Clearing Houses

A bank check may be defined as a written order drawn upon a bank by a depositor directing the bank to pay a certain sum of money to bearer, to a payee named on the instrument, or to someone else named by the payee. In the majority of cases the payee does not himself present the check for payment. Instead he deposits it to his credit in another bank, thus constituting that bank his agent. The principal business dealings that banks have with each other grow out of the use of checks by individuals and their presentation and collection by banks.

The extensive use of the check is interesting from the bank clerk's point of view. Approximately 90 per cent, of payments are made by check. These settlements are not made in money but in credit. That is to say, the credit that A has with his bank is transferred to B in the payment of debt through the use of the check. Very little money, in comparison with the volume of transactions involved, ever changes hands. This use of the credit instrument instead gives employment to probably more than 75 per cent, of all the employees of banks doing a commercial business. Tellers, bookkeepers and their assistants in all departments are engaged principally in keeping the records incidental to deposits and withdrawals by check.

In a small town having but one bank all of the checks growing out of purely local business are drawn upon that institution. Let us suppose that A and B are both depositors in the same bank. A gives B his check for $100.00 in payment for a horse. It is not necessary for B to present the check, receive the money and then redeposit the cash to his own credit. Instead, he deposits the check, the bank crediting his account and charging the account of A. The same process is being followed by all the depositors in making settlements with each other. No actual cash changes hands; there is merely an offsetting of debits with credits on the books of the bank. This is known as the "clearing principle."

Banks make use of this principle in settling accounts with each other. The agency through which they avoid the constant transfer of money among themselves is the Clearing House. The term is used to apply either to the building used for this purpose or to the organization or association of the banks united together for this and other purposes. In its practical sense the clearing house represents a plan rather than a tangible thing. Let us suppose there are five banks which are members of a clearing house. At the end of the day's business each member finds itself with checks drawn upon the other four. The checks of each are endorsed with the bank stamp, enclosed in a separate envelope for each bank and a total of the checks is listed on the outside. The totals are then listed opposite the bank names on a double column sheet and a footing is struck. In theory each bank assumes that these checks are not payable by the individual banks but by the "clearing house." Therefore, at a fixed time, usually about ten o'clock A.M., each bank sends a messenger to the clearing house with its checks against the other banks. In a small town the office of one of the members is used as a clearing house and an officer of that bank acts as "manager." The packages are then exchanged. Each clerk writes opposite the proper name, the amount of the checks on his bank presented by the others.

These amounts are added up and the smaller amount is subtracted from the larger. If the messenger receives more checks on his own bank than his bank had on the others, then he is a "debtor." If the reverse is true then he is a "creditor." The manager then takes the record of the debtor and creditor balances which, of course, must be equal, thus proving the correctness of the exchange. The clerks return to their respective banks having checks only on themselves, whereas they came to the clearing with checks only on their neighbors. The whole transaction will not have consumed more than ten minutes. Even in the very largest cities, with millions of dollars involved, the exchange is made almost as quickly. The large cities usually have a separate building for clearing purposes and employ a regular manager who is in charge of the clearing process.

The exchanges having been made, the banks now prepare to settle the balances. There are various ways of doing this, depending upon the size of the city and the number of banks in the clearing house. In the smaller towns the manager of the clearing house draws drafts upon the debtor banks which he gives to the creditors, who then present them and receive either the cash or its equivalent. Or the manager may deposit the drafts of the debtor banks with one of the members and draw his own checks against this deposit in favor of the creditors. Another method is to make payment by draft upon the Federal Reserve Bank of the district or upon other reserve agents. In the larger cities settlement is made in cash or its equivalent, payment being made by the debtor banks to the clearing house which acts as agent in paying over the money to the creditor banks. To avoid the handling of even this money, many clearing houses conduct a depository where deposits of gold and currency are received, and certificates in large denominations, $5,000.00 and $10,000.00 are then issued. Settlements made with these certificates are upon a cash basis, yet the danger of loss or error in handling the actual money is avoided. The saving of time and the use of money is well illustrated by the fact that in New York Cityevery clearing house member is enabled to exchange checks with every other member in about fifteen minutes each day, and the balances to be settled average less than 5 per cent, of the total checks exchanged.

Certain rules are prescribed by clearing house associations covering the method of conducting the exchanges and regulating in general the business which the banks do with each other. For example, the rules fix the hour for clearing, method of making settlements, returning of unpaid items, hours for opening and closing the banks, and many other matters that are adjusted in the interest of regularity and uniformity.

Some of the associations employ an official clearing house examiner who supplements the examination by the national or state bank examiner, paying particular attention to the loans and discounts. He is employed by the banks to give them advice as to their methods of doing business, his information and suggestions being extremely confidential. He makes record of the lines of credit being extended by the various member banks and is thus able to check unsound lines before any damage is done. His functions will be described in greater detail in the next chapter.

The clearing principle as applied to check collection is not limited to the items payable in one city. Many clearing houses have also a department for the clearing of country checks. In such cases all the member banks send their out-of-town items within a certain district to the clearing house which operates as one bank acting for all. Thus, instead of receiving a daily letter from each bank in the city, the country bank gets all its checks from that city in one letter from the clearing house, to which it then remits with a single draft. The Federal Reserve Act has carried this process one step further by requiring the Federal reserve banks to act as clearing houses for their member banks. Checks which each member bank sends to the Federal reserve bank acts as the credit offset to the checks which the Federal reserve bank receives on that member. It may be said that much of the Federal Reserve Act is the result of experience with clearing house methods and regulations.