Cash and call money 23 per cent. Investments 24 per cent.
while bank I (as shown by the table) stands—
Cash and call money 32 per cent. Investments 11 per cent.
This somewhat reduces the wide disparity at present shown in the respective figures, and it is quite possible that this difference could be still further reduced if we knew the actual amount held by each of these banks in securities, other than Consols, guaranteed by the British Government, and made the same assumptions with regard to these as in the case of Consols. As a matter of fact, considerably more than half of the 26·6 per cent. of investments held by bank E appears in the balance sheet of the bank as being composed of such securities, and these might prove a more valuable asset in time of trouble than so much money nominally at “call” or “short notice.”
From this example we can see that in examining the balance sheet of any bank, particular attention must be paid to the composition of the investments, whether they are of such a character that one may fairly rely on being able in time of stress to realise them immediately, or, in the alternative, borrow from the Bank of England on their security. We may repeat, as the matter is of importance, that the actual amount of securities held, or the proportion which they bear to the total balances, is not of such importance in the case of a bank, as the nature of the securities which form the investments. One London bank’s investments simply consist of a large holding of Consols; and though times might conceivably come when it would be impossible to realise even such a holding at short notice, yet such an investment forms a backbone and reserve which cannot be overestimated.
Having considered the securities which constitute the “liquid assets” of bankers, we will now briefly turn our attention to the manner in which the remainder of bankers’ funds are usually utilised. As we have already seen, this remainder is used mainly in discount operations and advances to customers, while a certain amount is generally sunk in premises, etc. These three items have been classified together in our table, as the necessary information is not given in some of the published balance sheets to enable us to specify them separately. As regards “premises,” it may be repeated that though they form a valuable asset, yet they are not an available one, and would, generally speaking, only be realised in the event of a winding-up.
The bills held under discount comprise bills which are discounted for the customers in the ordinary course of business, and also bills bought from bill-brokers; and they constitute a fairly available asset.
The “Advances” to customers is a security of a very fixed nature. In times of trouble it is the asset most difficult of realisation, and it is the rock on which the majority of banks which have come to grief have struck.
No information respecting this asset is vouchsafed in any balance sheet beyond the bare total. It is a known fact that banks are lenders on practically any kind of security which has a fairly steady value, and in which there is a “market”; stocks, shares, produce, houses, lands—all are offered as security, and all are accepted under various conditions. But it is of the utmost importance that bankers should closely watch and scrutinise the aggregate of advances which they may make upon any one kind of security, so as to keep the amount within due limits. If too large a sum is advanced on one kind of security, and that security should become much depressed in value, the banker may be caught between two fires: on the one hand, the customers who have deposited this security will, from its fall in value, have become financially weakened, and perhaps not be in a position to repay the advances; and on the other hand, if the banker wish to repay himself by realising the securities, he may find that the margin of value has run off, and what can be obtained by selling the securities in the market will not cover the advances, or possibly, for the time being, they will prove to be unsaleable. Thus he will be left in the dangerous position of having a considerable proportion of his assets indefinitely locked up, and a certain number of his customers in a weak and reduced condition financially.
Neglect of the precaution of spreading advances over different suitable classes of investment has brought many banks to ruin in the past, and under similar conditions would do so in the future. This danger is not now so pressing as in former times. Owing to the present custom of establishing branches, and to amalgamations, the operations of banks are now frequently spread over wide areas, and therefore automatically their advances tend to spread over many more industries and securities than was formerly the case. When banks were more local, their prosperity rose or fell with the industry and conditions of their particular district.
We see then there is danger in locking up too large amounts in advances on any one class of security. But there is an equal danger in advancing too large sums to a few customers. A firm may be of very good standing and report, and keep a first-class and highly remunerative account with its banker. From time to time it has advances from its banker, which he is very glad to make, and which are regularly repaid. But a time may come when an advance may not be repaid when due; instead, a further advance is asked for. This is made without question, and probably further advances, always increasing and never reducing. After a time the banker may become a little fidgety, and cautiously suggest a reduction, but will probably be told that ample funds will come to hand shortly. When this time comes the funds may not have been received, and the customer may insist that he _must_ have further help, or he will not be able to meet his obligations. The banker should require ample cover before advancing further sums; but if he is weak and yields to pressure, matters will go from bad to worse, until the customer may practically rule and command the bank, the two concerns will be involved together, and when the customer “goes” the banker will go too, or at the best suffer a big and weakening loss—not only loss of money, but loss of credit, which will affect him seriously in the future, and may ultimately cause his fall.
