(e) Receiving time deposits at a low rate of interest to lend or invest in securities at a higher rate of interest. Such time deposits are not subject to withdrawal by customer's check, excepting after notice to the bank (if required). Re ceiving time deposits is the essential function of savings banks (as distinct from commercial banks) and will be more fully discussed in a later chapter.
(f) Selling its credit, that is, giving its promise to pay at some other place, or at some other time, in return for a payment that yields a profit.
§ 3. The essential banking function. The one essential Not to be confused with a trust in the sense of a monopolistic enter prise, with which it has no connection except by mere verbal accident, through the word trust.
function of a bank is selling (lending) its credit to its cus tomers in some form that will conveniently serve the same function as money. A bank of this kind is sometimes de scribed as a bUsiness whose income is derived from lending its promises. The bank's credit is sold in the form of its promises, the evidences of which are its receipts, depositors' account books, drafts and checks on other banks, and bank notes. The indispensable condition to the exercise of this function by a bank is public confidence in its abilty to fulfil its promise to pay whenever it is due. This confidence is built upon the bank's paid-up capital ; its surplus and un divided profits; the further liability of the stockholders to make good any losses up to an amount equal to the capital stock each holds ("stockholder's double liability") ; the finan cial prestige of the bank's officers, directors, and stockholders; the bank's established reputation and "good will" in the community after a period of successful operation; the char acter of its loans and of the securities which it owns; and, finally, the reliance placed upon the control and inspection by official examiners. The bank then may (in addition to receiving time deposits) sell its credit in any one or in ala of the following four ways: (1) by receiving demand deposits; (2) by the method of discount and deposit ; (3) by selling exchange of funds to distant points; (4) by issuing bank notes.
§ 4. Demand deposits. Demand deposits are those pay able on demand, the demand in practice being by means of personal checks requesting the bank to pay to (or on the order of) a specified person, or to pay to bearer. A custom
er's bank account consisting of demand deposits is called a checking account. Since the turn of the century it has be come increasingly the practice to pay a low rate of interest (about 2 per cent) on current balances, oftener to large depositors. Banks attract demand deposits mainly by the convenience and economy which they offer to their customers in the guarding of funds from theft and fire and in saving the time, trouble, and expense of carrying money for making payments. A deposit in a bank is to the depositor for most purposes "just as good" as money in the pocket and for many purposes is even better. Thus the banks have become the custodians of a large proportion of the money (or funds) needed for current use by individuals and business corpora tions. Large amounts of deposits (though only a small pro portion of the total) are brought to the banks in the form of bags and rolls of money, or as funds consisting of credit papers, such as checks and drafts, calling for the payment of money. But most deposits are created in another manner now to be described.
§ 5. Discount and deposit. The process of discount and deposit is the purchase of the promissory note of a customer,' the price being a credit in the form of a demand deposit on the books of the bank. This—the central and most char acteristic banking operation—has something of mystery in it at first view. In simple deposit, described in the last section, the bank becomes the debtor and the depositor be comes the creditor of the bank. But in discount and deposit the depositor brings no money, and the credit paper that he gives is his own promise to pay, whereby he becomes the bank's debtor. For example, when a bank discounts a $1000 note for three months and credits its customer with the pro ceeds, its deposits are at that moment increased (let us say) $985. Notice that hereby the bank does not add a cent to the cash in its vaults while it has added to its liabilities pay able on demand. As an offsetting asset it holds the note of its customer receivable at some future time. Most of the loans and discounts of commercial banks serve thus to create deposits, and the two items (loans and deposits) rise and fall in about the same ratio. In 1920 in all reporting banks (exclusive of the twelve Federal Reserve banks) individual deposits were $38,000,000,000 and loans were $31,000,000,000.