Lombard Street, we may rest assured, would not risk so drastic a change. It may be urged that, were the banks to keep their own reserves, the Bank could not finance the Government, which would then have to borrow to a greater extent in the open market; and perhaps such would be the case. But though the Bank of England is at present largely dependent upon the "bankers' balances," and upon the power derived from its position in the centre of the system, it must not be assumed, even if the banks could agree among themselves as to the ratio of cash each should hold, that the Bank would be compelled to bow to their decision.
As a matter of fact, such a decision on the part of Lombard Street would change the Bank of England from a discount bank into a deposit bank--a metamorphosis which Lombard Street could not face with equanimity. The Bank, whatever arrangements it may make with its own customers, does not at present compete against Lombard Street for deposits at interest; but were the bankers to withdraw their balances, the Bank would be compelled to appeal to the public for deposits, and who can doubt that it could not attract as much capital to its vaults as it required? The Bank would only have to make its rate of interest sufficiently attractive, and the public would rush to it with deposits. Where would Lombard Street be then?
Unless the Bank rate be unusually high, the banks allow one-and-a-half per cent. below it upon money left at interest in London. The country deposit rate, which is somewhat higher, is affected to a certain extent by competition in the provincial towns and cities. But the Bank would not confine its efforts to London if its hand were forced. It would offer high rates at its branches, and might even open fresh offices. The bankers' deposit rates would then be forced upwards in order to arrest the drain from themselves to the Bank of England. No; Lombard Street cannot play fast and loose with the Old Lady; and, if certain critics will reflect, they will see that the Bank has less to fear from a change in our present system than have those who occasionally threaten her. Her position, were the banks foolish enough to withdraw their balances, is not quite so hopeless as it is sometimes made to appear upon paper. Indeed, the better the understanding between the Bank and Lombard Street, the safer is our "one reserve" system, and consequently the less liable is the country to financial crises--for it is only by the united action of all the great banks that the situation can be saved in times of stress. This was clearly proved during the Baring scare of 1890.
The "clearing" bankers from time to time fix the deposit rate for London by the Bank rate, and though their country branches are not bound by their decision--which is advertised in the newspapers directly a change is made--the country deposit rate fluctuates with the Bank rate, though, as a rule, it neither falls so low as the London rate when capital is cheap, nor advances so far when it is dear. Further, the rates charged for loans and advances should be regulated to a certain extent by the Bank rate. However, that is a question which need not be entered into here.
Should the bankers decide to keep their own reserves, it is evident that the Bank of England's rate of discount would immediately cease to be a representative rate, and that a powerful rival, with a great history and a clean record, would at once begin to compete against the bankers for both deposits and advances. Were the Bank of England, so to speak, to decide to remain outside the system, Lombard Street could not even fix a minimum deposit rate for London, because the Bank, if it required capital, would bid against its rivals, and would soon obtain all it needed. Instead of being more stable, rates in the open market would move up and down with startling suddenness. Would-be borrowers, puzzled by such irritating movements, would soon grow nervous, for the prices of commodities would fluctuate too, and everybody would be afraid to make large purchases. The closer one examines the question, the more absurd appears the suggestion of a split between the Bank and our great joint stock banking companies; and the only wonder is that any person with the slightest sense of proportion can seriously advance so dangerous a proposition, which that friend of our youth, "Euclid," would have at once pronounced "absurd."
Custom has placed its seal upon our banking system; and the person who is rash enough to break that seal may discover that he has released new forces, which, though theory plainly demonstrates that they will act in a certain direction, are pretty sure to make their way through an unsuspected flaw which offers less resistance. A system which has been over two hundred years in the building cannot be changed in a day--especially a system which, even if it be not understood, has entered into the daily life of the people. It is because the system is not understood that the change would be so dangerous--so irritating. It would be asking the British public to think, to change its habits, to suddenly adopt new ideas; and as that mysterious body has never yet been educated up to thinking for itself, it would be found that it would kick against a new system like the stubborn donkey it is. Here is the real danger. The change, if the public would adapt itself to it, might prove beneficial--but the public would not; and as even its advantages over the present system are doubtful, where is the practical banker who would suggest the move? His one aim is not to disturb the money market, and for that reason alone he would hesitate to remove the Bank of England from its position in the centre of the system; but when we remember that the Bank, by accepting deposits, could probably beat Lombard Street at its own game, the change in question need not be discussed seriously.
