such as tender of payment in a man ner calculated to take as much time as possible, the refusal of payment in reliance on the inability of the agent to find a notary public willing to make protest, or by offering in payment drafts rather than legal tender. Payments were sometimes made in silver and other coins which would be difficult to transport, some times bills were wadded and mixed up with other currency. Such tactics made it difficult at times for the Federal reserve banks to secure agents willing to act for them . In one instance the Amer ican Express Company refused to act as agent, after serving for a short time, because of the trouble involved in making collections. In another instance an agent, within a few days after his appoint ment, gave notice to the Federal reserve bank that he would no longer act as agent for fear of injury to his business. Local agents were reluctant to incur the disapproval of their own com munity in attempting to act for the Federal reserve bank against their local bank . Some opposing banks, including some member banks, resorted to the device of stamping legends on their blank checks to the effect that the check was not valid if presentation were made through the Federal reserve banks. At one time in 1920 over three hundred banks were indulging in this practice in the ninth district.29 Another legend read , " Payable in cash or exchange draft at the option of...................Bank of..... » In cases like the latter , the Federal reserve bank involved frequently would refuse to accept such checks and would return them to the banks from which they came and add to the discomfort of the opposing bank by writing to the payees of the checks stating that it could not accept them , since such checks, by reason of the indorsement , were non - negotiable and as a medium of payment the usefulness of such checks was impaired.30 In 1920 the opposing banks organized the National and 2 Report of General Secretary, a pamphlet published by the National and State Bankers' Protective Association (Atlanta, Ga., 1920 ). 30Federal Reserve Bulletin , Vol. VIII ( 1922 ) , p. 1411 . THE PAR COLLECTION CONTROVERSY 251 State Bankers' Protective Association31 in order to secure con certed action in carrying on the fight against the enforced par remittance system . The first steps were taken towards its organ ization by calling a conference of the affected banks in the sixth district to meet in New Orleans in February, 1920. The invita tion was later extended to include the interested banks in other districts . Delegates from eight of the twelve districts were pres ent. Out of this New Orleans meeting grew the National and State Bankers' Protective Association, permanent organization being effected at a conference in Washington, D. C., in May, 1920. The objects of the association have been endorsed by the Bankers' Associations of a number of States at their annual conventions, including Alabama, Arkansas, Florida, Georgia, Idaho, Louisiana, Minnesota, Mississippi, South Carolina, Texas, Wisconsin and others, and by the National Association of State Bank Super visors in their annual conference at Seattle, Washington, in July, 1920.32 It was maintained by this association that most of the banks objected to par remittance, but were forced into the system by the Federal reserve banks because of the absence of organized re sistance. The association with headquarters and staff at Atlanta, planned to extend its organization to each State and endeavored to have the State legislatures pass laws protecting the State banks in the right to charge exchange and against the coercive methods of the Federal reserve banks. It planned to carry the fight to Congress, and to persuade members of the association to bring the matter to the attention of their Congressmen and Senators. The association has been effective in its methods, in organizing the op position and in carrying the fight into the State legislatures, Congress and the courts . In 1920 the legislatures of various States, chiefly in the South, began to legislate in favor of the exchange-charging State banks. Mississippi passed a law, approved March 6, 1920, with the ex " This organization is virtually an offshoot from the American Bankers' Association representing to a large extent the country bankers, and in their opinion, threatening to split the American Bankers' Association into two fac tions . In 1920 they claimed a membership of 15,000 of the 21,000 in the Ameri can Bankers' Association . A Committee of Five in the American Bankers' Association , appointed under resolutions adopted in Kansas City in 1916 to secure the so -called rights of banks to make exchange charges, was continued by the Association in October, 1921. The State Bank Section of the Associa tion adopted strong resolutions against the position of the Federal Reserve Board on this question and appointed a Committee of Seven to work in favor of exchange charges and to place the matter before Congress. 32Bulletin on Par Clearance, the National and State Bankers' Protective As sociation ( Atlanta, Ga., September 28, 1920 ) , passim . 252 CLEARING AND COLLECTION OF CHECKS press purpose of preventing the Federal reserve banks from col lecting at par, checks drawn on the banks located in that State 33 Seven other States followed rapidly in the order mentioned : Louisiana ,34 South Dakota, 35 Georgia 36 ,36 Alabama,37 North Carolina,38, Tennessee ,39 and Florida.40 The Mississippi law, which is an excellent sample of these laws, reads in part as follows : “ For the purpose of providing for the solvency, protection and safety, of the banking institutions of Mississippi, the established custom on the part of the banks of this State to charge a service fee ( commonly called 'exchange' ) for collecting and remitting, by exchange or otherwise, the proceeds of checks, drafts, bills, etc. ( commonly known among banks as 'cash items' ) , is hereby de clared to be the law of this State, and the banks of this State, both State and national, shall continue to make such charge as fixed by custom when such 'cash items' are presented to the payer bank for payment through or by any bank, banker, trust com pany, Federal reserve bank, post office, express company, or any collection agency, or by any other agency whatsoever ; and the amount of such charge is hereby fixed at one-tenth of one per centum of the total amount of such 'cash items' so presented and paid at any one time, and not less than ten cents on any one such transaction .. . " 41 This law provides further that banks are not to charge for checks or drafts drawn to settle obligations with the United States government or the government of the State of Mississippi, or for checks on banks in the same city or town. It is optional with banks whether they charge exchange on checks or drafts payable to a person within that State, and drawn on a bank, trust company or person within or without that State. No officer of the State is permitted to protest for non -payment any such “ cash items” when such non-payment is solely on account of 33 *Mississippi Laws, 1920, Chap. 183. Effective March 6, 1920. * Acts of the State of Louisiana, 1920, No. 23. Approved and effective June 25, 1920. 38 3 Laws of South Dakota, 1920, Chap. 31. Approved and effective July 3, 1920. 30Georgia Laws, 1920 , Part I, Title VI, p. 107. Approved and effective August 14, 1920. 87 General and Local Laws of Alabama, 1920, No. 35. Approved Septem ber 30, 1920, effective thirty days later. 28Public Laws of North Carolina, 1921, Chap. 20, Sec. 2. effective February 5, 1921 . Ratified and ** Public Acts of Tennessee, 1921, Chap. 37. Passed and effective March 17, 1921 . **Laws of Florida , 1921 , Chap. 8532. Approved and effective April 29, 1921 , « Mississippi Laws, 1920, Chap. 183. Effective March 6, 1920. THE PAR COLLECTION CONTROVERSY 253 the failure or refusal of any of the banks to pay exchange, nor is there any right of action against any bank in the State for refusal to pay such “ cash items,” when the refusal is based on the ground of the non-payment of such exchange. The Act finally provides that should any court hold that the national banks in the State are not required to charge and collect exchange, the Act is to remain in force as to all the other banks in the State, and in case of such a decision by the courts or the re fusal of any national bank in the State to comply with the Act, then it is to be optional with State banks located in the same mu nicipality with a national bank or State bank which are members of the Federal Reserve System as to whether the charge should be made. The title of the Tennessee Act reads as follows : “ An Act to prevent the Federal Reserve System from forcing the banks of this State into what is known as the passing [ sic ; should read parring) of checks, drafts, bills, etc. ( commonly known as 'cash items' ) and for that purpose making it optional on the banks of this State to charge exchange on such 'cash items' and fixing the rate of exchange." 42 The Louisiana law differs sufficiently from the others to require brief mention. The law in that State pro vides that any bank has the option to claim three days' grace in which to pay in cash or by a draft on correspondent, and presen tation of more than three drafts or bills of exchange over five days after their receipt by the bank presenting them shall constitute prima facie proof that the checks have been withheld from presen tation in order to injure the drawee bank.43 Relative to making exchange charges, the laws of Mississippi and Florida are mandatory. The wording of the Alabama law is both mandatory and optional ; it provides that a bank shall charge exchange, but may remit in money or exchange drawn on reserve agents on which it may charge exchange, provided the minimum may be ten cents.44 The laws of Tennessee, South Dakota, Georgia and North Carolina are optional. The following States have included provisions in their laws prohibiting any officer from protesting any check for non-payment, when such non -payment is on account of the refusal of any bank to pay exchange : Florida, " Tennessee, South Dakota , Mississippi, Alabama and North Caro lina ; Louisiana and Georgia have no such provisions. Tennessee Public Acts of Tennessee, 1921, Chap. 37. * Acts of the State of Louisiana , 1920, No. 23. "General and Local Laws of Alabama, 1920, No. 35. Italics are the author's. 254 CLEARING AND COLLECTION OF CHECKS and North Carolina have included provisions also which prohibit legal action against any officer for refusal to protest such items ; South Dakota and Mississippi prohibit legal action against the bank ; the remaining States have neither provision. The Federal Reserve Board took the position that these laws were clearly unconstitutional in so far as they purported to re quire national banks and State banks which had joined the Fed eral Reserve System to make exchange charges against Federal reserve banks, and the Board, therefore, continued to collect on of the banks in these States in the usual manner. Prior to the enactment of the South Dakota and Louisiana laws all banks many in South Dakota, and in that part of Louisiana which is located in the eleventh Federal reserve district (Dallas ) , had been placed upon the Federal reserve bank par lists, and the Federal Reserve Banks of Minneapolis and Dallas, after the enactment of those laws continued to receive for collection at par all checks drawn > on those banks .45 In 1920 petitions and protests were sent to the Federal Re serve Board and to Congress by organizations representing the opposing banks. In February of that year charges were made by State bankers of Nebraska that employees of the Omaha branch of the Federal Reserve Bank of Kansas City had used op pressive methods in the presentation of checks on non -member banks. The Federal Reserve Board held hearings to inquire into these alleged acts and methods with the result that the Federal reserve bank officials and employees involved denied, under oath, the charges in every particular. The hearings were attended by a delegation of Congressmen from Nebraska, and the State bankers making the charges, as well as their witnesses, were also invited to be present. For the convenience of the latter the Board offered to have a committee of its members hold a hearing in Nebraska. No witnesses on behalf of the State bankers were produced, how ever, and the only evidence submitted in support of the charges consisted of a series of affidavits. In the Board's opinion, there was no instance in which any specific charge of improper conduct on the part of an employee of the Omaha branch was substan tiated. In May, 1920, the Congressional Committee on Rules gave a hearing to representatives of the National and State Bankers' Protective Association. This committee had before it the King Resolution No. 476 calling for an investigation of the administration of the Federal Reserve Act. . It embodied practi * Seventh Annual Report of the Federal Reserve Board ( 1920) , pp. 65-66. THE PAR COLLECTION CONTROVERSY 255 cally the resolutions adopted by the National and State Bankers' Protective Association at New Orleans on February 6, 1920. At the same time the House Committee on Banking and Currency gave a hearing to representatives of the association. This com mittee had before it at this time House Bill No. 12,646, known as the McFadden Bill, and House Bill No. 12,376, the Steagall Bill, both bills having for their purpose the amendment of the Federal Reserve Act so as to give both member and non-member banks the right to charge exchange on remittances, not to exceed 10 cents on $100. Both of these bills were supported by the National and State Bankers' Protective Association. The contentions of the country banks were forcibly impressed upon the Congressional Committees as well as upon the Federal Reserve Board. Governor Harding of the Federal Reserve Board promised the neutrality of the Board in the fight before Congress for an amendment to the Act and freely admitted that par collection was not a neces sary function of the system. In view of all the circumstances, the Board decided to lay the facts before Congress for such action as it might care to take. Accordingly, the Board addressed a letter in May, 1920, to Edmund Platt, Chairman of the House Committee on Banking and Currency, calling attention to the opposition to par collec tion and to the obstacles which the Federal reserve banks were encountering, and suggested that after a hearing the committee adopt one of two definite courses : " ( 1 ) that it report a bill authorizing both member and non-member banks to make charges against the Federal reserve bank as well as against each other for remitting for checks, not to exceed ten cents per one hundred dollars, with the provision that the Federal reserve banks be authorized to charge to sending banks any exchange charges paid in collecting checks for them, or ( 2 ) that it report a bill clearly and definitely establishing the universality of the par remittance system by imposing such conditions or penalties as will insure compliance with the law by all banks of deposit, non -member State banks and private bankers as well as member banks. " 46 Congress, however, did nothing in this matter. This inac tivity, combined with the fact that the United States Circuit Court of Appeals, in reviewing the case of the American Bant: and Trust Company et al. v. Federal Reserve Bank of Atlanta et * Extract from a letter of Governor W. P. G. Harding to Hon . Edmund Platt, Chairman , Committee on Banking and Currency, House of Representa tives, in Bulletin on Par Clearance, p . 14. 256 CLEARING AND COLLECTION OF CHECKS al.,47 supported the Board in its position, caused it to go forward with its announced policy of attempting to establish universal par collection. From this time on, the opposition manifested itself largely in litigation which will now be reviewed . The Atlanta par collection case The legal battle was started in the sixth district on December 23, 1919, by the Governor of the Federal Reserve Bank of At lanta mailing a letter to each of the non-member banks of the district, saying the time had come to put universal par remittance into effect in the district and inviting the banks to agree to the procedure. Among other things, the letter stated that " while, as stated, the Federal Reserve Act does not permit us to pay ex change for the remittance of bank checks and drafts payable upon presentation, we can incur any cost that is necessary in order to carry out the purpose of the Act, and we would very much regret to be forced to adopt methods of collection that would prove " embarrassing, annoying and expensive to you ." 48 The Georgia banks affected by the proposed action banded together in their own defense through the medium of the Country Bankers' Association of Georgia, raised a fund, employed coun sel, and filed a petition to enjoin the officials of the Federal Reserve Bank of Atlanta from carrying the above threat into effect. The grounds on which the opposing banks sought an injunction against the Federal Reserve Bank of Atlanta were set forth at great length in a petition presented to the Superior Court of Fulton County, Georgia, in January, 1920, by counsel for the petitioning banks and may be summarized briefly as follows :49 ( 1 ) That the purpose of the Federal reserve bank was to collect checks in large numbers drawn on them and present them over the counter for payment rather than through the customary channels of correspondent banks or clearing houses and that this course was intended to coerce State banks into becoming members of the Federal Reserve System, ( 2 ) that the action of the Federal reserve bank was ultra vires, and ( 3 ) that they were depriving the petitioning banks and others in like position of the customary $ 7280 Fed . 940 ( 1922 ) . * Bulletin on Par Clearance, p. 2. “ From a pamphlet entitled The American Bank and Trust Company et al. 08. The Federal Reserve Bank of Atianta et al., No. 44,323, Superior Court of Fulton County , Georgia (1920 ), distributed by the Georgia Country Bankers' Association. This pamphlet does not include the case as its title might sug gest ; nor is this case reported officially. See also the Federal Reserve Bulle tin, Vol. VI ( 1920 ), p . 196 . THE PAR COLLECTION CONTROVERSY 257 compensation for collection and remittance when checks reached them under the present method of doing business. Their prin cipal prayer was to restrain the defendants from the adoption of any method of collecting checks drawn against the petitioners except through the usual and ordinary channel of collecting checks through correspondent banks or clearing houses. On January 15, 1920, Judge W. D. Ellis in the Fulton County Superior Court issued a temporary order restraining the Federal reserve bank from employing and putting into effect any method of collecting checks drawn against the opposing non-member banks " that would prove embarrassing, annoying or expensive to such banks ; and from collecting such checks in any manner except in the usual and orderly way now employed among corresponding banks and clearing houses ; and from interfering with any such bank in charging, collecting or retaining the usual customary rate of exchange charges now in effect between corresponding banks and clearing houses. " 50 This temporary restraining order held matters in status quo pending a hearing on the merits of the case. The Federal reserve bank filed an application to remove the case to the United States District Court for the Northern District of Georgia , on the ground that the Federal Reserve Bank of Atlanta was a Federal corporation and that the plaintiffs cause of action arose under the Constitution and laws of the United States. The application was granted and the State banks of Georgia then moved to have the case remanded to the State court while the Federal reserve bank moved to have the case dismissed. On April 5, 1920, United States District Judge Beverly D. Evans dismissed the case on its merits in favor of the Federal Reserve Bank of Atlanta . He held that Federal reserve banks are not national banking associations within the scope and meaning of the Acts of Congress of July 12, 1882, August 13, 1888, and the Judicial Code, Section 11 , which place national banking asso ciations, for the purpose of action by and against them , upon the footing of other citizens, which means that they can sue and be sued in State courts ; they are Federal corporations and come under the jurisdiction of the Federal courts. After establishing the jurisdiction of the United States District Court, Judge Evans ruled, in brief, “ that this method of collection of checks will deprive the drawee banks of the revenue previously enjoyed where checks * Par Points , a pamphlet, National and State Bankers' Protective Associa tion ( Atlanta, 1920) , pp. 5-6. 258 CLEARING AND COLLECTION OF CHECKS on them came through the mails from correspondent banks, but does not make the transaction unlawful. It is the duty of the drawee bank to pay a check of the drawer, if it holds sufficient funds of the drawer to pay it. It is no less the duty of the drawee bank to pay several checks than it is to pay a single check, when presented over the counter within banking hours. The policy of the Reserve Bank of Atlanta, as outlined in the petition, is neither ultra vires nor unlawful. It is not to be presumed that the agency employed by the Federal reserve bank will act otherwise than may be lawful and proper in the presentation of the checks for payment. The allegations of conspiracy are lacking in essential features to charge an actionable wrong."51 On appeal, the United States Circuit Court of Appeals for the Fifth Circuit, in an opinion filed November 19, 1920, upheld the District Court.52 The Circuit Court held that Federal reserve banks have the right to collect checks, drawn on non -member banks which refuse to remit at par, by having such checks pre sented at the counters of the drawee banks, and that the case was one in which the United States District Court had jurisdiction. In these lower courts the defendant Federal reserve bank inerely demurred to the bill of the plaintiff and no evidence was taken either to establish or to disprove the allegation that the Federal Reserve Bank of Atlanta proposed to use embarrassing and op pressive methods in forcing non-member banks to remit at par, although, as pointed out elsewhere, representations had been made to the Federal Reserve Board and to committees of Congress that improper methods had been and were being used by the Federal reserve banks, particularly in the West and Northwest . The case then was appealed to the United States Supreme Court and a decision was rendered May 16, 1921 , Mr. Justice Holmes delivering the opinion of the Court.53 The plaintiffs had filed a motion to remand the case to the State court, and the de fendants moved to dismiss the complaint for lack of equity. This latter motion was in the nature of a demurrer and the issue before the Supreme Court upon this motion was merely whether, as a matter of pleading, the plaintiffs' bill of complaint stated a cause "See Federal Reserve Bulletin, Vol. VI ( 1920 ) , pp. 496-497. Case not re ported. 62 American Bank and Trust Co. et al. v. Federal Reserve Bank of Atlanta, Ga. , et al., 269 Fed . 4 ( 1920 ) . The opinion is given also in the Seventh An nual Report of the Federal Reserve Board ( 1920 ), pp. 330-334, and the Federal Reserve Bulletin , Vol. VI ( 1920 ), p. 1303 ff. 53American Bank and Trust Company et al. v. Federal Reserve Bank of Atlanta , Georgia, et al., 256 U. S. 350 ( 1921 ). THE PAR COLLECTION CONTROVERSY for action. 259 The Supreme Court held, purely as a matter of pleading, that the allegations of the complaint stated a cause for action and, if sustained by the evidence, would entitle the plain tiffs to the injunction sought. The Court said , “ On the merits we are of opinion that the courts below went too far. The question at this stage is not what the plaintiffs may be able to prove, or what may be the reasonable interpretation of the defend ants' acts, but whether the plaintiffs have shown a ground for re lief if they can prove what they allege. We lay on one side as not necessary to our decision the question of the defendants' powers, and assuming that they act within them consider only whether the use that according to the bill they intend to make of them will 54 infringe the plaintiffs' rights.' The Court further stated certain principles which had an omi nous sound and which proved to be indicative of what the Court would do once a case reached it on its merits and it was demon strated that the Federal reserve banks were using oppressive methods in collecting on non-par banks. It said : " If without a word of falsehood but acting from what we have called disinter ested malevolence a man by persuasion should organize and carry into effect a run upon a bank and ruin it, we cannot doubt that an action would lie. A similar result even if less complete in its effect is to be expected from the course that the defendants are alleged to intend, and to determine whether they are authorized to follow that course it is not enough to refer to the general right of a holder of checks to present them but it is necessary to consider whether the collection of checks and presenting them in a body for the purpose of breaking down the petitioner's business as now conducted is justified by the ulterior purpose in view. “... The policy of the Federal reserve banks is governed by the policy of the United States with regard to them and to these relatively feeble competitors. We do not need aid from the debates upon the statute under which the reserve banks exist to assume that the United States did not intend by that statute to sanction this sort of warfare upon legitimate creations of the States . ” 55 The Supreme Court, therefore, remanded the case to the District Court of the United States for the Northern District of Georgia for trial upon its merits. This decision, in addition to those of the District and Circuit courts mentioned above, estab ** Loc. cit . , p. 357. * Ibid ., pp. 358-359 . See also comments of C. T. Murchison, “ Par Clear ance of Checks ,” The North Carolina Law Review , Vol. I , No. 3 ( January .. 1923 ) , pp. 146-147 . 260 CLEARING AND COLLECTION OF CHECKS lished the jurisdiction of the Federal courts over any suit brought by or against any Federal reserve bank, provided it involved the necessary jurisdictional amount of money, namely, $ 3,000.56 In the District court Judge Beverly D. Evans, on March 11, 1922, decided that a Federal reserve bank may employ any proper means or agency to collect at par checks drawn on non par banks. The opinion may be summarized briefly as follows :57 Under the Federal Reserve Act the Federal reserve banks are em powered to accept any and all checks payable on presentation, when deposited with them for collection, and checks thus received must be collected at par, since the Federal reserve banks are not permitted to accept in payment of checks deposited with them for collection an amount less than the full face value of the checks. In the discharge of its duties with respect to the collection of checks deposited with them , and with respect to performing the functions of a clearing house, the several Federal reserve banks are empowered to adopt any reasonable measure designed to accomplish these purposes. To that end a Federal reserve bank may send checks to the drawee bank directly, for remittance through the mails, without cost of exchange. If the drawee bank refuses to remit without deduction of the cost of exchange, it is in the power of the several Federal reserve banks to employ any proper instrumentality or agency to collect the checks from the drawee bank , and it may legitimately pay the necessary cost of this service. The process of the daily collection of checks, in the exercise of the clearing house functions, is not rendered unlawful because of the fact that of the checks handled two or more of them may be drawn on the same bank . The Federal reserve bank may also publish a par list as a legitimate feature of its clearing house function , and while it should not include on that list the name of any bank that has not agreed to remit at par or has not authorized the use of its name, it may indicate, through the par list, its ability to collect checks upon all banks located in a par ticular place. The Court also found from the facts that the Federal Reserve Bank of Atlanta had not used or proposed to use improper or illegal methods for the purpose of coercing the non -member banks, but that the plaintiff banks were entitled to the writ of injunction against the inclusion of their names on the boSee also Federal Reserve Bulletin , Vol. VII ( 1921 ) , pp. 700-701 . 57American Bank and Trust Co. et al. v. Federal Reserve Bank of Atlanta 87 et al., 280 Fed . 940 ( 1922 ) . THE PAR COLLECTION CONTROVERSY 261 par list without their consent, but for no other matter complained of against the Federal reserve bank.58 Appeal from this decision was taken by the plaintiff banks to the United States Circuit Court of Appeals from which a decision was handed down on November 2, 1922.59 This court affirmed in toto the decision of the District Court, and added, “We are not of opinion that a bank , in receipt for collection of checks on other banks, is guilty of an abuse of its right as such holder when, in due course, with reasonable promptness, without designed delay or accumulation, and in proper manner, it presents, or causes to be presented, those checks to the drawees for payment in cash. In so doing the collecting bank would be exercising its rights as the holder of checks received by it for collection, and would not be guilty of an abuse of that right for an unlawful purpose. If the holder of the checks is guilty of no wrong, the fact that the payee [sic ; drawee ? ] is inconvenienced by having to pay in cash would not give the latter a valid ground of complaint. Inconvenience resulting to one party from another's exercise of a right in a law ful way does not give the former a right of action . ” 60 When the case finally reached the United States Supreme Court for the second time, the rulings of the lower courts were upheld in an opinion delivered by Mr. Justice Brandeis on June 11 , 1923.61 The Court found no adequate reason for not accept ing the concurrent findings of fact made by the two lower courts and considered as the main question whether, on the undisputed facts, the plaintiffs were entitled to additional relief. In deciding this question the Court considered the course of business formerly prevailing and the changes wrought by the attempt to introduce universal par clearance and collection of checks through the Fed eral reserve banks. As a result of these considerations, the Court found that although there was no intentional accumulation or holding of checks in order to embarrass, the advantages offered by the Federal reserve banks have created a steady flow in increased volume of checks on country banks so routed . It seemed clear that the action contemplated by the Federal reserve banks would subject the country banks to certain losses and " in order to ro tect them from such losses it would be necessary to prevent the 5*See also Federal Reserve Bulletin , Vol. IX ( 1922 ) , pp . 258-259 . S® American Bank and Trust Co. et al. v. Federal Reserve Bank of Atlanta et al., 284 Fed . 424 ( 1922 ) . "Loc. cit., p. 425 ; Federal Reserve Bulletin, Vol. VIII ( 1922) , pp. 1408 1409 . 61 " American Bank and Trust Company et al. v. Federal Reserve Bank of At lanta et al., 262 U. S. 643 ( 1923 ) . 262 CLEARING AND COLLECTION OF CHECKS Federal reserve banks from accepting the checks for collection. For these banks cannot be compelled to pay exchange charges or to abandon superior facilities. ” 62 After reviewing the provisions of the Federal Reserve Act re lating to the powers of the Federal reserve banks in collecting checks, the Court held that wherever collection can be made by the Federal reserve bank, without paying exchange, neither the common law nor the Federal Reserve Act precludes their under taking it, if it can be done consistently with the rights of the country bank already determined in the case of the American Bank and Trust Company et al. v. Federal Reserve Bank of At lanta, Georgia, et al., 256 U. S. 350 ( 1921 ) . Federal reserve banks are authorized by Congress to collect for other reserve banks, for members, and for affiliated non-members, checks on any bank within their respective districts, if the check is payable on presentation and can in fact be collected consistently with the legal rights of the drawee without paying an exchange charge, and within these limits Federal reserve banks have ordinarily the same right to present a check to the drawee bank for payment over the counter, as any other bank, State or national, would have. The Court further held that the findings of fact negatived the charges of wrongful intent and of coercion. The Federal re serve bank had strengthened its case in this respect since the case has been tried in the United States District Court by filing an amended answer to the charges and disclaiming any intention of demanding payment in cash , when presenting checks at banks, and averred its willingness to accept payment in drafts, either on the drawees’ Atlanta correspondents or on any other solvent bank, if collectible at par. " Country banks, " the Court said, "are not entitled to protection against legitimate competition. Their loss here shown is of the kind to which business concerns are commonly subjected when improved facilities are introduced by others, or a more efficient competitor enters the field . " 63 The Court held that the course of action contemplated by the Federal reserve bank was not ultra vires.64 This decision thus establishes the principle that Federal re serve banks may collect checks at par on banks which refuse to remit at par by presenting the checks directly over the counter, provided they do not accumulate checks with the intention of em barrassing or coercing such banks and if the checks in fact can 62Loc. cit., p. 646. 631bid., p. 648. " Ibid . See also the Federal Reserve Bulletin , Vol. IX ( 1923 ) , pp. 788-789. THE PAR COLLECTION CONTROVERSY 263 be collected consistently with the legal rights of the drawee with out paying exchange charges. To the italicized portion of the paragraph the Court has permitted some vagueness to attach itself. Before studying another case of equal, if not greater signifi cance, decided by the United States Supreme Court on the same date and adverse to the interests of the Federal reserve banks in their attempt to establish a universal par collection system, a brief review will be made of two other cases which in the meantime attracted attention. The San Francisco par collection case In 1921 a case arose in Oregon in which the United States District Court for the District of Oregon ruled that a Federal reserve bank may not use the check collection system to coerce non-member banks to remit at par . The facts may be sum marized briefly. The Brookings State Bank , a small corpora tion in southern Oregon, with correspondents in Portland and San Francisco, refused to remit at par for checks sent it by the Federal Reserve Bank of San Francisco or its branch at Port land. The Federal reserve bank established an agent in Brook ings who collected checks over the counter to the extent of $102,850.33 at an expense of $1,915.32 during the space of about a year. This method caused the Brookings bank much annoyance and required it to maintain a materially larger reserve than ordi narily would have been necessary in the usual conduct of its busi ness.. The agent was finally withdrawn and the Brookings bank notified that thereafter checks would be forwarded for collection by mail direct to the bank, with a request that they be paid at par and the proceeds remitted by exchange on Portland or San Fran cisco. Checks were then forwarded , indorsed “ Pay to Brookings State Bank for collection only and remittance in full without de duction for exchange or collection charges. Portland Branch, Federal Reserve Bank of San Francisco, Frederick Greenwood, Manager.” These were returned by the Brookings bank without payment on the ground that the bank was not called upon to act as agent for the Federal reserve bank to make collections under the terms imposed. The Federal reserve bank , upon the return of the checks, returned them to its correspondents, advising them, in * Brookings State Bank v . Federal Reserve Bank of San Francisco , 277 Fed . 430 ( 1921 ) ; Ninth Annual Report of the Federal Reserve Board ( 1922 ) , pp. 271-274 . See also Murchison , op. cit., pp. 148-149. 26+ CLEARING AND COLLECTION OF CHECKS effect, that the Brookings bank refused to pay and had not pro tested the paper, and that they must look to the Brookings bank for their protection. Suit was brought September 29, 1921, in the United States District Court for the District of Oregon to enjoin the Federal Reserve Bank of San Francisco from indulging in certain alleged practices supposedly injurious to the plaintiff's business . Judge Wolverton rendered his decision December 19, 1921 . He held, in the first place, that the State bank, if it so desired, had the right to charge a reasonable rate of exchange for its re mittances even though there may exist a custom by which banks make remittances without the exaction of exchange. In the second place, he ruled that while the Federal reserve bank was acting within its authority in maintaining an agent at Brookings for the purpose of making collections over the counter of the plaintiff and in paying the expenses entailed thereby, it was at fault in two particulars : “ First, in attempting to impose the con dition that the plaintiff bank pay without its charge for exchange; and, second, in attempting to hold the plaintiff bank responsible for not having its own paper protested for non -payment." 66 The judge held, further, that the method employed by the Fed eral reserve bank was extraordinary, extravagant and unbusiness like and indicated most convincingly that it was for the purpose of coercing the State bank into adopting the policy of remitting at par . A preliminary injunction was issued restraining the Federal reserve bank from sending letters to its clients, advising them that they must look to the plaintiff bank for their protection through failure to protest such paper. This preliminary injunc tion was made permanent on June 26, 1922, Judge Wolverton again rendering the decision.97 At this time he held that two questions were presented : ( 1 ) Whether the reserve bank has the authority to make collections from non -member banks ; and ( 2 ) whether it can coerce such banks to remit at par. On the first question he ruled that the wording of the Federal Reserve Act in this respect is optional— “ that the Federal reserve bank may at its option receive paper against such banks for col lection. Having that power, it may collect it , if it can find a way of doing so without the payment of exchange which it is pro hibited from paying by the act. It is a banking custom, as well 66277 Fed. 432 ( 1921 ) . 