This danger is not a hypothetical one. It is unfortunately founded on fact. It was this cause which led to the disastrous and all-reaching failure of the City of Glasgow Bank. When the position of that bank was examined it was found to have lent as much as six million pounds among four customers. Gilbart says: “Almost every bank that has failed can point to some one, two, or three large accounts to which it mainly attributes its failure.”
On looking at the last column of our table we see that all the banks hold assets in excess of liabilities to the public; the excess is in respect of the capital and reserve fund. As an additional security for the depositors, each bank has only a part of its subscribed capital paid up. The remainder, the uncalled capital, constitutes an extra reserve for the benefit of the depositors.
The profits made by joint-stock banks are high, the majority of dividends varying between 10 and 20 per cent.; and notwithstanding such satisfactory dividends, large reserve funds have been accumulated from undivided profits. These reserve funds in some cases equal, and even exceed, the total of the paid-up capital. It may be added that many of the banks are popularly credited with holding other reserves which do not appear in their balance sheets.
CHAPTER X
THE BILL-BROKERS
The business of the bill-broker is one that has grown up during the past century—chiefly during the latter part of it. A bill-broker acts the part of an intermediary between banker and merchant. At first glance the need of such an intermediary is not very apparent, considering the large number of banks now in existence which keenly compete for business. On looking further into the matter, however, the importance and utility of the bill-brokers, both to banker and merchant—that is, to those who wish to buy bills and those who have them to sell—become apparent.
To undertake the business of discounting bills successfully great knowledge and discrimination are necessary; knowledge that can only be obtained by experience, and discrimination by keeping in touch with the changes occurring in the standing and position of the mercantile and financial community. As with the rest of the world, merchants and financiers do not stand still; they progress or they fall back. Many bills which in 1893 would have been treated as first-class paper are now, in 1903, looked at askance; while the acceptances of many firms who were unknown ten years ago are now readily taken. It is the business of the bill-broker to keep himself thoroughly informed of the “standing” and “position” of the mercantile community, so that he can readily discriminate good bills from doubtful ones.
A bill-broker does not confine his operations to what is called “bank paper”—that is, to bills accepted or endorsed by one of our well-known banks or leading finance houses—but he is prepared to deal in bills accepted or endorsed by members of the ordinary mercantile community, provided he is satisfied as to the position of the parties whose names appear on the bills. These latter bills are called “trade bills.” The rate for discounting such bills is always somewhat higher than the rate for bank paper because of the slightly greater risk.
The bankers of the present day discount a large number of bills for their customers in the ordinary course of business. Bills obtained from this source, however, do not meet a banker’s requirements in several particulars. For one thing, the amount of bills offered directly to bankers for discount is not sufficient, as a general rule, to satisfy their demands; and, moreover, a banker has no power of regulating the supply of bills offered to him in this way. One day he may be asked to discount bills to a very large amount, when he is not anxious to increase the amount of his holding of bills; on another day he may wish to increase his holding, but none may come forward. And lastly, with bills offered for discount by ordinary customers a banker has no power of so picking his bills that he can ensure having a large amount of bills maturing at any given period, when he anticipates that he will require to increase his cash. But all these conditions can be met by dealing with the bill-brokers. A banker can obtain bills to any desired amount from the bill-brokers, he can regulate the supply of the same according to his wishes, and he can stipulate that the bills sent in by the bill-brokers are to mature within any given time—thirty days, sixty days, ninety days, and so on; and he is thus in a position to provide automatically for an expected demand for cash at certain times, by the maturing of bills.
Bankers therefore find it easier, and, owing to the broker’s specialised knowledge of the position of parties, on the whole safer, to buy bills from the bill-brokers than to try to obtain directly all that they require. Bills so purchased possess a further advantage, for not only are they secured by the names on them, but, in addition, they usually carry the guarantee of the bill-brokers as well; and this, when dealing with large and wealthy firms, is a distinct advantage. It must also be remembered that there are a large number of banks—principally country banks—who are so situated that in the ordinary course of business they never have what is called “A1 paper” offered to them for discount, and yet they require to invest a certain amount of their funds in such bills. These institutions of necessity make use of the bill-brokers to satisfy their needs.