There is one other phase in modern banking which, perhaps, calls for notice, and that is the fierce competition for safe business taking place between the banks themselves both in London and the provinces. Most of our large towns and cities are overbanked. Consequently, the public has a choice of many markets, as it were; and, quite naturally, it tries to lend in the dearest and to borrow in the cheapest. It may be asked: How much longer will this state of affairs exist? And the answer is: Just so long as the banks decide that it shall; and not a day longer!
The better the risks of banking are understood by the public the more difficult will it be for a weak bank to attract custom; and as the smaller banks, especially in the manufacturing centres, are unable to obtain sufficient deposits to meet the demands for advances, it follows that, when their loans grow out of all proportion to their resources, they are compelled to amalgamate with a large institution possessing numerous branches, and therefore in a position to collect huge sums of loanable capital, and distribute it just where it is wanted.
For instance, a large bank collects very much more capital in certain districts than it lends therein; but at branches situated in busy manufacturing cities the demand for capital, especially when trade is brisk, approximates much too closely to the sums collected at those branches to be compatible with sound banking. However, the bank has accumulated more than it requires in other towns, and is therefore in a position to transfer the surplus to those places where demand is strong, and, at the same time, to maintain a good ratio of liquid assets to liabilities, whereas a local bank in a busy centre can often only meet the requirements of its customers by advancing to a dangerous extent.
The directors of such banking companies are beginning to realise this danger; and fearful that one day they may be caught short of cash, the smaller joint stock banks are gradually being absorbed by the greater companies, whose numerous tentacles enable them to distribute their capital evenly throughout their system, and to maintain fair cash reserves against their liabilities.
As the small banks disappear, competitors are removed from the market; and there is every probability that banking in this country will by-and-by be in the hands of a few large and powerful banking companies. The public could not resist the banks were they to unite against it. Already the "clearing" banks have fixed the deposit rate for London, and it is only one step farther to declare the minimum rate at which they will advance--for what resistance can the public offer to a combination with more than £910,000,000 in deposits alone behind it?
Were the banks to hold a conference, and to decide that competition must be kept within bounds, the public would not have a voice in the matter. The English banks, like those of Scotland, would, after having come to some arrangement among themselves, meet from time to time in order to fix the minimum rates of interest and commission, and their customers would either have to pay those rates or else obtain accommodation outside the confederation. Of course, all the banks would have to close up their ranks before this arrangement would be possible, and, at the moment of writing, it seems improbable that certain companies, which make a business of competition, could be persuaded to come inside. So long as the banks are divided the public will be able to drive bargains with them, but, directly they fall into line, their rule will begin, and the quicker the smaller companies disappear the nearer the reign of the banks approaches.
Seeing that our banking system can only work smoothly so long as both Lombard Street and Threadneedle Street work in harmony, it follows that in time the link which connects the large banking companies will become stronger, and the relations between them pleasanter, because, in business as elsewhere, friendship is centred in the head rather than in the heart. The banks must draw closer together, because, if they do not, their system is unworkable; and, as they are now compelled to adopt certain precautions in order to protect themselves against panic on the part of their customers (who in that respect are their enemies), it is only natural that they should take steps to put an end to excessive competition, which weakens their position and prevents their acting together at a moment when united action alone can restore confidence in their ability to meet their liabilities.
We all know the stale apothegm: "Self-preservation is the first law of nature." It is the religion of the world. We can see the law at work among our friends, but, being polite, we refrain from comment--though if we be wise, we reflect; for here is the great unpreached gospel which governs the actions of men. Self-preservation clearly dictates that the banks cannot afford to allow competition among themselves to weaken the system upon which their safety depends; and, should the danger become pronounced, they are certain to combine against the public in order to at least agree to certain minimum rates below which none will do business.
It may be said: You yourself were the first to point out that certain customers are in a position to make terms with the bankers, and to advise them to do so. That is true enough; and so long as the banks are divided amongst themselves this is possible; but it by no means follows that, because the customers can make certain bargains this year, they will be able to make similar arrangements next, for the banks have their remedy, and when the right time comes they will not neglect to take it.
We have dissected that complex machine, which is called the Money Market, and of which the Bank of England is the heart. As each unit is dependent upon the strength of the whole, no bank should be allowed to trade upon the credit of the rest, for obviously it cannot exist outside the system during a time of stress unless it possess an adequate reserve of cash. Therefore each unit ought to bear its fair share of the burden when the sun is shining, and, if it refuse, it should be made to take the consequences when the storm bursts.
