The clearing house appoints a special loan committee in emergencies, consisting of about five leading bankers and the president of the clearing house, to provide for the issue of loan certificates. Member banks under actual or prospective pressure for cash funds submit to this committee acceptable collateral, usually commercial papers, on the basis of which the committee, keeping what is deemed a safe margin, issues the clearing house loan certificates; the certificates are in various denominations, having varied in the past from 25 cents to $1oo,000. They bear interest, payable by the bank to which they are issued and to the banks which receive them in settlement of balances. If the rate is made exceptionally high, the borrowing bank will have reason for retiring them as soon as the emergency occasioning them ceases. If the debtor bank wishes to retire them, notice is sent through the committee to the creditor banks that it is desired to retire them and that interest will cease on a specified date. As the certificates arc retired, the collateral is released to the debtor bank.
The interest on these loans is a charge between members; the clearing house may let the members concerned adjust the account or it may administer the assessment and payment. The amount owing by the debtor bank is easily calculated, the rate, period, and principal of the loan being known to the committee; but there is difficulty in knowing the creditors and the amount contributed by each. One way of obtaining and using this information is for the clearing house to require the members to report daily the amount of certificates held, and these amounts are averaged monthly and interest is allowed on the average amount. The debtor bank may then be drawn on for the interest in favor of the creditor bank.
The certificates stay out for varying periods. In the panic of 1907 the New York Clearing House made its first issue October 26, 1907, and the first cancellation was on November 14; the final issue was on January 30, 1908, and final cancellation March 28. The total amount issued was $101,060,000, and the greatest amount out at any one time was $88,420,000 on December 16, 1907. Collateral substitutions were allowed. The total collateral (original and substitutions) amounted to $450,000,000, of which 73 per cent consisted of commercial paper and the rest of securities of different classes. All told there were 5,548 certificates issued in denominations of $5,000, $20,000, $5o,000, and $100,000. To any one bank the greatest amount issued was $17,000,000, and the smallest amount $250,000. The total amount of loan certifi cates issued by the New York Clearing House since the practice was begun in 186o without exception has been paid in gold, with out loss.
General Purpose of Loan Certificates Not all members have found it necessary to take out certifi cates, and the amounts taken by those who have found it necessary to do so differ greatly. It is regarded as a proof of strength and conservatism for a bank to ride a panic without them; and by some banks and outsiders, inability to do this is thought to reflect prejudicially. Probably the majority of the members feel that they are doing an heroic and patriotic thing to loan in the face of a panic and rescue a failing bank and save the business community from collapse and disaster; at least, in most of the times of severe stringency, when any member has found it necessary to take out certificates, all the other members have also taken out certificates, however strong they were and however easily they might have weathered the panic without using cer tificates.
The purpose and function of the loan certificates are to con serve the money funds of the members so that they may be able to use them to meet the demands of customers and banks other than the affiliated members. To provide for payments of balances at the clearing house, members have found it necessary to carry till money, varying with the bank and the times, but averaging per haps 5 per cent of their demand liabilities. The issue of clearing house certificates sweeps away the necessity of carrying this extra till money, which can be diverted to the payment of the demands of local customers or correspondent banks; in other words, by this means the member is better enabled to meet runs. The pro cess amounts to a pooling of the gold funds of the members and diverting them to succor needy members so long as they, in the eyes of the loan committee, arc solvent and can pledge acceptable securities as collateral for the loan of this gold. The member which is solvent, but whose ready cash is insufficient, is sustained until the run is passed and the cash store built up; and since credit is a psychological thing and the banks arc highly interrelated, and a failure of one drags others in its train, the issue of clearing house loan certificates may stifle a panic in its inception or mitigate its severity once it is started.
The other clearing houses of the country, even very small ones, have followed the precedent of New York and issued loan certifi cates to allay money "squeezes." This became the accepted and usual way of meeting panics. The weaknesses of the system have been related in Volume II, Chapter XXI. The federal reserve system, it is expected, will obviate the necessity of the issue of clearing house loan certificates, as rediscount operations will per form their function.