2. THE FUNCTIONS OF BANKS. The functions of banks may conveniently be divided Into those relating to loans and investments, and those relating to money and the substitutes for coined money provided by banks. Savings banks, the simplest class of banking institu tions, are entirely concerned with the first of these functions. The inducement of the interest return brings to them deposits, most of which remain undisturbed for long periods. Safety of principal and the income yield are there fore the considerations which determine the character of the investments of savings banks. State and municipal bonds, the bonds of estab lished public service corporations with a good dividend record and real estate mortgage loans meet these requirements and make up the bulk of the investments of this class of banks. Through the facilities which they supply, thrift is encouraged and much income which other wise might be wasted is made available to in crease the total capital of the community.
Loans and Income yield and safety are quite as important for other banks, but they must be sought in a narrower investment field. With them the quality of liquidness is also essential, since most of the funds which they employ are payable on de mand, and large and unexpected payments must frequently be made. The deposits of these i , commonly known as commercial or credit banks, consist mainly of cash resources which are being currently used for business purposes, or for personal expenditure. They are therefore subject to continued change, being constantly drawn upon by their owners. To meet this situation the funds of commercial banks must, in large measure, be employed in those investments which can quickly be con verted into cash. In other words, they must be liquid.
Securities for which there is a broad mar ket, such as most of those which are listed on stock exchanges, meet this requirement of liquidness. A far more important avenue for the employment of the funds of commercial banks, however, arises from the demand for short periods of time which comes to the banks from everyone engaged in active business. Working capital requirements in many lines of business vary with the seasons, and in every line of business with the volume of dealings.
In satisfying these requirements the banks secure investments ideally suited to their own needs. At the same time a valuable service is rendered to the community. Capital is econ omized. It is not necessary for each business to supply itself permanently with sufficient capital to take care of its maximum require ments. The supply of capital is also made more elastic, and finally the trained foresight of the banker is exercised in selecting from the mass of would-be borrowers those who have mani fested capacity to employ capital wisely and effectively.
Commercial banks, including the banking departments of trust companies, unlike savings banks, do not limit their loans and other invest ments to the funds received from depositors and shareholders. They lend their credit and thus create a large part of the funds utilized 2 by bdrrowers. They are able to do this be cause they provide more or less generally acceptable substitutes for coined money. The bank note, the promise of a bank to pay money on demand, is obviously a credit instrument which is a substitute for money. But partly because of legislation limiting the power to issue notes, and even more because the check has been found more convenient for most purposes, the bank note has become a subordinate and rather special means of extending credit.
Banks, of course, do not extend credit directly by issuing checks, since the check is an order on a bank to pay money, not its promise to pay money. Such orders are based upon obligations to pay money recorded on the books of the banks, and known as de posits. Clearly, a bank cannot lend its already existing obligations to pay money on demand.
It may indeed happen that a bank receives, let us say, $1,000 in money from a depositor, and is on that account in position to lend more than might otherwise be advisable; but even here it is not the deposit which it lends but either the $1,000 or (and this is far more likely) a new right to draw $1,000, both transactions—the receipt of the thousand dollars and the loan of the thousand dollars—creating absolutely lar deposit obligations.