THE DANGERS OF JOINT-STOCK BANKING.* Tim volume will, we think,
add to the reputation of the author as a writer who combines a grasp of economical principles, * Banking Reform. By A. J. Wilson. London: Longraana and Co. 1870‘
with considerable knowledge of the facts of business and the practices of the commercial world. He has dealt here with many problems' of great intricacy ; his suggestions are for the most part cautious and reasonable ; and even where his pro- posed remedies do not commend themselves to the reader, the failure is never due to the author's want of insight into the conditions of the disease. We cannot on the present occasion follow Mr. Wilson in his wide survey of the entire field of banking policy. If we somewhat narrow the inquiry, it is from no want of appreciation of his book as a whole, but simply because we wish to emphasise one or two points which are of cardinal importance, and which Mr. Wilson's exposition brings out into peculiar prominence. In what follows it must be understood that we are greatly indebted to him, and we recom- mend all readers who are interested in the subject to read his book for themselves.
A banker is a person who makes it his business to borrow money in order to lend it again. His business cannot be carried on profitably unless he receives more for the use of the money from the people to whom he lends it, than he pays to the people from whom he has borrowed it. Moreover, the money which a banker borrows is only lent to him, upon the understanding that he will repay it to the lender either upon demand (which is the case with current accounts), or after short notice (which is the case with most deposits). His business, therefore, cannot be carried on safely unless he can, at any moment, call in either immediately or after the briefest possible delay the money which he has lent. In other words, it is essential to a healthy system of Banking, first, that there should always be a margin between the interest allowed to depositors and the interest charged to customers seeking advances ; secondly, that money should not be advanced or credit given, except upon securities which nre at the same time sound and realisable,—securities, that is, which are not only convertible into money, but convertible into money without difficulty or delay. This is, of course, the alphabet of banking, and some apology might seem to be needed for even restating, much more for insisting upon, principles so trite that they have the air of truisms. But experience shows us that here, as elsewhere, the most elementary truths are often -those which are most habitually disregarded. It is impossible to deny that recent events have created a feeling of distrust in our Joint-Stock Banks; which, though it may have been, for the moment, allayed by the reassuring explanations and the excep- tional frankness of chairmen and directors, is by no means net finally at rest, High dividends are declared, and flourish- ing reports are presented, the profit-and-loss account still tells its flattering tale ; and yet after four years of con- tinuous and increasing depression, affecting every branch of trade and every market in the world, the question cannot fail to suggest itself why' banking alone is still almost as prosperous and profitable as ever. Primel facie, one would have thought that the banker would have been almost the first to suffer in an era of industrial stagnation. That the deposits of the leading London Joint-Stock Banks have fallen off considerably, there can be no doubt ; Mr. Wilson estimates the diminution under this held, in the case of nine of them, at £9,000,000. It is true that the Banks have probably gained rather than lost by this large withdrawal of money, for which they would have been sorely pressed to find remunerative em- ployment; but after making every allowance for this, the problem still remains how they have been able, during four or
• five years of cheap money and bad trade, to use the immense mass of deposits which they still retain in such a manner as to return to their shareholders dividends which show very little falling-off, when compared with those of the most prosperous times. We can see only three possible explan- ations of the difficulty. Either the Banks have been managed with a combination of dexterity and caution for which it would be difficult to find a parallel; or the dividends declared do not represent profits really earned ; or the money of the depositors has been hazarded in speculative business, in which the returns are high, because the risks are great.
In the absence of any confirmatory evidence, and having re- gard to the fact that in other branches of business the most skilful and experienced management has been unable to avert loss, we may at once reject the first of these hypotheses. As to the second of them, which there is in many quarters a disposi- tion to adopt, the information vouchsafed by the Banks them- selves is so scanty that we have scarcely the materials for forming a judgment. We must, however, be careful not to visit the sins of the City of Glasgow Bank upon others. We believe that the system upon which the affairs of that institution were managed during the last few years of its history was, and is likely to remain, unique. There are banks, no doubt, which, like it, conceal heavy losses, grant excessive credits, and distribute high dividends out of fictitious earnings. They may, as some of them have done, tide over their difficulties without exposure, or even suspicion. But if this becomes impossible, and they reach, as the City of Glasgow Bank did some years ago, the point at which the choice has to be made between disclosure and fraud, there is every reason to believe that they will follow better examples, and honestly declare that they are unable to carry on their business. The third of our hypotheses— namely, that the profits of joint-stock banking in recent years, so far as they have been real, and not merely apparent, have been made to a large extent out of "illegitimate" busi- ness—seems to us to be most in accordance with probability, and to be best supported by such evidence as we have. It must be remembered, as Mr. Wilson very clearly explains, that an era of cheap money is not necessarily inconsistent with profitable banking. By a long-established custom, the interest allowed to depositors by the London Joint-Stock Banks varies with the Bank rate. If the Bank rate is raised or lowered, it rises or falls in exactly the same proportion. Hence, so far as Bankers lend money at the Bank rate, the margin of profit on each transaction is the same, whether money is dear or cheap, never being either more or less than the conventional difference (of 1 per cent, or thereabouts) between the rate of discount and the rate of interest on deposits. But further, the Bank rate only represents the terms upon which money or credit will be given in exchange for the best possible security,—security which it is obvious that the majority of persons who apply for accom- modation to a banker cannot offer. The