Banking Laws

aws affecting banking by which banks are organized, regulated and controlled in their relations with the public and with each other, are the result of many years' of experience in banking. As we have had occasion to note in the opening chapters, banking is based primarily on natural or economic laws. Statute laws pertaining to banking have been added to and revised from time to time, not because there has been any appreciable change in the fundamentals of business, but because men through experience and a study of the lessons taught by experience have found how to correct flaws in banking methods and so avoid the dangers and pitfalls of a previous generation. Thus banking systems have undergone a gradual but steady change toward safer and more efficient standards. It is like the discovery of a safe channel in a narrow and dangerous waterway. After there have been many wrecks and disasters the difficult harbor is finally reached in comparative safety by following buoys and lights that mark the location of submerged rocks. So with banking laws. Each is a lighthouse that safeguards all who would embark in this business of chance and risk, from losing ship and cargo upon the same treacherous reef that has wrecked many another.

A study of financial history with its eras of commercial prosperity alternating with crises and depressions will disclose the reason for many present-day banking laws. In our own country where each state has had and still has a banking code of its own, modified it is true by the national system made necessary by one of the most terrible wars of modern times, we can trace the effect of all these factors upon our latest legislation, the Federal Reserve Act.

It is not within the scope of the present volume to discuss the Federal Reserve Act. Before the student is able to grasp the true significance of its provisions, he must first have a clear conception of the underlying principles involved in banking and banking laws, and it is with this elementary phase of the subject that we are here concerned. We may, therefore, discuss briefly a few typical national bank laws that will serve to illustrate the nature and purpose of all banking legislation, whether state or national.

Many of the more important regulations have to do with the capital, in fact nearly all the privileges and restrictions of the business are based directly or indirectly upon this first item of the bank's liabilities. The minimum amount of capital is fixed by the population of the town or city where the bank is located; the larger the city the greater the amount of capital required. The reason for this is that since there can be no limit to the amount of business a bank may do, it is necessary to anticipate the probable security that must be given to prospective depositors who would very likely be more numerous in a large city than in a small village. To make the security even greater, stockholders of all national banks and also in many state institutions are doubly liable. That is, if the bank should fail with not enough assets to meet the claims of depositors and other creditors, not only would the money due the stockholders represented by the capital and surplus be forfeited, but the stockholders may be assessed an amount up to the par value of their stock to meet any deficiency. A bank may not hold or purchase its own stock since the effect of such a privilege would be to reduce the amount of the capital by that much. Not all the provisions in law tax the stockholder or owner of the bank to safeguard the interests of those who trust their deposits with the institution. There is one provision which protects the capital as well as the deposit. National banks are required to build up a surplus until that item is at least 20 per cent, of the capital stock.

Any losses can then be charged to this fund without depreciating the capital. Thus it is the aim of all well-managed banks to create as large a surplus as possible which gives additional strength and has a tendency to attract deposits.

One of the greatest financial dangers that beset a nation is credit inflation. In "boom" times, when all lines of trade are active, crops good, labor well employed and everybody enjoying unusual prosperity, there is a national tendency for men to reach out for even greater riches. This is the result of that predominant characteristic of human wants which we noted in an early chapter, the insatiability of men's desire for more and better things. During such periods as we have described, men are apt to become overly optimistic as to their prospects. The result is that credit is often extended too freely, being based upon hopes founded on fancy rather than on fact. When several important ventures collapse, the credit that was based upon them becomes valueless and then a sudden fear takes hold of the public. The result is a "panic." It is the purpose of such laws as the Federal Reserve Act not only to curb an undue expansion of credit, but also to help banks prevent a panicky situation from spreading.

There are many safeguards provided by law against credit inflation. As the first may be set down the trained judgment of the sagacious banker who investigates his customer's statements upon which the loan is to be based. The banker knows that if the loan cannot be paid at maturity, his bank may lose money. Then there is the scrutiny of the bank examiner to be counted on; will that loan pass his inspection? There is the further restriction that not more than 10 per cent, of the capital and surplus can be loaned to one interest. This, too, has a tendency to prevent too wide an extension in any one direction. It prevents the bank from risking too many eggs in one basket. Next, then, is the provision in the Federal Reserve Act which restricts rediscounting to loans growing out of actual commercial transactions. That is, the loans must be "self-liquidating" or payable out of the proceeds of the sale of the commodity the loans represent. It will not do to rediscount real estate loans, because real estate is a fixed and constant quantity which does not increase merely by change of ownership, whereas staple goods that men use in the satisfaction of wants are produced, bought and sold - and paid for - at all times and in ever - increasing amounts. And when more money is needed to handle the increase of business, the issue of Federal reserve notes must be "covered" by 100 per cent, of paper representing these liquid commercial loans. The issue must also be backed by 40 per cent, gold reserve. If we trace the entire process back to the original loan we discover that at every step the law throws one safeguard or another against inflation.

The successful banker, therefore, is not he who is satisfied merely to avoid losses and make profits for his stockholders; he is the man trained not only in local credits, but also in national and international conditions. He is well versed in fundamental economics; he knows the financial history of his own and other countries, he does not protest against sound bank laws because he knows why those laws are written. In fact, for him there is no law, because his judgment is proof against those errors which law seeks to prevent. And finally, he never forgets that banking is conducted for the benefit of all the people and not for the exclusive profit of the banker; that it is other people's money as well as his own that is entrusted to his care, that it may be wisely used for the welfare of all men.