Settlement by Book Entries with Federal Reserve Bank A third device for settling balances is by book entries with the federal reserve bank. This Method began in New York in March, 1917, and has been adopted in Boston, San Francisco, and other cities. It has several purposes. One is to reduce the risk and in convenience of carrying money through the street. A second is that it encourages the member institutions to hold smaller re serves in their own vaults and larger reserves with the federal reserve bank, and thus encourages the concentration of the gold stock of the banks in the central institutions. One of the argu ments against the amendment to the Federal Reserve Act of June 21, 1917, requiring members to keep their whole legal reserve with the federal reserve bank, was that the till money necessary to meet business demands and the clearing house balances would exceed 5 per cent, the amount by which the reserve requirement was reduced by the amendment. This objection is obviated by settlement through the federal reserve bank by book entries, since no till money need be kept to meet clearing house balances. The said amendment also permitted banks and trust companies not members of the federal reserve system to deposit funds with the federal reserve banks for exchange or collection purposes only; and on May 21 the New York State law was amended to permit state banks and trust companies to deposit all but 3 per cent of their reserves with the federal reserve banks. These amendments open the way for the settlement of all the exchange balances by book entries at the federal reserve banks.
But whether all members of the clearing house avail them selves of the device or not, the method is applicable among as many as do. It simply requires that the manager of the clearing house certify the sheet showing the debits and credits and that the federal reserve bank make the adjustments by book entry, crediting those banks which appear as creditors and debiting those which appear as debtors, as a result of the day's clearings. The federal reserve bank could then pay a net balance, taking into consideration its own balance and those members who choose to use the federal reserve bank service for this purpose. For in stance, the situation might be as follows on a certain clay: The members of the latter group would pay, as formerly, $7,000,000 to the clearing house manager and get from him $4,000,000, and the federal reserve bank would get one payment of $3,000,000, representing the net credit clue it and the banks for which it settles.
Other Methods of Settlement The methods of settling clearing house balances discussed above are: r. The payment of actual moneys, either transported to and from the clearing house, or deposited in the clearing house and exchanged by means of clearing house certificates.
2. The payment of clearing house loan certificates, based upon securities pledged with the clearing house committee.
3. The adjustment of balances by book entries with the federal reserve bank, which is a special member of the clearing house.
These are the methods that have been employed in New York. Of the methods adopted in other cities and regional clearing houses which differ from those used in New York, three expe dients are worth notice.
. Borrowing and Loani-ng Balances. One device has in the past characterized the Boston Clearing House, although it is not used there now—the borrowing and loaning of clearing house balances. It was the custom of such members as found that their balances at the morning exchanges were debits and larger than they could conveniently pay with cash, to go into the street and borrow from other banks. To lessen the inconvenience and risks of this prac tice it became the custom for the bank officials to meet in the clearing house and, after the exchanges had taken place, to borrow and lend their balances. A bank with a favorable balance and disposed to loan gave to the bank with an unfavorable balance and desiring to borrow, an order on the clearing house, which the latter might use in settlement of its balance; the manager ac cepted the order in settlement to the amount of its face value; the borrowing bank might pay part in coin and part in these orders, in which case it would not borrow all the balance; on the other hand, the borrower might have to go to several members before it procured orders for amounts big enough to settle its balance.
The customers of the banks differed widely as to the degree to which they resorted to such loans; some borrowed only, some loaned only, some did both, and some did neither. The rate of interest on these loans followed closely the market rate, and the clearing house rate was reported regularly in the finan cial papers.
The common criticisms of this method are: (I) that it is an unsecured demand loan which endangers the borrowing bank if insistence is made for immediate repayment; (2) that it deprives a bank which is an habitual borrower of the advantages of clear ing house loan certificates; for as soon as a bank takes out loan certificates and is therefore with funds, a bank which has loaned a balance will demand payment; the bank simply exchanges clearing house loan certificates backed by very high collateral for unsecured loans outstanding; in borrowing balances it anticipates the help which would be rendered it when clearing house loan certificates are issued.
2. Settlement by Manager's Check. Another device, the mana ger's check, finds illustration in many clearing houses. The plan is to have the manager of the clearing house draw a check on the debtor bank in favor of the creditor bank; a representative of the creditor hank calls at the clearing house for the manager's check; it is presented to the debtor bank and paid by cashier's check or exchange on another city, or it is deposited in the federal reserve bank or its branch or is sent through the clearings next day. A time, say, three o'clock, is fixed by the clearing house rules at which the liability of the clearing house on such manager's check ceases and it is carried over to the next clay at the risk of the creditor bank; the most common reason for carrying a check over is to keep down the share of clearing house expense to be paid by the bank in case such expenses are allotted on the basis of clearings made.