But the supposition of a sole or isolated bank is far removed from business facts. In the United States there are thousands of banks; many communities have more than one between which customers divide their patronage. A customer of bank A may hand a check to a customer of bank B, who will deposit it with B, and B will collect the cash from A. The loss of cash by A in meeting such collections over the counter, through the mails, and at the clearing house, would seriously affect the ratio of cash to deposits and endanger the ability of the bank to meet its de mand liabilities. Now if one bank, by the method of loans and discounts, creates an unduly large sum of deposits, it is sure to suffer adverse clearing house balances, for, although many of the checks drawn against these accounts will be redeposited in the drawee bank by holders into whose hands they fall, many others will be deposited in other banks which will collect cash from that bank. Of course, if all other banks of the system are creating deposits at the same pace, it is possible that the checks drawn against A and deposited in banks B, C, D, and E, will just equal those drawn against B, C, or D, respectively, and deposited in A. But if any one bank creates deposits out of proportion to the others, it faces the impossibility of maintaining its cash. For the banking system as a whole the deposits may reach a high multiple of the cash reserve, but the multiple for any one bank of the sys tem must approximate that prevailing in other banks.
If a customer of A applies to A for a loan, one of the factors determining whether it will be granted is the average daily bal ance of his account with A. Furthermore it is quite common for banks to insist that their borrowing customers maintain balances at or above some minimum percentage of their borrowings.
Probably zo per cent is the commonest requirement; that is, if a loan of $100,000 is extended, the average daily balance of the borrower for the period of the loan must not be less than $20,000. From the date of the loan, the credit is checked against until it reaches some minimum amount; then a few days before maturity the borrower will probably build up his balance so that he may pay the loan. His checks drawn during the loan reach other near and distant banks, which present them to A for pay ment. The attendant loss of cash by A forces it to reduce or limit loans, but this acquisition of cash by bank B makes it possible for B to extend loans. Part of this cash will stay with B, but the larger part will be drawn out by bank C when C collects checks against B; in turn, C will extend loans and B will retract. By a continuation of this process the cash will be widely dispersed and become the basis for successive expansions of loans and deposits, but in smaller and smaller amounts. The sum of these deposits created by the loans process and based upon an increment of cash reserve deposited in some bank of the system may increase until the ratio of the cash to the new deposits approximates the ratio for the system as a whole. The total expansion of the
system's deposits derived by the loans method is therefore de termined by the cash reserve and the prevailing ratio of reserve to deposits. The deposits, however, arising out of loans by one bank in a system of otherwise homogeneous banks cannot exceed the increment of cash reserve probably by more than 25 per cent, because when such deposits are created the borrower proceeds to check out all but a minimum balance during the life of the loan and the checks may be largely presented through the clearing house or otherwise for payment. Nor can such deposits be much out of proportion to deposits derived by other banks from loans.
Illustration of Need of Common Ratio The necessity of this common ratio as among the banks of a system may be illustrated numerically. Assume the following data: Bank A has $ioo,000 cash reserve, and likewise all the other banks, B, C, D, and E, have together, $ioo,000 cash reserve; bank A keeps io per cent reserve, the other banks, B, C, D, and E, keep 20 per cent; one-fifth of the deposits of each bank is not checked out, three-fourths of the checks are redeposited in the drawee bank, and the rest are deposited in the other banks and presented through the clearing house. Then the situation will be as follows: It is seen that bank A suffers an adverse clearing house bal ance of $200,000 less $ioo,000, or $ioo,000, which wipes out its reserve. Had it kept the same per cent reserve as the other banks its clearing house balance would have been zero. On the other hand, a more slender reserve would have resulted in suspension and failure. In fact, the above adverse balance of $ioo,000 is a minimum, for in all probability some of the checks on B would have been deposited in C, D, or E, and presented by them and not by A at the clearing house. If the cash reserve of B, C, D, and E combined had been assumed to be less than $1oo,000, the adverse balance of A would have been greater.
If, instead of supposing that bank A's cash reserve is equal to the total reserve of banks B, C, D, and E, combined, we suppose that the reserve of each bank is $100,000, then the total reserve for B, C, D, and E will be $4o0,000, deposits $2,000,000, and clearing house items $400,000. One-fourth of $400,000, or $roo, 000, of these clearing house items will be presented against, let us say, B. The banks presenting checks on B are A, C, D, and E, and, as it has been assumed that they are all the same size, one fourth of $roo,000, or $25,000, will be presented by A. By the same reasoning A will present $25,00o against each of the other banks, C, D, and E, in the group, thus presenting a total of only $100,000 to be deducted from the $200,000 which B, C, D, and E present against it. Under these assumptions it is evident that A would suffer an adverse clearing house balance of $roo,000.