6 Brookings State Bank v. Federal Reserve Bank of San Francisco, 281 Fed. 222 ( 1922 ) . THE PAR COLLECTION CONTROVERSY 265 as a legal right, which a holder of a check has at all times, to pre sent paper at the counter of the drawee bank and demand pay ment, and, if denied, the paper is subject to dishonor. Paper so presented and paid over the counter is not subject to exchange. It is also a custom among banks, in making collections from other banks, where there is not more than one bank in a place, to send checks to the drawee bank with request for remittance, and the request is honored unless there is some special reason why the bank should not pay. These banking rules are conceded . ” 68 In answer to the Federal reserve bank's insistence that it was its duty, imposed upon it by the Federal Reserve Act, to collect such checks, Judge Wolverton pointed out that the Federal reserve bank itself had recognized the optional character of its function in this regard, by notifying its correspondents that it would accept no more paper on the Brookings State Bank for collection. As to the second question, Judge Wolverton ruled that the non-member banks being without the pale of the Federal Reserve Act, have the right, if they see fit, to charge reasonable exchange on remittances ; that it is a right the bank may relinquish at its option, but ought not to be coerced into doing so and any strategy which has for its purpose the coercion of such non-member bank to yield its legal right in this respect is unlawful, and will not be approved by the courts ; that the testimony impelled him to the conclusion that the Federal reserve bank had gone to the length of endeavoring to coerce the Brookings bank to accede to its demand that the latter bank agree to remit at par. In harmony with the opinion rendered at the preliminary hearing, he held that the return by the Brookings bank without payment of checks sent to it indorsed “ Pay to Brookings State Bank, for collection only and remittance in full without deduction for exchange or collec tion charges ” was not tantamount to dishonor ; that while the defendant bank , under the prevailing custom , could rightfully remit its checks and drafts against the plaintiff bank direct to the latter for collection and could thereby exact payment of them , it could not impose conditions upon which such payment should be made, much less could it make the plaintiff bank its agent for causing protest to be made for non -payment and that the idea of requiring that a maker or drawer shall have protested his own paper is so inconsistent with the functions of an agent that it can hardly receive the sanction of law. While the permanent injunction enjoined the Federal reserve ** Ibid., p. 226. Italics are the author's. CLEARING AND COLLECTION OF CHECKS 266 bank from advising its clients that they must look to the Brook ings bank for their protection through failure to protest such paper, it did not apply respecting the maintenance of an agent at Brookings as he had been withdrawn practically at the time of the institution of the suit, and there appeared to be no intention upon the part of the Federal reserve bank to replace him . It is unfor tunate in the interest of clearness that the agent was not present in order to determine definitely whether the injunction would have been used to exclude him from Brookings. In the light of the Cleveland par collection decision, next to be reviewed,, there seems to be but little doubt that the injunction would be extended to the agent also if he uses oppressive methods.69 The Cleveland par collection case o This case, like the San Francisco case, established the prin ciple that a Federal reserve bank, may not use oppressive or coer cive methods in its efforts to collect checks at par. In these two cases the Federal Reserve Banks of San Francisco and Cleveland were guilty of oppressive methods and objectionable motives not proved in the Atlanta case and which , in line with the opinion of the United States Supreme Court delivered by Justice Holmes, were subject to condemnation. The decision in the so-called Cleve land par collection case was rendered by the United States Dis trict Court for the Eastern District of Kentucky on October 14, 1922, and was in accordance with the reasoning of the United States Supreme Court in its decision of May 16, 1921 , when it remanded the Atlanta case to the lower court for retrial on its merits to determine whether the plaintiff banks had grounds for relief. The facts in the Cleveland par collection case will be sum marized briefly . The plaintiff bank, the Farmers and Merchants Bank of Cat lettsburg, Kentucky, was unwilling to remit at par to the Fed eral Reserve Bank of Cleveland, or more accurately, to the branch at Cincinnati. From January, 1918, to December, 1919, the Federal reserve bank had attempted to persuade the Catletts burg bank to enter into an agreement to remit at par,, but was unsuccessful . Consequently , the Federal reserve bank resorted to other methods for collecting the checks than sending them through the mails. It sent its traveling representative, H. A. **See Ninth Annual Report of the Federal Reserve Board ( 1922 ) , pp. 271 274 ; Murchison, op. cit ., pp. 148-149. TºFarmers and Merchants Bank of Catlettsburg, Ky . v. Federal Reserve Bank of Cleveland, Ohio, 286 Fed. 610 ( 1922 ) . THE PAR COLLECTION CONTROVERSY 267 Magee, to Catlettsburg to interview the bank officials. Failing to persuade them, he insisted and demanded that they agree, and finally threatened to use the American Express Company as a col lecting agent. He anticipated that this would be very embar rassing to the Farmers and Merchants Bank , and, according to affidavits filed by that bank , he said that the bank “ . would be mighty glad to sign up before long, as no bank could exist that did not ; that the Federal Reserve System was like aa mighty battle ship coming up as it were from a smooth sea, and all banks that did not affiliate with it could not stand its swells and must get in its wake for safety, and that in the next five years there would be no small banks." 71 From January 6, 1920, to February 26, 1920, the American Express Company was employed to collect the checks, during which time the local bank countered by furnishing checks to its depositors endorsed with the words : “ Payable in cash or exchange draft at the option of the Farmers and Merchants Bank of Catlettsburg, Ky." When checks so endorsed were pre sented for payment the bank would offer drafts but no cash When drafts would not be received, no payments would be made The express company finally refused to act as collecting agent because of the trouble involved . Local individuals then were em ployed as agents, although Magee was frequently on the ground doing what he could, according to the affidavits, to bring the bank into line by driving away depositors, creating scenes, and acting in a boisterous, domineering, dictatorial and quarrelsome manner, and doing many other things designed to bring discredit upon the local bank . With few exceptions, the court found little evidence to disprove the charges made in the affidavits. Suit was brought in the State court on July 15, 1921 , by the Farmers and Merchants Bank of Catlettsburg against the Fed eral Reserve Bank of Cleveland, from which court the case was re moved to the United States District Court, Eastern District of Kentucky, upon the joint petition of the two defendants, on the ground that it arose under the Constitution and laws of the United States. A temporary restraining order was granted by the clerk of the State court and continued in force until the case was tried in the District court where a preliminary injunction was granted. In bringing suit, the local bank claimed that the method adopted by the Federal reserve bank , of advertising that it would collect all checks on the local bank free of charge, resulted in a large number of checks being presented through that channel in order * Loc. cit . , p. 612. 268 CLEARING AND COLLECTION OF CHECKS to avoid remittance charges, with the result that they were pre sented in great numbers at once by the Federal reserve bank with resulting embarrassment to the local bank. The bank insisted that this practice was injurious to it in that it deprived it of such charges, required it to keep a greater reserve in cash than it would have had to do otherwise, scandalized it, affected its credit, and humiliated it . The United States District Court held that the law in the case had been settled by the Supreme Court in the Atlanta case, and that it all depended on the purpose of the Federal reserve bank in adopting “... this unusual and heretofore unheard of pro cedure of seeking out plaintiff's checks for collection and pre senting them in a body for payment over the counter." 72 If the purpose were to break down the plaintiff's business as then con ducted, it was unlawful and subject to be restrained by a court of equity. “ It does not follow that because the holder of a check has a right to present it to the bank upon which it is drawn for payment over the counter, one has the right to seek to become the holder of all the checks drawn on a bank as they are drawn and then present them in a body for payment in cash over the counter. If such was the defendant bank's immediate purpose in so doing, it was not justified by the ulterior purpose which it has in view, to wit, of freeing commerce from the burden of such charges. Such a course of procedure is a kind of refined holdup. It is one of the inalienable rights of a person to be unprogressive, selfish and even mean . This is said without intending to so characterize plaintiff's position. No other person has the right to coerce him . into being otherwise. “ What then was the defendant bank's purpose in initiating . this movement against the plaintiff and keeping it up for over a year and a half — that is, until stopped from further doing so by the temporary restraining order ? There is but one answer to this question, and that is that it was to break down plaintiff's business. as it was being conducted, not to put it out of business, but to compel it to do business in this particular as it would have it do, and not as plaintiff desired. ... It desired to impose its will on plaintiff. That such was defendant bank's purpose is the meaning of the course of procedure adopted. It can be accounted for on no other basis . Such a purpose was avowed by those acting on its behalf. 973 . 721bid., p. 618. * Ibid ., pp . 618-619 . THE PAR COLLECTION CONTROVERSY 269 The court was somewhat at a loss to know why the plaintiff delayed so long in asserting its rights, but could see in the delay no reason why the defendant Federal reserve bank should be per mitted to continue to make collections in this unlawful manner and as a result granted a preliminary injunction restraining the defendants from continuing to make such collections of checks on the plaintiff bank , from advertising that it would collect such checks free of charge, and from doing anything else for the pur pose of coercing the plaintiff to remit at par.74 The Richmond par collection case The case which originated in the district of the Federal Re serve Bank of Richmond is of the utmost importance, since it re sulted in the United States Supreme Court upholding the legality of the legislation in North Carolina which was designed to protect State banks in their practice of making charges for remittance. It constitutes a severe set -back to the attempt on the part of the Federal reserve banks to establish a universal par collection sys tem, and may have far- reaching consequences for the clearing and collection system in this country. The United States Supreme Court in its decision on June 11 , 1923 — the same day on which it rendered its opinion in the Atlanta par collection case-reversed the Supreme Court of North Carolina which had declared the State statute unconstitutional.75 These two decisions are worthy of careful review because of the different lines of reasoning fol lowed and the important consequences involved . The Atlanta case has been summarized above ;76 we will turn our attention now to the Richmond case . It will be recalled that North Carolina was one of the States which attempted to preserve exchange charges for its State banks by passing an Act , ratified February 5, 1921." This Act author ized State banks in North Carolina to charge a fee not in excess of 18 of 1 per cent. on remittances covering checks, or a minimum fee of 10 cents, and provided that in the event a Federal reserve bank , post office or express company should present checks at the counters of the drawee bank and demand payment in cash , such drawee bank should be permitted to pay by means of a draft drawn upon its exchange deposit, excepting, however, checks pay " See also the Federal Reserve Bulletin , Vol . VIII ( 1922 ) , pp. 1409-1413 . * Farmers and Merchants Bank of Monroe, North Carolina, et al. v. Federal Reserve Bank of Richmond , Virginia, 262 U. S. 649 ( 1923) . * See pp. 261-263 above. **Public Laws of North Carolina, 1921, Chap. 20, Sec. 2. See p. 252 above. 270 CLEARING AND COLLECTION OF CHECKS able to the State or to the Federal government and checks upon which the drawer had expressly designated to the contrary. The Federal Reserve Bank of Richmond , being advised that the statute was unconstitutional, presented checks at the counter of the drawee bank, demanding the full amount due and returned the checks as dishonored when payment in cash was refused. In re turning checks which had been so presented, the Federal Reserve Bank of Richmond was careful to state that the check had been duly presented and that payment in money at its face amount had been demanded, but had been refused , since the drawee bank claimed the right to discharge its obligations by its own draft. The return of the dishonored checks to the depositors created great dissatisfaction among them and the State banks found diffi culty in explaining satisfactorily to their customers why the checks were not honored. Some depositors transferred their ac counts to member banks, in order to make sure that their checks would circulate at par. Relying upon the Act of February 5, 1921 , the Farmers and Merchants Bank of Monroe and twelve other banks and trust companies in North Carolina brought action in the Superior Court of Union County, North Carolina, against the Federal Re serve Bank of Richmond to enjoin that bank from refusing to ac cept drafts drawn by plaintiff banks on their reserve deposits in payment of checks presented for collection and from returning such checks to the drawers as dishonored when plaintiffs refused to pay them in cash . The Superior Court granted a temporary restraining order in February, 1921 , which prevented the Federal reserve bank from refusing to accept exchange drafts drawn by the plaintiffs on their reserve deposits in accordance with the Act of February 5, 1921 ; it was enjoined from returning as dishonored any check, payment for which had been tendered by plaintiff banks in exchange drafts under the provisions of the Act and had been refused by the Fed eral reserve bank ; it was enjoined from protesting such checks for non -payment; and it was also enjoined from publication or authorizing the publication of the name of any of the plaintiff banks, literally or by inclusion, in any list or other publication designed for circulation. The restraining order provided that all such institutions as the original thirteen might become plaintiffs in the action and have the benefit of the restraining order, and as a result, some 265 State banks and trust companies became par ties plaintiff. The suit was removed to the United States District Court for THE PAR COLLECTION CONTROVERSY 271 the Western District of North Carolina at the instance of the Federal reserve bank , but, in turn, was remanded to the Superior Court of Union County for trial on its merits because the juris dictional amount of $3,000 was not involved, the minimum that must be involved before a Federal court obtains jurisdiction. Argument was heard in the State court from February 27 to March 3, 1922. No evidence substantiating the allegations of oppressive and unreasonable methods employed by the Federal reserve bank was offered. On the contrary, it appeared from the evidence that the Federal Reserve Bank of Richmond throughout the whole of the par point campaign in North Carolina had prac-. ticed the utmost consideration for the non-member banks that was consistent with what it believed to be the duties imposed upon it by the Federal Reserve Act.78 Although finding the motive to harm on the part of the Federal reserve bank lacking, Judge James L. Webb, on March 29, 1922, entered the final order mak ing the injunction permanent and sustaining the State statute as constitutional.79 The case was appealed then to the Supreme Court of North Carolina, and Mr. Chief Justice Clarke gave the opinion rendered by the court on May 24, 1922, the outstanding features of which may be summarized as follows : 80 The court held that it did not need to consider the allegations of the plaintiff banks as it had found them untrue. These allegations were to the effect that the Federal Reserve Act which prohibited Federal reserve banks from paying exchange would cause all collections to be made through the Federal reserve banks which thus can collect without charge. and also that the Federal Reserve Bank of Richmond was under taking to coerce the non-member banks to abandon their right to charge by saving up checks until they reached a large amount and then demanding payment for them at the counter, with the prob able effect of driving the bank into liquidation. The court added the following significant statement : " It would be unnecessary to notice this proposition but that such conduct was condemned by Mr. Justice Holmes in the case of the American Bank and Trust Company v. Federal Reserve Bank of Atlanta, opinion filed May 16, 1921. That decision was rendered upon a demurrer on which , ** Letter No. 6, pp. 8-10. ** Ibid . * Farmers and Merchants Bank et al. v . Federal Reserve Bank of Rich mond , Va., 183 N. C. 546 ( 1922 ) ; 112 S. E. 252 ( 1922 ) ; Federal Reserve Bulletin, Vol. VIII ( 1922 ), pp . 701-703; Ninth Annual Report of the Federal Reserve Board ( 1922 ) , pp . 261-265. 272 CLEARING AND COLLECTION OF CHECKS of course, the court assumed that all the allegations of the bill and all reasonable inferences from them were true. The finding of fact on the trial in the present case eliminated this question en tirely from our consideration ." 81 It was held that a Federal reserve bank under the provisions of the Federal Reserve Act has the right to receive for collection a check drawn upon a non-member bank or upon any other person within its district. The real question, then, according to Mr. Chief Justice Clarke, was whether the Legislature of North Caro line, by such an act as the one mentioned above, could interfere “... with this provision or regulation of the Federal corpora tion by a valid act of Congress by providing that a State bank need not pay its obligations in lawful money when checks, which upon their face are unconditional orders for the payment of money, are presented by Federal reserve banks." 82 The statute of North Carolina was intended for the benefit of the State banks .. but that policy, however desirable for such banks, is clearly in conflict with the valid constitutional provision of the Federal statute . No act of this State can authorize the drawee bank to pay less than the face amount of the check drawn upon it by its depositor or to remit its check in payment or pay it other wise than in legal-tender money. Nor can it require that the Federal Reserve Bank shall pay a fee, or that the bank here may remit less than the face value of the check when the Federal stat ute forbids such charge. It is true that the Federal Reserve Bank, as holder of the check , has no contract rights with the drawee bank until the check is presented, but as holder it can require payment of the face amount on the check in legal tender, and under the act of Congress it cannot pay a deduction from 1 that face value by accepting a remittance to the Reserve Bank of a lesser amount. " The Federal statute, being a regulation of the Federal Cor poration by Congress , the act of this State authorizing the payee bank here to exact exchange is in direct conflict with the duty im $ 1183 N. C. 551 ( 1922 ) . 82Ibid . This decision is in harmony with the legal definition of the check as generally accepted in this country, and with the general literature dealing with the nature of deposit currency evidenced by checks, as a demand liability ( See pp . 1, 76-77 above ). It is to be noted also, that the of the bank . United States Supreme Court in the case of Federal Reserve Bank of Rich mond v. Malloy et al., Trading as Malfoy Brothers, 44 Sup. Ct. 296 (1924 ), asserted again and again that a check on a bank or banker is payable in money and in nothing else, and held that acceptance by the collecting agent of any thing else rendered it liable to the holder as though it had collected the cash. ( See pp. 284-286 below ). THE PAR COLLECTION CONTROVERSY 273 posed upon the Federal Reserve Bank by the act of Congress and the Reserve Bank acts within its duty to observe the provision of the Federal act and refuse to receive a check for less than the face amount of the check sent by it for collection. “ The United States Constitution, Article VI ( Sec . 2 ) , pro vides that the Constitution of the United States, and the laws . made in pursuance thereof, 'shall be the supreme law of the land ; and the judges in every State shall be bound thereby, anything in the Constitution or laws of any State to the contrary notwith standing . In the matter before us the act of Congress which provides that no exchange shall be allowed by the Reserve Bank for remitting for the collection of any check by any bank is in direct conflict with the statute of this State authorizing the payee bank to remit a lesser amount than the face amount of any check paid by it if presented by the Federal Reserve Bank. In this conflict of authority the Federal law is supreme. The in junction, therefore, was improvidently granted and the judgment must be reversed . " 83 The court dismissed the injunction issued by the lower court against the Federal Reserve Bank of Richmond . The plaintiff banks petitioned for a rehearing of the case before the Supreme Court of North Carolina , but the court dis missed the petition on December 13, 1922, reaffirmed its former decision by a mere memorandum decision, and did not modify or supplement its former opinion.84 On a writ of certiorari the case was taken to the United States Supreme Court, from which an opinion was handed down June . 11 , 1923, reversing the decision of the Supreme Court of North Caro lina and deciding in favor of the non-par State banks.85 Mr. Justice Brandeis delivered the opinion of the Court which holds that the State statute in question does not obstruct the perform ance of any duty imposed upon the Federal Reserve Board and the Federal reserve banks, that it does not interfere with the exercise of any power conferred upon either, and that it is consistent with the Federal Reserve Act and with the Federal Constitution. From this opinion Mr. Justice Van Devanter and Mr. Justice Suther land dissented. The Court after reviewing the State law bearing upon the question, insisted that the issue was whether this statute conflicted with the Federal Reserve Act or otherwise with the Federal Con 83183 X. C. 552-553 ( 1922 ) . **Federal Reserve Bulletin, Vol. IX ( 1923 ) , p . 20. «Farmers and Merchants Bank of Monroe, North Carolina, et al. v. Fed eral Reserve Bank of Richmond , Virginia, 262 U. S. 619 ( 1923 ) . 274 CLEARING AND COLLECTION OF CHECKS stitution. The Court reviewed the development of the Federal reserve clearing and collection system , and pointed out the circum stances which gave rise to the North Carolina statute, stating that the attempt of the Federal reserve banks to establish univer sal par collection would cause the exchange-charging State banks to suffer a loss if not render them insolvent, and that the Act was passed to protect the State banks from threatened loss which might disable them . It observed that the Federal reserve banks insisted that no alternative was left open to them , since they had to collect the checks and were forbidden to pay exchange charges, while the State banks, on the other hand, denied that the Federal reserve banks were obliged to accept these checks for collection and insisted that Federal reserve banks should refrain from ac cepting for collection checks on banks which did not assent to par remittance. Finally, the Court pointed out that the statute merely sought to remove ( when the drawer acquiesced ) the abso lute requirement of the common law that a check presented at the bank's counter must be paid in cash , thus giving the drawee bank the option to pay by exchange only in certain cases, namely, when the check was presented by or through any Federal reserve bank, post office, or express company, or any respective agents thereof.se The Court said that the North Carolina statute “ made no at tempt to compel the Federal reserve bank to pay an exchange charge. It made no attempt to compel a depositor to accept something other than cash in payment of a check drawn by him. It merely provided that, unless the drawer indicated by a notation on the face of the check that he required payment in cash, the drawee bank was at liberty to pay the check by exchange drawn on its reserve deposits. Thus the statute merely sought to re move ( when the drawer acquiesced ) the absolute requirement of the common law that aa check presented at the bank's counter must be paid in cash .” The question, said the Court, was " whether this legislative modification of the common law rule which 2requires payment in cash violates the Federal Constitution. That it did was asserted by the Federal reserve bank on five grounds. The first contention disposed of by the Court was that in authorizing payment of checks by draft on reserve deposits, Sec tion 2 of the State law violates the provision of Article I, Section 10, clause 1 , of the Federal Constitution , which prohibits a State from making anything except gold and silver coin a tender in pay ment of debts. The Court held that this claim was clearly un **Loc. cit. , pp . 649-659. THE PAR COLLECTION CONTROVERSY 275 founded, since the debt of the bank is solely to the depositor and the statute does not authorize the bank to discharge its obligation to its depositor by an exchange draft but merely provides that, unless the depositor in drawing the check specifies on its face to the contrary, he shall be deemed to have assented to payment by such draft. Further, the Court held that there is nothing in the Fed eral Constitution which prohibits a depositor from consenting, when he draws a check, that payment may be made by draft, and, as the statute is prospective in its operation, there is no constitu tional obstacle to a State's providing that in the absence of dis sent, consent shall be presumed. The second contention was that Section 2 violates the due process of law clause since it deprives the Federal reserve bank of the right to do business common to all banking institutions, which is a valuable property right, and that to compel it to accept in payment of checks exchange drafts on reserve deposits, whether good or bad, deprives it of liberty of contract , and in effect of an important branch of its business, since that of collecting checks cannot be conducted under such limitations. To this argument the Court replied that it was the purpose of the statute to pro mote the solvency of State banks and that so construed it is merely an exercise of the police power, by which the banking busi ness is regulated for the purpose of protecting the public, and promoting the general welfare and that the regulation here at tempted is not so extreme as inherently to deny rights protected by due process of law. It was contended, in the third place, that the statute is ob noxious to the equal protection clause since the Federal Reserve Bank of Richmond is obliged to accept payment in exchange drafts, whereas other banks with whom it might conceivably com pete may demand cash, except in those cases where they present the check through an express company. Relative to this argu • ment the Court ruled that it is well settled that the legislature of a State, in the absence of controlling provisions, may direct its police regulations against what it deems an existing evil, without covering the whole field of possible abuses ; that if the legislature finds that a particular instrument of trade war is being used against a policy which it deems wise to adopt, it may direct its legislation specifically and solely against that instrument ; and finally that the facts disclosed ample ground for the classification made by the legislature. The fourth contention was that Section 2 conflicts with the 276 CLEARING AND COLLECTION OF CHECKS Federal Reserve Act because it prevents the Federal reserve banks from collecting checks on such State banks as do not acquiesce in the plan of par collection, the contention resting upon the assump tion that the Federal Reserve Act is mandatory in requiring the Federal reserve banks to receive such checks and make such col lections. On this point the Court ruled that the law was permis sive only, that neither Section 13 nor any other provision of the Federal Reserve Act imposes any obligation to receive checks for collection, and that the word "may" in this connection was used 87 advisedly. The Court insisted that no duty or right of the Federal reserve bank to collect checks is obstructed by the North Carolina statute, which merely gives to the drawee bank the right to pay in the cus tomary exchange draft, where its depositor has, by the form used in drawing the check, consented that this be done. The fifth contention was that Section 2 conflicts with the Fed eral Reserve Act because it interferes with the duty of the Federal Reserve Board to establish in the United States aa universal system of par clearance and collection of checks. In reply to this the Court held that Congress did not confer in terms upon the Federal Reserve Board or the Federal reserve banks a duty to establish universal par clearance and collection of checks, and that there is nothing in the original Act or in any amendment from which such duty to compel its adoption may be inferred. In neither Section 13 nor Section 16 is there any suggestion that the Federal Reserve Board and the Federal reserve banks shall become an agency for universal clearance. It seems apparent that under this decision a State may pass valid laws taking away from the Federal reserve banks the right to collect checks over the counter in cash and at par, which is the only weapon they have had to prevent non-member banks from deducting a remittance charge. It is possible that such action may be forestalled by amending the Federal Reserve Act so as to make par remittance mandatory. Such an amendment, presum ably, would nullify the North Carolina law or any similar one and would settle a serious controversy . 88 87On this point, see Murchison, op. cit. , pp. 149-150, who insists that although the term “ may ” is used, the content and purpose of the Act makes it man datory in nature and that any other interpretation weakens the Federal re serve banks in their attempt to function as they were intended to function . 68 Federal Reserve Bulletin , Vol. IX ( 1923 ), pp. 789-793 ; see also J. T. Holdsworth, Money and Banking, 4th ed. ( 1923), p . 446, who agrees with this point of view . THE PAR COLLECTION CONTROVERSY 277 The case of the Pascagoula National Bank of Moss Point, Missis sippi v. Federal Reserve Bank of Atlanta , et al.89 The first litigation involving the rights of the member banks. in the Federal reserve clearing and collection system was started by the Pascagoula National Bank of Moss Point, Mississippi, on : August 9, 1924, when it filed suit against the Federal Reserve Bank of Atlanta, its Federal reserve agent, and the Federal Re serve Board to recover alleged damages of $12,750 suffered for the last six years as a result of the fact that the Federal reserve bank accepted checks for deferred rather than immediate credit. It also sought an injunction to prevent the Federal reserve bank from receiving for collection any check drawn upon and payable by any bank outside the home district of the Federal reserve bank ;, it sought to compel the Federal reserve bank to give immediate credit at face value on deposit of checks payable within the dis trict ; it sought to establish the right of the member banks to charge exchange on checks drawn on them and presented by or through the Federal reserve bank ; it sought to enjoin the Federal reserve bank and the Federal Reserve Board from operating a clearing and collection system except within very narrow limits alleged to have been established by the United States Supreme Court, and prayed that they be stopped permanently from seek ing to be an universal agency for the clearance of checks. Judge Samuel H. Sibley of the United States Court for the Northern District of Georgia , on October 3, 1924, refused to issue an inter locutory injunction, reassigned the case for hearing on its merits, and ruled that the Federal Reserve Board could not be held liable to the District court.90 883 Fed. (2nd Series ) 465 ( 1924 ) ; Federal Reserve Bulletin , Vol. XI ( 1925 ) , pp. 100-102, "See Federal Reserve Bulletin , Vol. X ( 1924 ), p. 866 ; Commercial and Financial Chronicle, Vol. CXIX, No. 3100 ( New York , November 22, 1924 ) , p. 2367; Wall Street Journal, Vol. LXXXIV, Nos. 84 and 85 (October 8 and 9, 1924 ) . This suit is in harmony with the Claiborne-Adams Check Collection Plar. advocated by the opponents of par remittance . Mr. Charles DeB. Claiborne, Vice - President of the Whitney -Central National Bank of New Orleans, and Chairman of the Committee of Five on Exchange of the American Bankers' Association, and Mr. L. R. Adams, General Secretary of the National and State Bankers' Protective Association, were the sponsors of this plan. It provided that each Federal reserve bank was to receive on deposit at par from member and non -member clearing banks in that district for immediate credit and availability, checks which were payable in that district and which were drawn upon any bank which agreed to remit at par in funds acceptable to the Federal reserve bank . Checks drawn upon non-par banks and upon those outside of the district were to be received by the Federal reserve banks as forwarding agents only and for deferred rather than immediate credit. When such checks were sent to the drawee bank, the bank might remit to the Federal 278 CLEARING AND COLLECTION OF CHECKS When the case came to trial before the same court on Decem ber 15, Judge Sibley, who rendered his decision on December 29, reviewed the following four contentions of the complainant : First, that by the provisions of Section 16 of the Federal Reserve Act, it is entitled to immediate credit at par for checks drawn on any of the depositors of the Federal Reserve Bank of Atlanta, no matter at what distance from Atlanta the drawee may be. Second, that under the Hardwick Amendment of Section 13, it has the right to make a charge for remitting payment to the Federal Re serve Bank of Atlanta for checks drawn on itself when these are not the property of the Federal reserve bank, but are handled for collection . Third, that under Section 13 the Federal Reserve Bank of Atlanta has no right to have or to collect any checks drawn on the complainant which come to the Federal reserve bank from a source outside the sixth district. Fourth, that if the Act authorizes this deprivation of complainant's right to charge for remittance, it takes its property without due process of law, con trary to the Constitution. Considering the first contention, Judge Sibley analyzed that provision of Section 16 of the Act which, according to the com reserve bank in an exchange draft and make a deduction of not over ten cents for each $ 100 of checks, but in no case to be less than ten cents for any one remittance, the avowed purpose being to pass the charges back through the Federal reserve banks to the depositing banks. All member banks were to be permitted to make such deductions on checks returned from a bank in -another district, if they so desired . This plan was rejected on August 1 , 1923, by an advisory committee of governors of the Federal reserve banks to which it had been referred by the Federal Reserve Board, on the grounds that a return to the immediate credit principle for a large proportion of the checks would revive one of the worst faults of the old system , would result in the building up of fictitious reserves, a large float, and the imposition of a large amount of exchange charges on the business of the country . The Federal Advisory Council concurred with this re port and advised the Federal Reserve Board that it considered the plan un sound. The attitude of the Board is reflected in the provisions of Regulation J , Series of 1924. See Federal Reserve Bulletin , Vol. IX ( 1923 ) , pp. 1089, 1194; Tenth Annual Report of the Federal Reserve Board ( 1923) , p . 466 ; C. S. Tippetts, “ The Par Remittance Controversy,” The American Economic Re view, Vol. XIV ( December, 1924 ) , pp. 641-646. Dr. Tippetts does not favor forcing the non -par banks to remit at par through legislative complusion. The into the system, and it does not seem to do it while the non-par banks can still writer does not agree with this view. If competition does not force the banks collect through member banks, then there remains but one effective remedy, and that is to amend the Federal Reserve Act and force the non-par banks to remit at par. This measure would be no more drastic than was the measure taxing State bank notes out of existence in 1865. Our clearing and collection system would then approach the ideal. In a large sense the nation would then be clearing all its checks and drafts, although it is of course true that so long as the deferred credit and debit principle is used, perfect clearing or offsetting cannot take place. The nature of checks, however, makes it unwise to use any but the deferred availability principle, and consequently the perfection of the universal clearing plan would lie in the perfect offsetting which would then take place through the Gold Settlement Fund . THE PAR COLLECTION CONTROVERSY 279 plainant, required the Federal reserve bank to give immediate credit for checks received. It reads : " Every Federal reserve bank shall receive on deposit at par from member banks or from Federal reserve banks, checks and drafts drawn upon any of its depos itors.” The pertinent question was whether the Federal reserve bank was really receiving items on deposit at par when, in con formity with Regulation J, it gave credit only according to the time schedule and acted only as an agent in collection. The court held that " a check so received and handled is really received for collection and not on deposit in the common sense of the word, meaning general deposit in which arises the relation of debtor and .. Usually the de creditor, not that of principal and agent. positor may check immediately, but this is not of the essence of a general deposit. The parties may agree otherwise ; and it is not uncommon in banking practice, where large checks, payable at a distance, are taken at par, to delay availability on the checking account so that the banker may not, by honoring checks in ad vance of collection, be lending his money without interest. The inclusion of the time schedule only in the terms upon which the reserve bank will receive deposits would be ordinary prudent bank ing, considering the enormous volume of the aggregate reserve bank ' float,' as the mass of checks in transit is called. It may be noted that, by Section 13, non-member clearing banks are required to protect their deposited checks in transit by maintaining a balance sufficient to offset them , which is another way of saying that the checks are not available credits while in transit . It must be re membered also that these deposit accounts of the member banks in the reserve bank , though subject to check, constitute their re serve required under Section 19. By amendment of this Section this reserve must be an 'actual net balance. ' Net' means that all proper charges and deductions have been made from the account ; “actual excludes what is merely fictitious or supposed . Uncol lected checks, though supposed to be drawn against actual, avail deposits, may not be, and if so they may nevertheless be defeated of payment by many circumstances, such as the death or counter mand of the drawer, or offset by the banker upon the drawer's insolvency. An immediate credit of them must be largely on the faith of the depositor's indorsement, but the mere obligation of the member bank is not the actual reserve intended by the law. More over, the requirement that the reserve bank itself maintain a re serve in gold or lawful currency of 35 per cent. of its deposits is involved if the 'float is to be counted as present deposits. The time schedule by which credit is deferred until checks would ordi 280 CLEARING AND COLLECTION OF CHECKS narily be collected minimizes the chance of accumulated disap pointments in collection, and the amount of merely supposed bal ance in the reserve of members, and seems a very reasonable recon ciliation of the requirement of Section 16, that the checks be re ceived on deposit in the reserve account, with that of Section 19, that the reserves be actual net balances. “ The additional stipulation that the reserve bank will act only as agent makes greater difficulty. It probably means that the checks are at first received only for collection ; Ward v. Smith, 7 Wall. 447. 'Deposits for collection' are spoken of in Section 13. but 'on deposit in Section 16 does not mean for mere collection. Since, however, credit is to be given at the expiration of the period fixed by the time schedule, whether returns from the check have actually been received or not, at that time certainly the agency is to cease and the check is to become and does become the property of the reserve bank and the transaction ripens into a general deposit. The check is then “received on deposit at par,' as required by Section 16.” Considering the second contention of the plaintiff bank, Judge Sibley first reviewed that part of Section 16 which provides that “ Nothing herein contained shall be construed as prohibiting a member bank from charging actual expenses incurred in collecting and remitting funds or for exchange sold to its patrons. The Federal Reserve Board shall, by rule, fix the charges to be collected by the member banks from its patrons whose checks are cleared through the Federal reserve bank and the charge which may be imposed for the service of clearing or collection rendered by the Federal reserve bank ."" 