The closer our banking system is examined the stronger becomes the conviction that the interests of all the banks are identical, and that, therefore, if banking is to be conducted in this country with comparative safety, every bank should be compelled, either by the law of the land or by public opinion, to keep a fair reserve in legal tender against its liabilities. Further, the true interests of the banks are the same as those of the public--for the good business man is always a cautious man, and if he takes the trouble to study the risks to which a banking business is exposed, he will hardly care to place his money with a company unless it be well prepared to face those storms to which its environment peculiarly exposes it.
Under our one reserve system the banks must either stand or fall together during a crisis. The system, therefore, requires the support of all; consequently, the duties or obligations of each bank should be clearly defined, and this can only be done by an Act of Parliament or by an understanding between the banks. The closer the banks draw together the safer is our system of banking.
CHAPTER XVII.
Bank Stock.
When the trade of the country is prosperous, we expect to see banking companies paying high dividends, because rising prices stimulate borrowing on the part of the public; and, consequently, as the resources of the banks are limited, the increased demand for loanable capital sends up rates, with the result that distributions are enhanced, and that the prices of bank shares advance in sympathy with improving dividends.
We all know that there is a link which binds industries together, and that a depression in one trade, if it prove lasting, must communicate itself to the rest. Nor is this movement confined to any one nation. Therefore, when we hear that a depression exists in Germany or in any other great manufacturing country, it is a matter for regret rather than otherwise, because the goods of that country are almost certain to be exported here in large quantities.
If there be stagnation in Germany, then money will be cheap in that country, and commodities will be cheap too. Manufacturers, therefore, will be able to obtain better prices in foreign markets; consequently, German exports will increase, and prices will soon begin to fall in England. Again, depression in the States speedily makes itself felt in the English markets, which become glutted with American goods, with the result that production lessens at home, and times gradually become, as we colloquially say, "bad."
But there is one factor with which we have not reckoned, and that is time; for though after a period of prosperity prices generally fall suddenly--as, for instance, during 1901--it usually takes two or three years before production is again in full swing. In these days, when commercial ties bind the whole world so closely together, one nation cannot afford to rejoice at the misfortune of another; and when this fact is more clearly seen and is better understood, possibly large standing armies will become an unnecessary evil, for the secret of true progress is the fact that commerce and civilisation always advance together.
The Bank of England, which deals in money and credit like every other bank, is exposed to the same influences as the rest of its kind; consequently, when trade is brisk and loanable capital dear, it pays larger dividends than during the depressed portion of a cycle. The following table will illustrate the fact:--
======================================================================== £14,553,000 STOCK. ---------------------+---------+---------+---------+---------+---------+ | 1892. | 1893. | 1894. | 1895. | 1896. | ---------------------+---------+---------+---------+---------+---------+ | | | | | | Highest | 344 | 343 | 338 | 336 | 345 | | | | | | | Lowest | 325 | 325 | 322 | 322½ | 322 | | | | | | | Dividend % per annum | | | | | | 5th April | 10 | 10 | 8 | 8 | 8½ | | | | | | | Dividend % per annum | | | | | | 5th October | 9½ | 9 | 8½ | 8½ | 10 | | | | | | | ---------------------+---------+---------+---------+---------+---------+ Average Distribution, 9½ per cent. ========================================================================
====================================================================== £14,553,000 STOCK. ---------------------+---------+---------+---------+---------+-------- | 1897. | 1898. | 1899. | 1900. | 1901. ---------------------+---------+---------+---------+---------+-------- | | | | | Highest | 351½ | 367 | 36½ | 349 | 342 | | | | | Lowest | 326 | 341 | 325 | 326 | 319¼ | | | | | Dividend % per annum | | | | | 5th April | 10 | 10 | 10 | 10 | 10 | | | | | Dividend % per annum | | | | | 5th October | 10 | 10 | 10 | 10 | 10 | | | | | ---------------------+---------+---------+---------+---------+-------- Average Distribution, 9½ per cent. ======================================================================
It is at once evident that when its distributions are compared with those of the large banking companies, the Bank does not excel as a dividend-payer, and the reason, of course, is because it has to distribute its earnings over so large an amount of stock or capital; but, although it pays fluctuating dividends--which are regulated by the average rate capital may earn during any half-year--it is noticeable that, since 1899, despite the fact of dividends being maintained at ten per cent. per annum, the price of Bank stock touched lower figures than any recorded during the decade, when, according to every financial rule, prices ought to have been well maintained. Further, the shares of the joint stock banks did not exhibit this tendency to any marked extent. Why, then, should Bank stock be an exception to the rule?