In consideration of the bill-broker’s guarantee, and of having had the advantage of his knowledge in selecting and collecting bills, a banker is content to buy bills from a broker at a slightly lower rate than the ruling market rate, usually ⅛th or ¹/₁₆th per cent. per annum lower. For instance, if bank or first-class paper is quoted in the market at 2⅜ths per cent. per annum for bills due in three months’ time, bankers would buy such bills from the broker at 2¼ per cent. The broker thus makes a turn of about ¹/₃₂nd per cent. on the deal, but in active times this “turn” is often divided with the merchant from whom he buys. This profit may seem small, but when the enormous turnover of a bill-broker is taken into consideration, it is apparent that the total profits derivable from this business are very considerable. This is confirmed by the satisfactory dividends paid by the two or three public companies conducting discount business.
Looking at the other side of the question, persons who have good bills to discount find they have a readier market in the bill-brokers than in the banks, and practically all the first-class bills throughout the country find their way to the London market for discount.
In order to keep their connection, bill-brokers must be prepared to do business in good bills at any time, to practically any amount; and to be in a position to do this, they rely either on borrowing the necessary funds from the banks, or on selling some of their stock of bills in hand to the banks. The interest on the call and short-notice money borrowed from banks is on an average materially lower than the rates at which bills are discounted, and consequently a profit is made by the bill-broker (who holds the bills he buys), of the difference between the two rates; and when bills are sold to the banks a turn is made on the transaction, as we have already seen. Competition among the various brokers, however, is always tending to keep down rates, and consequently the profits of the business.
Bill-brokers also buy very large amounts of trade bills from colonial, and in some cases foreign banks, which are endorsed by the banks in question. These bills, when not held by the brokers, are sold to various banks throughout the country, and of course form a first-class security. It may be mentioned that it is not the custom now for any London bank to rediscount bills which they may have discounted for their customers, and only in very rare instances do country banks adopt this course, though the names of two or three of such sometimes appear as endorsers.
Unlike a banker, a bill-broker has to pay interest on all his working funds, and this makes him anxious always to utilise those funds to their fullest extent. Unlike a banker also, he has no large reserve of idle funds to keep for meeting sudden demands. Should such demands arise, he relies on being able to borrow from banks or elsewhere, sufficient funds to meet those demands, or, as a last resort, to obtain assistance from the Bank of England.
As regards the funds with which the bill-brokers conduct their business, we have already seen that they are largely borrowed from various banks. The business is very simple, and is marked by an absence of any kind of red tape. Every morning the representatives of the brokers call on the banks with which they do business, and ascertain whether the latter wish to lend any more money, or if any of the money already borrowed is required to be repaid; at the same time usually arranging the rate to be paid for money. They also ascertain if the banks wish to buy any bills, and arrange the rate for such business.
In the case of money being lent to a broker, he simply sends in security to cover the advance, and draws a cheque on the banker for the agreed amount. In the case of money being “called in” by a banker, the broker sends in his cheque on some other banker for the sum called, and takes away a corresponding amount of security.
The securities deposited by bill-brokers for loans of this class consist either of first-class bills or what are known as “floaters.” “Floaters” are bearer securities of the highest class, such as Consol certificates, the debentures of certain Indian railways, the bonds of the Corporation of London and the London County Council. They obtain the name of “floaters” from the fact that they float from bank to bank, as one bank calls and another lends.
In the case of a banker buying bills from a broker, the broker sends in a parcel of bills which roughly amount to the agreed figure, and draws a cheque for the amount less the discount. It is not usual for brokers to endorse the bills they so sell, but they give the banker a continuing guarantee in respect of all the bills which he may buy from them from time to time.
It frequently happens at certain seasons of the year when there is a pressure for money, or on special occasions—such as on the issue of a big public loan, when a large amount of bankers’ floating balances is temporarily withdrawn—that heavy demands are made on brokers to repay money they have at “call” from the bankers. The brokers are then placed in the position of having large sums to repay, and as none of the banks are lenders, they are forced to apply to the Bank of England for assistance. The brokers are then said to be “in the Bank,” and they usually try to get out as soon as they can, in order to escape the higher interest there demanded from them. Formerly the Bank of England declined to discount any bills for brokers and would only make them temporary advances. This rule, however, is now relaxed, and the Bank will either discount approved bills at the “official” rate, or make temporary advances. The bills discounted with the Bank of England are not supposed to have more than sixty days to run before maturity, and must bear the names of at least two British firms, one of which must be the acceptor.