91 The court held that “ whether the right established in the first clause quoted, of a member bank to charge actual expenses for collecting and remitting, would include a re mittance in payment of checks drawn on it and presented by the reserve bank ; or whether the term 'its patrons' in the second sen tence refers to those sending checks to the reserve bank and im plies that all expense of clearance of their checks is to be charged back to them were questions that did not require a deci sion since “... the later legislation, known as the 'Hardwick Amendment of Section 13 is directly applicable and controls. It provides that ‘nothing in this or any other section of this Act shall be construed as prohibiting a member or non-member bank from making reasonable charges, to be determined and regulated by the Federal Reserve Board, but in no case to exceed ten cents "Quotation is from the court's decision, not trom the Act. THE PAR COLLECTION CONTROVERSY 281 per $100 or fraction thereof, based on the total of checks and drafts presented at any one time for collection or payment and remission therefor by exchange or otherwise; but no such charges shall be made against the Federal reserve banks.' The complain ant argues that the last clause is in the nature of a proviso or exception wholly repugnant to the main enactment preceding it, and therefore void, leaving the grant of the right to make reason able charges unrestrained by the exception. Or, if the last clause is to be treated as a part of the main enactment equally with what precedes, that the two parts are so inconsistent as to render the whole legislation abortive, and leave Section 16 to control.” It was held that there is no such repugnance in the Hard wick Amendment as to cause either consequence, and that the right to make the charge is established as to checks sent for col lection or payment by other member banks or non-member banks, but it cannot be made against reserve banks. The court then con sidered the contention of the plaintiff that the charge is not made against a reserve bank unless such bank is the lawful owner of the checks dealt with, and that if it is handling them only as the agent of another, for collection, the charge is against the true owner and is to be passed back by the reserve bank to that owner. It was held that the proceedings of Congress in adopting the amendment show that par clearance through the reserve banks was the issue dealt with and that the Hardwick Amendment was made with the intent, and has the effect, to firmly establish it and give to the Federal Reserve System and to the public whatever advantage in clearing and collecting checks may flow therefrom, as well as to save the reserve banks from an expense in collecting their own checks. “ To forbid remittance charges against reserve banks means no more than that remittances to them shall not be diminished by such charges, without any inquiry, if that would be practicable, into the real ownership of the items remitted for. The reserve banks cannot recognize as proper such charges made against them, and in this sense are forbidden to pay them .” The third contention of the plaintiff that the Federal Reserve Bank of Atlanta cannot handle checks coming to it from sources outside the sixth district was held to be erroneous, since Section 13 of the Act specifically authorizes such procedure. Considering the contention that if the Act authorizes the deprivation of the complainant's right to charge for remittance, it takes its property without due process of law, contrary to the Constitution, the court ruled that " this takes none of the prop 282 CLEARING AND COLLECTION OF CHECKS erty or property rights of complainant without due process of law. Complainant may refuse to pay otherwise than in cash over its counter, according to the common law, as on the other hand, the reserve bank may insist on that sort of payment. What is lost is the right to agree on a compensation for a more convenient payment by draft on more accessible reserves when both parties are willing so to agree . That the State, having power over the State banker and his business, may regulate his method of receiv ing and paying out his deposits, was ruled in Farmers and Mer chants Bank of Monroe v. Reserve Bank of Richmond, 262 U. S. 649. A similar power must be recognized in the United States to regulate banking in the Federal Reserve System. Complainant being a National bank, chartered to do its business under Federal laws, cannot complain that those laws are not , or do not remain, such as it would prefer. It is not compelled to do anything with out compensation. It is simply told that if it does the thing in question it must be done without compensation. Noble State Bank v. Haskell , 219 U. S. 575." Nothing unlawful appearing in any of the acts of the defend ants complained of, a decree was taken dismissing the bill. While this decision is no more than could be expected with confidence, it undoubtedly will go far towards settling some aspects of the par collection controversy concerning which some doubt apparently existed. Regulation J amended as a result of the United States Supreme Court decisions of June 11 , 1923 In conformity with the United States Supreme Court's deci sion in the Richmond par collection case the Federal Reserve Board on June 29 amended Regulation J which governs the par collection system of the Federal reserve banks by inserting two new provisions in the regulation.92 This Regulation J, Series of 1923 , was to have been effective August 15, 1923, but on July 25 was postponed until further notice. It was finally suspended in definitely, Regulation J, Series of 1920, remaining in effect until Regulation J , Series of 1924, became effective on May 9, 1924. The new conditions inserted in Regulation J, Series of 1923, were : “ ( c) No Federal reserve bank shall receive on deposit for collec- . tion any check drawn on a non -member bank which refuses to remit at par in acceptable funds. ( d ) Whenever a Federal re Regulation J, Series of 1923, Federal Reserve Bulletin, Vol. 1X ( 1923 ) , pp . 903-905. THE PAR COLLECTION CONTROVERSY 283 serve bank receives on deposit for collection a check drawn bys indorsed by, or emanating from any non-member bank which re fuses to remit at par in acceptable funds, it shall make a charge for the service of collecting such check of 1/10 of 1 per cent., the minimum charge to be 10 cents for each item ." The reasons for this action as made public by the Board were, ( 1 ) that even though the recent court decision made the clearing and collection system voluntary so far as non-member banks are concerned, the system has fully justified its operation and is of such value to the banking and commercial interests of the country that its continuance as a voluntary system is of vital im portance ; ( 2 ) that since the system was designed wholly for the benefit of the banking and commercial interests of the country and is now ( July, 1923 ) so comprehensive in scope that it in cludes about 92 per cent . of all banking institutions and ap proximately 98 per cent . of the total banking resources of the country, and having shown its merits and inestimable value by its enormous saving to those actively engaged in carrying on the commerce of the country, by having eliminated a very large por tion of the time formerly consumed in the collection of checks, and by having cut down the cost of making the country's exchanges to the minimum , it should be supported by all who share in its ad vantages . The Board pointed out further that the more inclu sive a collection system is, the more efficient it will be, and the greater will be the service it can render alike to the business and banking community. Consequently the Board felt that non. member banks which are unwilling to remit without deduction for checks drawn on themselves have no right to share in the advan tages of the par collection system.. In November, 1923, the Federal Reserve Board made one other interesting ruling in order to conform to the fullest possible extent to the spirit as well as to the letter of the recent court deci sions . The Board directed the Federal reserve banks to discon tinue the use of agents other than banks for the purpose of mak ing collections at par of checks upon non -member remitting banks in any district in which such practice still existed.93 But as mentioned above, Regulation J, Series of 1923 , never became effective. Instead , it was replaced by Regulation J, Series of 1924. The reasons for this can be appreciated more fully only after reviewing briefly the so -called Malloy case. " Federal Reserve Bulletin , Vol. IX ( 1923 ) , pp. 773-774, 1194. 284 CLEARING AND COLLECTION OF CHECKS Federal Reserve Bank of Richmond v. Malloy et al., trading as Malloy Brothers94 The Malloy case is significant, not because of any very direct bearing upon the par collection controversy, but for two other important reasons which have but an indirect bearing upon the controversy. ( 1 ) It throws light upon the additional burdens placed upon the Federal reserve banks as a result of the decision in this case ; ( 2 ) it affords an explanation for some of the recent provisions incorporated in Regulation J, Series of 1924 . The facts in the case are briefly as follows : Malloy Brothers received a check for $9,000 drawn upon the Bank of Lumber Bridge, North Carolina, which they properly indorsed and depos ited with the Perry Banking Company of Perry, Florida, for col lection and credit. A credit card was delivered to the Malloys upon which was printed the following : “ Checks, drafts, etc., re ceived for collection or deposit, are taken at the risk of the en dorser until actual payment is received . " This provision was authorized by Florida law. The Perry Banking Company in dorsed and transmitted the check through two banks to the Fed eral Reserve Bank of Richmond, which sent it to the Lumber Bridge bank for collection and return. That bank stamped the check “Paid ,” charged the account of the drawer, and remitted to the Federal Reserve Bank of Richmond with a draft on the At lantic Banking and Trust Company, of Greensboro, North Caro lina , which returned the draft to the Federal reserve bank because of lack of funds . The Federal reserve bank then tried to collect on the Lumber Bridge bank, but that bank failed and did not pay the draft . The check was then charged back through the proper channels to the Malloys, who brought suit against the Federal Reserve Bank of Richmond for recovery . The Court deemed it necessary to consider two questions : ( 1 ) Could the action be maintained by the plaintiffs against the Federal Reserve Bank of Richmond ? and ( 2 ) If so, did the failure of the Richmond bank to require payment of the Malloy check in money, and its acceptance of what turned out to be a worthless draft in lieu thereof, create a liability against it in favor of the Malloy Brothers for the amount of the loss ? Regarding the first question the Court found the State deci sions in hopeless conflict . A number of States followed the so called “ New York Rule” and held that the initial bank alone is responsible to the owner. An equal number of States, on the *4 Sup. Ct . 296 ( 1924 ) ; 264 U. S. 160 ( 1924 ) . THE PAR COLLECTION CONTROVERSY 285 other hand, followed the “ Massachusetts Rule” which holds that the initial bank is authorized to employ sub-agents who become directly responsible to the payee. The Court held that the Florida statute had the effect of importing the “ Massachusetts Rule" and decided that the Federal Reserve Bank of Richmond was liable. Relative to the second question the Court ruled that “ It is settled law that a collecting agent is without authority to accept for the debt of his principal anything but that which the law de clares to be legal tender, or which is by common consent considered and treated as money, and passes as such at par' :95 Ward v. Smith, 7 Wall . 447, 452 ( 19 L. Ed. 207 ) . The rule applies to aa bank re ceiving commercial paper for collection, and if such bank accepts the check of the party bound to make payment and surrenders the paper, it is responsible to the owner for any resulting loss. It is unnecessary to cite other decisions since they are all practi cally uniform. Anderson v. Gill, supra , [ 79 Md. 312, 317 ] pre sented a situation practically the same as that we are here deal ing with, and the Supreme Court of Maryland, in disposing of it, said : ' Now a check on a bank or banker is payable in money, and in nothing else. Morse Banks & Banking ( 2d edition ), p . 268. The drawer having funds to his credit with the drawee has a right to assume that the payee will, upon presentation, exact in payment precisely what the check was given for, and that he will not accept, in lieu thereof, something for which it had not been drawn. It is certainly not within his contemplation that the payee should upon presentation, instead of requiring the cash to be paid, ac cept at the drawer's risk a check of the drawee upon some other banker. When the collecting bank being the did make demand it was only author ized to receive money ( Ward v. Smith, 7 Wall . 451 ) ; and the ac . agent of the holder . . ceptance by the collecting agent of anything else rendered it liable to the holder as though it had collected the cash .' ” Following the above reasoning, the Court held that the plaintiffs were en titled to recover from the Federal Reserve Bank of Richmond, and that there was nothing in Regulation J , Series of 1920, which authorized the Federal reserve banks to accept drafts instead of money as required by law. Even though it was customary to use drafts in making remittances, the Court held that a settled rule of law, rather than custom, established the principles to be fol lowed in this case. * Italics are the author's. 286 CLEARING AND COLLECTION OF CHECKS This decision placed the Federal reserve banks in a peculiar position. The Richmond par collection case established the prin ciple that drawee banks, under authority of a State statute, may remit to the Federal reserve banks by means of drafts if the de positor does not specifically object, since the bank's liability is to the depositor only and not to the holder of the check. The Malloy decision now holds that the Federal reserve banks cannot accept legally anything but money in remittance without assuming liabil ity to the payee, or unless specifically authorized to do so by the payee. The result of this decision is that the Federal reserve banks may no longer collect on such banks as those in North Caro lina, or elsewhere for that matter, without assuming great risk. Regulation J, Series of 1924 In order to remove the Federal reserve banks from this pre dicament , the Federal Reserve Board, on May 9, 1924, issued the new Regulation J, Series of 1924, which includes, among other things, the following provisions : “ Section III. (3 ) No Federal reserve bank shall receive on deposit or for collection any check drawn on any non -member bank which cannot be collected at par in funds acceptable to the Federal reserve bank of the district in which such non-member bank is located .” “ Section V. Terms of collection “ The Federal Reserve Board hereby authorizes the Federal reserve banks to handle such checks subject to the following terms and conditions ; and each member and non -member clearing bank which sends checks to any Federal reserve bank for deposit or collection shall by such action be deemed ( a ) to authorize the Fed eral reserve banks to handle such checks subject to the following terms and conditions, (b) to warrant its own authority to give the Federal reserve banks such authority, and ( c ) to agree to indem nify any Federal reserve bank for any loss resulting from the failure of such sending bank to have such authority . “ ( 1 ) A Federal reserve bank will act only as agent of the bank from which it receives such checks and will assume no lia bility except for its own negligence and its guaranty of prior indorsements. “ ( 2 ) A Federal reserve bank may present such checks for payment or send such checks for collection direct to the bank on which they are drawn or at which they are payable, or in its dis cretion may forward them to another agent with authority to pre THE PAR COLLECTION CONTROVERSY 287 sent them for payment or send them for collection direct to the bank on which they are drawn or at which they are payable. “ ( 3 ) A Federal reserve bank may in its discretion and at its option, either directly or through an agent, accept either cash or bank drafts in payment of or in remittance for such checks and shall not be held liable for any loss resulting from the acceptance of bank drafts in lieu of cash , nor for the failure of the drawee bank or any agent to remit for such checks, nor for the non payment of any bank draft accepted in payment or as a remit tance from the drawee bank or any agent. “ ( 4 ) Checks received by a Federal reserve bank on its mem ber or non-member clearing banks will ordinarily be forwarded or presented direct to such banks, and such banks will be required to remit or pay therefor at par in cash or bank draft acceptable to the collecting Federal reserve bank , or at the option of such Fed eral reserve bank to authorize such Federal reserve bank to charge their reserve accounts or clearing accounts ; provided, however, that any Federal reserve bank may reserve the right in its check collection circular to charge such items to the reserve account or clearing account of any such bank at any time when in any par ticular case the Federal reserve bank deems it necessary to do so. “ (5 ) Checks received by a Federal reserve bank payable in other districts will be forwarded for collection upon the terms and conditions herein provided to the Federal reserve bank of the dis trict in which such checks are payable. “ (6 ) The amount of any check for which payment in actually and finally collected funds is not received shall be charged back to the forwarding bank , regardless of whether or not the check itself can be returned ." 96 It should be noticed, however, that the provisions do not pro tect the banks and trust companies of the country against the pos sibility of loss under the law established by the Malloy case, for the reason that under the provisions of Regulation J, Series of 1924, each member and non -member clearing bank which sends checks to any Federal reserve bank for collection authorizes the Federal reserve bank to handle such checks according to the pro visions of the Regulation, warrants its own power to give such authority to the Federal reserve banks, and agrees to indemnify any Federal reserve bank for any loss resulting from the failure of the sending bank to have such authority. But this leaves the member and non -member clearing banks open to great risk unless * Federal Reserve Bulletin, Vol . X ( 1924 ) , pp. 489-490 . CLEARING AND COLLECTION OF CHECKS 288 they can enter into agreement with their depositors by which the depositors agree to permit them to make collections according to the terms outlined in Regulation J. The National Bank Division of the American Bankers' Association in June, 1924, recom mended a form of contract which appears to cover all these points. Various clearing house associations and many banks individually have adopted other forms of contract which are similar in most respects. Such contracts should be printed upon deposit slips, credit advices and pass books of the bank in order that there may be no question that the depositors are bound by the terms of the contract.97 Conclusion Certain definite principles may be said to have been estab lished relative to the operation of the Federal reserve clearing and collection system as a result of these court decisions. 1. The Federal Reserve Act so far as it affects the clearing and collection system is not mandatory in nature and does not compel the Federal Reserve Board or Federal reserve banks to make the system universal . 2. Federal reserve banks are not obliged to receive and attempt to collect checks drawn on banks which will not remit at par . Federal reserve banks may receive and attempt to collect 3. checks on banks which will not remit at par by presenting the checks directly over the counters of such banks through the use of collecting agents, provided the Federal reserve banks do not use this method to oppress or coerce, by collecting an unusual amount of checks for presentation or by indulging in any other practice not consistent with customary banking methods.98 4. So far as the non -member banks are concerned the Federal reserve clearing and collection system is entirely voluntary. 5. Federal reserve banks may not include on their par lists the names of non -member banks which do not agree voluntarily to remit at par and do not sanction the publication of their names. All member banks, obviously, are par banks. 6 6. Federal reserve banks cannot lawfully demand payment in For an additional discussion of this subject, see H. F. Strater, “ Develop ment and Functions of Federal Reserve Collection System ," Proceedings of Departmental Conferences held at Baltimore Convention of the American In stitute of Banking ( July, 1924 ) , pp. 367-369 . It is to be borne in mind, however, that Section III of Regulation J, Series of 1924, provides that no Federal reserve bank shall receive such checks on de posit or for collection. THE PAR COLLECTION CONTROVERSY 289 legal tender if a State law, which supersedes the common law, per mits the non-member banks to make arrangements with their de positors to remit in some other form, since the debt of the bank has been held to be solely to the depositor of the bank and not to the holder of the check, and if the depositor and drawer of the check consents to have the bank pay the holders of his checks by some means other than legal tender, the legal tender provisions of the Constitution which prohibit a State from making anything but gold and silver coin аa tender in payments, are not violated . 7. If aa State statute authorizes the non-member banks to pay by some means other than legal tender, the Federal reserve banks, as collecting agents, become liable to the payee banks for accepting anything other than legal tender unless they have an agreement with the payee banks by which they are relieved of the liability. In the latter case the payee banks become liable to the depositors unless they, too, have a similar agreement with the depositors.99 It is, of course, hazardous to guess as to the results which finally will flow from such decisions as those rendered in the Rich mond par collection and Malloy cases. There is a rather general feeling among competent judges, however, that the system of par collections can never be a success and be incomplete, and that it must go either forward or backward . Many non-member banks joined the system expecting that the remaining banks would enter in due time. Encouraged by these court decisions, the recalcitrant banks will not only not enter the system but will be the cause, doubtless, of others dropping out and much ground that has been gained so laboriously will be lost. It seems unfortunate that the new Regulation J does not embody a provision similar to that inserted in the Regulation J, Series of 1923, to the effect that a Federal reserve bank may not receive on deposit for collection a check drawn by, indorsed by, or emanating from any non-member bank which refuses to remit at par in acceptable funds. This would prevent the non-par banks from securing the benefits of the Federal reserve clearing and collection system while at the same time exacting charges for making remittances. Depriving them of the gains which result from their parasitic relations with the system , might drive them into the system , which , undoubtedly, It seems that it might have simplified matters if the liabilities of the Fed eral reserve banks as collecting agents were determined in conformity with the various State laws, that is, that the Federal reserve banks were to incur no liability for accepting in remittance that which a State has decided is legal . Thus, in some States the Federal reserve banks would be required to accept cash only, in others, such as North Carolina, drafts would be acceptable. v 290 CLEARING AND COLLECTION OF CHECKS would be to their advantage ultimately . If they are shut out of the system in this manner, competition would be more effective in forcing them into the system, since the tendency would be for de positors to move their deposits to par banks. The insistence by these recalcitrant banks upon their so-called right to charge ex change may cost them dearly in the end. They have placed them selves directly across the path of banking progress and are at tempting to levy a tribute upon business, while progressive ten dencies in business and banking indicate that such charges should be eliminated and that a more equitable method can be found for distributing the burden . The par collection principle is not an arbitrary plan devised by Congress and imposed upon the banks of the country. It has been developing gradually as the wisdom of it became more evi dent . Many banks remitted at par prior to the establishment of the Federal Reserve System. Country clearing houses were being established in many parts of the United States for the purpose of reducing or eliminating exchange charges. It is the result of changing and progressive banking methods, based upon sound principles, and it is unfortunate that it is not permitted to de velop to its logical conclusion. Consequently, it would seem alto gether wise - assuming that such a measure would be constitu tional—if the Federal Reserve Act could be amended so as to make par remittances mandatory and thereby nullify the obstruc tive State laws which are arresting the logical development of an efficient system . CHAPTER VIII THE GOLD SETTLEMENT FUND Nature of the Gold Settlement Fund At the apex of the clearing and collection system is the Gold Settlement Fund established in May, 1915. It acts, as it were, as the keystone binding together the Federal reserve banks and their branches into an unified inter-district clearing system ; these banks, in turn, act as clearing centers for their member and non member clearing banks. The Fund is one owned by the Federal reserve banks and held by the Treasurer of the United States in the name of the Federal Reserve Board . Closely connected with the Gold Settlement Fund, but to be distinguished from it, is the Federal Reserve Agents' Fund. It is held in the same manner by the Treasurer of the United States to the credit of the Federal Reserve Board, but is controlled by the Federal reserve agents. The Gold Settlement Fund proper is the fund through which the inter-district clearing of checks and drafts is effected and is the fund to be associated primarily with this and other closely allied functions, such as telegraphic transfers, growing out of any inter district transfer of funds. The Federal Reserve Agents’ Fund was designed to facilitate transfers between the Federal reserve banks and their own Federal reserve agents necessitated by the issue of Federal reserve notes . Ownership in these funds is represented by entries on books maintained by the Federal Reserve Board with corresponding en tries on books kept by the Federal reserve banks and Federal re serve agents, respectively. Ownership is transferred by book en tries from one bank to another, from an agent to his bank, or from a bank to its agent with a minimum movement of gold or gold certificates. Transfers of claims are effected speedily by tele gram with the minimum of friction and expense. The system rep resents the utmost refinement in clearing. Inter - district clearing before the creation of the Fund Although the Federal reserve banks began to operate in 1914, many of the functions later assumed were developed only grad 291 292 CLEARING AND COLLECTION OF CHECKS ually. This was the case with the inter-district clearing and col lection system. The legal provisions contemplated only in a gen eral way the final organization of the system. Section 16 of the Federal Reserve Act provided for inter-district clearing of unde fined extent and authorized the Federal Reserve Board itself to act as a clearing house for the several Federal reserve banks or to designate one of the Federal reserve banks to perform the service. ' It has been pointed out elsewhere that the Board believed it the part of wisdom to proceed cautiously in order not to disturb unduly the established practices and consequently permitted the Federal reserve banks to free themselves from any obligations rel ative to clearing and collections while they devoted themselves to the collection of installments of subscriptions to capital stock and effected a more complete organization in other respects. Member banks were expected and advised to use the old and customary methods for clearings and collections, although some checks were collected through the newly -organized Federal reserve banks. With the payments of capital subscriptions and the required re serves , many checks were received on certain designated cities. It was found expedient to accept such checks in order not to create undue disturbance, although subscriptions to stock were to be made in gold or gold certificates and reserve-deposit payments were to be made in gold or lawful money, except that the Federal reserve banks were authorized to receive from member banks not exceeding one-half of each installment in eligible paper as de scribed in Section 14 of the Act, properly indorsed and accept able to the Federal reserve banks. Notwithstanding the restricted nature of the business con ducted at that time, balances in excess of the required reserves were created, and checks against these balances found their way into other districts. No special machinery had been set up to effect settlements between the Federal reserve banks other than the fact that they carried reciprocal accounts with each other and it was generally understood that any Federal reserve bank had the right to require a remittance in gold of any other Federal reserve bank if such a payment were needed to settle accounts between the two banks. See First Annual Report of the Federal Reserve Board ( 1914 ) , pp. 19-38. 'See The Collection of Checks by the Federal Reserve Banks, Letter No. 3, Federal Reserve Bank of Richmond ( February , 1922 ) , pp . 1-2, hereafter cited as Letter No. 3 ; and The Gold Settlement Fund, Letter No. 7, Federal Re serve Bank of Richmond ( September, 1922 ) , p. 2, hereafter cited as Letter No. 7. The author of these excellent letters is Mr. Charles A. Peple, senior Deputy Governor of the Federal Reserve Bank of Richmond. The letters THE GOLD SETTLEMENT FUND 293 During this time when the Federal reserve banks maintained reciprocal accounts with each other, each bank gave careful atten tion at all times to the state of the accounts between it and other Federal reserve banks . By shifting debits and credits all balances. were kept within reasonable limits. The competent writer of the series of letters on the Federal Reserve System for the Federal Reserve Bank of Richmond gives an example of the equalization of balances by the shifting of credits as follows : “ If the Federal Reserve Bank of Richmond owed the Federal Reserve Bank of New York one million dollars and, at the same time, the Federal Reserve Bank of Cleveland Bank of Richmond a million dollars, send the New York Bank a draft on New York Bank would then forward owed the Federal Reserve the Richmond Bank could the Cleveland Bank . The the draft to the Cleveland Bank, charging the account of the Cleveland Bank. If this cre ated an undesirably large balance against Cleveland and in favor of New York, Cleveland could correct the situation by trans ferring its claim on some other Federal reserve bank ." 3 Although the creditor bank had the right to require the debtor bank to ship gold at any time to cover the debt, but few, if any, such shipments were actually made. Steps leading to the creation of the Gold Settlement Fund Prior to the organization of the Federal reserve banks a re port was made to the Reserve Bank Organization Committee, pro vided for by the Act, by the Preliminary Committee on Organiza tion. This committee suggested, among other things, that a Fed eral Reserve Clearing House be established and that each Federal reserve bank deposit a certain amount of gold with the Federal Reserve Board or with a Federal reserve bank, to be designated by the Board to act as a clearing agent, and to settle balances arising from time to time between Federal reserve banks by means of book balances on books to be kept by the settling agent or by actual certificates of ownership in the special gold fund, the cer tificates to be issued by the settling agent. It also suggested that settlements be effected weekly." During the preliminary period of organization the Federal are subjected to the criticism of the various officers of the bank and submitted to the Governor for his approval, after which they are issued in the name of the Federal Reserve Bank. 'Letter No. 7, p. 3. ' Ibid . 'Ibid. 294 CLEARING AND COLLECTION OF CHECKS Reserve Board and officers of the Federal reserve banks were studying a number of plans for effecting settlement between the Federal reserve banks. At the first conference of Governors held in Washington, December 10-12, 1914, a special committee was appointed to study the subject and report to the next conference. At the second conference the report of the committee was re ceived, discussed by the conference, and with several amendments was submitted to the Federal Reserve Board. This plan was sub stantially that outlined in the report of the Preliminary Commit tee on Organization, though many details had been considered and conclusions with reference to such details were submitted by the conference. The Board took the matter under advisement, but did not effect final arrangements until April, 1915, when it was announced that the plan had been completed and was expected to become effective about the middle of May of that year. Provisions for the Gold Settlement Fund Tentative suggestions had been made by the Federal Reserve Board in Circular No. 8, issued October 17, 1914, looking for ward to the establishment of a central clearing house at Wash ington in order to make the facilities for the collection of checks nation-wide, yet definite steps towards its creation were not taken until May, 1915. As a result of the conferences, mentioned above, and careful study on the part of the Board, a definite plan was submitted to the Federal reserve banks on May 8, 1915. On that date the Board issued a circular of regulations for the8 establishment and operation of the Gold Settlement Fund . According to the provisions of this circular each Federal reserve bank was required to forward, not later than May 24, 1915, to the Treasury or the nearest sub-treasury, for credit to the ac count of the Gold Settlement Fund, $ 1,000,000 in gold, gold cer tificates, or gold order certificates, and, in addition, an amount at least equal to its net indebtedness due to all Federal reserve banks. Upon the receipt of these funds the United States Treas urer was to issue to the Federal Reserve Board gold order certifi cates in denominations of $ 10,000, made payable to the order of the Federal Reserve Board, covering the sum so deposited. Each Federal reserve bank was required to maintain a balance in the Gold Settlement Fund of not less than $1,000,000, and excess bal °Held in Washington , January 20-23, 1915. ' Letter No. 7, p. 3. 'Regulation L , Circular No. 13, Series of 1915. See Second Annual Report of the Federal Reserve Board ( 1915) , Exhibit E , pp. 77-79. THE GOLD SETTLEMENT FUND 295 ances, at the convenience of each Federal reserve bank might re main deposited with the Gold Settlement Fund or be withdrawn at will . Should the debit balance of any Federal reserve bank be in excess of its credit in the Gold Settlement Fund this deficit was to be covered immediately by the deposit of gold, gold certificates, or gold order certificates in the Treasury or nearest sub -treasury, or by credit operations with other Federal reserve banks which might have an excess balance with the Gold Settlement Fund . At all times each Federal reserve bank was required to have a balance of $1,000,000, and any delay beyond a week of grace in restoring the balance was to be subject to such charge as the Federal Re serve Board might impose. On the other hand, any excess balance, on request of any Federal reserve bank , would be refunded in any one of three ways: ( 1 ) By return to the Federal reserve bank of gold order certificates properly indorsed, ( 2 ) by the indorsement and delivery to the United States Treasurer of a like amount of such certificates for which he would give in exchange bearer gold certificates which the Federal Reserve Board would send to the Federal reserve bank by registered mail, or ( 3 ) the Treasurer, by wire or mail , might direct that payment be made by a sub-treasury office through the medium of the general account , provided funds were held in such office available for the purpose. Gold order cer tificates, when presented to the Treasury or any sub-treasury and bearing the signature of the duly authorized officers of the Fed eral reserve bank , were payable in gold or gold certificates. Any expense incurred by the Treasurer in shipping funds for such set tlement purposes from one section of the country to another was to be refunded by the Federal Reserve Board. The Board then apportioned, semi-annually, the expenses of currency shipments as well as the general cost of operation of the Fund among the Federal reserve banks . At least once in each three months an audit was to be made of the Gold Settlement Fund by a represen tative of the Federal Reserve Board and a representative ap pointed by the Federal reserve banks. The total amount of the Fund at any one time consisting of gold order certificates was to be kept in a safe in the Treasury vault, set apart for the exclu sive use of the Federal Reserve Board , and to be opened only in the presence of two persons designated by the Secretary of the Treasury and two persons designated by the Board . A proper vault memorandum was to be maintained . A settling agent and a deputy settling agent were appointed by the Board to keep all the necessary records and accounts. To ascertain the amount which each Federal reserve bank 296 CLEARING AND COLLECTION OF CHECKS should deposit, a preliminary settlement or clearing was made on Thursday, May 20, 1915, on the basis of figures reported by the Federal reserve banks at the close of business on the preceding day. On the evening of the 19th each Federal reserve bank ad vised the Federal Reserve Board by wire of the amounts, in even thousands, due by it to every other Federal reserve bank as of that date. On the next day the settling agent telegraphed to each Fed eral reserve bank the amount of credits to its settling account, giving the name of each bank from which such credits were re ceived , also the net debit or credit balance in the settlement. Con firmations of these telegrams were sent by mail after the receipt of these advices ; and not later than May 24, each Federal reserve bank remitted gold or gold certificates to the Board, directly or through the nearest sub-treasury, in an amount sufficient to cover its debit balance, if any, and to establish a credit balance of at The Federal reserve banks made their deposits with the nearest sub-treasury, after which the assistant treasurers forwarded telegraphic advices of the deposits to the least one million dollars. Treasurer of the United States, who, in turn, issued gold order certificates of $ 10,000 denominations, payable to the Federal Re serve Board. The total amount remitted at that time was $ 18, 450,000. The first regular settlement was made on Thursday, May 27, 1915.9 Each Federal reserve bank in its relations with other Fed eral reserve banks was required to keep an account showing bal ances " due to” other Federal reserve banks representing the pro ceeds of items which it actually had collected , and payments and transfers which had been made to it for the account of such other Federal reserve banks ; and an account showing balances “ due from ” other Federal reserve banks representing the proceeds of items which it had sent to such other Federal reserve banks, and payments and transfers which had been made to such other Fed eral reserve banks for its account. The gold in the Fund as part of legal reserve At the time the announcement of the plan was made, the Board also communicated to the Federal reserve banks an opinion pre pared by the counsel of the Board, to the effect that, under the law, gold held in the Gold Settlement Fund for the account of a Federal reserve bank could be counted by that bank as a part of its required reserve. 10 ' Federal Reserde Bulletin, Vol . I ( 1915 ) , p. 82. Ibid., pp . 9-11 . THE GOLD SETTLEMENT FUND 297 Provision originally made for weekly settlements The original system provided for weekly settlements through the Gold Settlement Fund, a method employed until July 1 , 1918, when daily settlements were instituted. At the close of business each Wednesday night, each Federal reserve bank was required to telegraph to the Federal Reserve Board the amounts in even thousands due to each other Federal reserve bank as of that date. The telegram was confirmed by mail. If Wednesday happened to be a holiday, the telegram was to be telegraphed at the close of business on Tuesday. The settling agent, on each Thursday, made the proper debits and credits in the accounts of the Fed eral reserve banks with the Fund and telegraphed each bank the amount, in even thousands, of credits to its settlement account, giving the name of each Federal reserve bank from which each of its credits was received and also its net debit or credit balance in the weekly statement . Upon receipt of the telegram from the settling agent each Federal reserve bank charged its appropriate deferred credit account and credited the Gold Settlement Fund with the amount reported by it to the settling agent ; it also charged its Gold Settlement Fund account by the total amount of the credit received , in accordance with the telegram from the settling agent, and credited this amount to its deferred debit account . The difference between the total debits and credits should equal the net debit or credit to the Gold Settlement Fund as advised in the telegram from the settling agent . The same general principles obtain today except that settlements are made on a daily rather than weekly basis. The voluntary intra -district system and the Gold Settlement Fund It has been pointed out already that the Federal reserve banks at the request of the Federal Reserve Board introduced the volun tary intra-district clearing and collection system in June, 1915, and that it functioned in a half -hearted manner until July, 1916. While the operation of this plan did not primarily involve rela tions between Federal reserve banks, such relations were indi rectly involved. Clearings under the plan depleted the reserve accounts of some member banks and resulted in excess balances in the reserve accounts of other member banks. Adjustments be tween such banks had to be made by remitting in the one case or by checking against the excess reserves in the other. Checks on one Federal reserve bank were received for credit by other Fed eral reserve banks. Also, under a special arrangement , Federal CLEARING AND COLLECTION OF CHECKS 298 reserve banks continued to accept exchange on certain designated reserve cities. These transactions, in so far as they affected ac counts between Federal reserve banks, tended to increase the volume of the weekly settlements through the Gold Settlement Fund . In addition , Federal reserve banks had the privilege of mak ing special transfers to other banks of balances in excess of the required million and these transfers were effected by book entries upon telegraphic or mail requests from the Federal reserve bank making the transfer. In such cases the two Federal reserve banks affected by the transfer were allowed to make their respective debits and credits only upon receipt of specific authority to do so, which authority was sent by wire by the settling agent of the Federal Reserve Board. During the week ending June 25, 1915, the Federal Reserve Bank of San Francisco transferred in this way to the Federal Reserve Bank of Boston $200,000. During the week ending July 1, 1915, this same bank made two transfers, $ 450,000 to the Federal Reserve Bank of New York and $30,000 to the Federal Reserve Bank of Chicago. After that time trans fers between Federal reserve banks became more frquent. During the period when settlements were made weekly, a Federal reserve bank had the right to require a remittance or a transfer between settlement dates to cover any large balance due to it by some other Federal reserve bank.11 The first withdrawal from the Gold Settlement Fund was made on July 14, 1915 , by the Federal Reserve Bank of Chicago. Its telegram requesting the payment was received by the Federal Reserve Board at 10:30 A. M. and at 2 P. M. on the same day the Assistant Treasurer of the United States at Chicago advised the bank of his readiness to make the payment. Although in a number of cases thereafter such withdrawals occurred from time to time, the convenience and usefulness of the Gold Settlement Fund became more and more apparent as time went on, and there developed a tendency to allow credit balances to accumulate, so that the Fund passed the one hundred million dollar mark on November 18 , 1915.12 Results for the year 1915 Through the procedure thus provided, the Federal Reserve Board, up to the close of the year 1915, settled through the Gold "Letter No. 7 , p. 6. " Ibid . 