In order to secure this feature of easy and sure re demption it is necessary for a bank to keep on hand a certain amount of gold or of convertible credit money. The proportion which the reserve should bear to out standing circulation depends upon the customs of the people—upon the rapidity with which notes are brought in for redemption. This rapidity is found out by experience, and it may differ widely in various countries and even in different banks in the same country.
Each bank aims to carry as small a reserve as is consistent with safety, because money stacked away in the vaults earns nothing and requires storage space that is expensive. On the other hand, a good banker is always anxious to maintain a sufficiently large re serve, as otherwise he would suffer in the loss of popu lar confidence and eventually in the ruin of his busi ness. Not all bankers, however, are wise enough to carry adequate reserves, and governments have often found it necessary to make certain reserve require ments. In such cases, the ratio of reserve is usually made the same for all banks of a particular class.
This forces some banks to carry a larger reserve than necessary, and for that reason it is unscientific. The burden is borne ultimately by the business public, and not by the banks. For these reasons, a legal require ment should not be made, unless it is absolutely necessary.
National banks are not required to keep in their own vaults any reserve against notes, but they must maintain a five per cent fund at Washington. Fed eral reserve banks are required to keep in their own vaults a reserve of 40 per cent in gold against out standing circulation. Some foreign countries do not find it necessary to make a legal-reserve requirement. Other features of the reserve question, such as the combined reserve, will be discussed in connection with reserve against deposits. In the United States, we have had occasion to make more stringent legal re quirements concerning reserves against deposits than in regard to reserves against note issue.
4. Security for the maintenance of a cash reserve, various other means have been devised for insuring the note-holder against loss. So long as a bank is solvent and in operation, the prime requisite of its notes is that they be currently convertible into standard money on demand. But when a bank comes to wind up its affairs, whether for insolvency or not, note-holders are interested primarily in the question of ultimate redemption. It will be evident that some of the classes of security hereinafter men tioned may be used to insure current, as well as ul timate, redemption. They are primarily intended, however, for guaranteeing ultimate redemption, and must not be relied upon to any great extent for pur poses of current redemption. The maintenance of an adequate cash reserve is the only way to insure cur rent redemption.
5. Guarantee fund.—The establishment of a com mon guarantee fund, sometimes called "safety fund" or "circulation fund," is one of the means that have been devised to secure circulation. Under this sys tem all banks contribute a certain amount to a com mon fund, which is used to redeem the notes of any banks that fail. The amount that each bank sub scribes should bear a certain ratio to its outstanding circulation. When the fund is drawn upon to pay the notes of a bank that has failed, it should be built up again by a proportionate contribution from all the remaining banks. The objection may be made that this plan places a premium on bad banking by guar anteeing the notes of good and bad banks alike. The objection is valid. The establishment of a safety fund does not give any excuse for lessening the rigor of other methods of providing security.
A distinct advantage of the plan is that it causes each banker to watch all other bankers to see that nothing goes wrong. It undoubtedly gives an added security to the notes. The plan is being carried out successfully in Canada, but, as we shall see later, it is not the principal thing that gives Canadian bank notes their high standing. It was tried in New York State before the Civil War and did not work well, but its failure is generally attributed to the fact that the fund was used at first to secure the deposits as well as the notes of failed banks.
6. banks set aside a certain part of their assets as a special security against their notes. National banks, for example, are required to keep with the Treasurer of the United States a deposit of United States bonds equal in amount to their outstanding circulation. In case a bank fails, these bonds are sold, and the receipts of the sale are applied toward the redemption of its notes. Bonds may be withdrawn by the banks by re tiring their circulating notes or by depositing in the Treasury lawful money to an equal amount. This feature, along with other methods of securing notes, places the ultimate redemption of national bank notes beyond the shadow of a doubt. No holder of national bank notes has ever lost a cent thru the fault of the system. The great defect of the plan is that it limits the amount of notes that a bank can issue to the amount of bonds it can buy at a price sufficiently low to make the transaction profitable. Moreover, the issue and retirement of notes is attended with too much time-consuming formality. Often the notes cannot be had when they are needed and, on the other hand, they may not be retired as soon as they have served the purpose for which they were issued. This defect is so serious that it renders the whole scheme undesirable.