Nor was the situation relieved by direct investment or loan ing by the client bank in the stock market. If any country bank through its reserve bank as agent loaned in its own name any of the surplus funds which it had on deposit with the reserve bank, it might earn a greater return than the 2 per cent interest allowed on the balance, but when it called the loan and paid the amount again into its balance, the effect would be exactly the same as if the reserve bank had loaned the balance for its own account. Indeed, it was probable that the New York borrower in paying the direct loan to the country bank borrowed from some other New York bank.
Fictitious Reserves Another evil of the system of redeposited reserves arose from the fact that the actual available reserve was much less than the minimum reserve required by the banking laws, not only because of the inconvertibility of the call loans as above described, but also because much of the reserve was fictitious. A great deal of the balance carried with the reserve agent was created by re mitting checks, drafts, bills of exchange, notes, and collection items in general for collection and credit. If credit was given in advance of actual collection, the country bank gained in reserve balance, but the reserve bank had items that were inconvertible, at least for a day or so, because it is physically if not financially impossible to secure immediately the cash equivalent of credit items. When the country bank prepared its cash letter and re mitted a number of cash items it was a common practice to credit its reserve account; during the day or days this letter was in the mails a discrepancy would exist between its reserve ac cording to its books and its reserve according to the books of its reserve agent. Upon the arrival of the cash letter, credit for the amount either was given immediately to the country bank or was deferred one or more days, according to the contract between the two banks but the too common practice was to give immediate credit. Many of the country banks, how ever, refused to reciprocate and permit their accounts to be im mediately charged with the cash letters sent to them by the re serve bank. Instead they would insist that they be permitted to remit to the reserve bank after the items had been examined and charged to the customers drawing them. The common method of remittance was by draft on the reserve city. The result of these practices was that no small fraction of what were booked as Cash Reserves was afloat in the mail. The amount of this "float" was
variously estimated between $300,000,000 and $500,000,000.
The inconsistency of the system was further exemplified in the distinction drawn between "gross deposits" and "net de posits." Net deposits were the deposits after certain deductions were made, among which were items in the process of collection; gross deposits included all items tendered by and credited to depositors. The law did not specify against which kind of de posits—net or gross—the per cent reserve should be calculated. It was the practice of the country banks to count the gross deposits with its reserve agent in calculating its reserve balance, but only its net deposits in calculating the amount of reserve required. Against the amount of items in the process of collection, therefore, no reserve was kept, although these items were counted as part of the reserve to support the other deposits.
Evils of Legal Minimum Reserve Again, objection might be raised against the system on the ground that the fixation by law of a minimum per cent reserve against deposits is very questionable policy. The other govern ments of the world have left the question of reserve to business expediency. In the older countries with a strong central bank closely affiliated with the government and conscious of its public responsibilities, the plan of voluntary reserves has worked ad mirably. The tendency in America has been to keep the least possible reserve; as shown above, the banks of New York City in a recent decade barely kept the required minimum. Before the panic of 1907 the trust companies of New York, which were not then directed by law, kept reserves of only 2 per cent, although they were increasingly invading the field of commercial bank ing. Banks operating under state laws that required only very low reserves uniformly kept only the reserves required. Con servatism and a high sense of public responsibility have not at all times and places characterized our banking class; the force of law may have had the virtue of teaching what the public regards as proper security. The danger of a legal minimum reserve re quirement, however, is that the bankers may misinterpret the law and construe it as a command to keep merely reserves to the amount stipulated and no more. As a result the minimum re serve required tends to become the maximum kept, and this has been the experience in the United States.