299 THE GOLD SETTLEMENT FUND Settlement Fund for the Federal reserve banks an indebtedness aggregating $1,052,649,000 with a net change of only $ 85, 697,000 in ownership of the gold 13held in the Fund, or 8.14 per cent . of the total amount cleared . The total amount of intra district clearings amounted to $5,442,123,252.14 The direct ex pense incidental to the administration of the Gold Settlement Fund in handling its transactions was approximately $1,150, principally for equipment and telegraph service. Another fea ture noteworthy from the very beginning of the operation of the system has been the general avoidance of the necessity for the shipment of funds. The growth of the transactions through the Gold Settlement Fund as well as the changes in ownership , cost of operating, etc. , are set forth in the table on page 318 below . The Federal Reserve Agents' Fund It will be recalled that Federal reserve notes were originally secured by 100 per cent. commercial paper and at least 40 per cent. gold and at present are secured by at least 40 per cent . gold combined with at least enough commercial paper to make 100 per cent.. security. This means that from the beginning of the issue of Federal reserve notes each Federal reserve agent had the cus today of more or less gold held as part security for the notes, since he must hold at least 35 per cent . in gold against the outstanding notes, the remaining 5 per cent. being deposited with the Treas urer of the United States as a redemption fund . As the issues of these notes increased, аa considerable amount of gold found its way into the hands of the Federal reserve agents. The transactions involving the issue and retirement of Federal reserve notes neces sitated frequent payments in large sums from the bank to the agent and from the agent to the bank . When these payments were made in gold or gold certificates much counting and recount ing was necessary on the part of the employees of the bank and representatives of the Federal reserve agents. After the estab lishment of the Gold Settlement Fund it became obvious that it would be advantageous to apply the same principle to the Federal reserve agents' reserve funds in order to eliminate much of the counting and recounting of gold and gold certificates. In September, 1915, as a result of a resolution by the Federal Reserve Board , a gold fund called the Federal Reserve Agents' Fund was established , in close co -operation with but not a part of " Second Annual Report of the Federal Reserve Board ( 1915 ) , pp. 79, 80 . "Ibid., p. 82. CLEARING AND COLLECTION OF CHECKS 300 the Gold Settlement Fund.15 The settling agent and deputy settling agent of the Federal Reserve Board were authorized and directed to open and maintain on their books and records a dis tinct and separate account for each Federal reserve agent, and to receive from the Federal reserve agents or from the Federal reserve banks for the accounts of the agents, deposits of gold cer tificates to be held subject to the order of the Federal reserve agent for whom such deposit had been made. The safe keeping of all deposits so received and the withdrawal or transfer of them to the account of the Federal reserve bank or to the redemption fund account held by the Treasurer of the United States, upon the order of the Federal reserve agent, and all indorsements of gold order certificates incidental to the transfers of such funds, were subject to the same regulations as those which applied to the oper ation of the Gold Settlement Fund . The accounts and records of this Fund were to be kept sepa rate at all times from the records and accounts of the Gold Set tlement Fund. The gold order certificates, representing the Fed eral Reserve Agents' Fund, which was held by the Federal Reserve Board, were separated from those representing the Gold Settle ment Fund which was held also by the Federal Reserve Board. Consequently when transfers were made from an agent to his bank or from a bank to its agent, it was necessary for the representa tives of the Board to make an actual shift of gold order certifi cates from one safe to another, or from one compartment in a safe to another compartment. This practice involved much counting and handling and proved a great burden. Whenever a transfer was made it was necessary for the two representatives of the Federal Reserve Board and the representatives of the Treas ury Department to be present at the opening of the safe. Such payments were made from one fund to the other as well as from either fund to the Treasurer of the United States and with the increase of these transactions the burdens increased until a change in method became imperative . The Federal Reserve Bank of Atlanta was the first to make such a transfer under this old system . On September 8, 1915, the day on which the books were opened for business, $2,500,000 18The balances in the Gold Settlement Fund of the Federal reserve banks and in the Gold Fund of the Federal reserve agents, which are held at present by the United States Treasurer in trust for the Federal reserve banks and agents, are combined and shown as one figure in the daily statement of the United States Treasury, but the two funds are separate and distinct, and are so treated by the Federal Reserve Board and the Federal reserve banks and agents. THE GOLD SETTLEMENT FUND 301 were passed from the account of the Gold Settlement Fund to the credit of the Federal reserve agent of the Atlanta bank. Simul taneously, the Federal reserve agent of the Atlanta bank released to that bank the same amount in gold or gold certificates held by him at Atlanta. The second bank to make use of this facility was the Federal Reserve Bank of Richmond, the amount of the trans fer being $2,600,000 from the account of the bank to the account of the agent.16 Discontinuance of gold order certificates, June 21, 1917 On June 21 , 1917, Congress, upon the recommendation of the Federal Reserve Board, amended Section 16 of the Federal Reserve Act for the purpose of simplifying the operations of the Fund, which had grown to such proportions as to make the handling of gold certificates evidencing deposits of Federal reserve banks and Federal reserve agents a heavy responsibility. According to the new plan, the Treasurer of the United States opened an account with the Federal Reserve Board, giving credit to the Board for the sum of the deposits of Federal reserve banks and Federal reserve agents. The accounts of the two funds were kept separate as formerly by the Federal Reserve Board. When a Federal reserve bank or Federal reserve agent desired to make a deposit for credit in the Gold Settlement Fund, the gold was de livered to the nearest sub-treasury. The Assistant Treasurer gave a receipt, the form of which was prescribed, and advised the Treasurer of the United States by wire. The Treasurer then issued a duplicate receipt to the Federal Reserve Board, and credit was given on the books of the Gold Settlement Fund to the Federal reserve bank or Federal reserve agent who had made the deposit. Payment out of the Fund was to be directed by the Fed eral Reserve Board and was in the form of checks drawn by the Treasurer of the United States and endorsed by officials of the Federal Reserve Board. 17 The Treasurer of the United States who had formerly received the gold and issued gold certificates in denominations of $10,000 each against it, still received and re tained the gold , but instead of issuing certificates in large num bers one receipt was given for the lump sum . The advantages of the new method soon became manifest. The Federal Reserve Board was not only relieved of a considerable 10George J. Seay , “ The Evolution and Practical Operation of the Gold Settlement Fund,” The Annals of the American Academy of Political and Social Science, Vol. XCIX ( January, 1922 ) , pp. 100-101 ; Letter No. 7, p. 7 . 17Fourth Annual Report of the Federal Reserve Board ( 1917 ) , p . 24. Year 1,589,500 924,000 755,000 1921 1922 1923 Dec. 30 . D .' ecember 31 December 30 . D .‘ ecember 28 .'December 29 675,440 1918 565,704 609,502 498,585 487,372 1,060,700 1920 165,000 451,350 1,023,854 492,900 148,500 1,011,370 1919 1917 1916 21,480 411,087 1,011,831 D8-(S).3ept. 1ec 4,400 27,320 1915 Gold Reserve . Board Federal of Reports Annual the from Compiled 1,651,210 1,326,816 1,140,000 1,479,640 1,118,300 94,520 852,881 1,512,297 52,460 Total 1,559,285 2,176,872 1,533,502 1,320,704 1,686,810 48,800 with 1,288,500 1,819,716 1,644,640 1,569,650 2,675,064 Total Percentage urer of the United States and the Federal Reserve Board ; bal funds no longer existed . Accounts were kept between the Treas 56,860 28.89 withdra deposit bank bank to from 31 Dec. from notes swals serve busines rs Federal Transfesrs transfe re Gold at includi against held of close ng of balance Balance deposits to total gold drawals Pon of in Reserve ’F' ercentage Agents total to und held gold Federal against notes Dec. .reserve 29 Pheld of in Reserve Agents ’F'onercentage Dec. und gold total to 31 against Federal notes reserve 102,580 36.3 489,9494 62.7 * % 960,031 74.56 886,327 71.6 892,6926 69.99 * 74.8 " 1,381,524 1,712,0998 77.85 ? 1,648,894 78.33 AGENTS RESERVE FEDERAL THE OF OPERATIONS 1'FUND SUMMARY TRANSACTIONS OF BY ,1915-1923 YEARS dollars [In of )thousands TABLE XXVI 302 CLEARING AND COLLECTION OF CHECKS amount of detail, but the necessity for periodic audits of the THE GOLD SETTLEMENT FUND 303 ances could be verified and certified to in detail if necessary . The Federal Reserve Board gives an idea of the size of the two funds at the time the transfer was made in 1917 in the following descrip tion of the transaction : " Some idea of the magnitude of the fund may be formed from the fact that a truckload of gold certificates was transferred from the Federal Reserve Board to the Treasury of the United States. It took three men over two days to place a stamped endorsement upon the certificates. Had the amount represented been in the form of gold it would have weighed 963 short tons. " 18 Although the balances of the Federal reserve banks for clear ing and collection purposes and of the Federal reserve agents for security against Federal reserve notes were and are kept sepa rately on the books of the settling agent in charge of the funds, common terminology is inclined to include both in the term “ Gold Settlement Fund.” The two funds should be distinguished clearly in the reader's mind. The leased wire system , June 4 , 1918 All communications between the Federal reserve banks by means of telegrams prior to June, 1918, were sent over the com mercial wires ; and practically all communications between the Board and the banks were by telegram. While the service, on the whole, was very prompt and efficient, delays had occurred fre quently, and as the number of transactions increased it became apparent that some better arrangement was necessary. After a study of the situation, a plan was perfected by which all the Fed eral reserve banks and branches and the Federal Reserve Board were put into instant communication with each other by means of a leased wire system to be used exclusively by the Federal Reserve Board, the Federal reserve banks, and the Treasury Department. The system was opened on June 4, 1918. Each bank and branch as well as the Federal Reserve Board has its own telegraph operators.19 As indicated in Chapter VI, Wash ington and Chicago were made relay points for the East and West respectively. The Federal Reserve Bank of Chicago was given charge of the operations of the system, and the chief tele graph operator is stationed at the Chicago office, with a super vising operator at Washington as an assistant.20 18Federal Reserve Bulletin , Vol . III ( 1917 ) , p . 521 ; Letter No. 7, pp. 10-11 ; George J. Seay, op . cit., p. 102. " Letter No. 7, p. 11 . * Fifth Annual Report of the Federal Reserve Board ( 1918 ) , pp. 558-559 . 304 CLEARING AND COLLECTION OF CHECKS The telegraphic transfer system It has been pointed out in a previous chapter21 that while telegraphic transfers of funds for member banks had been made as early as 1915, the Gold Settlement Fund as a central medium through which Federal reserve banks could transfer funds for their member banks did not become of prime importance until 1917 and especially after the introduction of the leased wire system in June, 1918. By June 10, 1918, or shortly thereafter, the Federal reserve banks advised their member banks of their readi ness to render them such a service free of charge. The system of telegraphic transfers was designed primarily to effect the speedy transfer of large funds between Federal reserve banks, member banks, or individuals. It virtually eliminates the time element and constitutes the highest achievement in the method of settling distant claims. The table on page 318 will give a condensed idea of the growth of the transfers effected through the Gold Settle ment Fund. Such transfers are included in the daily settlements made through the Gold Settlement Fund. Relation of the Gold Settlement Fund to rediscounting between Federal reserve banks Rediscount transactions carried on between Federal reserve banks are effected through the Gold Settlement Fund, but en tirely independent of the settlements made through the Fund as a result of the clearing and collection of checks. A brief account of rediscount transactions by which reserves may be equalized between Federal reserve banks has been given above on pages 216-217 . The Federal reserve bank requiring the rediscount wires the Federal Reserve Board, stating the amount needed and the character of the paper offered . The Board assigns the redis count to some other Federal reserve bank which the Board knows has a surplus reserve. This assignment is in the nature of a re quest rather than a requisition, although the Board has the power to require one Federal reserve bank to rediscount for another. Upon receipt of this advice, the second Federal reserve bank transfers the gross amount through the Gold Settlement Fund to the credit of the Federal reserve bank requiring the rediscount. This transfer is made at any time and is not included in the regu lar daily settlements growing out of the clearing and collection of checks. The discount is calculated by the bank requesting the rediscount and later is verified by the other Federal reserve bank, 21See Chapter VI , pp. 208-211 . THE GOLD SETTLEMENT FUND 305 to be handled as an ordinary credit and to be cleared through the Gold Settlement Fund on the next settlement day. Maturing dis counts are paid, in like manner, through the Gold Settlement Fund, also independently of the regular settlements.2 In their Annual Report for 1919 the Federal Reserve Board pointed out that it “ has carried out its policy of equalizing as far as practicable the reserve position of the several Federal re serve banks. All rediscount transactions and sales between Fed eral reserve banks have been arranged by the Board under author ity of Section 11 of the Federal Reserve Act, which provides that a Federal reserve bank may be permitted or, upon the affirmative vote of at least five members of the Federal Reserve Board, re quired to rediscount the discounted paper of another Federal reserve bank at rates of interest fixed by the Federal Reserve Board. There has, however, been such a spontaneous spirit of co-operation between the Federal reserve banks that all trans actions suggested by the Federal Reserve Board have been made voluntarily, and in no case has the Board found it necessary to exercise its statutory power to require such operations. By means of the Federal reserve leased-wire system rediscount trans actions have been consummated almost instantaneously. All pay ments have been made on the day the transactions were com pleted by direct transfers through the Gold Settlement Fund, through book entries at the banks and at the office of the Board, without involving any physical transfer of gold ." 23 Rediscount transactions between the Federal reserve banks, as a rule, have not been negotiated by the banks themselves, but through the medium of the Federal Reserve Board, instructions being given by telegraph , and transfers incident to the operations have been effected in the same manner .?24 The statements made by the Board in 1918 and 1919 are equally true today. Daily settlements supplant weekly settlements in the Gold Settle ment Fund The next step in the evolution of the gold funds was the insti tution of daily instead of weekly settlements. The daily settle ment plan was put into effect on July 1 , 1918. Transactions had 22 Fifth Annual Report of the Federal Reserve Board ( 1918 ) , pp. 33-35 ; Letter No. 7, pp. 11-12 ; Practical Operation of the Gold Settlement Fund , Letter No. 8, Federal Reserve Bank of Richmond (October, 1922 ) , p. 4, here after cited as Letter No. 8. * Sixth Annual Report of the Federal Reserve Board ( 1919 ) , pp . 5-6. 2 Fifth Annual Report of the Federal Reserve Board ( 1918 ) , p. 3. CLEARING AND COLLECTION OF CHECKS 306 been increasing at such a rapid rate that the change became im perative. In addition to the weekly settlements, the Federal re serve banks had the privilege of demanding transfers at any time upon the net debit balance as shown in accounts with other Fed eral reserve banks, and these steadily increased. War financing caused a large increase in the volume of business between the Fed eral reserve banks . The sale of certificates of indebtedness and Liberty bonds, and subsequent redistribution of these funds among various centers in payment for munitions and supplies for the account of the United States and the allied governments, necessitated a large transfer of funds. Furthermore, the institu tion of the compulsory clearing and collection system combined with other measures to extend its scope had resulted in a larger use of the clearing, collection and transfer facilities.”25 It was a part of the plan of July, 1918, that the Board should receive figures from each bank and settling branch as soon as possible after the close of the day's business. Obviously, due to the differences in time between the eastern and western banks the reports received by the Board would be some hours apart. The Board, after receiving all the reports, would make the general settlement and send out wire advices to all the Federal reserve banks as soon as possible on the morning of the next day. Upon receipt of these advices appropriate entries were made by each Federal reserve bank as of that day. In other words, charges and payments through the Gold Settlement Fund were always one day late, and more than one day if Sunday or a legal holiday inter vened . As a result some Federal reserve banks carried an inter Federal reserve bank float on account of payments received by the correspondent Federal reserve bank one day in advance of payment through the Gold Settlement Fund . In order to elim inate this float a plan of evening settlements was installed on March 1 , 1920. The new arrangement, which is the present one, provided that each Federal reserve bank and direct settling branch should telegraph the Board the gross amount collected for the account of each other Federal reserve bank and direct settling branch before the final closing of the books for the day. The Board then makes the settlement the same day and dispatches telegrams to each bank and settling branch so as to reach them before the opening for business the following morning, when the necessary entries are made and their books finally closed as of the close of the preceding day.26 * Ibid ., pp. 32-35 . 20 Seventh Annual Report of the Federal Reserve Board ( 1920 ), p. 70. THE GOLD SETTLEMENT FUND 307 Certain branches of Federal reserve banks clear directly through the Gold Settlement Fund Since December 2, 1918, certain branches ( Class I ) 27 of Fed eral reserve banks have been authorized to make settlements di-. rectly through the Gold Settlement Fund in the same manner as the Federal reserve banks except that the net debit or credit bal ance of each such branch in the Fund is adjusted through the Gold Settlement Fund account of the parent Federal reserve bank, since the branches do not maintain accounts with the Fund. These branches participate in the Gold Settlement Fund by wiring credit figures to the Board each day in time for the settlement, although settlements with the branches are not made by the Board. After the settlement has been made by the Board, the branches are notified of the amounts credited to them by each other ,Federal reserve bank and direct -settling branch, although the net debit and credit of each branch is settled through the balance maintained by the parent bank . This method of clear ing was made in order to eliminate unnecessary work between the Federal reserve banks and their branches, and other Federal re serve banks, and delays in reconciling differences due to the dis 28 tances between the parent bank and its branches.? Nature of the " cash items" cleared through the Gold Settlement Fund The so-called “ cash items, ” composed chiefly of checks and drafts drawn upon banks, which are received by a Federal re serve bank as a collecting agent come from the following sources : ( 1 ) From member banks in its own district, ( 2 ) from non -member clearing banks in its own district which will remit at par, (3 ) from the Treasurer of the United States and collectors of internal revenue in its own district. These items may consist of checks drawn upon ( a ) the Federal reserve bank itself, (b ) upon members and non-members on the par list, ( c ) upon other Federal reserve banks, ( d ) upon member and non -member par banks in other Federal reserve districts, and ( e ) upon the Treasurer of the United States . A Federal reserve bank may also receive items ( 4 ) from other Federal reserve banks, and ( 5 ) from member banks, and non -member clearing banks, in other Federal reserve districts,29 and these items can consist only of checks drawn upon * See pp . 186 and 216 above, and pp. 547-550 below. 28Fifth Annual Report of the Federal Reserve Board ( 1918 ) , p. 33 ; Seventh Annual Report of the Federal Reserve Board ( 1920 ) , p. 92. * Direct routing items. CLEARING AND COLLECTION OF CHECKS 308 the Federal reserve bank itself or upon member and non-member banks which will remit at par, in its own Federal reserve dis trict.30 The immediate and deferred credit system The cash items received by a Federal reserve bank for collec tion from its own member, non -member clearing banks, or from collectors of internal revenue are received for immediate credit if drawn upon the Federal reserve bank itself, the Treasurer of the United States, or upon member banks and non-member par banks, located in the same city and received in time to be cleared on the day of receipt. Such items do not affect settlements between Federal reserve banks since they neither come from nor go outside of the district . The inter-district clearing and collection system and the Gold Settlement Fund are concerned primarily with those items for which the Federal reserve bank will give only deferred credit.31 The items which are subject to deferred credit are those re ceived by a Federal reserve bank from its member or non-member clearing banks or from collectors of internal revenue, drawn upon the member, non -member clearing or par banks in its own or other districts but not drawn upon the Federal reserve bank itself, the Treasurer of the United States, or member and non -member par banks in the same city. Checks received from member or non member clearing banks, or collectors of internal revenue for the credit of the Treasurer's account , and payable in other districts are received for deferred credit of one or more days. Such items are forwarded immediately to the proper Federal reserve banks or branches and are charged to special deferred debit accounts. "They enter into settlements between Federal reserve banks only when collected. Each lot of checks so forwarded is represented a Cf. Letter No. 8, p. 1. Non -member clearing banks should not be con fused with non -member par banks. The former are those non -members which carry sufficient deposits with the Federal reserve banks to off-set the items which they collect through the Federal reserve banks or branches; they use the Federal reserve banks and branches as collecting agents. Non -member par banks merely agree to remit at par for items sent to them by the Federal re serve banks or branches, but do not carry deposits with the Federal reserve banks and may not use them as collecting agents. Consequently, when items are presented by the collecting Federal reserve banks or branches it is necessary for them to remit in acceptable funds, since they cannot authorize the Federal reserve banks or branches to debit their accounts, which may be the practice of many of the non -member clearing banks. See pp. 543-547 below. 31A Federal reserve bank will give immediate credit for certain items drawn upon a Federal reserve bank or branch in another district, as, for example, ex change and transfer drafts or telegraphic transfers. See pp. 206-211 above. THE GOLD SETTLEMENT FUND 309 by a deferred debit ticket, the maturity of which is noted on the ticket, and the ticket is filed according to the due date, to be cleared out as will be explained below. Items received from other Federal reserve banks, or from member banks or non-member clearing banks in other Federal re serve districts for the credit of their Federal reserve banks, whether accepted for immediate or deferred credit, are credited, in like manner, to a deferred credit account, in accordance with the published time schedule. Immediate credit items which are placed in the deferred credit account are taken out on the same day. Each batch of items of the same maturity received at any one time is represented by a deferred credit ticket, which ticket shows the date of maturity of the items.32 It has been pointed out already in a preceding chapter that . out-of-town and inter-district items are placed upon a deferred availability basis until they can reach the bank upon which drawn, or, as in the case of the Federal Reserve Bank of San Francisco, until they can reach the Federal reserve bank or branch of the district upon which drawn. The length of time for which such items are unavailable as reserves to the depositing bank depends upon the time schedules as worked out by each Federal reserve bank.33 In the weekly consolidated statements of the Federal reserve banks it will be noticed that under “ Resources” there is an item listed as " Uncollected Items." 34 Under " Liabilities" there is an item listed as " Deferred Availability Items."” The term “Uncol lected Items” includes such items as : (1) Due from banks, at present a small item. ( 2 ) National bank notes which are not lawful money for re serve purposes and consequently will be sent home for collection. ( 3 ) Federal reserve notes of other Federal reserve banks. which cannot be paid out under 10 per cent. penalty. ( 4 ) Unassorted money. 5 ( 5 ) Transit items ( checks and drafts ) . The fifth item is the largest single item in the list of " Uncol lected Items” and is the one with which we are concerned primarily . “ Deferred Availability Items” correspond to “ Uncollected Items" under Resources . To revert to our previous illustra 32Letter No. 8, pp . 1-2 . 23 See pp. 180-185 above. **For a consolidated statement, see p. 368 below. 310 CLEARING AND COLLECTION OF CHECKS tion ,35 if a check drawn on a bank in Rochester, New York, were sent to the Federal Reserve Bank of Richmond by one of its mem ber banks, credit would be given three days after receipt. One of the days would be consumed in sending the item from Rich mond to the Federal Reserve Bank of New York , one in forward ing the item from New York to Rochester, and the third day in sending the returns from the Rochester bank to the Federal Re serve Bank of New York . This check will appear once as a “ Deferred Availability Item ,” that is, a deferred liability of the Federal Reserve Bank of Richmond, since, in three days, it will owe that amount to the bank sending in the check. This same check will appear once as an “ Uncollected Item ,” that is, as a deferred asset, because at the end of three days the Federal Re serve Bank of Richmond will have a claim on the Rochester bank . " The two deferred items should be approximately the same.336 With these facts in mind it will be practicable at this point to follow a transaction through the Gold Settlement Fund. Method of making settlements through the Gold Settlement Fund At the close of business each day the Federal reserve bank assembles all tickets representing all the items due to other Fed eral reserve banks or clearing branches on that day. These tickets are assorted according to the banks and branches to which the amounts are due ; they are footed up in each case, and from the totals so obtained a telegram is made up and sent to the Federal Reserve Board advising the total amount due by the Fed eral reserve bank or branch sending the telegram to each other Federal reserve bank or clearing branch named in the telegram , the total of all the amounts being the last item in the telegram . The writer of Letter No. 8 for the Federal Reserve Bank of Rich mond on the Practical Operation of the Gold Settlement Fund gives the following skeleton copy of such a telegram as would be sent by the Federal Reserve Bank of Richmond in which the amounts are omitted.37 It will be observed that the name of each Federal reserve bank is designated by its assigned letter : (A ) Boston , ( B ) New York , ( C ) Philadelphia , ( D ) Cleveland , etc. 3sSee pp. 180-184 above. ** They are not always the same, since the time for collection does not coin cide, necessarily, with the published time schedule. Other items in these ac counts are also partly responsible for the inequality. See pp. 181-184 above, and pp . 512-513 below . ** Letter No. 8, p . 2 , THE GOLD SETTLEMENT FUND 311 Each clearing branch is designated by the letter of the parent bank together with the letter A, B, C, D, or E, these second letters being assigned in the order in which the branches were opened for business by the parent bank . Upon receipt of such a telegram from each Federal reserve bank and clearing branch, the settling agent makes up a settling sheet, arranged like a checkerboard, the names of the Federal OUTGOING GOLD SETTLEMENT FUND CLEARING TELEGRAM AVALEC FEDERAL RESERVE BANK OF RICHMOND The Federal Reserve Board, Washington , D. C. Code word (indicating Gold Settlement Fund clearing telegram ). A ΕΑ ( Boston ) . ( New York ) ( Philadelphia ) ( Amount ) 66 ( Cleveland ) Baltimore) 66 ( Atlanta ) FA ( New Orleans) G ( Chicago ) GA H HA HB HC ( Detroit ) I IA J JA JB K KA KB L LA LB LC LD LE 66 ( St. Louis ) ( Little Rock ) ( ( Louisville ) (Memphis ) ( Minneapolis) · ( Helena ) (Kansas City ) 60 ( Denver ) (Omaha ) (Dallas ) ( El Paso ) ( Houston ) ( San Francisco ) ( Seattle ) 66 ( Spokane) ( Portland ) (Salt Lake ) · (Los Angeles ) 66 Total reserve banks and settling branches appearing in regular order at the head of the vertical columns and in the same order at the left-hand side of the horizontal columns. For example, the amounts reported as due by the Federal Reserve Bank of Boston are entered in the first horizontal column, each respective amount being placed in the column headed with the name of the Federal reserve bank to which the reported amount is due, and in the last column to the right the total amount due by the Federal Reserve 312 CLEARING AND COLLECTION OF CHECKS Bank of Boston is entered . The amounts reported by each Fed eral reserve bank and settling branch are entered in like manner on the line opposite the name of that Federal reserve bank. The totals obtained by adding each column vertically will indicate the total amount due to the Federal reserve bank or branch whose name appears at the head of the column. Adding this total line across will give the same grand total as by adding the last column INCOMING GOLD SETTLEMENT FUND CLEARING TELEGRAM TO THE FEDERAL RESERVE BANK OF RICHMOND Code word ( indicating “ your balance in fund at close of operations of previous day " ). Code word ( indicating " Incoming Clearing Telegram " ) . А ( Amount ) ( Boston ) 66 B C D ( New York ) ( Philadelphia ) ( Cleveland ) EA (Baltimore) F FA G GA H HA HB HC ( Atlanta ) ( New Orleans ) 66 66 66 ( Chicago ) (Detroit) 66 66 ( St. Louis ) (Little Rock ) ( Louisville ) (Memphis ) ( Minneapolis) I 6 IA J JA Јв K KA KB L ( Helena ) 66 (Kansas City ) ( Denver ) ( Omaha ) ( Dallas) (San Francisco ) (Seattle ) ( Spokane ) ( Portland ) ( Salt Lake ) ( Los Angeles ) LA LB LC LD LE 66 ( El Paso ) ( Houston ) 66 6 66 . 66 Total Gain or Loss vertically. The total payments taken from the last vertical column on the right are then entered on a horizontal line directly under the total amounts due each Federal reserve bank , and in the two horizontal lines below this line the gain or loss for each Fed eral reserve bank is calculated . The total gain for all banks, of course, balances the total loss for all banks.38 Upon completing the settlement, the settling agent dispatches a8Ibid. , pp . 2-3 . THE GOLD SETTLEMENT FUND 313 to each Federal reserve bank and settling branch a telegram ad vising the Federal reserve bank or branch of the result of the set tlement. In these telegrams, as in the telegrams already de scribed, the name of the paying Federal reserve bank or branch is indicated by one letter in the case of a Federal reserve bank or by two letters in the case of a branch . The incoming telegram from the settling agent is shown on the opposite page.39 It has been pointed out already that in the books of the Fed eral Reserve Board covering the operation of the Gold Settlement Fund, there is an account kept for each Federal reserve bank, but no accounts are kept for the settling branches. The amounts re ported by the branches as due to other Federal reserve banks and branches are charged to the Gold Settlement Fund account of the parent bank , and the amounts due to the settling branches are, in like manner, credited to the account of the parent bank . Upon receipt of the telegram showing the result of the day's clearings, the Federal reserve bank charges its appropriate de ferred credit account and credits the Gold Settlement Fund with the amounts reported by it to the Board in the telegram of the previous day, and takes out of the current file the credit tickets from which the figures in the telegram dispatched by it have been made up . It also charges its Gold Settlement Fund account by the total amount of credit received, in accordance with the tele gram from the Board, and credits this amount to its deferred debit account . The tickets representing the indicated debits cleared are not removed from the current file, however, until mail advices are received from the other Federal reserve banks and clearing branches, giving in each case a complete list of the items covered by the day's payments reported by these banks and branches to the Federal reserve bank by wire. Such advices are forwarded by each Federal reserve bank and settling branch to every other Federal reserve bank and settling branch at the time the telegram is made up and dispatched to the Federal Reserve Board , for the purpose of effecting settlement. The books of the Federal reserve bank , which have been com pleted in all other respects at the close of the day, are kept open for the closing entries involved in the daily settlement. Upon re ceipt of advice from the Federal Reserve Board early the fol lowing morning, the necessary entries , as just explained above, are made as of the day before and the books are promptly closed. This 29Ibid . 314 CLEARING AND COLLECTION OF CHECKS practice tends to eliminate the necessity for the creditor banks carrying a float. 40 It will be observed, also, that settlements are not made between Federal reserve banks and settling branches upon net balances due by one Federal reserve bank or settling branch to another, but upon the basis of all matured credits. Therefore, if there has been a delay in the mails affecting any particular letter sent by one Federal reserve bank to another, it will mean that the send ing bank will get payment later than it expected, but no confusion will result in the actual settlement. In like manner, while each Federal reserve bank receives payment each day for all items due to it on that day by other Federal reserve banks or settling branches, it is frequently necessary for the bank receiving the credit to wait several days for the detailed list of the items mak ing up the credit and dispatched by a Federal reserve bank or branch making the payment before it is able to match up the credit received against the exact items held by it in its deferred debit account. However, so far as actual collections are con cerned and so far as its own reserve position is concerned, it is just as well off as though it had received full information by wire. 41 In making payments through the Gold Settlement Fund of all amounts due to other Federal reserve banks, it has been the uni form practice to make certain deductions. For example, the Federal Reserve Bank of New York in reporting the amount due by it to the Federal Reserve Bank of Richmond will ascertain the amount by adding together all immediate credit items received that day and all deferred credit items that have matured that day, and then will deduct the amount of Federal reserve exchange drafts drawn by member banks in the Fifth District on the Fed eral Reserve Bank of Richmond and presented to and paid by the Federal Reserve Bank of New York. It will also deduct returned items,42 officers' checks drawn by the Federal Reserve Bank of Richmond, or transfer drafts, if any, drawn on the Federal Reserve Bank of New York by the Federal Reserve Bank of Richmond, thus obtaining, in effect, immediate payment for these items. The report dispatched by mail by the Federal Reserve Bank of New York will indicate all items so deducted , the items themselves being sent with the report or mailed separately at the same time. “See pp. 215-216 above. " Letter No. 8, pp . 3-4 . 41 “ For an account of the procedure followed in returning items, see pp. 553 and 559 below . THE GOLD SETTLEMENT FUND 315 Transactions which are not included in the daily settlements Since the inauguration of daily settlements on July 1 , 1918, and particularly since the adoption of the plan by which the re sult of the daily settlement is included by each Federal reserve bank in the statement of the same day, all transactions between Federal reserve banks are included in the settlement except the following : ( 1 ) Rediscount transactions between Federal reserve banks, (2 ) special transfers by one Federal reserve bank to an other for the account of the Treasury Department , ( 3 ) settle ments between Federal reserve banks for Federal reserve notes paid by one bank and forwarded to the Federal reserve bank through which such notes were originally issued, if fit for circu lation, or to the Treasury Department for redemption if unfit, ( 4 ) transfers from the Gold Settlement Fund to the Federal Re serve Agents’ Fund and vice versa, and ( 5 ) transfers to the re demption funds . An account of the rediscount operations between Federal re serve banks has been given above and will not be repeated here except to recall to the reader's mind that settlements between Federal reserve banks growing out of these transactions are made as quickly as possible and entirely independent of the daily settle ments resulting from the clearing and collection of checks. The discount , however, exacted as the price for rediscounting, is settled through the Gold Settlement Fund on the following settle ment day. Maturing discounts are also paid through the Gold Settlement Fund independently of the regular settlements.43 Special transfers by one Federal reserve bank to another for the account of the Treasurer of the United States are effected by special telegrams between Federal reserve banks and between the banks and the Federal Reserve Board. No Federal reserve bank can make an entry on its books affecting the Gold Settlement Fund without receiving directions to do so from the settling agent acting for the Federal Reserve Board, a regulation quite neces sary, since the accounts on the books of the Federal reserve banks must be always in exact agreement with the accounts kept by the Federal Reserve Board on the Gold Settlement Fund books in Washington.14 The present method of making adjustments between Federal reserve banks as a result of Federal reserve note transactions has " Fifth Annual Report of the Federal Reserve Board ( 1918 ), pp. 33-35 ; Letter No. 7, pp. 11-12 ; Letter No. 8, p. 4. “Fifth Annual Report of the Federal Reserve Board ( 1918 ) , pp. 33-35 ; Letter No. 8, pp. 4-5 . 