With the last named reason in view, the law aims to have the amount of capital required bear some rea sonable proportion to the volume of business which the bank may be expected to do. A rough and un scientific approximation is sometimes made by vary ing the minimum requirement according to the size of the community in which the bank is located. A more scientific plan would be to limit the total lia bilities which a bank might assume in some definite ratio to its paid-up capital and surplus, say from ten to twenty times the amount paid in. Of course it is still more important that the liabilities be limited ac cording to the cash reserve held by the bank.
It is a common practice to require that a part of the earnings be set aside as surplus, instead of being paid out in dividends, until a minimum surplus has been built up. The principles involved here are the same as in the case of capital requirements. The only important difference between capital and sur plus is that surplus may be paid out in dividends at the will of the directors unless the law fixes a mini mum amount which must be kept in the business. It is a general principle of law that capital must not be reduced by dividend payments.
3. Stock of the hardest struggles in the development of sound banking has been the fight to make stockholders actually pay cash for their shares. In the national banking system, at least 50 per cent of the capital must be paid in cash before the bank can begin business, and the remainder must be paid in monthly instalments of not less than ten per cent each. This is almost the same as requiring that all the stock be paid for in the beginning. Some of the state laws are more lenient. A high capital requirement is sometimes made with the provision that only a small amount need be paid in. The re mainder that is not paid for stands as a liability of the stockholders subject to call by the directors; or, at least, it must be paid if needed in case the bank fails. The unpaid stock and the double liability clause act as security for creditors in the event of insolvency, provided the stockholders are able to pay. If the stockholders have exhausted their resources in buy ing the stock actually paid for, creditors have no protection. Early payment of a reasonable amount of cash should be rigidly enforced by law.
In the early days of banking, stockholders were often permitted to give their promissory notes in payment for shares. These notes were called stock
notes. The privilege was so flagrantly abused that it has been made illegal in most countries. Suppose a group of penniless but ambitious men desired to establish a bank. Even if initial payment of cash were required, the difficulty could be overcome in the following way: They would go to a friendly bank and borrow the funds necessary to pay for their stock; then they would buy their stock, paying cash, organize the bank, and elect themselves direc tors. One of the number would be president. The first act of the new bank would be to loan to each of the stockholders all, or nearly all, the cash which he had paid in. The stockholders would give their notes to the bank and secure them by depositing their stock in the institution as collateral. They would then take the cash back to the bank from which they borrowed and pay up their loans. If the new bank was a success, the dividends would more than pay in terest on the stockholders' loans; if not, both the bank and the stockholders would be bankrupt. The organ izers had everything to gain and nothing to lose except their reputation, which was probably an insignificant item. The whole thing was a pure gamble. Finally, laws were passed not only requiring the payment of cash for stock but also prohibiting loans to stockhold ers. The law is still evaded in some instances by hav ing loans made to near relatives or friends of the stockholders. These loans are often unsecured, as banks are prohibited from accepting their own stock as collateral. It is the duty of bank examiners to look out for this sort of business. Any business con cern which makes loans to stockholders or partners in the firm is looked upon with suspicion by bankers and creditors who learn of the practice.
4. Restrictions on restrictions are made with respect to loans. One of the most uni versal was described in the preceding section. An other common regulation is that a bank may not loan more than a certain amount to a single individual, firm or corporation. In the case of national banks and members of the Federal Reserve system, the amount cannot exceed ten per cent of the paid-up capital and surplus or 30 per cent of the total cap ital subscribed. Some of the states are more lax. Some such provision is wise. A cautious banker will even limit the amount of loans in a particular line of industry.