The years 1894 and 1895 were distinguished by cheap money and indifferent trade, therefore we should expect to see the Bank's dividends decrease, and its stock fall in sympathy with diminishing distributions. If we glance at the table we shall see that our deductions were realised. In 1896 trade began to improve. Rising prices lessened the purchasing power of money; consequently the industrial machine required more capital _after_ the rise, because a given sum would then purchase _less_. The result was an increased demand for loanable capital, which at once became dearer; and the Bank of England, together with the other banks in the country, earned more. Again, as one would have expected, dividends and stock moved up together. During 1897 the same movements were witnessed; but in 1899 Bank stock began to fall, although distributions were maintained. This deviation from rule evidently calls for explanation. Compare, for instance, the prices of the shares of the undermentioned banks during the period in question:--
=============================================================== | | | | | 1895. | 1899. | 1900. | | | | | | | | | ---------------------------------+--------+---------+---------+ | | | | London and County--_Highest_ | 95½ | 109½ | 107 | | | | | " " " _Lowest_ | 89½ | 103 | 101½ | | | | | London and Provincial--_Highest_ | 21¾ | 22½ | 22¾ | | | | | " " " _Lowest_ | 19¼ | 21 | 21½ | | | | | London Joint Stock-_Highest_ | 34¼ | 39 | 37⅞ | | | | | " " " _Lowest_ | 30⅞ | 33¼ | 34 | | | | | =============================================================== ======================================================== | | Dividend % | 1901. | per annum | | each year | | since 1898. ---------------------------------+---------+------------ | | London and County--_Highest_ | 107 | 22 | | " " " _Lowest_ | 100¼ | | | London and Provincial--_Highest_ | 23⅜ | 18 | | " " " _Lowest_ | 20½ | | | London Joint Stock-_Highest_ | 37¾ | 12 | | " " " _Lowest_ | 34½ | 1900 & 1901 | | ========================================================
We can see, in the above instances, that where dividends were maintained, prices moved between much the same figures, whilst in every case a marked advance is shown on the quotations of 1895, whereas Bank stock receded further in 1901, when the dividend was ten per cent. per annum, than it did during 1895, when the distribution for the year was only eight-and-a-quarter per cent. It is this anomaly which we have to discuss. The trade of the country from 1896 to the end of 1900 was progressive, and though in 1901 a reaction set in, the large requirements of the Government, and the state of uncertainty created by the war, kept loanable capital dear. The banks, consequently, were enabled to support their huge dividends during 1901, though their being able to declare the same rates for the last half of the present year seems doubtful.
But to return to the fall in Bank stock, which, at the moment of writing, is quoted at 326. The public, so little does it understand the position of the Bank of England, still looks upon it as a Government institution; and, as though to give colour to this illusion, we find its stock quoted in the same division as "British Funds &c." By The Trustee Act, 1893, trustees, where they are not prohibited by the trust deed, may invest in Bank of England stock; and, as a result of this enactment, there is an increased demand for its stock, which consequently yields less to a buyer; yet, strictly speaking, Bank stock cannot be classed with the so-called "gilt-edged" securities, because the interest it returns is variable.
It is true that the holder does not incur any liability, and in this sense Bank stock is a much more desirable investment than shares in a joint stock bank upon which the member is liable for certain stated sums in the shape of uncalled capital; but the Government does not guarantee the dividends of the Bank. Indeed, it is only interested in the Bank of England in the same manner that a large customer is interested in his banker; and, though, in every probability, so long as the Government banks with the Old Lady, it will assist her whenever cause may arise, it is not pledged so to do. Again, the twentieth century may be productive of great change; and, though it seems improbable that a Government would remove its accounts from the Bank, such an event is by no means impossible, for the only tie between the Government and the Bank of England is that the former is the Bank's oldest client.
On the other hand, so long as Government does keep its balances at the Bank of England, it cannot afford to allow the Bank to fail, even were there the risk of it doing so. But holders of Bank stock, like the holders of shares in any other bank, would be paid last should the Bank be wound up, however remote a possibility that may be; and seeing that their capital is not a prior charge upon the assets of the Bank, and that, therefore, £100 of stock is worth £326 only so long as the Bank of England is a going concern, it is difficult to see why Bank stock should be considered a desirable holding for trustees. It seems to me that, valuable though the security undoubtedly is, it does not possess a single one of those characteristics which should distinguish a "trustee" stock, for dividends are fluctuating, and capital is a _last_ charge on the assets of the Bank. In fact, the stock is a kind of guarantee to the customers--and a splendid guarantee too, for it is the Bank's large capital which makes it the safest bank for depositors in the land. But that the holders of a "trustee" stock should, in the event of a company being wound up, get the _last_ look in is surely somewhat odd. However, this is only another illustration of the confidence the public has in the Bank of England, which, people are convinced, will exist as long as the nation.