316 CLEARING AND COLLECTION OF CHECKS changed somewhat from the original. The Federal Reserve Act re quires the Federal reserve banks to redeem upon presentation, not only the Federal reserve notes issued through them, but all other Federal reserve notes issued through the other Federal reserve banks, and no Federal reserve bank is permitted to pay out the Federal reserve notes issued by another Federal reserve bank ex cept under a 10 per cent . tax penalty. The Federal reserve notes issued by a Federal reserve bank sometimes would drift into other Federal reserve districts, and finally into other Federal reserve banks, since no member bank has ever been required in shipping Federal reserve notes to its Federal reserve bank to assort the notes with reference to Federal reserve districts. Federal reserve notes so received were forwarded originally by the receiving Federal reserve bank to the various Federal reserve banks through which they were issued, and at first no distinction was made between notes fit for further circulation and unfit notes . When such a shipment was made by one Federal reserve bank to another, the notes comprising the shipment remained the property of the ship ping bank until they were received by the bank to which they were shipped. Upon receipt, immediate credit was given by the re ceiving bank to the shipping bank, which credit was advised in some cases by wire and in other cases by mail . Settlements for these shipments were made in whatever manner settlements for other items were made at the time. With the increase in note transactions, arrangements were made in 1921 by which Federal reserve notes were separated into two classes, ( a ) those fit for circulation, and ( b ) those unfit for further circulation .45 Those fit for circulation were forwarded direct to the bank of issue and credited by that bank to the send ing bank upon receipt; those unfit for circulation were forwarded to the Treasurer of the United States for redemption, not for the account of the sending bank , but for the account of the bank through which the notes originally had been issued . At the same time, the sending bank dispatched advices of the shipments to the other Federal reserve bank , and received credit upon receipt of 'the fit notes, or upon receipt of advice of shipment of the unfit notes to the Treasurer of the United States . Under this arrange ment , notes in transit remained the property of the shipping bank until they reached their destination. Under present arrangements each Federal reserve bank or branch daily ships directly to the Federal reserve banks through 45 Vinth Annual Report of the Federal Reserve Board ( 1922 ) , p . 28. THE GOLD SETTLEMENT FUND 317 which they were originally issued all fit notes which have been re ceived by it, assorted and properly packed for shipment. At the same time, each Federal reserve bank or branch ships to the Treasurer of the United States for the account of the Federal re serve banks through which they were originally issued, all unfit Federal reserve notes which it has received, assorted and properly packed for shipment. Instead of advising, as before, the Federal reserve banks to which shipments of fit notes have been made, or for which shipments of unfit notes have been made to the Treas urer of the United States, each Federal reserve bank or branch advises the Federal Reserve Board by wire of all such shipments, using forms similar to those already described in connection th the regular Gold Settlement Fund, describing separately each shipment to each Federal reserve bank and each shipment to the Treasurer of the United States for each Federal reserve bank. As some of the Federal reserve banks and branches are located in the far West, it is quite late in the day before all such tele grams are received. On the morning of the following business day, therefore, the settling agent of the Federal Reserve Board makes up a special settlement of Federal reserve notes in transit, and advises each Federal reserve bank by wire of the amounts of fit Federal reserve notes shipped to it by other Federal reserve banks and branches, and the amount of unfit notes shipped by them to the Treasurer of the United States for its account . Ad vice by wire is always given of the receipt of the previous day's telegrams. Each Federal reserve bank is then charged with the total of all Federal reserve notes shipped to it by other Federal reserve banks and branches, or shipped for it to the Treasurer of the United States ; and, at the same time, each Federal reserve bank is credited in its Gold Settlement Fund account by the total of all shipments made by it or its branches as advised in the tele . gram of the afternoon before. It is obvious that the total of all the debits in this settlement equals all the credits, but no en tries, either debit or credit, are made by the recipient banks until the morning telegram authorizing these entries is received from the settling agent. This settlement is made independently of the regular daily settlement resulting from the clearing and collection of checks. The plan for the separate daily settlement for Federal reserve notes was inaugurated February 1 , 1922.46 Both settle ments, however , although arranged independently are handled simultaneously by the settling agent of the Federal Reserve ** I bid . 318 CLEARING AND COLLECTION OF CHECKS Board, and each Federal reserve bank makes the proper entries on its books as of the close of business of the previous day, upon the figures advised or confirmed by the settling agent of the Fed eral Reserve Board with respect to both settlements.47 TABLE XXVII OPERATIONS OF THE GOLD SETTLEMENT FUND SUMMARY OF TRANSACTIONS BY YEARS, 1915-1923 { In thousands of dollars ] Net Total clearings Year 1915 (May 19 Dec. 31 ) 1916 1917 1918 1919 1920 1921 1922 1923 Total Total and clearings transfers transfers 35,476 150,045 2,643,846 4,812,105 7,930,859 7,551,585 3,289,081 1,153,975 1,039,150 1,052,649 5,533,966 26,962,906 50,251,592 73,984,252 1,028,173 5,383,966 .24,319,060 ,45,439,487 .66,053,393 ..85,074,220 .64,934,801 .75,335,987 .89,614,733 92,625,805 68,223,882 76,489,962 90,653,883 changes in ownership Per of gold centage of through change to transfers tot. clear- Gold and ings and with clearings transfers drawals: 85,697 223,870 272,033 238,314 281,385 471,555 391,922 312,258 173,899 8.14 4.03 1.01 78,040 136,550 482,858 0.47 102,433 0.38 0.51 392,293 539,684 652,011 466,218 624,344 0.57 0.41 0.19 Balance in Gold Year 1915 Transfers to Transfers Gold Agents' Agents' deposits Fund Fund (May 19 155,800 Dec. 31 ) . 301,570 1916 1917 1918 1919 1920 1921 1922 1923 966,556 693,181 1,124,304 .1,186,940 .1,880,634 ..1,215,832 ..1,215,366 from Settlement Fund at close of business Dec. 31 52,460 94,520 852,881 21,480 411,087 1,512,297 2,479,640 1,118,300 1,651,210 1,326,816 1,140,000 1,011,831 77,760 169,740 311,643 401,926 675,440 498,585 587,372 609,502 329,737 357,278 522,063 565,362 554,363 Cost of operation ( Actual; Cost not in per thousands) 1,150.00 1,343.37 3,539.79 $ 1,000 $ 0.0011 0.0002 0.0001 6,023.82 0.0001 250,000.00 370,000.00 485,000.00 500,000.00 0.0034 0.0039 0.0071 0.0065 'Compiled from the Annual Reports of the Federal Reserve Board and the Federal Reserve Bulletins. Transfers from the Gold Settlement Fund of a Federal reserve bank to the gold fund of its Federal reserve agent, and vice versa, also are settled independently of the daily settlements which re sult from the clearing and collection of checks. Such transfers. " Letter Vo. 8, pp . 5-6 . THE GOLD SETTLEMENT FUND 319 are effected by the Board upon advice wired by the bank or the agent, as the case may be, and the entries are made by the bank on its books and by the Federal reserve agent on his books upon receipt of wired advice from the Board. Such transfers do not affect the gold fund of any other bank or agent and, therefore, are made independently and not as a part of the regular daily Gold Fund Settlement participated in by all Federal reserve banks.48 Prior to June 1 , 1922, Federal reserve banks made payments through the Gold Settlement Fund to the Treasurer of the United States for the account of member national banks for credit to their 5 per cent. redemption fund against national bank notes. TABLE XXVIII AVERAGE WEEKLY VOLUME OF CLEARINGS AND TRANSFERS COMBINED FOR EACH YEAR SINCE THE ESTABLISH MENT OF THE GOLD SETTLEMENT FUND $31,898,000 106,422,000 522,206,000 1915 1916 1917 1918 966,377,000 1919 1920 1921 1922 $ 1,422,744,000 1,781,265,000 1,311,998,000 1,470,960,000 'Ninth Annual Report of the Federal Reserve Board ( 1922) , p. 28. These were also independent of regular settlements. Until April 10, 1920, such transfers were made in even dollars ; after that date they were made in any amount.49 On June 1 , 1922, the method of handling transfers for national banks to their 5 per cent. redemption funds against national bank notes was simplified by the adoption of the plan of making such transfers from the gold redemption funds of the Federal reserve banks against Fed eral reserve notes, instead of from the Gold Settlement Fund, thereby reducing these transactions to simple transfers by the Treasury between these two funds in its custody.50 Inter -district gold movements The analysis of inter-district gold movements is so involved and detailed in nature that only a general and summarized view will be attempted here. A detailed study of inter-district move ments would carry the subject beyond the space that can be allotted to it in this book . It must be observed at the outset that the net changes in own * Ibid., p. "Seventh Annual Report of the Federal Reserve Board ( 1921 ) , p. 70. “ Ninth Annual Report of the Federal Reserve Board ( 1922 ), p. 28. 320 CLEARING AND COLLECTION OF CHECKS ership in the Gold Settlement Fund through transfers and clear ings as shown in the table on page 318 refers only to a shifting of claims between the Federal reserve banks and does not refer to actual gold shipments among the Federal reserve banks in the set tlement of obligations. It is quite customary to make general and sweeping statements to the effect that with the concentra tion of reserves and the organization of the Gold Settlement Fund the shipment of gold has been entirely eliminated . Although the Gold Settlement Fund has reduced the shifting of funds, that is, the claims to the funds, to a very small percentage of the total trans actions settled through the Fund, as is shown by the percentage of net transfers given in Table XXVII on page 318, and has re duced the physical shipments of gold to a minimum, presumably, it must be observed that physical shipments do take place. The Annual Reports of the Federal Reserve Board give evidence of that fact in listing the expense that is incurred by the Board in paying for gold shipments under authority of Section 16 of the Act. Consequently, the question of the physical movement of gold from one geographical district to another must not be con fused with the transfer of net balances through the Gold Settle ment Fund. On this subject Mr. W. W. Stewart says : “ The extent to which specie or gold is shipped at present about this country to meet adverse balances is extremely small ; inter -bank settlements being made normally through the Gold Settlement Fund of the Federal Reserve Board . Figures showing expense of coin and currency shipments refer to shipments between the Fed eral Reserve Board and the Federal reserve banks, and to ship ments between the latter and their branches, and between Federal reserve banks or branches and their member banks." 52 In another letter to the writer, he says “ that the ship ment of gold in settlement of inter-district balances has practi cally ceased as the result of the operation of the Gold Settlement 51See Federal Reserve Bulletin , Vol . VIII ( 1922 ) , p . 400 ; Ivan Wright, Bank Credit and Agriculture (New York, 1922 ) , pp . 206-207. As an example, Wright says, in speaking of the advantages of the Gold Settlement Fund : " The savings on clearings and transfers, while large, is, perhaps , the smallest advantage derived from this service. The fundamental benefits are : the elimination of the risks of the actual transfers of gold , and the time saved by wire transfers and clearings, as against the physical exchange of gold. Under the old national banking system , currency was transferred from one section of the country to another, and from one bank to another, and exchange rates registered the relative demand for moneyed capital in the various sections of the country. Under the Federal Reserve System this is all consummated by wire transfers and moneyed capital flows freely to the section where needed, almost without any cost of transfer. " 62W . W. Stewart, Director of the Division of Research and Statistics, Fed eral Reserve Board , in a letter to the writer, March 5, 19:24. THE GOLD SETTLEMENT FUND 321 Fund. Gold coin and certificates, particularly the latter, are shipped between the Treasury and the Federal reserve banks, also between Federal reserve banks and member and non-member banks. The expense of gold shipments between Treasury offices and Fed eral reserve banks, under the provisions of Section 16 of the Fed eral Reserve Act, amounted in 1922 to $6,231.60, and in 1923 to $3,254.11 . “ Upon the abolishment of the sub-treasuries in 1920 and 1921, the Federal reserve banks took over the work formerly done by the sub-treasuries in connection with the receipt of gold, silver and minor coin for exchange and redemption. During the calen dar year 1923 the Federal reserve banks received and counted 2,076,000,000 pieces of coin of all classes and denominat having an aggregate face value of $308,000,000. Relatively little of this coin consisted of gold. Shipping charges (postage, expressage and insurance) paid by the Federal reserve banks on coin shipped to member banks and received from member and non-member banks during 1923 amounted to approximately $ 177,000 ." 53 Gold distribution in the United States The Federal Reserve Board estimated that on January 1, 1922, the total gold stock in the United States was $ 3,657, 000,000. Of this amount, $380,000,000 were held in the Treasury as assets of the United States government, $2,641,000,000 were held by the Federal Reserve System,54 and $636,000,000 were held outside. Most of the gold held outside of the Treasury and the Federal Reserve System-conceded to be a rough estimate is in small hoards in the hands of the general public, although some gold is in the vaults of member and non-member banks. Thus the gold in actual circulation is negligible. With nearly all the gold of the country held in central reservoirs and practically no gold in actual circulation , the Board points outs that changes in the gold reserves of the different Federal reserve banks can occur only in one of three ways : ( 1 ) Through imports from or exports to foreign countries, ( 2 ) through transfer from or to other reserve banks, or ( 3 ) through transfer from or to the United States government. Imports of gold are made chiefly through the port of New York, the gold being turned over to Letter to the author, March 17, 1924. **Exclusive of redemption funds with the Treasurer of the United States. 55Federal Reserve Bulletin , Vol. VIII ( 1922 ) , p. 400. 322 CLEARING AND COLLECTION OF CHECKS the Federal Reserve Bank of New York . Changes in the gold reserves of other banks are traceable almost entirely to the oper ations of the Gold Settlement Fund, through which gold payments between reserve banks and between these banks and the govern ment are effected . Factors affecting inter - district gold movements Some of the most important factors affecting the gold move ment between reserve districts have been classed by the Federal Reserve Board under the following heads: ( 1 ) Settlement of inter district balances on account of checks and drafts cleared or col lected through the Federal Reserve System, also transfers be tween Federal reserve banks for account of member and non member banks ; ( 2 ) government obligations and transferring funds in connection with tax collections, payments on contracts, etc.; ( 3 ) inter-district accommodation ; and ( 4) inter-district 56 movement of reserve notes." How clearings and transfers affect inter -district gold movements The principal element in the origin of inter -district balances are checks drawn in one district and sent in payment for goods purchased in another district. Another important factor affect ing the balances has been the large importation of gold during the recent period , the title to which has been shifted to the inte rior banks to pay for the exported goods which originated there. One way in which the imported gold is transferred to the interior banks is through the repayment by member banks of their borrow ings from reserve banks by draft on New York correspondents. A member bank may have borrowed from a reserve bank in order to finance a customer's exports. When the exports are paid for in gold it is received in New York and credited by the New York correspondent to the member's account. In paying off its debt this bank draws on its New York balance and thus adds to its re serve bank's credit in the Settlement Fund . The seasonal movement of funds from financial districts to country districts and vice versa is another important element in the movement of gold through the Gold Settlement Fund. Dur ing periods of heavy demand for funds in agricultural districts, balances of the country banks with their eastern correspondents, especially their New York correspondents, are greatly reduced by the country banks in order to meet local requirements. After 88 Federal Reserve Bulletin , Vol. VIII ( 1922 ) , p. 400. THE GOLD SETTLEMENT FUND 323 these obligations have been met, the opposite condition soon pre sents itself. There is little demand for the funds of the country bank and they tend to transfer them to eastern centers for de posit and investment. The large banks in New York , Boston, and Chicago also make loans to these country banks. In 1920 and 1921 , when the demand for funds in country districts was very heavy, these large banks extended large loans to country corre spondents. When the contraction of credit got under way in 1921 and a large portion of the funds loaned by the city banks was returned, a movement of gold—not necessarily a physical movement—to the financial centers resulted . Each year has been marked by certain distinguishing characteristics in business con ditions which would be reflected in the gold movements and a fuller treatment of the subject would show these variations. Space pre cludes any such survey here.57 Effect of the fiscal operations of the government on inter -district gold movements The principal fiscal operations of the United States govern ment which resulted in inter-district gold movements are the issue and redemption of Treasury certificates and notes, the payment of interest on outstanding obligations, the collection of income and excess profits taxes, and the payment on government con tracts . As a result of a study of the allotments of tax certificates, of their redemptions, and of income tax deposits at each quarterly income tax date in 1921 at each Federal reserve bank, the Fed eral Reserve Board learned that in New York redemptions far exceed allotments, especially since conditions in the money market have favored active trading in Treasury certificates. The Board goes on to say : “Certificates issued in other districts drift to New 57Professor Ivan Wright, op. cit., Chapters VII, VIII, and XVI, has made such a study. His analysis in Chapters VII and VIII is based upon currency movements between geographical districts for the years 1905-1908, the data being based upon the currency receipts and shipments for those years as gathered by the National Monetary Commission through the sending of cir cular inquiries to the managers of the clearing houses through the office of the Comptroller of the Currency. His Chapter XVI is a brief survey of seasonal variation in transactions through the Gold Settlement Fund . He sees a re markable correlation between the total transfers through the funds and the seasonal demands of agriculture, although in another place ( p . 214 ), he points out that the seasonal variations have almost been submerged due to two facts : ( 1 ) that the Gold Settlement Fund has been steadily increasing due to its popularity and convenience of service, and the increase in the number of mem ber banks, and ( 2) the enormous fiscal operations of the government in con nection with war finance, and the taking over of the work of the sub-treasuries by the Federal reserve banks. 324 CLEARING AND COLLECTION OF CHECKS York, the financial center of the country, and must be redeemed there at maturity. None of the other districts show a material excess of redemptions over allotments and most of them show larger allotments than redemptions. Tax collections in New York fall relatively far below the proportion of certificate allot ments and redemptions. This is due chiefly to the fact that New York possesses a much larger proportion of the country's bank ing resources, which form the basis of certificate allotments, than of its income. Nearly half of the tax certificates maturing in 1921 were redeemed in New York, but only about 27 per cent. of income and excess profits taxes were collected in that district. On the other hand, in the Boston, Richmond, and Atlanta districts tax receipts constitute materially larger proportions of the total for the country than do certificate redemptions. In the other districts the differences are less pronounced. As a consequence, on income tax dates and for a few days following, the government has not sufficient funds in New York to pay for maturing certifi cates and consequently issues to the Federal Reserve Bank of New York special certificates of large amounts. As income tax funds are collected in New York and in other districts the gov ernment finds itself with excess funds in other districts and trans fers them to New York, where they are used to retire the special Transfers of gold to New York on government account during the ten days following income-tax dates are ex certificates. ceedingly heavy and come from nearly every other district. On the other hand, it is in New York that most of the payments on government contracts are made, and the funds thus made avail able in New York become distributed throughout the country, when the headquarters of corporations send out dividend and in terest checks or supply working funds for plants and branches in other parts of the country. This is reflected statistically in the fact that New York gains through transfers and loses through clearings. In 1921 , for instance, the New York bank had a net credit through transfers of $745,000,000, and a net debit through clearings of $ 1,043,000,000.58 Effect of rediscount operations among Federal reserve banks on inter -district gold movements Inter -district accommodation in the form of rediscounting by one Federal reserve bank for another is reflected in the movement of gold reserves. The accommodated bank receives the proceeds 68Federal Reserve Bulletin , Vol. VIII ( 1922 ) , p. 401. THE GOLD SETTLEMENT FUND 325 as a credit in the Gold Settlement Fund and when the rediscount is liquidated the reserves move in the opposite direction. Gold reserves of the Federal reserve banks on October 29, 1920, for instance, were affected by the fact that there was a total of inter-district accomodation amounting to $ 260,440,000 . TABLE XXIX GOLD RESERVES OF EACH FEDERAL RESERVE BANK ON OCTOBER 29, 1920, and ON MARCH 22, 1929 ( Amounts in thousands of dollars) Federal Amount Mar. 22, Oct. 29, 1920 1922 Reserve Bank of Boston New York Philadelphia Cleveland Richmond Atlanta Chicago St. Louis Minneapolis Kansas City Dallas San Francisco 194,571 476,694 190,427 252,340 88,296 88,103 308,067 178,278 1,083,872 212,900 256,451 72,961 115,458 Per cent. of total Oct. 29 , Mar. 22, 1922 1920 9.7 23.8 9.5 12.6 In crease 6.0 36.4 7.1 8.6 2.5 4.4 3.9 16.0 3.6 16,293 607,178 22,473 4,111 15,335 27,355 73,053 49,350 97,202 71,864 4.4 15.4 3.6 2.5 72,317 46,557 163,545 80,340 43,019 287,809 2.3 8.2 2.7 1.4 9.7 124,264 2,003,320 2,976,703 100.0 100.0 973,383 476,549 3.3 2.4 De crease 168,482 24,149 22,514 8,023 3,538 35,166 *Federal Reserve Bulletin , Vol. VIII ( 1922 ) , p. 400 . The total inter-district accommodation of $ 260,440,000 was distributed on October 29, 1920, as shown in the following table : TABLE XXX Grantor Banks Boston Philadelphia Cleveland San Francisco Grantee Banks $ 84,396,000 New York 37,201,000 Richmond Atlanta .138,750,000 93,000 Chicago St. Louis Minneapolis Kansas City Dallas Total ... . $ 260,440,000 Total .. $61,362,000 14,275,000 36,122,000 7,050,000 37,305,000 26,603,000 44,895,000 32,828,000 . $ 260,440,000 *Federal Reserve Bulletin , Vol . VIII ( 1922 ) , p. 400. On March 22, 1922, there was no inter-district accommoda tion outstanding, so that the changes in gold reserve shown in Table XXIX above reflect in part the transfer of $ 260, 440,000 of gold from the eight banks accommodated to the four banks which had extended the accommodation . Thus, Cleveland gained $139,000,000 from this source, and the fact that this total gain is much smaller indicates that gold moved from Cleveland as CLEARING AND COLLECTION OF CHECKS 326 the result of other transactions, mainly in connection with the inter-district movement of reserve notes discussed below. On the other hand, New York shows a gain in gold reserves, largely through imports from abroad, of $607,000,000 over and above the liquidation of $61,000,000 of rediscounts with other Federal reserve banks.59 Effect of inter -district movements of Federal reserve notes The inter -district movement of Federal reserve notes is an other important factor responsible for the inter - district move ment of reserves . The Federal reserve notes of one district will find themselves in other districts, although some districts are af fected quite differently from others. For example, the New York district is characterized by the fact that the notes of other dis tricts seem to float towards New York . Many people who come to New York for business or pleasure spend money chiefly in the form of Federal reserve notes of their home districts. These notes are deposited by the store or hotel keepers in their banks which, in turn , deposit them with the Federal Reserve Bank of New York . The Federal Reserve Bank of New York sends these notes to the parent bank if fit for further circulation , or to the Treasury if unfit . On the other hand, the notes of the Federal Reserve Bank of New York do not go out of District No. 2 to the same extent as the notes of other banks, and consequently the Federal Reserve Bank of New York continuously returns more notes to other districts than it receives from them . Notes finding their way to Cuba and other islands in the West Indies, to Can ada , Mexico, and to other foreign countries are also a factor. These notes originate in various parts of the United States, but when deposited with banks in foreign countries they are likely to be brought back by returning tourists or to be shipped to New York correspondents, thus increasing the amount of “ foreign” reserve notes in the hands of the Federal Reserve Bank of New York . During the War another element entered into the inter -district movement of notes. The United States Treasury had to pay the soldiers, and for this purpose used whatever Federal reserve notes it happened to have on hand in Washington. These notes which found their way to the various camps throughout the coun try were returned in most cases to New York correspondents, which turned them into the Federal Reserve Bank of New York , 5*Ibid., p. 402. THE GOLD SETTLEMENT FUND 327 which , in turn, sent them either to the issuing banks or to Wash ington. The Boston bank , for example, as a result of these notes paid to soldiers, had a constant excess of notes received from New York . During the two or three years preceding March , 1922, the Federal Reserve Board reports that the Boston and Cleveland banks had been losing gold as a result of excess receipts over shipments of Federal reserve notes. The reason for this develop ment appears to be that these banks had a supply of new notes on TABLE XXXI INTER -DISTRICT MOVEMENT OF FEDERAL RESERVE NOTES ( Excess of Notes received is indicated by a plus ( + ) sign ; excess of notes returned by a minus (- ) sign ] ' Federal Reserve Bank of Boston New York Philadelphia Cleveland Richmond Atlanta 1917 1918 -7,734 -16,272 --579 +5,197 -6,894 -22,824 +2,642 +19,117 +4,370 +4,511 +669 +1,561 1919 1920 1921 1922 1923 +8,708 +40,941 +1,971 +14,339 –27,572 -46,675 -126,713 —223,370 -79,731 -77,454 +6,767 +42,872 +25,872 +36,728 --16,225 +32,111 +58,387 +36,295 +10,563 +18,020 +1,459 +27,010 +12,656 -3,528 –2,105 +3,776 +6,378 +19,174 +3,296 -11,260 -10,139 -1,748 +20,372 +58,310 +86,475 + 49,564 +43,141 -4,653 --22,538 --25,089 -36,076 +4,187 +5,181 +9,903 +13,511 Kansas City +5,178 +6,664 +27,283 +11,805 -771 +6,651 +11,422 +2,258 Dallas San Francisco . +2,513 +10,488 +7,124 -6,965 -17,902 -16,468 -21,756 Chicago St. Louis Minneapolis -863 -34 +6,372 -4,057 +1,974 -5,996 +3,992 +5,773 -1,915 +44 -7,975 +1,705 Federal Reserve Bulletin , Vol. VIII ( 1922 ) , p. 403 ; Ninth Annual Report of the Federal Reserve Board (1922 ), pp . 110-111 ; Tenth Annual Report of the Federal Reserve Board ( 1923 ), pp . 129-130. hand when other Federal reserve banks were short of fresh cur rency, and many banks in other districts applied to their corre spondents in the Boston or Cleveland districts for currency. When prices began to fall and currency needs of the people de clined, the notes of the Cleveland or the Boston bank were depos ited with the member banks in other districts ; these banks sent them to their Federal reserve banks, which returned them to the Boston or Cleveland bank and thereby gained gold from these banks . 60 The Cleveland bank reported for a number of years excess receipts of Federal reserve notes over shipments, but this excess became very much more pronounced in the two years preceding March, 1922. In the case of Boston the movement was in the opposite direction during the years 1917-1919, inclusively. This Ibid . CLEARING AND COLLECTION OF CHECKS 328 is accounted for by the Federal Reserve Board on the ground that residents of the Boston district traveling in the much larger districts of the West spent Boston Federal reserve notes there. These notes would stay out in circulation for a considerable period of time, while notes of other banks spent in the much more compact Boston district would find their way into the Federal reserve bank more promptly. As a result of this and the fact that more notes are brought to New England by residents of other districts than are spent by New Englanders outside of their own district, the Boston bank had more notes to return to other dis tricts than it received from them . Table XXXI shows the excess of Federal reserve notes received over those returned to other districts or vice versa for the years 1917-1923 . The table below shows gold and total reserves, Federal reserve note circulation , total discounts, and inter-district accommoda tion for each Federal reserve bank for four selected dates : May 29, 1919, just before the gold embargo was removed ; March 26, 1920, about which time the outward movement of gold from the United States came to an end ; October 29, 1920, after the peak of credit expansion was reached and the recent gold movement into the United States started ; and March 1 , 1922 : TABLE XXXII RESERVES, NOTE CIRCULATION, AND DISCOUNTS OF FEDERAL RESERVE BANKS ON SELECTED DATES [ In thousands of dollars) reserve for own Inter -district accommodation ( net ) note circulation member banks Ex tended Total Federal discounts Gold Total reserves reserves Re ceived All F. R. Banks : May 29, 1919 .2,187,743 2,255,106 2,519,292 1,989,392 139,294 139,294 Mar. 26, 1920 Oct. 29 , 1920 Mar. 1 , 1922 .1,934,755 2,057,155 3,048,039 2,449,230 96,480 96,480 .2,003,320 2,168,038 3,351,303 2,801,297 260,440 260,4-10 ..2,951,434 3,080,793 2,196,983 707,551 Boston : May Mar. Oct. Mar. 29, 26 , 29 , 1, 1919 1920 1920 1922 192,771 165,752 194,571 203,175 179,171 261,697 296,168 170,359 192,682 155,898 May 29, 1919 751,488 504,689 476,694 802,172 611,462 742,390 831,188 876,706 847,649 25,571 31,096 985,223 61,362 626,673 90,323 130,127 168,014 151,679 172,466 109,918 47,749 858 20,414 84,396 New York : Mar. 26 , 1920 Oct. 29, 1920 Mar. 1 , 1922 729,929 ..1,087,314 606,610 1,192,445 127,340 140,539 190,427 127,613 141,295 191,144 205,734 232,122 244,579 273,266 242,255 148,560 210,637 219,224 188,463 74,958 Philadelphia : May Mar. Oct. Mar. 29, 26, 29 , 1, 1919 1920 1920 1922 35,533 35,555 37,201 329 THE GOLD SETTLEMENT FUND TABLE XXXII— ( Continued ) Total Federal discounts Inter-district accommodation ( net ) culation for own member banks tended 205,826 223,599 102,656 35,533 195,055 254,320 254,758 296,044 352,123 195,931 143,328 82,433 66,308 138,750 68,914 69,313 75,990 76,442 88,793 115,484 126,312 reserve Gold Total note cir- reserves reserves May 29, 1919 204,821 Mar. 26, 1920 Oct. 29, 1920 Mar. 1 , 1922 194,015 252,340 246,729 May 29, 1919 Mar. 26, 1920 Oct. 29 , 1920 Mar. 1 , 1922 Ex Re ceived Cleveland : 38,304 Richmond : 45,000 15,000 14,275 80,988 94,544 139,097 116,813 126,810 73,679 74,861 96,641 113,350 145,779 85,209 95,526 554,186 109,277 470,887 107,331 316,442 111,915 1919 1920 19:20 1922 401,006 404,934 422,327 314,510 316,835 316,442 479,536 194,412 396,545 470,887 99,833 52,332 7,605 554,186 May 29 , 1919 Mar. 26, 1920 Oct. 29, 1920 93,173 71,907 73,053 102,673 59,973 119,686 10,000 76,882 80,362 116,825 75,632 62,274 62,314 49,350 69,272 49,438 69,842 81,827 82,670 101,613 72,317 82,019 83,532 74,235 86,106 91,763 61,881 33,055 61,013 46,557 38,190 35,191 61,669 49,734 41,235 77,367 91,071 29,387 151,558 151,800 166,954 161,066 296,580 194,310 222,455 251,746 228,435 88,296 74,897 146,116 Atlanta : May 29, Mar. 26, Oct. 29, Mar. 1 , Chicago : May 29, Mar. 26, Oct. 29 , Mar. 1 , 1919 1920 1920 1922 73,158 94,816 308,067 308,067 466,489 520,065 369,180 3,351 7.050 51,490 7,050 St. Louis : Mar. 1 , 1922 95,482 104,180 136,004 137,898 85,180 157,959 33,300 83,894 81,906 35,545 55,353 82,714 111,273 52,134 31,078 95,585 89,310 104,542 11,829 37,305 Minneapolis : May 29, 1919 Mar. 26, 1920 Oct. 29, 1920 Mar. 1 , 1922 Kansas City : May 29, 1919 Mar. 26, 1920 Oct. 29 , 1920 Mar. 1 , 1922 75,738 111,575 15,000 10,029 26,603 1,871 44,895 160,672 37,748 Dallas : May 29, 1919 Mar. 26 , 1920 Oct. 29, 1920 Mar. 1 , 1922 San Francisco : May 29 , 1919 Mar. 26, 1920 Oct. 29 , 1920 Mar. 1 , 1922 166,580 163,545 291,437 46,268 85,146 48,189 110,466 32,332 7,825 32,828 37,945 84,286 106,878 26,429 7,081 160,301 93 60,140 Federal Reserve Bulletin , Vol. VIII ( 1922 ) , p. 403. CHAPTER IX THE COMPUTATION OF RESERVES An important question inseparable from the problem of clear ing and collection of checks, is that of computing reserves. Items in the process of being collected will become demand deposits in time, against which lawful reserves must be held. As a result, the banks have found it necessary to devise a definite system for the computation of reserves. This computation involves, not only the question of computing reserves against items in the process of col lection, but against many other types of demand and time obliga tions, and in order to secure clarity and completeness of treat ment, it is necessary to extend the scope of the subject to cover other aspects of the question of reserve computation than simply that of computing reserves against obligations resulting from the clearing and collection of checks. Reserve requirements of member banks of the Federal Reserve System Section 19 of the Federal Reserve Act provides that the three classes of member banks in the Federal Reserve System shall main tain the following reserves in lawful money against demand de posits : Country banks, 7 per cent . ; reserve city banks, 10 per cent .; and central reserve city banks, 13 per cent . Against time deposits, each class of banks is required to maintain 3 per cent. and all of the reserves are to be held in the Federal reservė banks. According to Section 19 demand deposits comprise all those pay able within thirty days, while time deposits comprise all deposits payable after thirty days, all savings accounts and certificates of deposit which are subject to not less than thirty days' notice be fore payment, and all postal savings deposits. If a reserve city bank is located in the outlying districts of a reserve city or in territory added to such a city by the extension of its corporate charter, it may maintain, upon the affirmative vote of five members of the Federal Reserve Board, the reserve balances required of country banks. Central reserve city banks 330 THE COMPUTATION OF RESERVES 331 similarly situated, in like manner may be reduced to the status of reserve city banks so far as reserve requirements are concerned. The required balance carried by a member bank with a Federal reserve bank , under regulations and subject to penalties pre scribed by the Federal Reserve Board, may be checked against and withdrawn by the member bank for the purpose of meeting ex isting liabilities provided the bank does not make any new loans or pay any dividends until the total balance required by law is re stored fully . Against national bank notes, national banks are required to maintain in the United States Treasury a 5 per cent. redemption fund in lawful money, in addition to the 100 per cent. bond secu rity. This redemption fund is not a part of a national bank’s legal reserve as was the case prior to the passage of the Federal Reserve Act. Penalties for reserve deficiencies are prescribed by Regulation J , Series of 1924, given below , pp. 366-367. Reserve requirements of the Federal reserve banks Against demand deposits, each Federal reserve bank is re quired, according to Section 16 of the Federal Reserve Act , to maintain reserves in gold or lawful money of not less than 35 per cent . Federal reserve banks have no time deposits. Government deposits are not exempt from the reserve requirements. Author ity is given the Federal Reserve Board to suspend for a period of thirty days, and to renew the suspension for fifteen -day periods, any reserve requirement specified in the Act , provided that it establishes a graduated tax upon the deficiency in the reserves. " Gold deposits standing to the credit of any Federal reserve bank with the Federal Reserve Board shall be counted, at the option of the bank , as part of the lawful reserve which it is required to main tain against outstanding Federal reserve notes, or as part of the reserve it is required to maintain against deposits. Federal reserve banks are required to keep against Federal reserve notes in actual circulation a reserve in gold of not less than forty per cent ., in addition to the other collateral required to make up the 100 per cent. security. When the Federal reserve agent holds gold or gold certificates as collateral for Federal re serve notes issued to the bank , such gold or gold certificates are counted as part of the gold reserve. The Act also requires that *See Federal Reserve Act , Section 20. Federal Reserve Act, Section 11, paragraph ( C ) . In 1920, eight of the Federal reserve banks paid penalties for deficient reserves. nual Report of the Federal Reserve Board ( 1920 ) , pp . 46-47. See Seventh An 332 CLEARING AND COLLECTION OF CHECKS each Federal reserve bank maintain a redemption fund in the Treasury for the purpose of redeeming the notes. This fund is a sum in gold sufficient in the judgment of the Secretary of the Treasury for the redemption of the notes issued to each Federal reserve bank , but in no event less than five per cent. of the total amount of notes issued, from which is deducted the amount of gold or gold certificates held by the Federal reserve agent as collateral security in order to determine the net liability against which the fund must be held. This redemption fund of gold is counted as part of the forty per cent . reserve that must be held against the Federal reserve notes . Should the gold reserve held against Fed eral reserve notes fall below the forty per cent. requirement, the Federal Reserve Board , according to the requirements of the Fed eral Reserve Act, is required to levy a graduated tax. This tax is paid by the reserve bank, but it adds an amount equal to the tax to the rates of interest and discount fixed by the Federal Reserve Board . 