The advances made by the Bank of England are not at “call,” as with other banks, but for a fixed number of days, never less than three, and sometimes for as many as ten. The rate charged varies from Bank Rate to ½ per cent., or even 1 per cent., above that rate.
It follows from this that when brokers have to obtain assistance from the Bank, the rate for money in the open market at once begins to stiffen, as demand exceeds supply; and if any considerable amount has to be borrowed from the Bank, the outside rate will rise until it is on a level with the Official Rate; or even slightly higher, if the Bank is charging above the Official Rate for its advances.
Generally speaking, the aggregate amount of money from all sources available for the use of the market keeps approximately at a level figure, but a portion of it is not always in the same hands; and it is this shifting balance of market money which really controls the rates charged for the use of the whole of the money. If this shifting balance finds its way into the Bank of England, all rates harden, owing to the competition among brokers to obtain money without applying to the Bank. On the other hand, if the shifting balance passes into the coffers of the bankers, the competition among them to lend their funds will tend to reduce the rate of interest which can be obtained for the use of the money.
CHAPTER XI
THE CLEARING HOUSE
A work dealing with the subject of the Money Market would not be complete without reference to the Clearing House—the institution by which our enormous financial operations are adjusted. Without such arrangements as are carried out so practically and automatically by the Clearing House, it would be impossible to carry on our present trade, and our banking system could not have developed into such a high state of efficiency as we at present find.
Although our Clearing House has now been established for more than a century and a quarter, London cannot lay claim to be the originator of the clearing system. Edinburgh established such a system some years before its adoption in London, and a somewhat similar arrangement appears to have been in vogue in certain continental towns, it is said, since the sixteenth century.
Up to the year 1775 all the cheques which a London banker held on other London bankers were presented daily to the bankers on whom they were drawn, and paid in cash or notes. Such a system was very inconvenient to both the collecting and the paying bankers, as not only did it entail the trouble of sending out clerks to present the various cheques, but every banker was bound to keep an unnecessarily large stock of cash and notes in his till, in order to be prepared to meet in cash any demand which might be made upon him. There was also considerable risk in the clerks’ carrying about such large amounts of notes and gold.
In the year 1775 certain of the private bankers of London arranged a scheme between themselves whereby to minimise this inconvenience and risk. They hired a room in which the representatives of each bank met daily, and exchanged the cheques and bills which they held on each other. The _balances only_ which each bank had either to receive or pay were settled in cash. By this means a great saving was effected in the use of actual cash, and the risk of transfer of large sums from bank to bank was to a large extent reduced.
At a later date the use of actual cash was still further economised. Each of the banks represented in the Clearing House was compelled by regulations to keep an account at the Bank of England. After this regulation came into force, instead of cash being paid or received at the end of the day, as was formerly the case, each banker’s account at the Bank of England was either credited or debited with the balance due to or by him on the aggregate of his daily transactions.
When the Clearing House was first established it met with much opposition, although its advantages were so apparent. Several of the largest bankers refused to countenance it. In course of time, however, the great advantages it possessed wore down all opposition, other bankers joined the “clearing,” a regular set of rules was drawn up for the conduct of its business, and a committee of bankers was appointed to supervise its working.
On the establishment of joint-stock banks in 1833 they were prohibited from enjoying the facilities of the clearing system, owing to the jealousy of the private banks. It was not until 1854 that this jealousy was overcome, and the joint-stock banks permitted to join the Clearing House; but the Bank of England did not take advantage of the system until ten years later.
In the year 1858 the Country Clearing system was established. Under this arrangement all cheques on country banks held by other banks are passed through the Clearing House into the hands of the London agents of the banks on which they are drawn. The London agent sends by post each night to the various country banks which he represents, a parcel of cheques consisting of the whole of the cheques on each respective country bank which have been passed to him through the clearing. Each of the country banks has thus but one remittance to deal with each morning, instead of numerous remittances from banks situated all over the country. On the other hand, the trouble to which each bank was formerly put of forwarding all country cheques received direct to the various banks on which they might be drawn was done away with.