The Bank, because the public imagines that it is connected more closely with the Government than in reality is the case, naturally suffers in credit when its patron does. Consequently during 1899, when the British reverses in South Africa increased the difficulties of the Government and depressed Consols, Bank stock, although dividends were maintained at ten per cent. per annum, fell in sympathy with Government securities, despite the fact that the shares of the large English banking companies were not appreciably affected. Of course this depreciation, which has proved lasting, was not the result of sound reasoning, for so long as the war continued money was sure to be dear, and dear money plainly indicated that the Bank would support its dividend of ten per cent. Further, the large Government borrowings constantly compelled the outside market to borrow from the Bank, which, had it so decided, could have charged exceptionally high rates, and thereby have added considerably to its profit; but, with its usual moderation, it wisely refrained from exacting excessive rates from those who, when Lombard Street was temporarily denuded of surplus capital, were compelled to apply to it for loans. The Bank, during the trying period in question, certainly did not attempt to make extra profit out of the nation's misfortune, as it assuredly might have done had its directors been actuated by a grasping spirit. Is there another bank in the land that would not have profited by the occasion? There may be; but I am disposed to doubt it, and I certainly should not care to attempt to name the institution.
Here, then, we find two influences at work at the same time, and the result is distinctly curious. The Bank of England, from the nature of its business, pays increased dividends when trade is good, therefore its stock should advance in value during the prosperous portion of a cycle; but, because of its business relation with the Government, its stock is looked upon by the public as a kind of Government security, and, consequently, when any political event causes Consols to fall, Bank stock recedes in sympathy with them. There is no reason for this movement, and if it proves anything it proves how little Finance is understood by the investing public. Here is a stock which pays fluctuating dividends classed with the so-called "gilt-edged" variety of securities; therefore its movements often seem erratic, because at one time it responds to the law that regulates the price of gilt-edged stocks, and at another to the law which decides the price of industrials.
It can be seen from our list that for the decade ended 1901 the Bank of England paid an average dividend of nine-and-a-half per cent. per annum. Based on the said average, a purchaser, if he require a return of three per cent. for his money, will have to buy Bank stock at 316⅔; but 319¼ in 1901 is the lowest price it has touched since 1888, and it seems highly probable that our would-be purchaser at 316⅔ would wait in vain for his stock at those figures. Indeed, the present price, 326, looks cheap for Bank stock. Bought at 325, and based on an average dividend of nine-and-a-half per cent., the stock would return about £2 18s. 6d. per cent. So small a return upon one's money is not calculated to make one anxious to buy, and Consols at 93 are perhaps a greater temptation, though neither investment appeals very strongly, so far as interest is concerned, to the imagination.
If purchased during the depressed portion of a cycle, the shares of the large banking companies can be bought at a price which will yield an average dividend of over four-and-a-half per cent. to the investor; but it must be borne in mind that, as a rule, he incurs a certain liability on such shares, whereas Bank stock is free from possible calls, and, consequently, not exposed to the objection which is constantly urged against the majority of bank shares as an investment.
Some of my readers, I dare say, will not agree with all my conclusions; and, perhaps, it may be urged that the information herein contained were better withheld from the general public. But the truth is always worth the telling, and if our banking system will not bear investigation then it must be a bad one. Despite obvious defects in construction, it is apparent, however, that our great credit machine, when skilfully managed, can successfully endure considerable strain; and, if gold be dangerously economised, our present system at least gives us that inestimable blessing--Cheap Money.
[Illustration]
_Sixth Edition._ _Price 1s. net._
BANKS AND THEIR CUSTOMERS.
By HENRY WARREN,
Author of "The Story of the Bank of England." and "Your Bankers' Position at a Glance."
"The book is amusing as well as instructive, and at the price we may reasonably say that no one who has a banking account should omit to read and store it in his library. More especially he who is in the habit of keeping a large balance, as also he who is in the habit of negotiating for an overdraft, should study what is revealed in this book."--_Field._
"Contains a vast mass of useful information intelligently discussed. To educate the public on a technical subject calls for more than ordinary knowledge. It needs what Mr. Warren undoubtedly possesses, and that is a sound practical understanding, and a thorough common-sense way of setting forth his knowledge in simple form. This our Author succeeds admirably in doing."--_Financial News._