3 Against Federal reserve bank notes which are issued up to the par value of the underlying bonds, the Federal reserve banks must also maintain in the Treasury a redemption fund in lawful money to the extent of five per cent. As in the case of national banks, this does not count as part of the legal reserve. Reserve requirements of Federal reserve bank branches It will be unnecessary to consider the branches of the Federal reserve banks separately from the parent banks in this discussion, because no branch of a Federal reserve bank has a separate cor porate entity distinct from that of the parent bank . Its opera tions are in effect the operations of the parent bank . It is pointed out elsewhere that there are two classes of branches in the United States. One type, designated as Class I for convenience of treat ment, renders practically the same services and has the same direct relations with the member banks as does the parent bank. Such a branch has certain territory and capital assigned to it ; it carries the reserves of the member and non -member banks assigned to it by the parent bank ; the correspondence of the member banks is with this branch rather than with the parent bank ; and it redis counts for the member banks of its assigned district, although it may not engage in open market transactions except under orders from and for the account of the head office. Thus everything ' Federal Reserve Act, Section 11 , paragraph (C ) . Penalties for reserve deficiencies are discussed below, pp. 371-374. THE COMPUTATION OF RESERVES 333 that may be said relative to the computation of reserves in Fed eral reserve banks is applicable, in general, to these branches, and need not be repeated in a separate treatment. Reserve deposits carried by member banks upon the books of the branch are techni cally actual reserve carried with the parent bank, and where de posits are made in a branch by an agent of the government and are charged to that branch on the books of the Treasurer of the United States, the Board understands that this is done merely as a matter of bookkeeping convenience. The deposit liability rests with the parent bank.4 This type of branch clears and collects checks and other items for its member and non-member clearing banks in the same manner as does the parent bank, and partici pates in the daily clearings through the Gold Settlement Fund, although the final settlements are made on the books of the parent bank, as no branch carries separate deposits in the Gold Settle ment Fund . The second type of branch, designated as Class II, is really a branch office maintained by the parent bank for the convenience of such member and non -member clearing banks as may desire to use it. Consequently, none of its functions can be considered in any sense as separate from those of the parent bank . No distinct capital or reserves are assigned to it, no member bank in any specific territory is required to deal with it, and no specific terri tory is assigned to it except for collection purposes. The princi pal operations of this type of branch are confined to the clearing and collection of checks, and to supplying currency, both paper and coin, to member banks within the collection zone assigned to it. The balance appearing to the credit of a member bank on the books of the head office constitutes its reserve, but member banks depositing with the branch may charge the parent bank with all items on the day of deposit unless drawn against banks for which allowance is provided in the time schedules, in which case such banks may obtain credit only at the expiration of the time indi cated . This type of branch makes daily reports to the head office showing the amounts received on deposit for credit with the head office, checks paid for the head office, discounts recommended ( as this type of branch may not rediscount for member banks ), and items received for collection and forwarded , and for which credit should be given by the head office at the expiration of the timo ‘Federal Reserve Bulletin, Vol . IV ( 1918 ) , p. 256 ; Eighth Annual Report of the Federal Reserve Board , ( 1921) p . 80. See also pp . 517-550 below . CLEARING AND COLLECTION OF CHECKS 334 stipulated in the time schedule. This type of branch does not clear through the Gold Settlement Fund, but reports directly to the parent bank each day the credits resulting from the items re ceived for collection within its collection zone.5 Reserve requirements of State banks, trust companies, and private banks State banks, trust companies, and private banks keep the re serves required by the various State laws or clearing house asso ciations in case the requirements of the clearing houses are higher than those of the State laws. In the State of New York, for example, the law requires that State commercial banks shall main tain reserves against aggregate demand deposits as follows : ( 1 ) If the bank has an office in a borough having a popula tion of two millions or more, 18 per cent . , and at least 12 per cent. , must be maintained as reserves on hand. ( 2 ) In a borough with a population of one million and less than two millions, 15 per cent. , and at least 10 per cent . must be maintained as reserves on hand. (3 ) When located elsewhere in the State, 12 per cent ., and at least 4 per cent . must be maintained as reserves on hand. Any part of the reserves on hand in excess of 4 per cent . of such deposits may be deposited , subject to call , with a Federal reserve bank in the district in which such bank is located, and the reserves on hand not so deposited shall consist of gold, gold bul lion, gold coin, United States gold certificates, United States notes, or any form of currency authorized by the laws of the United States. Any bank which is a member of the Federal Reserve System of course maintains the reserves required by the Federal Reserve Act. Every trust company in the State of New York is required to maintain reserves against aggregate demand deposits as follows : (1) If the trust company has an office in a borough having "The by-laws of this type of branch may be consulted in the Federal Reserve Bulletin, Vol. III ( 1917 ), pp. 935-936. See p. 923 in the same bulletin for a discussion of this type of branch. A further description is given in pp. 547 550 below . See the accompanying list of reserve requirements for State banks. From a pamphlet with the unusual title — of service to banks and business — Federal Re serve System , exhibit at annual convention of American Bankers' Association ( Atlantic City, Sept. 24-27, 1923 ) , pp. 24-27 . ' It will be observed that there are no reserve requirements for time deposits in New York . * State Banking Law , Section 112, amended by Chap. 579, Law of 1917 ; Chap. 92, Law of 1918 ; and Chap. 35, Law of 1919. THE COMPUTATION OF RESERVES 335 RESERVE REQUIREMENTS UNDER STATE LAWS States marked ( * ) do not permit State memberReserve banks Act to substitute reserve requirements of Federal Distribution Figures in parentheses refer to footnote's of reserves None 10 % 20 % None 20 % 16 % None 100.000 or over Under 50,000 18 % 15 % 12 % None None 20 % ( 2 ) 25 % . None 20 % 60,000-99,999 COLORADO : Savings banks Reserve agents ( 35 ) Other banks . Illi CALIFORNIA : Savings banks Commercial banks positaries 2/5 3/5 1/3 - None Other banks Balances 6% 15 % with de Cash in vault 1/4 1/3 16 % Il Illl ARKANSAS : Reserve agents ( 35 ) None 60,000 or over under 60,000 111 banks 15 % Ill ARIZONA : Savings bank , Other Reserves required to be held upon Savings Time Demand deposits deposits deposits Aggregate deposits ||| Population Restrictions ALABAMA : All banks 3/4 2/3 2/3 2/5 3/5 ( 38 ) ( 38 ) 1/2 1/2 1/2 1/2 ( 1 ) 1/2 1/2 1/5 1/5 1/5 4/5 ( 3 ) 4/5 ( 4 ) 4/5 ( 3 ) 1/3 2/3 ( 5 ) 1/2 1/2 • CONNECTICUT : Nono companies - State banks and trust 6% 12 % DELAWARE : Banks and companies trust Savings banks FLORIDA : All banking nies None None 1/3 ( 38 ) 2/3 ( 39 ) 6 %. None 20 % 2/5 3/5 ( 6 ) 5% (7) ( 38 ) ( 38 ) (8 ) 1/5 1/5 4/5 4/5 ( 38 ) ( 38 ) ( 38 ) ( 38 ) ( 38 ) 10 % 6 % ( 38 ) 5 % ( 38 ) ( 39 ) compa GEORGIA : 15 % None All banks 6% (7) IDAHO : 15 % 15 % 1 None None 11 State banks Trust companies • ILLINOIS : - None - bank ( 38 ) 8% 8 %. 8% 8% 3/20 3/20 17/20 17/20 8% 3/20 17/20 . 126 % ( 10 ) 1 ing companies - INDIANA : All banks and 25 % ( 9 ) 15 % ( 9 ) il Elsewhere 11 Chicago panies 11 Banks and trust com IOWA : State banks, ( 12 ) Under Trust companies • KENTUCKY : State banks and trust companies Central reserve cities ( 15 ) Reserve 13 % cities ( 15 ) Elsewhere 3% 3% 10 % 1/3 1/3 2/3 1/3 1/3 2/3 2/3 ( 13 ) 1/3 ( 14 ) 2/3 ( 14 ) 2/3 1/3 2/3 1/3 1/3 2/3 1/5 ( 16 ) 4/5 1 Under 1.000 None 7% 25 % IIlll 10 % 10 % 7% 10 % 7% 3% 3% 20 % - 00 . 50.000 15 % owwwes 50.000 or over Under 50.000 ( 11 ) . None 2007 1 10 or over Under 3,000 - Other savings banks KANSAS : State banks 3.000 III Illll trust companies , and banks savings doing commer cial business 2/3 .LOUISIANA : State banks None 1 CLEARING AND COLLECTION OF CHECKS 336 RESERVE REQUIREMENTS UNDER STATE LAWS- (Continued ) Distribution of reserves - Reserves required to be held upon Population Restrictions MAINE : and Trust Aggregate deposits Demand deposits Time deposits Savings deposits Cash in vault Balances with de. positaries banking 15 % ( 17 ) None companies All ( 18 ) MARYLAND : None None 15 % 15 % = - State banks Trust companies 1/3 = 2/3 All ( 19 ) 20 % 111 00 11 . In Boston within 3 miles of State House Eise where Il Trust companies III MASSACHUSETTS : 2/5 ( 20 ) 3/5 ( 20 ) 2/5 ( 20 ) 3/5 ( 20 ) ( 38 ) ( 38 ) ( 38 ) ( 38 ) 1/4 1/4 3/4 3/4 10 % ( 38 ) ( 38 ) 7% ( 38 ) ( 38 ) 7/18 2/5 ( 38 ) 11/18 3/5 ( 21 ) ( 21 ) ( 21 ) ( 21 ) 2/5 1/3 ( 38 ) 3/5 2/3 ( 38 ) 1/3 1/3 2/3 2/3 1/2 1/2 1/3 2/3 2/5 1/5 3/5 4/5 AII 1/3 2/3 ( 24 ) 1/3 1/3 ( 24 ) 2/3 2/3 ( 24 ) 1/3 13 8/13 ( 24 ) 5/13 100 % 10 2/5 ( 24 ) 3/10 ( 24 ) 7/10 15 % MICHIGAN : Under 100.000 None cities ( 35 ) Elsewhere 15 % 12 % 5% 5% 25 % 15 % 10 % 7% 18 % 15 % 15 % - Res. 20 % 12 % 12 % E * MINNESOTA : State banks 100,000 or over 111 Commercial banks Savings banks ( 38 ) ( 38 ) MISSISSIPPI: Elsewhere Il Over 50,000 State banks MISSOURI : 200.000 or over 25.000 to 199.999 Under 25,000 III ill State banks and trust companies 06 ( 38 ) MONTANA : 15 % NEBRASKA : 25,000 Elsewhere None 20 % 15 % E Over State banks Savings banks | | 10 % 11 Res. cities ( 35 ) Elsewhere 111 | | State banks 5% NEVADA : None 10 % None 15 % ( 37 ) こ - 1 25 % 15 % - 1 - not doing general banking business None None 11 Reserve agents ( 35 ) Other banks Savings banks and trust companies - NEW HAMPSHIRE : All banks NEW JERSEY : - ( 26 ) 18 % - NEW MEXICO : All banka - Trust companies 2/3 ( 24 ) 15 % 12 % = 12 % None 1 15 % ( 22 ) 15 % None None State banks NEW YORK : State banks Boroughs of 2.000.000 or over or - Elsewhere Boroughs of 2.000.000 1 00 Trust companies - Boroughs of 1.000.000 to 1.999.999 ( 23 ) 15 over Boroughs of 1.000.000 to 1.999,999 ( 23 ) : Elsewhere 11 2nd 11 and class cities under 1.000.000 11 1st d . 3/5 THE COMPUTATION OF RESERVES 337 RESERVE REQUIREMENTS UNDER STATE LAWS (Continued ) Distribution of reserves Population Restrictions Reserves required to be held upon Savings Time Aggregate Demand deposits deposits deposits deposits Balances Cash in with de vault positaries NEW YORK- ( Continued ) Private bankers Cities of 1st class - Elsewhere 15 % 10 % = 1/10 1/10 9/10 9/10 ( 25 ) ( 38 ) 2/5 2/5 3/5 4/15 demand 11/15 demand 2/15 13/15 NORTH CAROLINA : Banks and trust com None 15 % Savings banks None State banks None 11 panies 20 % 10 % None 15 % 6% • NORTH DAKOTA : 8 % ( 26 ) 7% 6 % ( 27 ) OHIO : Commercial banks time 4/15 11/16 demand time demand 8/10 time 1/3 1/3 1/3 2/3 2/3 - None time E Savings banks and trust companies 1/2 1/2 ( 6 ) 10 % 15 % 3/6 2/10 Over 2.500 Under 2.500 None 20 % 16 % 30 % None 20 % 111 State banks Reserve banks Savings banks 111 • OKLAHOMA : ( 28 ) 2/3 not ness - doing general busi 1 OREGON : State banks and trust companies 15 % None 10 % 10 % PENNSYLVAVNIA : All banks None 15 % ( 22 ) 1/4 3/4 1/3 demand 2/3 de 3/6 ( 38 ) mand ( 29 ) time ( 30 ) time ( 30 ) 74 % • RHODE ISLAND : 15 % 2/5 3% - None - companies - State banks and trust ( 38 ) SOUTH CAROLINA : All banks None 7% 20 % 174 % 10 % - None 11 TENNESSEE : State banks and trust panies None None 15 % 20 % = 11 Reserve banks ( 35 ) Other banks 11 • SOUTH DAKOTA : ( 38 ) ( 38 ) ( 38 ) ( 38 ) ( 38 ) ( 38 ) ( 38 ) ( 38 ) ( 38 ) ( 38 ) 1/8 1/8 1/4 7/8 3/4 1/5 ( 31 ) 4/5 ( 29 ) TEXAS : None None = 5 Banks - capital $ 25,000 or over Other banks = Savings banks 50,000 or over Under 50,000 None 20 % 15 % 10 % 111 Commercial banks 111 UTAH : 7/8 VERMONT : None 15 % ( 10 ) None 10 % - All banks 3% • VIRGINIA : 3% - State banks ( 32 ) ( 38 ) ( 38 ) ( 38 ) ( 38 ) 2/5 AII ( 34 ) 3/5 WASHINGTON : State banks and trust None 15 % ( 33 ) 1 panies None None 15 % 11 State banks and trust companies Savings banks 11 WEST VIRGINIA : 5 % ( 34 ) 338 CLEARING AND COLLECTION OF CHECKS RESERVE REQUIREMENTS UNDER STATE LAWS- (Continued ) Distribution of reserves Population Restrictions - Reserves required to be held upon Savings Demand Time Aggregate deposits deposits deposits deposits Cash in vault Balances with de positaries • WISCONSIN : Reserve banks Nono 20 % ( 38 ) ( 38 ) Other state banks and trust companies None 12 % ( 38 ) ( 38 ) ( 38 ) Mutual savings banks • WYOMING : Commercial bank , None and trust companies None None Savings banks - 20 % ( 36 ) - = 6% ( 38 ) 10 % ( 38 ) ( 38 ) 10 % ( 38 ) ( 38 ) ( 1 ) Or in U. S. bonds. ( 2 ) Deposits other than savings. ( 3 ) 6 % deposits may be in Liberty bonds . ( 4 ) 74 % deposits may be in Liberty bonds . ( 6 ) 1/4 of balances may be in approved bonds. ( 6 ) Or approved bonds. ( 7 ) Reserve against time and savings deposits may be in unpledged U. S. or Georgla bonds. ( 8 ) Not less than 5 % as cash in vault . ( 9 ) Ruling of auditor - not state law. ( 10 ) Commercial deposits payable on demand and subject to check. ( 11 ) Banks having 20 % or more of deposits due to banks. ( 12 ) Banks having less than 20 % of deposits due to banks. ( 13 ) ( 14 ) ( 15 ) ( 16 ) ( 17 ) ( 18 ) ( 19 ) ( 20 ) ( 21 ) 1/4 of reserves as cash with approval of banking commissioner . U. S. bonds and demand loans secured by U. S. or municipal bonds accepted 28 reserve. As designated by Federal Reserve Act . Member banks' balances with Federal reserve bank accepted as cash in vault. Including deposits subject to notice within 10 days . 1/3 may be in U. S. or Maine bonds . 1/3 may be in bonds. 1/2 of cash and 1/3 of balances, or in all 2/5 of total reserve , may be in approved bonds. Such portion of reserve as directors may determine may be on deposit with approved reserve agents, balance in cash . ( 22 ) All items or claims payable on demand . ( 23 ) Il bank does not have office in borough of preceding class. ( 24 ) Prescribed percentage may be on deposit with Federal reserve bank . ( 25 ) No requirements as to cash in vault ; all may be carried with reserve agents. ( 26 ) Total deposits on time certificates. ( 27 ) Deposits subject to notice as provided by law. ( 28 ) No specific law exists permitting state member banks to substitute Federal reserve in lieu of ( 29 ) ( 30 ) ( 31 ) ( 32 ) state requirements, but state authorities do not criticize such substitution, 1/2 of balances may be in approved bonds. 1/3 in approved bonds, 2/3 in cash or balances . 1/2 of cash may be deposited in bank in same town or county. State law by implication permits state member banks to comply with reserve requirements of Federal Reserve Act . ( 33 ) Reserve of 100 % required against uninvested trust funds. ( 34 ) Set aside from profits and held as cash. ( 35 ) Ag defined by state law . ( 36 ) Liability to depositors other than savings. ( 37 ) Deposits in banking or commercial department . ( 38 ) Reserves consist of cash in vault and balance with approved reserve agents, no provision being made for definite distribution between the two . ( 39 ) Upon approval of banking commissioner one- half of reserves may be in bonds or other obliga . tions of the United States . THE COMPUTATION OF RESERVES 339 a population of two millions or more, 15 per cent ., and at least 10 per cent. must be maintained as reserves on hand. ( 2 ) In a borough with a population of one million and less than two millions, 13 per cent . , and at least 8 per cent. must be maintained as reserves on hand. ( 3) When located elsewhere in the State, 10 per cent. Trust companies located in cities of the first and second class, but not falling within Sections ( 1 ) and ( 2 ) above, must maintain at least 4 per cent. of such deposits as reserves on hand ; trust com panies located in cities of the third class and in incorporated and unincorporated villages, must maintain at least 3 per cent. of such deposits as reserves on hand. Any part of the reserves on hand in excess of 3 per cent. of such deposits may be deposited , subject to call, with a Federal re serve bank in the district in which the trust company is located and the reserves on hand not so deposited must consist of gold, gold bullion, gold coin, United States gold certificates, United States notes, or any form of currency authorized by the laws of the United States. If the trust company is a member of the Fed eral Reserve System, it maintains the reserves required by that system.' Every private banker is required to maintain total reserves against his aggregate demand deposits as follows : ( 1 ) If in a city of the first class, 15 per cent. ( 2 ) If in any other city, 10 per cent . At least one-tenth of such reserves must be kept on hand and the remainder may be redeposited subject to call in any State bank , national bank, or trust company .'10 Reserve requirements of banks outside continental United States National banks, or banks organized under local laws, located in Alaska or in a dependency or insular possession or any part of the United States outside the continental United States may re main non-member banks, and in that event , shall maintain reserves and comply with all the conditions now provided by law regulating them ; or such banks , with the consent of the Federal Reserve Board, may become member banks of any one of the Federal re serve districts, and in that event shall take stock , maintain re serves, and be subject to all the other provisions of the National Bank Act as amended.11 State Banking Law , Section 197, amended by Chap. 579, Law of 1917 ; Chap. 92, Law of 1918 ; and Chap. 35, Law of 1919. 1°State Banking Law , Section 166. " Federal Reserve Act , Section 19 . 340 CLEARING AND COLLECTION OF CHECKS Reserve requirements of foreign branches of member banks Where national banks have established foreign branches the reserve requirements are regulated by the Federal Reserve Board. The Federal Act, itself, merely provides that every national bank ing association which establishes such branches shall conduct the accounts of the foreign branch independently of the accounts of other foreign branches established by it and of its home office, and shall at the end of each fiscal period transfer to its general ledger the profit or loss accrued at each branch as a separate item.12 Power is given to the Federal Reserve Board to prescribe the re serve requirements of foreign branches, but the Board has never stipulated definite requirements for such banks. As a result these branches maintain reserves in accordance with the general bank ing policy or needs of the country in which they are located, the parent bank not being required to carry any lawful reserve against such deposit liability. For example, in Cuba the branches of the National City Bank of New York are required, according to local regulations, to carry a reserve of 25 per cent . ; in Spain the branches generally carried reserves varying from 30 to 50 per cent ., due to unsettled political conditions. It has been held by counsel for the Federal Reserve Board that Section 19 of the Federal Reserve Act, which prescribes the reserve requirements of member banks, does not apply to their foreign branches.13 Reserve requirements of banking corporations authorized to do foreign banking business ( so -called Edge Corporations ) 14 Banking corporations organized under authority of Section 25 ( a ) of the Federal Reserve Act for the purpose of engaging in international or foreign banking and financial operations are re quired by the Act to carry such reserves as the Federal Reserve Board may prescribe, but in no event to be less than 10 per cent. per annum , against deposits received in the United States. Such banking institutions, commonly known as Federal foreign banking associations, may receive only such deposits within the United States as may be incidental to or for the purpose of carrying out 12Federal Reserve Act, Section 25 ; Federal Reserve Bulletin, Vol. IV ( 1918 ) , pp. 1123-1124 . " Federal Reserve Bulletin, Vol. IV ( 1918 ) , pp. 1123-1124. Cf. F. H. Curtis, " Bank Reserves under the Federal Reserve System ,” Harvard Business Re view , Vol. I ( October, 1922 ) , p. 46. **In April, 1924 ( date of writing) , there were but two such corporations, one at New York City and one at New Orleans. In the middle of April the New York Corporation, known as the First Federal Banking Association , was ab sorbed by the Bank of Manhattan Company. THE COMPUTATION OF RESERVES 341 transactions in foreign countries or dependencies or insular pos sessions of the United States . The Federal Reserve Board has ruled that "Against all de posits received in the United States a reserve of not less than 13 per cent. must be maintained. This reserve may consist of cash in vault, a balance with the Federal reserve bank of the district in which the head office of the corporation is located, or a balance with any member bank. Against all deposits received abroad the corporation shall maintain such reserves as may be required by local laws and by the dictates of sound business judgment and banking principles." 15 The Board has also ruled that against all acceptances out . standing which mature in thirty days or less, a reserve of at least. 15 per cent. shall be maintained, and against all acceptances out standing which mature in more than thirty days a reserve of at least 3 per cent . shall be maintained. Reserves against accept ances must be in liquid assets of any or all of the following kinds : ( 1 ) Cash ; ( 2 ) balances with other banks ; ( 3 ) bankers' accept ances ; and ( 4 ) such securities as the Federal Reserve Board, from time to time, may permit. 16 What constitutes reserves So far as member banks in the Federal Reserve System are concerned, reserves are composed of lawful money deposited with the Federal reserve banks. Lawful money consists of gold and silver, gold certificates, silver certificates, and United States notes. Clearing house certificates of any clearing house association, rep resenting specie or lawful money specially deposited for the pur pose, are also deemed to be lawful money in the possession of any association belonging to such clearing house, holding or own ing such certificate. Since the legal reserves of member banks are in the Federal reserve banks the lawful money has assumed the form of reserve deposits-balances due from approved Federal reserve agents. To keep lawful money in its own vaults to meet demands made at the bank is expensive, and , as a result, bank notes or Federal reserve notes should be used whenever possible as till money. The bal ances with the Federal reserve banks are available to meet those liabilities which can be discharged by checks or drafts drawn Regulation K , Series of 1923, Federal Reserve Bulletin, Vol. IX ( 1923) , pp . 907-908 . " Regulation K , loc. cit . 342 CLEARING AND COLLECTION OF CHECKS against them . Although clearing house deposits, usually in gold, are available to meet demands presented through the clearing house, and the 5 per cent. redemption fund, in lawful money, is available to redeem national bank notes, neither fund counts as part of the legal reserve. It means that in actual practice, the member banks are carrying as reserve much more than the legal reserve required. The reserves of member banks in the Federal reserve banks may be built up by the presentation of checks and drafts on other banks for collection and credit to these reserve deposits. But such items cannot be counted as part of the reserve until sufficient time has elapsed for the collection of the items. A violation of this regulation subjects the member bank to certain penalties. 17 The reserves of the Federal reserve banks against deposits are composed of gold or lawful money . The 40 per cent . re serve required against Federal reserve notes is composed of gold and includes the five per cent. redemption fund held at Washington. The five per cent. redemption fund held against Federal reserve bank notes is composed of lawful money and is ! not counted as part of the required reserve. This fund is also held at Washington, although the law does not require it. The re serves are computed against deposits and Federal reserve notes combined, and, as listed in the weekly consolidated statements of the Federal reserve banks, include the following items: ( 1 ) Gold and gold certificates, ( 2 ) Gold Settlement Fund, with the Federal Reserve Board, ( 3 ) gold with foreign agencies, ( 4 ) gold with Fed eral reserve agents, ( 5 ) gold redemption fund against Federal reserve notes , and ( 6 ) United States notes , silver, etc. The Fed eral Reserve Act does not state except by implication, where these reserves are to be carried. With the approval of its counsel the Federal Reserve Board has permitted or required the Federal réserve banks to keep portions of their reserves in various places. The gold coin, gold certificates, United States notes, silver, etc., are the till money held in the vaults of the Federal reserve banks ; the Gold Settlement Fund is held at Washington ; gold with foreign agencies is held by agencies abroad, such as the Bank of England ; gold with the Federal reserve agents is held by the Federal reserve agents as security against Federal reserve notes partly at Washington and partly in the vaults of the Federal reserve banks ; the gold redemption fund against the Federal re 11See Regulation J , Series of 1924, Federal Reserve Bulletin, Vol. X ( 1924 ) , pp . 489-491 . THE COMPUTATION OF RESERVES 343 serve notes is held at Washington. According to Westerfield's this allocation of parts of the reserve to different places and uses does not mean that it is any less a reserve, but rather that it is a more efficient reserve, for it is placed where payments are most conveniently and frequently made: The nature of the reserves of the State banks, trust compa nies, and private banks in the State of New York , as well as the requirements as to where they shall be carried, have been pointed out at sufficient length above.19 Banks outside the continental United States, such as national banks or banks organized under local laws such as those in Alaska or Hawaii maintain reserves in lawful money as defined above. Edge corporations are required to maintain reserves in cash against deposits. The reserves against acceptances may be in cash, balances with other banks, bankers' acceptances, or such securities as the Federal Reserve Board may permit . Nature of the deposits against which reserves are carried Before becoming involved in the more technical subject of computing reserves, it may simplify the problem to examine first of all the nature of the deposits against which the reserves are held. 1. In member banks Member banks may receive, as indicated above, demand or time deposits . Demand deposits comprise all cash deposits and deposits resulting from loans ( derivative deposits ) payable within thirty days. Cash (primary ) deposits include deposits of specie, bank notes, government paper money, and checks and drafts payable upon presentation. The checks and drafts may be deferred liabilities, however, depending upon the time required to convert them into cash . This will be true unless the bank indulges in the common practice of giving immediate credit for such de posit items even though some time must elapse before the bank can convert them into cash . Maturing notes and bills become effective deposits only when actually collected . Certified and cashier's checks are treated as demand deposits. Certificates of deposit may be either time or demand ; if demand , the full reserve must be carried against them . * R . B. Westerfield , Banking Principles and Practice, Vol. II ( New York , 1921 ) , p. 277 . "See pp. 331-339. 344 CLEARING AND COLLECTION OF CHECKS Demand deposits, in turn, may be composed of individual or ordinary deposits, bank deposits, or government deposits. Gov ernment deposits other than postal savings deposits, which are time deposits, are exempt, with certain exceptions, from reserve requirements, but are usually secured by the deposit of gov ernment securities. Government deposits include the general and current funds of the government. Other funds that may be deposited with member banks are reserve funds of the War Finance Corporation ; securities and current funds, subject to check and for interest payments, of the Federal land banks; current funds, subject to check, of national agricul tural credit corporations. In addition, member banks may re ceive deposits from virtually any other type of bank, such as private, State bank or trust company, Edge corporations, foreign banks, and other member banks. These deposits appear in the item “ Due to banks” . It will be unnecessary to enter into a dis cussion of bank note liabilities beyond that given above. (1 ) Government deposits in member banks against which re serves must be held . In addition to the fact that reserves must be held against postal savings deposits, the Federal Reserve Board, in May, 1923, ruled that certain other government de posits are not exempt from the reserve requirements set forth in Section 19 of the Federal Reserve Act. These deposits are classed as follows : ( a ) Deposits of Philippine funds made by the Philippine government and carried under the title “ Treasurer of the Philip pine Islands currency reserve fund account.” ( b ) Deposits of Porto Rican funds made by the Porto Rican > government. ( c ) Deposits of Indian funds under the control of the De partment of the Interior. ( d ) Deposits of States, counties or municipalities, ( e ) Deposits of the United States Shipping Board and de posits of the Emergency Fleet Corporation. In the same connection, however, it should be noted that the Board has held that deposits made by United States postmasters of government funds, other than postal savings deposits, col lected by them or which have come into their possession by virtue of their official position , should be deemed to constitute " deposits of public moneys by the United States,” and, when made in desig THE COMPUTATION OF RESERVES 345 nated depositaries, such deposits are exempt from the reserve re quirements specified in Section 19 of the Federal Reserve Act.20 (2) Time deposits. The Federal Reserve Act defines time deposits as all those payable after 30 days, all savings accounts and certificates of deposit which are subject to not less than 30 days' notice before payment, and all postal savings deposits. The term “ time deposits, open accounts, ” is held to include all accounts, not evidenced by certificates of deposit or savings pass books, in respect to which a written contract is entered into with the depositor at the time the deposit is made that neither the whole nor any part of such deposit may be withdrawn by check or other wise, except on a given date or on written notice which must be given by the depositor a certain specified number of days in ad vance, in no case less than 30 days. The term "savings accounts” is held to include those accounts of the bank in respect to which, by its printed regulations, ac cepted by the depositor at the time the account is opened, ( a ) the pass book, certificate, or other similar form of receipt must be presented to the bank whenever a deposit or withdrawal is made, and ( b ) the depositor may at any time be required by the bank to give notice of an intended withdrawal not less than 30 days before a withdrawal is made. A “ time certificate of deposit ” is defined as an instrument evidencing the deposit with a bank, either with or without inter est, of a certain sum specified on the face of the certificate pay able in whole or in part to the depositor or on his order ( a ) On a certain date, specified on the certificate, not less than 30 days after the date of the deposit, or ( b ) After the lapse of a certain specified time subsequent to the date of the certificate, in no case less than 30 days, or ( c ) Upon written notice, which the bank may at its option require to be given a certain specified number of days, not less than 30 days, before the date of repayment , and (d ) In all cases only upon presentation of the certificate at each withdrawal for proper indorsement or surrender.21 (3) Reserves against trust funds. A national bank or other member bank exercising fiduciary powers need not carry reserves against trust funds, which it keeps segregated and apart from its general assets. This is true, also , if the trust funds are deposited with another bank to the credit of its trust department. When, * Federal Reserve Bulletin , Vol . V ( 1919 ) , p. 1054 ; Vol. IX ( 1923 ) , p. 559. *Regulation D , Series of 1923, Federal Reserve Bulletin, Vol. IX ( 1923) , pp. 896-897 . 316 CLEARING AND COLLECTION OF CHECKS however, a national bank deposits trust funds in its commercial department or mingles them with its general funds, a deposit lia bility is created against which reserves must be carried in the Federal reserve bank . But trust funds cannot be deposited in the bank's commercial department unless the bank deposits proper collateral in its trust department as security to the trust estate for the funds thus used. This security must consist of United States bonds or other readily marketable securities owned by the bank , and which shall at all times be equal in market value to the amount of the funds so deposited. If the national bank receiving funds in its fiduciary capacity deposits those funds in another institution, the liability of that other institution is a deposit liability against which it must carry a reserve balance with its Federal reserve bank , if it is a member bank. Such a deposit should be designated in some way as a deposit for account of the national bank as fiduciary and the depositary bank must treat it as an individual deposit rather than a bank deposit ; that is, in computing its required reserve, the de positary bank may not include its liability to the national bank as fiduciary among the amounts due to other banks from which the amounts due from other banks may be deducted. This necessarily results from the fact that the transfer of trust funds to the de positary bank constitutes a deposit by the national bank as fidu ciary and not a deposit by such bank in its own right, and conse quently the deposit is not an item due to banks generally, but is an item due to the national bank as fiduciary and so analogous to an individual deposit . Whether or not funds deposited by a corporate debtor to meet maturing obligations are trust funds depends upon the terms of the agreement, expressed or implied. If the bank is acting as trustee under a deed of trust for the holders of the obligations which are to be paid, the presumption would be, in the absence of evidence to the contrary, that it was the intention of the parties that the funds received should be held as trust funds subject to the terms of the deed of trust. On the other hand, if the bank has no duty to the holders of the obligations, and there is no special agreement setting forth the bank's duties in regard to handling the funds, the bank being authorized merely to pay the obliga tions when and as presented, the presumption would be that the transaction was intended to give rise to an ordinary deposit lia bility, the bank having authority to mingle the funds with its gen THE COMPUTATION OF RESERVES 317 eral assets and acting merely as the agent of the corporate debtor in paying the obligations.22 2. Nature of deposits in Federal reserve banks The usual distinction between demand and time deposits loses its importance when one considers the nature of deposits in the Federal reserve banks. The weekly Federal reserve statements list but three kinds of deposits under the general term “ Deposits" : ( 1 ) Government, ( 2 ) member banks-- Reserve account, and ( 3 ) all other . ( 1 ) Government deposits. Section 15 of the Federal Re serve Act provides for the deposit, subject to the discretion of the Secretary of the Treasury, in Federal reserve banks of the general and current funds of the government, except the funds for the redemption of national bank notes and Federal reserve notes. The revenues of the government, or any part of them, may be deposited in the Federal reserve banks, and disbursements may be made by checks drawn against such deposits. Against govern ment deposits the Federal reserve banks are required to keep the usual reserves of 35 per cent.23 If any moneys or bullion, con stituting trust funds or other special funds required by law prior to 1920 to be kept in Treasury offices are deposited in any Federal reserve bank , such funds must be kept separate from the assets, funds and securities of the Federal reserve bank and held in the joint custody of the Federal reserve agent and the Federal re serve bank.24 The general and current funds of the government are carried in an account called “ Treasurer United States General Account, which is built up chiefly through deposits of tax collections by col lectors of internal revenue and other revenue collecting bureaus, deposits resulting from the sale of government securities, and transfers of funds from other depositaries. It represents a credit available for the general purposes of the government. The principal charges to this account are for the redemption of gov ernment securities, the payment of interest on the public debt , transfers to other depositaries, and the payment of checks and warrants of the United States Treasurer. This account is under "Federal Reserve Bulletin , Vol. VIII ( 1922 ) , pp. 572-573. » Federal land banks and joint stock land banks, when serving as govern ment depositaries, are required to deposit the proper collateral security in the form of United States bonds or otherwise. Section 6 of the Farm Loan Act , approved July 17, 1916 . * Appropriation Act, approved May 29, 1920. CLEARING AND COLLECTION OF CHECKS 348 the control of the Treasurer of the United States and entries may be made only after authorization by the Treasury Department. (2 ) Reserve deposits of member banks. The reserve of a member bank consists of the deposit rights against the Federal reserve bank . This reserve balance of a member bank is divided into account current" and " reserve account ” , and transfers from one account to the other can be made at the member's direction. In addition to their reserves, member banks may deposit current funds in lawful money, national bank notes, Federal reserve notes, checks and drafts payable upon presentation, and for collection, maturing notes and bills. Collection items become demand de posits against which reserve must be kept only when actually col lected. Checks and drafts, likewise, are available as reserve de posits according to the time schedules . (3) All other deposits. In addition to government and member bank deposits , a Federal reserve bank may receive de posits from various sources . Section 13 of the Act provides that a Federal reserve bank , “ solely for purposes of exchange or of collection ,” may receive from other Federal reserve banks deposits of current funds in lawful money, national bank notes, or checks upon other Federal reserve banks, checks and drafts, payable upon presentation within its district , and maturing notes and bills payable within its district . Because of the operation of daily settlements through the Gold Settlement Fund the neces sity of an account for exchange purposes no longer exists, and for the same reason the credits created in the name of another reserve bank for collections made for its account are paid to it at the close of business each day in gold, so that in actual practice a reserve bank does not carry the deposits of another reserve bank, although it does maintain on its books two very active accounts with each of the other reserve banks : ( 1 ) The debit or Due from account , and ( 2 ) the credit or Due to account. These items do not appear in the statements issued by the Federal reserve banks. A non-member bank or trust company may carry with the Federal reserve bank of its district a balance sufficient to offset items sent to the Federal reserve bank for collection and may make deposits, “ solely for the purpose of exchange or of collection , " of such items as those enumerated for member banks. It is entirely optional with a Federal reserve bank whether it will or will not receive deposits from non -member banks. The Act, itself, men tions but one condition to such deposits, and that is that a non member bank shall maintain a balance sufficient to offset the THE COMPUTATION OF RESERVES 349 items in transit. The Federal reserve bank accepting such de posits may make such conditions as may be desirable concerning the balance to be maintained, the service to be rendered , etc. Funds of the Philippine Islands and a certain part of the net earnings of the War Finance Corporation, which are accumu lated as a reserve fund may be deposited in Federal reserve banks. The latter is deposited in the Federal reserve banks upon the direction of the Board of Directors of the War Finance Corpo ration and with the approval of the Secretary of the Treasury. Federal reserve banks act as depositaries for and fiscal agents of national agricultural credit corporations and Federal interme diate credit banks.. Banking corporations doing foreign banking business25 may carry their reserves with the Federal reserve banks. The Federal Reserve Act does not state specifically that the farm loan banks either may or shall deposit in the Federal reserve banks. The deposits of the farm loan banks, therefore, are re ceived under a special arrangement and for a single purpose , which is the payment of interest on the farm loan bonds. The Federal Reserve Bank of New York pays all this interest and in 1921 was the only reserve bank having any account with the farm loan banks.26 The accounts with a few of the foreign gov . ernments and with foreign banks are all carried under special arrangements for mutual convenience in the transaction of busi ness . 3. Nature of deposits in non -member State banks, trust com panies, and private banks State banks, not members of the Federal Reserve System, re ceive all deposits authorized by the State law ; in general, those common to all commercial banks. According to the provisions of the Federal Reserve Act, no bank not a member of the Federal Reserve System may act as a government depositary. Nor may any member bank keep on deposit with any State bank or trust company which is not a member bank a sum in excess of ten per cent. of its own paid -up capital and surplus. During the early years of the War, however, public funds were deposited in non -member banks. This was due partly to steps taken by the Secretary of the Treasury in his effort to keep government funds widely scattered and partly to a series of war acts more or less * Edge Corporations. * L . R. Rounds, “ Deposits and Reserves of the Federal Reserve Banks, ” Lecture No. 6, Federal Reserve Act Course, Federal Reserve Club Magazine ( February, 1921 ) , p . 