Objects of Protecting Bank Notes When bank notes are given special protection, three objects are kept in view: 1. To keep the bank notes of a going or suspended bank at par.
2. To provide that the noteholder shall be secured against loss, at least ultimately.
3. To provide for elasticity of issue.
i. Maintaining Parity The first of these objects may be attained in several ways.
In Canada, for example, the note of a suspended bank be gins to bear interest at 5 per cent from the date of suspension until it is redeemed by the central authorities from a special fund kept for the purpose; the result is that notes of suspended banks may be preferred to notes of solvent banks and be held back as investments, while those of the solvent banks are used in payments.
Voluntary or compulsory subscription to a common fund, in proportion to each bank's issues, may be arranged and placed with the government or a trustee who pays from the fund the notes of suspended banks. This is called the "safety fund system." Again the state may declare the notes legal tender in all or special cases. Such declaration, like any legal-tender law, by clothing the notes with debt-paying power, tends to maintain their circulation at par.
The best and most general method of keeping bank notes at par is to provide means of immediate and constant con vertibility. If the holder can at any time, at his Will and with little trouble, convert his notes into standard money, they will not go below par. Various devices for achieving immediate con vertibility have arisen. The issuing bank must ever accord ing to its promise stand ready to convert over its counter, and if this is done anyone within reasonable distance of the bank might regard its notes as good as gold. To provide for redemptions at distant places and thus give the notes parity over a wide area, a system of local and central redemption agencies may be established, particularly at the chief money centers. Another method of redemption for notes of both active and liqui dated banks is immediate redemption by a guarantor. In the United States, national bank notes are redeemed by the federal Treasury upon demand, from a fund contributed by the banks and recouped by sale of pledged securities and other assets, the gov ernment, at least by implication, thus guaranteeing redemption.
The best means of assuring ability to redeem on demand is to require that the issuing bank keep in its vaults, or with some near by institution, either a fixed amount of gold or an amount bearing a fixed minimum ratio to the notes issued. The federal reserve banks, for instance, are required to hold gold equal to 4o per cent of the federal reserve notes issued.
2. Providing Payment at Par The second object in protecting bank note holders, namely, to provide ultimate payment at par if immediate conversion proves impossible, is attained in several ways in the different existing banking systems, according to the local or political conditions of each country.
The simplest of these various plans is to give the note holder no more protection than the depositor and to rely upon the business self-interest of the banker. The theory upon which this method is based is as follows: A bank note is a simple promise on the part of the bank to pay and circulates on the credit of the issuer. This credit is improved if the bank has adequate sound and liquid assets, for the bank notes together with the deposits are ultimately paid from the general assets. Fear of failure and of bankruptcy makes the banker conservative in his investments, hence the self-interest of the banker, as well as the requirements of law and government regulation, is as sumed to provide adequate protection to the noteholder. This method of attaining ultimate payment at par, while theoretically sound, has proved delusive and dangerous, particularly in the early history of our state banking. It works best in old districts in which banks, chastened and taught by failures, have assumed a full responsibility for the continuous and conservative financial welfare of the district. It is also less likely to succeed in a decentralized system of note issue, where competing banks act independently and for their own advantage and exercise little or no restraint on a bank which is known to be overextended.