needy stock-jobber, for instance, whose stability depends on his being able to " carry over" some speculation in foreign bonds till the next settling day, cannot expect to receive advances on the rotten secu- rities which he pledges upon the same terms as the iner- chant whose bills are endorsed by half-a-dozen well-known names. In all probability, the larger proportion of the advances made by any bank in ordinary times have very little to do with the Bank rate. Money is rarely so plentiful, but that some means of employing it profitably for the moment may be found. It may be plentiful, either because, from the un- usual profitableness of trade, there is an excessive supply of loanable capital, or because, from the unusual dullness of trade, there is a contraction of the area within which capital can be lcgitimately and safely employed. Each of these states of the Money Market has its own peculiar temptation for the Banks. In the former case, the danger is lest they should spend their overabundant resources in launching enterprises of dubious promise ; in the latter, lest they should use them in keeping afloat concerns which are in everything but appear- ance already wrecked. When trade is bad, there are fewer transactions ; when there are fewer transactions, there are fewer good bills ; when there • are fewer good bills, the Banks must either keep part of their deposits unemployed, which they can- not afford to do ; or refuse to receive fresh deposits, which they have not the courage to do; or lend their funds at high rates, upon accommodation paper and all manner of unmarketable securities, which is what we suspect that, in some instances, at all events, they do. Such a suspicion is certainly justified by what we now know of the Banks which have recently failed. Their ruin may in all cases be ultimately traced to their abandonment of the rule that the securities upon which a bank advances its funds should be sound, widely distributed, and capable of speedy realisation. Depositors begin to ask whether this new style of banking, under which huge credits are given to single individuals or firms upon the security of land at the Antipodes, or mines in Wales, or depre- ciated foreign bonds, is superseding the wise and cautious sys- tem upon which the reputation of the Scotch and English Joint- Stock Banks was built up.
This brings us to the question of Bank balance-sheets, If the shareholders and customers of the Joint-Stock Banks are really ignorant of the manner in which their profits are made, it is very largely their own fault for not insisting long ago upon a complete revolution in the form of the periodical report of the Directors. Let any one compare the elaborate and detailed accounts presented by any of the groat Railway Companies with the almost obtrusive meagreness of the last balance-sheet but one of the London and Westminster Bank, reprinted by Mr. Wilson in a note at p. 92. The contrast between this balance-sheet us it was, and as, according to the Chairman's statement, it ought to have been, is almost equally striking. The total sum to be accounted for was £25,500,000, and yet on the debit side there are only five items, and on the credit side only six. The acceptances of the Bank, and the securities held against them, do not appear in the account at all. There are some people who doubt whether a bank should " accept " at all,—an opinion which we by no means share ; but on what principle, we should like to know, are acceptances, where they exist, not included among the liabilities of a bank? To deal, however, with the account as it stands, we find on the debit side, huddled together without distinction of amount in a single item, deposits, current accounts and credit balances, cash (if any) on rediscounted bills, and rebate on bills not yet due. Now, there can be no difficulty in separating these several heads of liability, and assigning to each its share of the total ; and as nothing can be more material for intending investors, or depositors, or for the public, to know than the manner in which the obligations of a great Bank are distributed, why is this information withheld ? If we turn to the credit aide of the account, the obscurity of the statement is equally baffling. The cash in hand is not separated from the cash in the Bank of England. The whole of the assets of the Bank, so far as they consist of loans, bills, and securities other than Government and railway stock, are comprised in two items, which are expanded in the Chairman's statement into eight. But for that statement, no one could have told either that the loans granted by the Bank to its customers amount to over £5,000,000, or that out of this £5,000,000 more than 21,000,000 is lent on the security of "leases, deeds, &c.," as distinguished from the "marketable securities" which cover the remaidier. We need scarcely say that the balance-sheet of the London and Westminster Bank has been selected for examina- tion, solely on the ground of that Bank's high reputation and unquestioned stability. The recently published accounts of another great Bank—the National Provincial Bank of England
—present almost exactly the same features. Our point is that under the presenti system, the best of the Joint-Stock Banks, no less than the worst, keep back from the public the data without which it is impossible to understand their posi- tion, or to criticise their policy. If their business is sound, and their manner of conducting it undeserving of suspicion, one would have thought that they would, iu their own interest, have been lavish of the disclosures which, from a false sense of dignity, or from mere adherence to an evil tradition, they persistently withhold. We may add, that since a fuller balance-sheet is to be made compulsory, we hope that the better Banks will not be content with that set out in the schedule to the Government Bill, which, though a great improvement on the present "common form," might well be amplified by the subdivision of some items and the introduction of others. The stability of our Banking system in the long run depends upon the use which the Banks habitually make of the deposits en- trusted to them. So long as they confine themselves to their legitimate function of supplying capital where it is needed and can be profitably employed, they are safe. But if, forsaking their traditions, in the race for dividends, they become vendors of produce, owners of foreign bonds, mortgagees of land, and generally enter into a competition with traders and others, in which they are heavily weighted by the most unfavourable conditions, it may be predicted with confidence that when the hour of danger comes, not a few of them will find themselves unable to meet their engagements. In so far as the limitation of liability and more detailed, balance- sheets will diminish or avert the danger, we heartily desire their adoption. But unless our fears are exaggerated, some more drastic remedy must be applied, before the danger will cease to exist..
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