666 . CLEARING AND COLLECTION OF CHECKS 350 amendatory in nature. Under authority of acts passed in 1917 and 1918, the proceeds of the sale of Liberty bonds of the first, second, and third issues could be deposited in non -member banks.27 The Act of May 18, 1916, amending the Postal Savings Act, authorized the deposit of postal savings funds in non-member banks.28 What has been observed relative to non -member State banks is applicable in general to non -member trust companies. Wide variations in the types of private banks make generalization more difficult. They may be classified as either investment banks or small country banks. Both types are too diversified in nature to make any sort of generalization safe. Data on the latter type are very incomplete. Some are entirely outside corporation law. 4. The nature of deposits in Federal foreign banking associations Federal foreign banking associations receive only such de posits within the United States as may be incidental to or for the purpose of carrying on their foreign business ; that is, they do not have ordinary deposit accounts. Their liabilities take the form, rather, of acceptances. They make advances on export drafts through acceptance credits, accept drafts drawn on themselves by responsible exporters, and sell them to banks throughout the country. It is primarily against acceptances that their reserve is held. The computation of reserves . 1. Of member banks The fundamental purpose underlying the present plan of reserves is to compel member banks to com pute real reserves against real deposits. It eliminates the prac tice indulged in prior to the establishment of the Federal Re serve System and the organization of the present clearing and collection system , of counting as reserve, checks in the mail before computing they reach the drawee bank . The statute provisions regulating the computation of reserves are brief. First of all, demand de posits are distinguished from time deposits. Section 19 of the Federal Reserve Act provides, in part : “ Demand deposits within " Section 7 of the First Liberty Bond Act, approved April 24 , 1917; Section 8 of the Second Liberty Bond Act, approved September 24, 1917, and amend ing Section 15 of the Federal Reserve Act relating to government deposits, and Section 19 which prescribes reserve requirements of member banks; and Section 8 of the Third Liberty Bond Act, approved April 4, 1918 ; and also amending Sections 15 and 19 of the Federal Reserve Act . " Section 2 of the Postal Savings Act, approved June 25, 1910, as amended by the Act approved May 18, 1916. THE COMPUTATION OF RESERVES 351 the meaning of this act shall comprise all deposits payable within 30 days, and time deposits shall comprise all deposits payable after 30 days, all savings accounts and certificates of deposit which are subject to not less than 30 days' notice before payment , FORM PREPARED BY THE FEDERAL RESERVE BOARD FOR THE COMPUTATION OF RESERVES TO BE CARRIED BY MEMBER BANKS WITH FEDERAL RESERVE BANKS Date NET DEMAND DEPOSITS 1. Deposits payable within thirty days not including U. S. Government Deposits and Items 2 , 3, 4 and 5 7. Balance due to Banks other than Pedera ! Reserve Bank (include Foreign Banks) $. 3. Amount due to Federal Reserve Bank $ Deferred Credits 4. Cashier's checks outstanding S S Certified checks outstanding Total due to banks ( Items 2 , 3, 4 and 5) Less Deductions of the following items are permitted only from the total of Items 2, 3, 4 and 5. Should the total of Items 6, 7 , 8 and 9 exceed the total of Items 2, 3, 4 and 5 , both groups must be omitted from the calculation 6. Balances due from banks other than Federal Reserve Bank and Foreign banks 7. Items with Federal Reserve Bank in process of collection 8. Exchanges for Clearing House 9. Checks on other banks in the same place $. Total deduction (Items 6, 7 , 8 and 9) 10 Net Balance due to banks 11 . Total Net Demand Deposits ( Items 1 and 10) TIME DEPOSITS 12. Savings accounts ( subject to not less than thirty days' notice before pay . ment) 13 Certificates of deposit ( subject to not less than thirty days' notice before pay ment) $ Other deposits payable only after thirty days 15 Postal Savings Deposits 16 Total Time Deposits (Items 12 , 13 , 14 and 15 ) FORM 1 and all postal savings deposits.” It further provides that “ In estimating the balances required by this Act, the net difference of amounts due to and from banks shall be taken as the basis for ascertaining the deposits against which required balances with the Federal reserve bank shall be determined .” Demand deposits for reserve calculations consist of : ( 1 ) De posits ( including dividends unpaid ) other than United States 352 CLEARING AND COLLECTION OF CHECKS government deposits, payable within thirty days ( Item 1 ) ,29 and ( 2 ) the net balances due to banks. The reserve required against these demand deposits is 7, 10, or 13 per cent. of the sum of these two items, according to the location of the bank . The net balance due to banks is ascertained in the following manner : First, are added together these items : ( a ) The balances due to all banks ( including foreign banks ) other than the Federal reserve bank ( Item 2 ) , ( b ) amount due to Federal reserve bank deferred credits ( Item 3 ) , ( c ) outstanding cashier's, secretary's or treasurer's checks on own bank ( Item 4 ) , and ( d ) certified checks outstand ing ( Item 5 ) . From the total of these items is deducted the fol lowing : ( a ) Balances due from banks other than Federal reserve . bank and foreign banks ( Item 6 ) , ( b ) items with the Federal re serve bank in process of collection ( Item 7 ) , ( c ) exchanges for the clearing house ( Item 8 ) , and ( d ) checks on other banks in the same place ( Item 9 ) . Member banks are permitted to treat checks on other banks in the same place and exchanges for clearing houses as balances due from other banks, and to deduct the aggregate of such items from the aggregate balance due to other banks in order that items payable in the same city in which the member bank is located may be placed on a parity with items payable elsewhere.30 How ever, in the same year, the Board ruled that member banks cannot deduct cash on hand from liabilities against which reserves must be held . The Board took the position that since cash in the vaults of member banks cannot be counted as reserve there were no grounds on which it could be deducted. To permit such a deduction would amount to a reduction of the reserve require ments. These can be suspended only upon the affirmative vote of five members of the Board , in which case a tax must be imposed upon any impairment.31 If the aggregate " Due from Banks" exceeds the aggregata “ Due to Banks , " both amounts are omitted from the calculation. Member banks are not permitted to deduct checks on the same place, or exchanges for the clearing house directly from gross de mand deposits, but in deducting balances “ Due from Banks ” from “ Due to Banks, ” these items may be included in “ Due from Banks. " This procedure does not permit reductions to the ex 2"See Form I. 3°From a ruling of the Federal Reserve Board, rendered July 19, 1917. See Federal Reserve Bulletin , Vol. III ( 1917 ) , pp. 692-693. * Federal Reserne Bulletin, Vol. III ( 1917 ) , p . 614. THE COMPUTATION OF RESERVES 353 tent that would be possible if member banks were permitted to deduct checks and exchanges for the clearing house from gross demand deposits. Adding such items to “ Due from Banks” may cause the total of “ Due from Banks” to equal or exceed “ Due to Banks” in which case both items are ignored . If checks and ex changes for the clearing house on other banks in the same place were deducted from gross demand deposits, there would be no instance in which they would be ignored . Thus, under this method of computation, a higher percentage of reserve is re quired. See Form 1 on page 351 . The account “ Due to Federal Reserve Bank Deferred Credits" ( Item 3 ) is the one to which items received from the Federal re serve bank are credited on the day of receipt if they are to be paid by a charge against the bank's reserve account ; and the account, “ Due to Federal Reserve Bank Deferred Credits, ” will be debited , and the account, " Due from the Federal Reserve Bank , Reserve Account,” will be credited on the day when these items become a charge against the bank's reserve account on the books . of the Federal reserve bank . As to the wisdom of deducting items with the Federal reserve bank in process of collection some question arises . On this sub ject Mr. F. H. Curtis says : “ Recent court decision have tended to establish the right of a depositor to draw against checks credited to his account, even though uncollected , thus raising a question of the bank's liability for uncollected funds, and therefore it would appear that if a bank does create a deposit liability through such a credit, reserves should be carried on the aggregate deposit liability and there should be no deductions as at present.'" 32 The process of computing reserves against time deposits is simple. It has been pointed out elsewhere that time deposits, for purposes of reserve calculations, consist of the sum of the follow ing items: ( 1 ) Savings accounts subject to not less than thirty days' notice before payment, ( 2 ) certificates of deposit subject to not less than thirty days' notice before payment, ( 3 ) other de posits payable only after thirty days, and ( 4 ) postal savings de posits. The reserve required against the time deposits is 3 per cent. for all member banks regardless of their location. See Form 1 , p . 351 . “F. H. Curtis, “ Bank Reserves under the Federal Reserve System ,” Har vard Business Review, Vol . I (October, 1922 ) , p. 46 . CLEARING AND COLLECTION OF CHECKS 354 The analysis of reserve account by member banks It is important for a member bank to know not only each week or each two weeks how its reserve account stands, but on 1 each day. To accomplish this end the Federal reserve banks pro vide their member banks with forms in accordance with which they analyze their reserve accounts. The Form 2 below , which H ANALYSIS OF ACCOUNT WITH FEDERAL RESERVE BANK OF NEW YORK SHOWING AMOUNT AVAILABLE AS LEGAL RESERVE ITEMS AVAILABLE July 16 and before DATE SENT DEBIT 11 14 14 14 000 000 000 000 3.50 3 1000 20 8 16 15 15 15 16 25 000 TOTAL 83 350 DATE SENT 14 14 14 15 15 15 15 16 16 TOTAL 5 000 600 16 500 10 000 6 000 200 1000 12 000 DATE SENT 14 14 15 16 16 17 DEBIT 2 300 1400 2 100 12 500 DATE SENT 16 16 16 16 75 300 TOTAL 84 250 Dedact 26 300 Available Available Reserve 92 365 Time Deposita 92 365 Today 79 865 Required Net Demand Deposito To date 985 000 Net Demand Deposits 987 000 17 17 9 500 400 TOTAL 38 800 Average TOTAL DATE SENT CREDIT 1 17 17 000 12 500 15 300 Deposits Total Required Reserve 84 Required To date 84 395 Average Required To date Deduct Today's Credits Average Available To date 86 115 Available Reserve Today 515 000 Reserve Average Available To date Reqaired Reserve at 7 % 69 090 Net Demand Deposits Reserve at 75 Required Time Deposits Reserve at 3 % Total Required Total Required 250 TOTAL RESERVE POSITION Available Res . Required Reserve at 3 % 16 450 Time Reserve at 3 $ 000 500 000 Required Reserve at 7 % 68 950 Required 510 000 5 11 25 38 800 Available Today 000 Add yesterday's 92 365 118 665 Deduct Today's Credits To lay's Credits 75 300 Reserve 6 1 15 16 RESERVE POSITION Add yesterday Available kes Average To date DEBIT 800 500 6 000 Required 167 665 DATE SENT 9000 15 000 Add yesterday's 84 315 CREDIT 2 000 AESCRVE POSITION Available Res . ITEMS AVAILABLE July 18 ITEMS AVAILABLE July 17 CREDIT 84 540 Reserve In the illi xtration above it is aaruined that the analysis www startel on July 16 and that the debit balance as shown by the statement on July 13 was all available by Jets 16 Itu prible to trace by the entri a padle on the Analysis sheet froin the arcount It will be noted that all iteras suable on or belore Joly 16 have been entered under that date shile the available later have tm * n entered under the proper subquest datra By the ua of this analysis the available reserve balanke for each day can be de ' s available balance the the items of the current day and delueting irun thewalthe credit itens of the current itay . wrininart by aver to the previo scartint and as the basia of making Meinbar the trakeinana ninga collection scount with the Federal Reserve Bankwilland this forn ofuseas an analysis of the collection rolletion to the marre account , transfer from The land also provide for sh wing the actual required prve each day which 6 cam should be arrived at from Ure form on which net.lemand and time deposits are close late ! lails. (Fora & B 14) . It will be found desirable also to ahow the arerage rejoire reserve to date for either Use weekly or scuni-monthls feriad, N the detay be, and the average available nerve for the same period. FORM 2 is prescribed by the Federal Reserve Bank of New York for member banks, will repay careful study. Items sent by a member bank to its Federal reserve bank for collection and credit will become available at certain dates according to the time schedule provided by its Federal reserve bank . For example, it will be noticed that on July 14 items amounting to $11,000 were sent to the Federal reserve bank which were available in one day as reserve, although on the accompanying form, all items available as reserve on the 14th and 15th are listed on the 16th. A more 355 THE COMPUTATION OF RESERVES simple illustration is to be found in the one-day items amounting to $12,500 which were sent to the Federal reserve bank on July 16. This item will be found under the day July 17 as available reserve . In like manner, the two-day items amounting to $5,000 are found available under the date July 18. All items are listed in this manner when sent out for collection, and a bank, at all KR . 21-2-20 ANALYSIS OF RESERVE ACCOUNT It is of value and importance to a memberbank to know each day the amount of its available reserve. By the use of a form ,similar To use this form it will not be necesary for the member bank to make any change whatever in its present method of keeping its account with the Feleral Reserve to that shown on the lower ball of this sheet, it is a very easymatter to analyze the account DUE FROŃ FEDERAL RESERVE BANK and arnveat the amount of grailable reærre. Bank . It will only be necessarytoenter each item whether debit or creditgoing intotheaccount under the date on which it I figured the corresponding entry will be made on the books of the Federal Reserve Bank . Member banks maintaining but one account with the Federal Reserve Bank can readily prove this analysis to their ledger account by adding to the current day's Available reserve all of the debit items and subtracting all credit itens appearing under bent dates The figures showa in the analysis are taken fron the specimen statement of account appearing immediately below . MONTHLY STATEMENT OF RESERVE ACCOUNT ACCOUNT OF THE MONTH OF July 1919 X NATIONAL BANK DUE FROM FEDERAL RESERVE BANK DATE DEBITS AMOUNT DATE AMOUNT CREDITS DATE DEBIT BALANCE BALANCE 14 15 CL Re Disc Currency CL 10 . 3 D 3D ID 2 D 3D 11,006 2.300 1.400 20.000 + 8.000 + 16.000 2.100 6.000 14 5,000 600 16,500 + + + 10,000 t 15 6.000 + 200 1.000 Dit 13 84,315 14 94.915 15 103,165 16 84,865 17 87,265 For CL Wire Transfer Note Dit . . Con Letter Currency 16 CL 12,000 350 1D 2D Re Disc Currency 3.000 12.500 5.000 25.000 2.000 16 9.000 800 1,500 11.500 15.000 25.000 17 CL Con Letter Re Disc 1D 9.500 400 6,000 17 1.000 12,500 For CL Note Dit For CL Wire Transfer Dit .. For CL • Dele , in-licates the namber of daya that should elap between the late items are for arded and the date it is expected they will be available on the booke of the FejeraiRene Batik . This intonation wile ruil , letenoined by referring to the time schedule issued by the Federal Hrve Bank # Lebits and creliu entering into analysis on July 1tar July 15 are in this illustration all entered mader date of July 16. FORM 2— (Continued ) times, is able to determine the size of its reserve with its Federal reserve bank . The method of computing semi-monthly and daily reserve require ments in a country national bank Since approximately 9,000 of the 9,928 banks which were members of the Federal Reserve System at the close of June, 1922, HECKS CLEARING AND COLLECTION OF CHECKS 356 constitute country banks, it seems quite proper to show the method of computing reserves in one of these banks.33 Accounting procedure in country banks, as a rule, is not car ried to the extent found in the reserve city, and central reserve city banks, and as a result Mr. Smelser undertakes to point out how , with two very simple forms, country banks may obtain a daily proof of their individual ledgers, obtain the necessary in formation with which to compute their reserve requirements, and at the same time provide a record which, from day to day, is inval uable in determining the average daily excess or deficiency in reserve. The first form to be described is the Auditor's Proof of Indi vidual Ledgers, Form 3. This form is executed daily by the individual books department after the control figures for individ ual deposits have been assembled and the customers' accounts in each ledger are listed and balanced . According to this form the twenty -five ledger divisions are divided among ten bookkeepers. Each bookkeeper is required to sign his name opposite his divi sion of accounts and certify that the balance appearing on this report is correct as reflected by the trial balance taken off the ledgers.34 As soon as each bookkeeper has listed all accounts in his division and balanced the total amount to the daily control fig ures, the total amount of the net balances together with the amount of all overdrafts, is entered in the space provided . The five bookkeepers who handle public funds and government deposit accounts are required to enter in the lower left space, “ Deduc tions from deposits,” the balance appearing on the accounts as designated. When this form is completed by the bookkeepers, the manager of the department enters the total balance of " Inactive " accounts, verifies the balances of public funds and government deposit accounts with the ledger accounts, as entered on the form, initials the report and sends it to the auditing department. Mr. Smelser points out parenthetically that all individual ledgers are posted each day before the bookkeepers leave the bank . No checks or deposit tickets are ever held over for posting the fol lowing morning. The work of the statement clerks and the pro " The method outlined here is that followed by the First - Second National Bank of Akron, Ohio. This method was described by Mr. C. R. Smelser, the auditor of this bank, in The Burroughs Clearing Å ouse (November, 1922 ) , pp . 8-9, 48-49. Of the 9,000 country member banks, over 7,000 are national ; consequently this method as described here should serve as a typical example, although methods vary from bank to bank . The Burroughs Clearing House and Mr. Smelser have kindly permitted the writer to use this material. " The signatures of the bookkeepers bave been omitted purposely in the ac companying form . THE COMPUTATION OF RESERVES 357 cedure necessary in checking the statement and account balances is performed the morning following the day's postings. When this form, the Auditor's Proof of Individual Ledgers, is received in the auditing department the figures are supplied with which to complete the report. The total general ledger balance of AUDITORS PRCCF CF INDIVIDUAL L DGERS Dato UWN Ledger Division Net Balanceel Overdrafts 47 29 82 68 66 02 16 55 54 E0734 588 56 24905 64 36 380 244 14 947 76 60 79 79 24 Totals 33 212 64 7 1054 896 48 326958 Gen. Led . Balance 7 054 896 48 638 054 1497 344 1326 500 343 919 410753 803 506 1997 535 815 70 1404 106 1 2 . co 3 4 5 6 7 8 9 Inactive Overdrafts 192_2 8/7 Signature of Bookkeeper Remarks 3 269 58 7 058 166 06 Deductions from Deposits City Depository Trustees of Sinking Fund 12 006 58 101749 33 10302 94 1 50 000 503 48672 Demand Individuals State , County -Municipal Dividende Unpaid Total Domend ( Subject to reserve ) 61320 935 686 ) 545 . Board Education Akron Board Education Macedonia Board Education Suffield This Spece for Use of Auditing Department 514151 7012 899 Time Poetmaster's Acct . Money Order Acct . Postal Savings 686 545 -- Total 20 000 10 1000 20 686 -- Certificates of Deposit Postal Savings Savings 1586 487 .. 20 686 9825 430 Total Timo ( Subject to reserve) 11 532 603 Total Deductions from 737231 - -- Demand Deposite Reserve Required 4901 902 345 978 836 880 -- 7% Total Net Demand 3% Total Net Time Total Reserve to be Maintained with Federal Reserve Bank FORM 3 individual deposits amounted to $7,054,896.48 on August 7, 1922, the date of this report, and agrees with the total amount reflected by the control department, the figures of which , shown opposite the word " Totals,” is $7,054,896.48. Overdrafts amounted to $3,269.58, making the total demand deposits $7,058,166.06 . 358 CLEARING AND COLLECTION OF CHECKS State, county, and other municipal deposits amounted to $686,545.00 and United States deposits amounted to $50,686.00, making a total of $737,231.00, which is deducted from demand deposits of $7,058,166.00, and leaving $6,320,935.00 as “ Indi vidual deposits ," which is entered in the lower right -hand section under “ Demand ” . Next is entered the amount of State, county, and other municipal deposits, being brought over on the amount of $686,545.00. The amount of dividends unpaid, which is entered next, is obtained from the general ledger account and is shown to be $5,415.00. Adding the individual, State, county, and other municipal deposits and dividends unpaid, the amount of demand deposits subject to reserve is found to be $7,012,895.00, which is entered opposite " Total demand ( Subject to reserve).” In the “ Time deposits " section of this report is entered the amount of certificates of deposit, $1,586,487.00 ; postal savings deposits, as shown by the opposite total, $20,686.00 ; and savings deposits amounting to $9,925,430.00, making a total of $ 11 , 532,603.00, which is subject to 3 per cent. reserve. The section “ Reserve required ” is too obvious to require explanation. It will be noticed that the items “ Due to ” and “ Due from " banks are omitted. Banks having bank deposits would change the form to include that form of the reserve computation which deals with such items, With the average country banks the amount " Due from the banks " greatly exceeds, at all times, the amount “ Due to banks" and as a result both items would be omitted from the computation. In like manner, this form is adaptable to the peculiar needs of different types of banks. If demand certificates of deposit are issued , or if by the wording on time certificates, thirty days before maturity they become demand certificates, this form may be so changed as to take care of the situation. The chief value of this form seems to be due to the fact that along with the outline for computing the required reserve, the auditor or other supervising officer has a definite report each day on what is accomplished in the individual books department in the way of keeping the accounts in balance, reporting over drafts, etc. The second form to be described is the Daily Statement of Required Reserve, Form 4 , and is used only in the auditing de partment. The reserve requirements for each day of each period are entered in Column A and are those amounts which were com puted daily according to Form 3. In Form 4 it will be ob THE COMPUTATION OF RESERVES 359 served that the total reserve required for August 7, as shown by Form 3 ( $836,880 ) , is entered on Form 4 ( Column A ) oppo site August 7. Column B provides for accumulating the total requirements from the first day of the period to its close, so that on any given date the average for the period may be deter mined . In averaging the reserve over the semi-monthly period the calculation becomes very simple. On each day the excess or DAILY STATEMENT OF REQUIRED RESERVE Period Ending Vonth с Aug. A B Date Daily Totale ه لمبهانهی ه و هم 3 4 5 6 8 10 11 12 13 14 15 192 2 713 786 771 764 764 764 836 779 782 785 782 793 793 802 798 221 082 961 042 520 520 880 744 061 050 703 787 787 789 846 713 1499 2271 3035 3799 4564 5401 6180 6963 7748 8530 9324 10118 10921 11719 D Daily Balance 7-31 8-1 2 Auz . 15 Requirements 221 303 264 306 826 346 226 970 031 081 764 571 358 147 995 614 713 683 772 764 614 614 524 780 782 785 782 794 794 000 350 800 300 890 700 225 175 900 010 010 802 870 798 910 700 260 600 Adjustments 103 000 150 150 313 000 GOO 000 Totals 713 350 1500 150 2272 450 3037 340 3802 040 4566 740 5404 000 6184 600 825 6966 7752 000 8534 900 9328 910 10122 920 10925 790 11724 700 Average Daily R'P'H'TS Average Daily Reserve 4781,64600 $ 781,33300 $ 31300 Averego Daily Exc088 FORK 4 deficiency of the reserve to date can be determined almost immedi ately. In Column C is entered the amount of reserve with the Federal reserve bank as shown by the daily transcript of the Akron bank's account which is received each day from the Fed eral Reserve Bank of Cleveland. Column D takes care of any adjustments to be made between the reserve balance of the Akron bank and the balance shown on the books of the Federal reserve bank . These result from mail delays and correction entries cov ering items charged or credited in error to the account of the Akron bank . Column E shows the accumulating totals of the 360 CLEARING AND COLLECTION OF CHECKS reserves ; its purpose corresponds to that of Column B. From this form the bank is in a position to determine at any time the amount required as reserve at the Federal reserve bank. The transit account of a country national bank Of prime importance in the subject of clearing and collec tion of checks is the question of handling the transit account , otherwise known as " Items with Federal reserve bank in process of collection - not available as reserve " and the “ Deferred credits” account. Mr. Smelser gives an informing although con cise explanation of how the transit account is handled in his bank. In arriving at the general cash balance each day, the transit department of the Akron bank furnishes the general bookkeeper with copies of all cash letters to the Federal Reserve Bank of Cleveland, to its branches, and to other Federal reserve banks and their branches. Cash letters to the Federal Reserve Bank of Cleveland and its branches contain only items drawn on the vari ous Cleveland, Cincinnati, and Pittsburgh banks. Letters sent to any other Federal reserve bank or branch are sent out on letter forms for two, three, four, five, six, or eight-day points. All such letters are charged first through the transit account . Later as the letters become available as reserve the transit account is cred ited and the account " Federal Reserve Bank of Cleveland Reserve Account” is charged . In other words, a cash letter sent to the Federal Reserve Bank of Cleveland on the night of Septem ber 1 would be available as reserve September 2 and accordingly the transit account would be charged with the amount of the letter and on the morning of September 2 the entry would be reversed with aа charge to the reserve account . When the Akron bank has cash letters for other Federal re serve banks or branches, they are prepared in strict accordance with the direct sending advices furnished for the purpose. In making up these advices the transit department uses the current month's " Schedule of availability dates for cash letters sent direct to other Federal reserve banks and branches” which are furnished by the Federal Reserve Bank of Cleveland. For example, on Sep tember 2, the Akron bank sent out the following letters direct to other Federal reserve banks and branches : A three -day country, a four-day city, a five-day city, a five-day country, and an eight-day country . According to the schedule of availability dates, these letters would become available as reserve, in the order named above, on September 7, 6, 7 , 8, and 11 . THE COMPUTATION OF RESERVES 361 On September 2 the general bookkeeper would post the five letters separately to the transit account and at the same time journalize them on the dates of availability by crediting the tran sit account and charging the reserve account. In this way the necessary and proper entries to take care of these reserve credits automatically appear on the proper dates and are taken into the respective accounts . The account “ Federal Reserve Bank - Deferred Credits” op erates so that all cash letters from the Federal reserve bank are credited to this account on the day received . On the day follow ing, this account is charged and the reserve account of the Akron bank is credited. This brings the credit of the Akron bank to its reserve account on to the account the same day it appears on its account of the books of the Federal Reserve Bank in Cleveland. Collections sent to the Federal reserve bank, when paid, are charged on the books of the Akron bank to its reserve account on the date the advice of payment is received by the Akron bank. Such items have not proved of sufficient amount in the experience of the Akron bank to make any appreciable difference in its re serve account. Should unusually large items be sent out for col lection telegraphic advice of payment would be requested so that the proper charge could be made by the Akron bank to its reserve account which would be made on the same date it was credited by the Federal reserve bank . The Akron bank finds it the exceptional procedure to have drafts drawn against the reserve balance. When such remittances of an unusual amount are made, they are handled through the de ferred credits account of the Akron bank . Ordinary drafts are credited to its reserve account on its own books on the day issued, inasmuch as the balance of the Akron bank would exceed the bal ance shown by its own reserve account until the drafts are paid. The auditor of the Akron bank insists that the system of oper ating their Reserve Transit and Deferred Credits accounts, as just outlined, is highly successful. He says : " It does not require, at the most , over thirty minutes' time each day, to make the en tries necessary, compute the requirements and determine the aver age daily excess or deficiency to date, and in addition we are always assured that our periodical reports of reserve required are rendered correctly, and all danger of being penalized for deficiency in reserve is eliminated.”» 35 " Loc . cit ., p. 49. 362 CLEARING AND COLLECTION OF CHECKS Distinction between individual and bank deposits in computing reserves of member banks For many years the Comptroller of the Currency without any express provision of law had made a distinction between ( a ) indi vidual or ordinary deposits and ( b ) bank deposits. In the case of the latter, depositary banks were permitted to deduct “ Due from Banks" from “ Due to Banks" and were required to maintain a reserve only against the difference. This was not the case, how ever, with ordinary deposits. If a concern had a deposit of $10,000 with a bank and this bank at the same time held a $5,000 demand note of this corporation, the bank was never permitted to deduct the demand note from the deposit liability in computing its reserve . This practice and this distinction between the two types of deposits was incorporated in the Federal Reserve Act. The language of the statute is as follows: " In estimating the balances required by this act the net difference of amounts due to and from other banks shall be taken as the basis for ascertaining the de posits against which required balances with the Federal reserve banks shall be determined ." 36 Computation of reserves against balances held in foreign banks by member banks The Federal Reserve Board has ruled that balances due from foreign banks cannot be deducted from balances due to banks on the ground that from a practical standpoint foreign currency bal ances due from foreign banks are not quickly available to meet demand liabilities. Such balances would require selling in the market like any other investment and the proceeds of the sale de posited with the Federal reserve bank in order to become a part of the member bank's reserve . “ Dollar balances,” due to foreign banks, on the other hand, have been held by the Federal Reserve Board to be individual deposits and not bank deposits, and there fore do not fall within the meaning of balances due to other banks . 37 The Federal Advisory Council took issue with the Federal Re serve Board on these points and insisted that the banks princi pally affected by these rulings are those located in the central reserve cities and the reserve cities, especially the former. Banks 30Federal Reserve Act , Section 19 ; Federal Reserve Bulletin, Vol . V ( 1919 ) , p . 963 . " Federal Reserve Bulletin, Vol. V ( 1919 ) , pp. 963-964 ; Vol. III ( 1917 ) , pp. 692-693 . 363 THE COMPUTATION OF RESERVES in these cities are required to carry reserves of 13 per cent. and 10 per cent. respectively, against their demand deposits, while banks in other localities are required to carry only 7 per cent. against such deposits. The effect of the ruling is, therefore, to penalize still further the banks located in central reserve and reserve cities in regard to the amount of reserves they are to carry. Funds on deposit with a foreign correspondent, insists the Council, may be converted into reserve funds through sales of checks or of cable transfers just as quickly as the funds on deposit with a domestic bank may be realized upon through drafts or telegraphic trans fers. Foreign banks should be encouraged to keep balances with their correspondent banks in this country and if banks doing a foreign exchange business are not allowed to deduct balances due them by foreign banks from the amount of their balances “ due to banks, " the volume of their foreign exchange business might have to be undesirably and unnecessarily curtailed .38 Computation of reserve against balances due from foreign branches of domestic banks The Federal Reserve Board, in July, 1925, ruled that balances payable in foreign currency due from a foreign branch of any domestic bank may not be deducted from balances due to other banks by a member bank in computing its reserve. If, however, the balances due from a foreign branch of any domestic bank are payable in dollars instead of in foreign currency, they may be de ducted from balances due to other banks by a member bank in computing its reserve. The Board believes that the phrase " the net difference of amounts due to and from other banks" contained in Section 19 of the Act has reference only to balances payable in foreign currency. Another question, closely related to the preceding ones, is whether a member bank , in calculating its reserve requirements, may deduct balances due from its own foreign branch . On this point the Board has ruled ( July, 1925 ) that balances payable either in dollars or in foreign currency due to a member bank from its own foreign branch may not be deducted from balances due to other banks by a member bank in computing its reserve. No reserves required against balances due to foreign branches by member banks No reserve is required against balances due to foreign branches, in the opinion of the Federal Reserve Board , on the " Sixth Annual Report of the Federal Reserve Board ( 1919 ) , p. 531 . CLEARING AND COLLECTION OF CHECKS 364 ground that branch banks have no separate existence distinct from the parent bank, and a balance due to a foreign branch of a member bank from its parent bank, although shown as a liability on the books of the parent bank , does not constitute, within the meaning of Section 19, a deposit liability against which reserves must be maintained.39 Question of reserves against money paid by a customer in anticipa tion of acceptances Whether a bank is required to keep a reserve against money paid by a customer in anticipation of acceptances is held by the Federal Reserve Board to depend upon the relation between the bank and the customer . If, upon receipt of the money the mem ber bank credits it to the customer's general deposit account sub ject to check , or if the customer is permitted to withdraw such money either by check or after a certain length of time, that is, if the deposit is treated as a demand or time deposit , it is held that the money deposited constitutes a deposit liability against which the member bank is required to maintain reserves , in ac cordance with the provisions of Section 19 of the Federal Reserve Act . If this deposit, on the other hand, is not subject to withdrawal by check or otherwise, but is received in full or part payment of the customer's obligation to put the bank in funds at the matu rity of the acceptance, or if the money is received as a special deposit for the purpose of meeting the acceptance when it matures and the customer cannot demand the return of the money but can require only that the bank apply the money in payment of the acceptance at maturity, it is held that the deposit does not con stitute a deposit liability within the provisions of Section 19.40 “ Special savings deposits ” are demand deposits for reserve pur poses In June, 1923, the Federal Reserve Board ruled that certain deposits labeled as “ special savings deposits” in some of the State member banks in California could not be classified properly as savings accounts for reserve purposes. These accounts were seg regated in separate savings departments, the assets of which con stituted trust funds for the protection of savings depositors; they could be invested only in a restricted manner ; and were subject to Federal Reserve Bulletin, Vol. VII ( 1921 ) , p. 815. * Ibid . THE COMPUTATION OF RESERVES 365 many other special safeguards not applicable to ordinary commer cial deposits. They were represented by pass books, and the banks reserved the right to require the presentation of the pass books at each withdrawal, but in practice they were subject to withdrawal by check without the presentation of the pass books, and an unlimited number of checks could be drawn against them and collected through the clearing houses. Under the provisions of the California law and under the specific rules printed in the pass books, the banks reserved the right to require thirty days' notice before the withdrawal of such accounts, but in practice they did not exercise this right. The Federal Reserve Board, after analyzing these deposits, held that they were not “ payable 9 after thirty days,” because not payable on a definite date, nor a specified number of days after date, nor only after thirty days' notice which actually is required. The Federal Reserve Board also held that although they were subject to thirty days' notice they could not be classified as " savings accounts” or “certificates of deposit." 41 Periods over which reserves are computed by member banks Member banks are required to maintain the legal reserve under the regulations and subject to such penalties as may be prescribed by the Federal Reserve Board.. The present regulations of the Board provide that reserve balances may be averaged over a weekly period by banks in central reserve and reserve cities, and over a semi-monthly period by banks in all other places. From these figures there is computed the average net deposits of the period, and the required reserve which is then compared with the actual reserve as shown by the reserve bank's account with the member . This permits of some fluctuation in the reserve account as it is possible for the member bank to reduce its balance below the average required on some days provided the average for the period is maintained . In the event that the average balance is not equal to the required reserve, the penalties prescribed by the Federal Reserve Board become effective . Some objection has been raised by the central reserve city bankers in New York against the system of having their reserves computed on the basis of weekly averages on the ground that they are discriminated against as compared with the banks surround ing New York , whose reserves are computed on a semi-monthly "See Federal Reserve Bulletin , Vol. IX ( 1923 ) , p. 677. For a further dis cussion of this subject, see the Magazine of Wall Street , Vol. XXXII ( May , 1923 ) , pp. 54-55. 366 CLEARING AND COLLECTION OF CHECKS basis. It is contended in support of this objection, that the country banks are not only permitted to carry a smaller reserve, but that their reserves are not subject to such radical fluctuations in cash and deposits . Many of the Manhattan banks may main tain their average for the week up to Friday and then may receive telegraphic instructions from correspondents to transfer funds to the Federal reserve bank for credit to another Federal reserve bank, and if these transfers cause a shortage in their own reserves with the Federal Reserve Bank of New York , they will be penalized by a charge of interest on the shortage for the two days, Satur day and Sunday. Interest for two days must be paid on this shortage, although the two-day items in the deferred credit ac counts of the banks, credited to the reserve accounts upon pay ment after that elapsed time, may put the reserves over the re quirements. While it is true that if a bank is short on its seven day average reserve it may borrow from some other member which has excess reserve that week , nevertheless, interest must be paid on the amount borrowed, usually at a rate a fraction of one per cent. below the ruling rate for street money. In fact , quite a business in one-day funds is done by one bank which is a large purchaser of such funds in the early days of the week and a heavy seller at the close of the week . These makeshifts, however, are looked upon as just so much expense that should not have to be borne by member banks, which through force of circumstances over which they have no control are frequently short on their seven-day average, but have ample reserves over a fourteen -day period . At least it would be but fair, they insist, in enforcing the seven-day period, to compute the average from Wednesday to Wednesday rather than from Friday to Friday.42 Penalties for deficiencies of member bank reserves Regulation J, Series of 1924, provides that items cannot be counted as part of the minimum reserve balance to be carried by a member bank with its Federal reserve bank until such time as may be specified in the appropriate time schedule. If a member bank draws against items before such time the draft will be charged against its reserve balance if such balance be sufficient in amount to pay it ; but any resulting impairment of reserve balances will be subject to all the penalties provided by the Act . On this point Section 19 of the Federal Reserve Act provides, in part, as fol " The Financial Age, Vol. XLVI, No. 14 ( September 23, 1922 ) , p. 437; Vol. XLVII, No. 3 ( January 20, 1923 ) , p. 96. THE COMPUTATION OF RESERVES 367 lows : “ The required balance carried by a member bank with a Federal reserve bank may, under the regulations and subject to such penalties as may be prescribed by the Federal Reserve Board, be checked against and withdrawn by such member bank for the purpose of meeting existing liabilities : Provided, however, That no bank shall at any time make new loans or shall pay any dividends unless and until the total balance required by law is fully re stored.” Regulation J provides for penalties as follows : " (c ) Basic penalty.