The West End and suburban banks of London cannot, by reason of distance, be directly represented in the Clearing House. A system, however, is in operation by which practically the total of their daily transactions becomes merged in the total figure of each day’s clearing. Cheques presented to these banks by other banks are paid by what is known as a “payment.” A “payment” is in effect a draft on their head office or clearing agent, and these drafts are passed through the Clearing House.
By these various developments it has come about that the vast majority of bills and cheques passing through the hands of bankers, throughout the country, become focussed in the London Clearing House, and the returns of that institution, showing the total of the daily transactions with which it has dealt, consequently afford a good barometer of the state of trade throughout the country, the figures rising or falling as prosperity or depression affects our commercial condition. The returns are now published weekly, and the figures there shown are stupendous in their amount—the average daily clearing on ordinary days for the year 1902 amounting to £15,559,600, and on Stock Exchange settling days to £38,961,800, while the grand total for the year amounted to the record figure of £10,028,742,000.
Without going into detail as to the exact mode of procedure carried out in the working of the clearing system, we will roughly delineate the manner in which the transactions are brought to a head at the close of each day’s work.
The clerks of each bank represented in the Clearing House make out a summary at the end of each day, showing the amount of the “articles” (cheques, bills, and drafts) which they have handed to the representatives of other banks, and the amount of the articles handed to them by other banks, and the difference of these two figures shows the net amount which has to be received or paid as the result of the aggregate of all their transactions.
All the clearing banks must keep an account at the Bank of England, and a nominal account is kept at the Bank, called the “Clearing Bankers’ Account.” At the close of each day the amount owing by each bank, which on balance has to _pay_, is debited to that bank’s account at the Bank of England, and credited to the “Clearing Bankers’ Account”; while as regards those banks which have to _receive_ on balance, the “Clearing Bankers’ Account” is debited, and the account of those banks credited. Thus while the Clearing Bankers’ Account at the Bank is automatically balanced each day—as, in the aggregate, the credits of one set of banks must be balanced by the debits of the other set—the whole of the enormous total of transactions thus brought to one head is settled by a few dozen entries in the books of the Bank of England.
Quite recently, and not before it was absolutely necessary, the building of the Clearing House was largely extended, and the internal arrangements reorganised, giving greater facility for the work carried out there; and an innovation has been made in supplying Burroughs’ Automatic Adding Machines for the use of the clerks of the house. About one hundred and forty of these machines are now in use, and though when they are all at work the Clearing House is certainly not the quietest spot in the City, yet the convenience and great economy of time and labour resulting from their use cannot be fully appreciated by any except those in daily touch with the work.[3]
[Footnote 3: Since the first edition of this book was published a new clearing has been established, called the “Metropolitan Clearing.” By means of this new system, cheques on various branch and private banks situated within a certain radius of Lombard Street are collected through the medium of the Clearing House and the head offices of the various banks, and the total of such collections is brought into the daily general settlement of the “House,” thus swelling the already enormous figures. This system has certainly increased the efficiency and unification of the Clearing House, and it has almost entirely eliminated the well-known “walk clerk.”]
CHAPTER XII
FOREIGN EXCHANGES
In the course of this book reference has been made on several occasions to the influence on the Money Market of the foreign exchanges. It will be impossible in the course of a short treatise such as this to enter fully into details and technicalities. Anyone wishing to obtain a fuller explanation of the subject cannot do better than study Mr. George Clare’s book entitled _The A B C of the Foreign Exchanges_.
Bills of exchange have been used in settling commercial transactions since very early times. The Romans appear to have employed them to some extent, but it is to the early Italian, and even more to the early Jewish merchants, that we owe the development of the system. By the fourteenth century the use of bills was firmly established, and their form, and the laws and customs relating to them, were much the same as at the present day.
Before inquiring into the effects which the foreign exchanges have on our Money Market, we will state clearly what a foreign bill of exchange really is. When a foreign bill is bought, what is it that is bought? The transaction is simply this, that so much money is paid here for the right to so much currency of a certain country to be delivered at once, or at a given date, at a certain place, to the buyer of the bill or to his nominee. The bill itself is merely an order to pay, and the transaction resolves itself into bartering so much money of one country for so much money of another country, to be delivered at a specified place and time.