SOLVENCY Liquidity is a special need of banks. Solvency is a requirement common to them and to all other enterprises. But the conditions of solvency of a bank are in certain respects peculiar. A trader's debts are incidental to his business, and ought to be moderate in proportion to his own capital. A banker's debts are the very basis of his business. Moreover if his debts are to be used by his customers without hesitation as the means of payment, the equivalent of money, the banker's solvency ought to be put be yond question. He ought not to take risks.
Short-dated Securities.—Against liabilities fixed in terms of money, he ought not to hold assets of which the money value is susceptible of wide variation. The money value of commodities, of shares and of long-dated securities is liable to heavy and un foreseen depreciation. The only assets secure against such de preciation are short-dated investments. That does not mean that a banker is to limit himself absolutely to bills, and to advances for periods not exceeding a few months. Bonds maturing in a moderate period of years are not liable to more than a slight degree of depreciation.
Collateral Security.—To some borrowers banks are willing to make advances unsecured, their wealth and standing being such that no doubt is felt as to all their obligations being fully and punctually met. Where this is not so, the bank will require col lateral security. The nature of the security depends on the circumstances. When a merchant borrows to buy commodities which are to be sold again without going through any productive process, it is usually possible to give the bank a lien on the com modities till they are sold. When a producer borrows to meet the cost of wages, etc., the products in which his expenditure is to be embodied have no separate existence when the loan is made. In that case sometimes the fixed capital of the concern can be pledged, debentures or a mortgage being handed to the banker and returned by him on repayment. Sometimes a trader possesses investments outside his business which he can pledge. If they are gilt-edged or readily marketable securities, the banker will prefer them to a lien on commodities or on fixed plant. A dealer in the investment market can provide security without difficulty, because when he borrows it is to buy marketable stocks and shares which can easily be pledged. This system of requiring collateral security for bank advances has other advantages besides safeguarding the lending bank against ultimate loss. The advance is never granted up to the whole value of the security. Some margin is required. Consequently the borrower is compelled to use a certain proportion of his own capital in his business ; he cannot work entirely with borrowed money. This prevents the abuse commonly called over-trading, the assumption of heavy commitments by a man who has comparatively little or nothing to lose. For bills collateral security is less necessary than for advances. The liability of the acceptor is supported by the guar antee of the drawer and of all the endorsers. Nevertheless where the names on the bill are not of first rate credit, collateral security is required. When a bill is drawn by an exporter in one place on an importer in another, and is bought in the former place by a bank before it has been sent to the latter to be accepted, it is a common practice to give security to the bill by attaching to it the bills of lading which constitute the title deeds to the goods while in transit. The bank is thereby given legal possession of the goods in the interval before acceptance.
Bank Capital.—By these methods risk can be minimized, but it is not in the nature of human affairs that it should be eliminated from the banker's business altogether. To provide for losses, the banker must have some capital of his own, a margin of his total assets over his total liabilities. This margin may be regarded as a guarantee fund. It may be increased by the accumulation of a reserve or surplus out of profits. A banker need not be so strict in the selection of investments for his capital and surplus as for his deposits. And the bigger the margin in proportion to his demand obligations, the freer he is. Banks on the continent of Europe are much less restricted in their investments than those in England or America. They regularly participate in issues of shares in industrial companies, though the shares are not likely to be marketable at any rate in the first instance, and they may result in loss. But these banks have relatively large capital in proportion to deposits. And the larger the capital in proportion to deposits, the less need is there for strictness in the selection even of investments to be held against the deposits themselves. The need for liquidity indeed is unaffected, but given an adequate proportion of liquid assets, a greater risk of loss can be incurred on the remainder without endangering the solvency of the bank. Risk in business, it will be remembered, is a means of profit. In countries where the commercial and financial business which needs short-term advances and discounts from banks is not very extensively developed, the tendency is for banks to be relatively highly capitalized and to assume a different character. They do a large business in shares, mortgages and long-term investments, and play a leading part in the investment market.