-Inasmuch as it is essential that the law in respect to the maintenance by member banks of the required minimum re serve balance shall be strictly complied with, the Federal Reserve Board, under authority vested in it by Section 19 of the Federal Reserve Act, hereby prescribes a basic penalty for deficiencies in reserves according to the following rules : “ ( 1 ) Deficiencies in reserve balances of member banks in central reserve and reserve cities will be computed on the basis of average daily net deposit balances covering a weekly period of seven days. Deficiencies in reserve balances of other member banks will be computed on the basis of average daily net deposit balances covering a semi-monthly period. “ ( 2 ) Penalties for deficiencies in reserves will be assessed monthly on the basis of average daily deficiencies during each of the reserve computation periods ending in the preceding month. “ ( 3 ) A basic rate of 2 per cent. per annum above the Federal reserve bank discount rate on 90-day commercial paper will be assessed as a penalty on deficiencies in reserves of member banks. “ ( d ) Progressive penalty.—The Federal Reserve Board will also prescribe for any Federal reserve district, upon the applica tion of the Federal reserve bank of that district, an additional progressive penalty for continued deficiencies in reserves, in ac cordance with the following rules : “ ( 1) When a member bank in a central reserve or reserve city has had an average deficiency in reserve for six consecutive weekly periods, a progressive penalty, increasing at the rate of one-fourth of 1 per cent. for each week thereafter during which the average reserve balance is deficient, will be assessed on weekly deficiencies until the required reserve has been restored and main tained for four consecutive weekly periods, provided that the max imum penalty charged will not exceed 10 per cent. “ ( 2 ) When a member bank outside of a central reserve or reserve city has had an average deficiency in reserves for three 368 CLEARING AND COLLECTION OF CHECKS NEW YORK FEDERAL RESERVE BANK Comparative statement of condition at the close of business : RESOURCES Gold with Federal Reserve agent Gold redemption fund with U. S. Treasury Gold held exclusively Mar. 12, 1924 $582,984,000 Mar. 5, 1924 $ 583,041,000 Mar. 14, 1923 $ 609,402,000 9,236,000 5,877,000 9,486,000 $592,220,000 $ 588,918,000 $618,888,000 168,477,000 150,581,000 286,331,000 185,322,000 147,669,000 against F. R. notes Gold settlement fund with F. R. Board Gold and gold certificates held by bank 187,544,000 Total gold reserves Reserves other than gold $ 948,241,000 30,620,000 $ 924,821,000 $1,052,891,000 29,654,000 17,043,000 Total reserves Non-reserve cash Bills discounted : $ 978,861,000 $954,475,000 11,251,000 11,047,000 $ 1,069,934,000 8,366,000 72,762,000 24,164,000 59,601,000 21,059,000 176,173,000 33,309,000 $ 96,926,000 44,284,000 $ 80,660,000 56,862,000 $209,182,000 35,264,000 1,202,000 28,971,000 9,933,000 1,202,000 20,940,000 8,313,000 1,149,000 13,278,000 10,000,000 $ 10,106,000 100,000 $ 30,455,000 $ 24,427,000 $181,416,000 140,409,000 13,987,000 4,491,000 $ 168,077,000 Secured by U. S. Government obligations Other bills discounted Total bills discounted Bills bought in open market U. S. Government securities : Bonds Treasury notes Certificates of indebtedness Total U. S. Govt . securities All other earning assets Total earning assets Uncollected items Bank premises All other resources Total resources 100,000 125,643,000 13,982,000 3,367,000 $ 269,173,000 152,414,000 10,872,000 1,896,000 . $ 1,330,418,000 $ 1,276,591,000 $ 1,512,655,000 LIABILITIES Federal Reserve circulation notes in actual $ 371,197,000 $ 372,537,000 $ 567,168,000 740,888,000 6,405,000 10,779,000 697,335,000 724,458,000 Deposits : Member bank- reserve account Government Other deposits Total deposits Deferred availability items Capital paid in Surplus $ 758,072,000 109,190,000 All other liabilities 29,728,000 59,929,000 2,302,000 Total liabilities $ 1,330,418,000 8,456,000 480,000 10,074,000 $715,865,000 9,815,000 96,445,000 29,728,000 59,929,000 2,087,000 $ 734,753,000 119,055,000 28,888,000 59,800,000 2,991,000 $1,276,591,000 $1,512,655,000 Ratio of total reserves to deposit and Federal Reserve note liabilities combined 86.7 % 87.7 % 82.2 % $ 2,185,000 $ 3,120,000 $ 13,857,000 Contingent liability on bills pur chased for spondents foreign corre THE COMPUTATION OF RESERVES 369 consecutive semi-monthly periods, a progressive penalty, increas ing at the rate of one -half of 1 per cent. for each half month thereafter during which the average reserve balance is deficient, will be assessed on semi-monthly deficiencies until the required re serve has been restored and maintained for two consecutive semi monthly periods, provided that the maximum penalty charged will not exceed 10 per cent.”:43 2. Computation of reserves by Federal reserve banks There are no definite or prescribed forms for computing re serves in the Federal reserve banks. The Federal Reserve Act and the regulations of the Federal Reserve Board prescribe defi nitely what the reserve shall be, its composition and minimum amount, and the liabilities against which the reserve shall be com puted . With these few requirements in mind, the reserve depart ment readily computes the reserves. These are reported each week and are consolidated into what is known as the Consolidated Statement of the Federal reserve banks . Using the statement of the Federal Reserve Bank of New York for March 12, 1924, as an example, the method of computa tion is readily comprehended. In a Federal reserve bank the reserve against deposits must consist of gold or lawful money and must equal at least 35 per cent . of the deposits. Against Federal reserve notes the bank must keep a reserve in gold of not less than 40 per cent . , the remainder to be covered by eligible commercial paper. Referring to the above statement it will be noticed that the Federal reserve bank totals the following items: ( 1 ) Gold with the Federal reserve agent, ( 2 ) gold redemption fund in the United States Treasury which must be equal to at least five per cent. of the Federal reserve notes in actual circulation and which counts as part of the 40 per cent . reserve. These two items combined indi cate the total amount of gold held against the Federal reserve notes . Next are added ( 3 ) the gold and gold certificates in the Gold Settlement Fund to the credit of the Federal reserve bank , and ( 4 ) the gold and gold certificates held by the bank , the total representing the total gold reserves. The reserves other than gold , which are composed of silver, silver certificates, and United States notes, are next added, the total giving the total reserves against notes and deposits. The liabilities against which these reserves are held are divided « Federal Reserve Bulletin , Vol. X ( 1924 ) , pp . 490-491 . 370 CLEARING AND COLLECTION OF CHECKS into two main classes : ( 1 ) Federal reserve notes in actual circu lation and ( 2 ) deposits. Consulting the statement of the Fed eral reserve bank given above, it will be noticed that the first item listed under liabilities is that indicating the amount of Federal re serve notes in actual circulation. This amount is determined daily. Every day each Federal reserve bank is shipping its own unfit notes and those of other Federal reserve banks to the Treas ury Department and is also shipping fit notes redeemed by it to the other Federal reserve banks through which such notes were originally issued. All such shipments are reported daily by wire to the Federal Reserve Board at Washington, the accounts are cleared daily by the Board, and wire advices of the results are sent daily to all Federal reserve banks, thus enabling them to know the amount of their notes in actual circulation against which reserves are computed. The second item listed under liabilities is deposits. It is divided into three classes as follows : ( 1 ) The reserve deposits of member banks, ( 2) government deposits, and ( 3 ) other deposits. The nature of these deposits has been explained above. The Fed eral reserve banks compute the required reserve against only real reserve deposits to the credit of member banks . Such deposits, when built up as a result of sending collection items through the Federal reserve banks for collection or direct to other banks for credit to their reserve accounts, become effective as reserve de posits only according to the published time schedules. The same principle applies to checks and drafts on all other deposits, but not to checks and warrants on the government deposits ; for the latter immediate credit is given. Reference was made above to the fact that each Federal re serve bank maintains on its books two active accounts with each of the other Federal reserve banks, although these accounts do not appear in the published statement.. One of these is the debit or Due from Account representing all items forwarded for collec tion and amounts due for transfer of funds . A settlement is re ceived at the close of business each day for the amount due as shown by the books of the other reserve bank . This account is, in fact, a remittance account and any unpaid balance after the daily settlement would not be represented by a corresponding credit on the books of the other bank, but rather by items in transit or not yet collected. The other item is the credit or Due to Account . This account is the exact opposite of the Due from Account and represents the credits due another reserve bank for items collected and for THE COMPUTATION OF RESERVES 371 transfers of funds during the day. The total of the account is paid through the Gold Settlement Fund, so the account shows a zero balance at the close of business ; the only exception being on local holidays when through the closing of a part of the reserve banks it is not possible to settle with them. In all such cases the account is paid at the close of the following business day. Even though a reserve bank does not maintain a balance with another reserve bank, it nevertheless may draw its drafts on an other reserve bank. Such drafts are charged by the paying bank to its Due to Account, thereby effecting an immediate collection of the draft by reducing the amount to be paid the other reserve bank at the close of business that day.44 Deferred availability items on the liability side and uncol lected items on the asset side of the bank statement are ignored in computing reserves. Prior to March 18, 1921 , “ net deposits " were used in calculating the reserve ratio, while since that date “ total deposits” have been used. According to the earlier prac tice, “ net deposits” were ascertained by taking the sum of gov ernment deposits, member banks' reserve deposits, other deposits, and deferred availability items and subtracting from the total the asset item, " uncollected items and other deductions from gross deposits," composed chiefly of clearing house exchanges, transit items, Federal reserve notes of other Federal reserve banks, un assorted currency, and domestic transfers. Since the change, total deposits include government, member bank, and other deposits, without reference to deferred availability or uncollected items. This action tended to apply a more severe standard of compu tation. 45 The question of reserve deficiencies in Federal reserve banks The question arises as to whether a Federal reserve bank whose total reserves against the aggregate of note and deposit liabilities is below the minimum requirements, may allocate its gold assets in such a manner that its reserves against notes are main tained at 40 per cent , while its reserves against deposits fall below 35 per cent. If, in determining whether a deficiency of reserve exists, a Federal reserve bank subtracts 35 per cent. of the de posits and finds the remaining reserve does not equal 40 per cent. “L. R. Rounds, op. cit., pp. 665-66 . "Eighth Annual Report of the Federal Reserve Board ( 1921 ) , p. 27. This plan was first provided for as early as December 19, 1919 in accordance with an opinion of counsel for the Federal Reserve Board , and was to have been effective February 12, 1920 , but was postponed until March 18, 1921. See Federal Reserve Bulletin , Vol. VI ( 1920 ) , p. 3. 372 CLEARING AND COLLECTION OF CHECKS of the Federal reserve notes outstanding, it becomes liable for a tax on the reserve deficiency as prescribed by the Act and as set forth below. Some of the Federal reserve banks in order to evade this tax, changed their method of computing the reserve by sub tracting the 40 per cent. reserve against Federal reserve notes from the total reserve so that the deficiency or excess of reserve would be shown with respect to deposits, as no penalties for de ficiencies of reserve against deposits had been prescribed by the Federal Reserve Board . In February, 1920, the Board faced this problem and ruled that Section 16 of the Federal Reserve Act implied that a Federal reserve bank may maintain its 40 per cent. reserve against Federal reserve notes even though the reserve against deposits, as a result , may fall below the 35 per cent. limit . Para graph 3 of Section 16, which fixes the minimum reserve require ments against both note and deposit liabilities, provides that when the Federal reserve agent holds gold or gold certificates as col lateral for Federal reserve notes issued to the bank, such gold or gold certificates shall be counted as part of the gold reserve which such bank is required to maintain against its Federal reserve notes in actual circulation. Under the terms of this paragraph all gold or gold certificates held by the Federal reserve agent as collateral for outstanding notes must necessarily be counted as reserve against those outstanding notes and cannot lawfully be considered as part of the reserve against deposits. So, also, Section 16 provides that gold deposits standing to the credit of any Federal reserve bank with the Federal Reserve Board shall be counted, at the option of said bank, as part of the lawful reserve which it is required to maintain against outstanding Fed eral reserve notes, or as part of the reserve it is required to main tain against deposits. Although there is no express provision in the law itself conferring upon the bank the right to allocate the free gold held by it46 as a part of its reserve against Federal re serve notes instead of as a part of its reserve against deposits, the Board held that such option exists. In other words, inasmuch as the bank is authorized to procure Federal reserve notes from the Federal reserve agent upon the deposit of as much as 100 per cent . gold, and inasmuch as all deposits with the Federal reserve agent must necessarily count as part of the reserve to be main tained against notes outstanding, the Federal reserve bank may “ That is, gold not with the Federal reserve agent and not with the Gold Settlement Fund. THE COMPUTATION OF RESERVES 373 always maintain its reserve against notes at the expense of its deposit reserve account by transfering free gold to the Federal reserve agent as collateral for outstanding notes . The banks may also accomplish this same purpose by depositing free gold in the Gold Settlement Fund since credits in the Gold Settlement Fund , by law may be counted, at the option of the bank, either as re serve against notes or as reserve against deposits. Thus in view of these facts the Board held that the Federal reserve banks had a right to consider free gold in its vaults as reserve against notes even though to do so results in a deficiency in the reserve against deposits. In a summarized sentence it may be said that the Board established the principle that an excess of reserve in the posses sion of the Federal reserve agents against Federal reserve notes may not count automatically as reserve against deposits, although an excess of reserve against deposits may count as reserve against the notes . At the same time the Board prescribed the penalty to be ap plied to the Federal reserve banks for deficiencies in reserves against their deposits. It held that paragraph ( c ) , Section 11 of the Federal Reserve Act, required it to establish a graduated tax on such deficiencies. This regulation, retroactive in nature, pre scribed a tax of 1 per cent. per annum on the first 5 per cent. deficiency below 35 per cent., the tax increasing 1 per cent. on each additional 5 per cent. the reserve falls. This means that in case the reserve falls to 25 per cent . the tax will be 1 per cent . per annum on the first 5 per cent., and 2 per cent . per annum for the second 5 per cent., but not 2 per cent . on the entire 10 per cent. deficiency. The following table will illustrate the manner in which the graduated tax applies : When the reserves against The tax rate upon each 5 per deposits are : cent. deficiency is : Below 35 to 30 per cent. Below 10 to 5 per cent . 1 2 3 4 5 6 Below 5 to 7 per cent. Below 30 to 25 per cent . Below 25 to 20 per cent. Below 20 to 15 per cent . Below 15 to 10 per cent. 0 per cent . per per per per per per cent. cent. cent . cent. cent. cent. As pointed out above, eight Federal reserve banks paid taxes on such deficiencies in 1920. There is nothing in the law specifying to whom such a tax must be paid, but the Board held that there is no one to whom the tax could reasonably be paid except to the government even though, as a matter of fact , it amounts to a tax upon the gov 374 CLEARING AND COLLECTION OF CHECKS ernment's own equity in the Federal reserve bank's surplus. It seemed to be the only way to give effect to the provision of the law imposing the tax upon reserve deficiencies against deposits. The penalties for deficiencies of reserves against Federal re serve notes are prescribed in paragraph ( c ) , Section 11 of the Federal Reserve Act . When the reserve falls below 40 per cent., a tax of 1 per cent . is levied upon this deficiency until the reserve falls to 32.5 per cent . after which the rate increases by 1.5 per cent . upon each 2.5 per cent . or fraction thereof that the reserve falls below 32.5 per cent. The following table will show the man ner in which the graduated tax applies : When the reserves against The tax rate upon the deficiency Federal reserve notes are : is : Below 40.0 to 32.5 per cent. 1.0 per cent. Below 32.5 to 30.0 per cent. 2.5 per cent. 4.0 per cent. 5.5 per cent. Below 30.0 to 27.5 per cent. Below 27.5 to 25.0 per cent. Below 25.0 to 22.5 per cent. Below 22.5 to 20.0 per cent. Below Below Below Below i 20.0 17.5 15.0 12.5 to to to to 17.5 15.0 12.5 10.0 per per per per cent. cent. cent. cent. Below 10.0 to 7.5 per cent. Below 7.5 to 5.0 per cent. 7.0 per cent. 8.5 per cent. 10.0 per cent. 11.5 per cent. 13.0 per cent. 14.5 per cent. 16.0 per cent. Below 5.0 to 2.5 per cent. 17.5 per cent. 19.0 per cent. Below 2.5 to 0.0 per cent. 20.5 per cent. To obviate deficiencies of reserves the Federal Reserve Board may cause any Federal reserve bank to rediscount paper for an other, thus making it possible for the Board to shift reserve bal ances at will. Or one Federal reserve bank may borrow from an other to " adjust" its reserves. As a result of such an operation two technical expressions have arisen : “ Unadjusted reserves” sig nifying the reserves the bank would have if it had not borrowed from other Federal reserve banks, and “ adjusted reserves,” sig nifying the reserves after the money borrowed has been added or money loaned has been subtracted . Such methods undoubtedly secure more elasticity in our credit structure than could be ob tained otherwise.47 Method of reporting the reserve condition of the Federal reserve banks Each week a consolidated statement is published in the public press showing the condition of the twelve Federal reserve banks. +7See Westerfield, op. cit . , II , p. 361 . THE COMPUTATION OF RESERVES 375 On January 11 , 1924, the consolidated statement appeared in a revised form which has raised some doubt and uncertainty in the public mind. The old and new methods of presenting the state ments may be contrasted most effectively by placing them side by side. Fortunately for our purpose, the weekly comparative state ment of the twelve Federal reserve banks as of January 9, 1924, was released by the Federal Reserve Bank of New York on Jan uary 11 , according to the old method, while the Federal Reserve Board released the statement from Washington for the same period according to the new method. The differences in the statements were explained in the report given out from Washington as follows : “ Beginning with this week a number of changes have been made in the arrangement of the items in the Board's statement showing condition of Federal re serve banks. The principal changes include the substitution of a sub-total representing 'Gold held exclusively against Federal re serve notes for the sub -total heretofore carried representing "Total gold held by banks,' the substitution of a sub-total of "Total bills discounted ' for "Total bills on hand ,' the addition of a sub-total of United States government securities, and the placing of the liabilities to the public and to the banks for Federal reserve notes and deposits at the beginning of the liability state ment." One of the critics of this change, Mr. Theodore H. Price,48 objects to the term " rearrangement ” and insists that the change amounts to something more than that. He thinks that in setting aside $2,158,153,000 and describing it as " held exclusively against Federal Reserve Notes ” there is created aa special reserve of more than 100 per cent. of the Federal reserve notes in circulation, which leaves but $972,389,000 of gold to be considered as a re . serve against $1,983,755,000. This amounts to less than 50 per cent. of the deposits. Mr. Price anticipates that the Board will order another rearrangement of the statement which will show the ratio of reserves to deposits, and after setting aside a 100 per cent. gold reserve for Federal reserve notes outstanding, will have the effect of deceiving the public as to the true ratio of gold re defeat the purpose of the Federal Reserve Act, which was to provide the nation with abundant credit serves to liabilities and “ . . . facilities at a reasonable cost rather than to create a quasi governmental agency that could be used to sustain or advance "See Theodore H. Price, " Juggling the Federal Reserve Statement,” Com merce and Finance , Vol . XIII , No. 4 ( January 23, 1921 ), pp. 211-212. CLEARING AND COLLECTION OF CHECKS 376 > interest rates whenever they threaten to decline.” Even though the Board does not rearrange the method of publishing the reserve against deposits, anyone attempting to compute the reserve against STATEMENT OF TWELVE FEDERAL RESERVE BANKS COMBINED January 9, 1924 As issued in New York RESOURCES $ 389,867,000 582,522,000 Gold and gold certificates Gold settlement fund , Fed. Res. Board $ 972,389,000 Total gold held by banks Gold with Federal Reserve agents 2,106,705,000 Gold redemption fund 51,448,000 Total gold reserves 3,130,543,000 106,965,000 Reserves other than gold Total reserves Non- reserve cash Bills discounted : 3,237,507,000 67,756,000 Secured by U. S. Government obligations 306,373,000 300,548,000 319,166,000 Other bills discounted Bills bought in open market Total bills on hand $926,087,000 81,992,000 18,366,000 51,000 United States bonds and notes U. S. certificates of indebtedness Municipal warrants Total earning assets Bank premises . $1,926,496,000 54,006,000 Five per cent. redemption fund against Federal Reserve Bank 28,000 606,178,000 15,576,000 notes Uncollected items All other resources Total resources . $5,007,547,000 LIABILITIES Capital paid in Surplus Deposits: Government $ 110,506,000 220,915,000 19,343,000 1,941,006,000 23,406,000 Member bank - Reserve account Other deposits Total deposits Federal Reserve notes in actual circulation . $ 1,983,755,000 2,147,064,000 Federal Reserve Bank notes in circulation - net liabilities Deferred availability items All other liabilities 456,000 532,205,000 12,646,000 Total liabilities . $ 5,007,547,000 Ratio of total reserves to deposit and Federal Reserve not lia bilities combined Contingent liability on bills purchased for foreign correspondents 78.4 % $18,175,000 THE COMPUTATION OF RESERVES 377 deposits after deducting the gold reserve against Federal reserve notes will arrive at the same conclusion. This change in method is in harmony with a demand made in certain quarters for a plan STATEMENT OF TWELVE FEDERAL RESERVE BANKS COMBINED January 9, 1924 As issued in Washington RESOURCES Gold with Federal Reserve agents .. Gold redemption fund with U. S. Treasury Goldheld exclusively against F. R. notes . $ 2,106,705,000 51,448,000 . $ 2,158,153,000 Gold settlement fund with F. R. Board 582,522,000 Gold and gold certificates held by banks 389,867,000 Total gold reserves Reserves other than gold $ 3,130,542,000 106,965,000 Total reserves $ 3,237,507,000 67,756,000 Non -reserve cash Bills discounted : Secured by U. S. Government obligations Other bills discounted Total bills discounted 306,373,000 300,548,000 $ 606,921,000 319,166,000 Bills bought in the open market U. S. Government securities : Bonds 19,903,000 62,089,000 18,366,000 Treasury notes Certificates of indebtedness Total U. S. Government securities All other earning assets Total earning assets Five per cent. redemption fund- Federal Reserve bank notes Uncollected items Bank premises $100,358,000 51,000 . $ 1,026,496,000 28,000 606,178,000 54,006,000 15,576,000 All other resources Total resources $ 5,007,547,000 LIABILITIES Federal reserve notes in actual circulation Federal Reserve Bank notes in circulation-net Deposits : Member bank - reserve account Government Other deposits Total deposits Deferred availability items . $ 2,147,064,000 456,000 1,941,006,000 19,343,000 23,406,000 . $ 1,983,755,000 532,205,000 Capital paid in 110,506,000 Surplus 220,915,000 12,646,000 All other liabilities Total liabilities .. $ 5,007,547,000 Ratio of total reserves to deposit and F. R. note liabilities combined 78.4 % Contingent liability on bills purchased for foreign correspondents $ 18,175,000 CLEARING AND COLLECTION OF CHECKS 378 to establish a " super- reserve " by segregating a part of this gold and so making the ratio appear smaller. " " Mr. Price insists that while the power of the government is being exerted in nearly every other direction to reduce the cost of living the Pederal Reserve Board is now working in the opposite direction by maintaining high interest rates. He continues : “We subrnit that the Federal reserve officials are presuming upon their power ; that the Federal Reserve Act does not warrant them in setting aside any part of the gold or other assets in their posses sion as held 'exclusively against Federal Reserve Notes' and that in “rearranging the weekly statement, as they have, they have disregarded the amendment to the Federal Reserve Act passed June 21 , 1917, and are attempting to read into the law an author ity that it does not give them and create an impression that is at variance with the facts. " Thomas F. Woodlock , in his column, “ By Way of Comment,” in the New York Herald , says : " If this represents a change of policy - and if it does the Board should so state it in a definite and formal way -- then the gold securing the note circulation is stripped of reserve functions and returns to a mere circulatory status. The effect of this is to abolish at one stroke note issuing powers to an amount of over $3,000,000,000, or, if member bank deposits with the system be considered, to obliterate aa reserve which would support not far from $4,000,000,000 additional re serve deposits. Putting it another way, it strips $1,300,000,000 of gold of reserve powers and makes it mere currency." 50 If these criticisms may be taken as typical of those who op pose the new plan, it may be anticipated that they will be answered by a large number of persons who will see in this practice a well advised move on the part of the Board to prevent an undue ex pansion of credit made possible by the great influx of gold as a result of foreign trade conditions growing out of the late War. It has not been long since the Board was severely criticised for not preventing credit expansion following the armistice by means of a sharp raise in the rediscount rates, which , combined with the stress generally found in banking literature on the wisdom of a policy which would prevent expansion to get beyond the control of the Board, would seem to indicate that the policy of the Board " Cf. the Magazine of Wall Street, Vol. XXXI, No. 12 ( April 14, 1923) , p . 1065. Quoted by Price, op . cit ., p . 212. For similar criticisms see the Commercial and I'nancial Chronicle, Vol. CXVIII ( January 12, 1921 ), p. 1 ; Commerce and Finance , Vol. XII , No. 49 (December 5, 1913), p. 2236 . THE COMPUTATION OF RESERVES 879 is in harmony with what a large percentage of the writers and thinkers in banking would advocate. 3. Computation of reserves in non -member State banks, trust companies, and private banks In general, the method of computing reserves in non -member State banks, trust companies, and private banks, does not vary widely from that employed by banks in the Federal Reserve Sys tem. In New York State — and this discussion will be confined to that State - reserves are required against aggregate demand de posits only. That term as used in the New York law means the deposits against which reserves must be maintained, by banks, trust companies, and private and individual bankers, and includes total deposits, all amounts due to banks, bankers, trust companies, and savings banks, the amounts due on certified and cashiers' checks, and for unpaid dividends, less the following items : ( 1 ) Total time deposits, ( 2 ) Deposits secured by the deposit of outstanding un matured stocks, bonds, or other obligations of the State or City of New York , ( 3 ) Deposits to an amount not exceeding either the market or par value of outstanding unmatured stocks, bonds, or other obligations of the State or City of New York owned and held by such corporation or banker, ( 4 ) Deposits due to the United States of America, represent ing the proceeds of the sale of bonds or certificates of the said United States, known as the war loan of nineteen hundred and seventeen, or the proceeds of any other bonds or certificates of the United States hereafter issued for war purposes , (5 ) The amount due it on demand from banks, bankers, and trust companies other than its reserve depositaries, including for eign exchange balances credited to it and subject to draft , ( 6 ) The excess due it from reserve depositaries over the amount required to maintain its total reserves, ( 7 ) The amount due for exchanges and checks on other banks and trust companies in the same city to be presented for collection the following day, (8 ) Cash items. 380 CLEARING AND COLLECTION OF CHECKS RESERVE AND METHOD OF COMPUTATION TRUST COMPANIES In Manhattan or Brooklyn Boroughs .. BANKS Total Reserves on hand Depositaries Total Reserves on hand 15 10 5 18 12 10 4 6 10 3 7 Depositaries 6 In the Boroughs of The Bronx, Queens and Richmond , and in the Cities of Buffalo , Rochester, Syracuse, Albany, Yonkers, Troy, Utica and Schenectady .... Elsewhere ADD 12 8 To ascertain amount of aggregate deposits upon which reserve is to be computed : 1. Amount due banks, bankers and trust companies ... 2. Amount due New York State savings banks and savings and loan associations.. 3. Amount due other depositors . 4. Amount due on certificates of deposit.. 5. Amount due on certified and cashier's checks.... 6. Amount due on unpaid dividends . Total DEDUCT 1. Amount due ( subject to call) from banks, bankers and trust companies not reserve depositaries, including foreign exchange balances credited to it and subject to $ draft .. 2. Amount due for exchanges and checks on other banks and trust companies in your city to be presented for collection the following day ...... 3. Amount due on deposits the payment of which cannot legally be required within thirty days ., 4. Amount of deposits secured by outstanding unmatured bonds of the State of New York and of the City of New York .... 5. Ainount of New York State and New York City bonds owned and held at market value but not exceeding par value, exclusive of amount necessary to cover item No. 4 ... 6. Deposits due to the United States of America, representing the proceeds of the sale of bonds or certificates of the said United States known as the war loan of nineteen hundred and seventæn , or the proceeds of any other bonds or certificates of the United States hereafter issued for war purposes ... 7."Amount of cash items..... 8. Amount due from reserve depositaries , excess over amount required to maintain its total reserve . Total Balance upon which reserve is to be computed .. NOTE---In case reciprocal accounts are kept with reserve depositaries, only the excess due to the institution under examination can be counted as reserve . FORM 5 THE COMPUTATION OF RESERVES 381 The accompanying form ( Form 5 ) shows the method by which the reserves are computed and, in the main, is self-explanatory. Reports are made weekly to the Superintendent of Banks. 4. Computation of reserves by non -member national banks The only exception to the general rule that all national banks must become members of the Federal Reserve System as the price of retaining their charters is to be found in the national banks of Alaska and Hawaii . Such banks may remain non -member banks, complying with the law applicable to them ,51 or, with the consent of the Federal Reserve Board, may become member banks of any one of the reserve districts, in which case they are subject to all the Provisions of the Federal Reserve Act . Section 5192, United States Revised Statutes, provided that three- fifths of the reserve of 15 per cent. required to be kept by country banks might consist of balances due to such associations from associations approved by the Comptroller of the Currency in one of the reserve or central reserve cities . These sections govern the reserve to be held by national banks in Hawaii and Alaska.552 Form 6 on the following page, for the computation of reserves as prescribed by the Comptroller of the Currency, is largely self explanatory. No attempt will be made to consider the methods by which re serves are computed in foreign branches since they are not re quired to maintain a specific amount of reserve or report regularly to State or national authority in respect to their reserves. 5. The computation of reserves by Federal foreign banking cor porations There is no prescribed form to be followed by Federal foreign banking corporations in computing reserves, nor are there any regulations requiring that such reports shall be made at stated intervals to the Federal Reserve Board. The reserves are com puted daily and can be reported to the Board at any time. There are no penalties for deficiencies ; it is presumed that the Board will prescribe such penalties as it sees fit if tlie occasion ever arises . 61Which is the National Banking Act as amended . b2Instructions of the Comptroller of the Currency Relative to the Organiza tion and Powers of National Banks Together with the Regulations of the Federal Reserve Board Relating to Nalional Banks ( Washington, 1923 ) , pp. 78-79 . 382 CLEARING AND COLLECTION OF CHECKS COMPUTATION OF RESERVE OF NON -MEMBER NATIONAL BANKS No. of blanks STATEMENT showing the Net Deposits, Reserve required, and Amounts composing the Reserve held by non-member National Banks located in the terriory of 19 at close of business on ITEMS ON WHICH RESERVE IS TO BE COMPUTED Due to Banks and Bankers - Less Due from National Banks Not reserve Agents Due from other Banks Net amount due to Banks Demand Deposits Time Deposits Total Gross Deposits DEDUCTIONS ALLOWED Exchange for Clearing House Checks on other banks in same place Notes of other National Banks... Due from U. S. Treasurer ( 1 ) Net Deposits ( 2 ) Reserve required is 15 % of above .. RESERVE AND PER CENT HELD ( 3 ) Cash in vault ( less National Bank notes ) ( 4 ) Reserve with Reserve Agents ( 5 ) Total Reserve held • • ( 6 ) Ratio of Reserve held ( No. 5) to Deposits (No. 1 ) .. per cent RECLASSIFICATION Reserve Required ID Vault Reserve Agents Total FORM 6 Held Excess CHAPTER X THE CLEARING HOUSE Nature of clearing operations A clearing house has been defined in an earlier chapter as a voluntary association of banks to simplify and facilitate the ex changes of such items as checks, drafts, bills and notes, to facili tate settlements of balances among the banks, and to serve as a medium of united action upon all questions affecting their common welfare. For the purpose of carrying on these operations, banks asso ciate themselves into clearing house associations, commonly called "clearing houses" . A brief account of the origin of clearing houses has been given in Chapter III. At present there are 362 clearing house associations in the United States. Most of them are unincorporated , co-operative associations and derive their authority over their members through their written assent to their respective constitutions.2 While most, if not all, clearing house associations exercise cer tain special functions in addition to that of clearing, this chapter is concerned principally with clearing, the primary function of clearing house associations. In principle, clearing houses do not vary widely ; consequently their nature, functions, and operations can be understood by the study of a clearing house association like that in New York City, the oldest if not the largest. The New York Clearing House Association The New York Clearing House Association was founded in 1853. At present it consists of forty member and six non -member clearing banks located in Greater New York, one of the forty being the Federal Reserve Bank of New York. In smaller cities or towns the clearing house facilities will be found to differ widely. 'Data from Clearing House Section of the American Bankers' Association. 'In Mississippi banks are prohibited by statute (Code Sec. 3628 et seq. ) from becoming members of unincorporated clearing house associations. See Thomas B. Paton, Jr., Digest of Legal Opinions ( New York, 1922 ) , p. 225. 383 CLEARING AND COLLECTION OF CHECKS 384 Some will have separate buildings, while others may use a single room in a rented building or in one of the banks. Outside of New York City, it seems that most, if not all, of the permanent quar ters are rented. In New York the association began in the early seventies to accumulate a building fund and in 1875 pur chased and equipped its first building which was formerly the National Bank of the Commonwealth Building, on the corner of Nassau and Pine Streets. Proving inadequate, this property was sold in 1894 and a new property located at 79 to 83 Cedar Street was purchased, title to it being held by a separate and newly organized corporation, called the “ New York Clearing House Building Corporation ”. This company drew upon the members of the clearing house association in proportion to their respective capital and surplus for funds sufficient to build and equip their present beautiful home. Altogether the New York Clearing House Association has occupied five different locations in its history.3 The administration of the clearing house association The constitution of the clearing house provides for the regu lation of the association and the guidance of its members. Ad ministration of the affairs of the association is vested in five officers and five standing committees. The officers are the presi dent, secretary, manager, assistant manager, and the examiner. The president, the secretary, and the five committees are chosen at annual meetings by ballot, from officers of members, to serve for one year or until successors are elected . The president and secretary are eligible for office for two successive years and after an interval of one year are again eligible in like manner. The president presides at the meetings of the association, is an ex -officio member of all committees except the nominating com mittee, and performs such other duties as may be incident to the office. He serves without compensation, this being generally true of clearing house presidents. The secretary exercises the powers usually vested in such He attends the meetings of the association, keeps a record of the proceedings, and performs such other duties as are officers. incidental to the office. The manager of the association is an important official. He is appointed by the clearing house committee and by custom the 'J.G. Cannon, Clearing Houses, U. S. Nat. Mon. Com . Pubs., 61st Cong., 2d Sess., Sen. Doc. No. 491 , pp. 155-159 THE CLEARING HOUSE 385 same manager has been retained from year to year. In fact , there have been but four incumbents of this office since 1853. The manager has full charge of the clearing operations. He controls the clerks and employees of the association as well as the em p