AMERICAN BANKING PRACTICE
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A TREATISE ON THE PRACTICAL OPERATION OF A BANK,
INTENDED FOR STUDENTS, BANK EMPLOYEES AND OTHERS
WHO WOULD KNOW OF THE CONDUCT OF A BANK UNDER
RECOGNIZED AMERICAN PRACTICE, WITH WHICH
IS COMBINED THE NEGOTIABLE INSTRUMENTS
LAW, UNIFORM IN FORTY-SIX STATES
WILLIAM H. KNIFFIN
AUTHOR OF "THE SAVINGS BANK AND ITS PRACTICAL WORK" (1912); "THE PRACTICAL,
WORK OF A BANK" (1915); "COMMERCIAL PAPER AND ANALYSIS OF CREDIT
STATEMENTS" (1917) ; "THE BUSINESS MAN AND HIS BANK" (1920).
INSTRUCTOR IN BANKING PRACTICE, NEW YORK UNIVERSITY,
AND VICE PRESIDENT BANK OF ROCKVILLE CENTRE,
McGRAW-HILL BOOK COMPANY, INC.
NEW YORK: 370 SEVENTH AVENUE
LONDON: 6 & 8 BOUVERIE ST., E. C. 4
COPYRIGHT, 1921, BY THE
McGRAW-HiLL BOOK COMPANY, INC.
For a long time past there has been an apparent need
for a treatise on practical banking that would give a
complete summary of the operation of a bank in such
form as could be used as a text for teaching.
While many excellent works have heretofore been
written on both the theory and practice of banking, no
one work has in itself adequately covered the subject,
making necessary the use of several books in order to
supply such information as the student requires. More-
over, no other work has attempted to weave into banking
practice the Negotiable Instruments Law, so essential
to bank operation. It has therefore been the aim to
present a simple, yet comprehensive picture of the work
of a bank in every detail.
The author wishes to make special acknowledgement
to that splendid work recently issued by the National
City Bank under the title Practical Bank Operation, from
which many valuable suggestions have been obtained as
to the conduct of a large institution. Supplementing
his own experiences and observations with such informa-
tion, he has attempted to present a composite picture of
banking practice as it is now conducted under recognized
American procedure. Credit is also due to the Irving
National Bank of New York for the use of its forms.
W. H. K.
ROCKVILLE CENTRE, LONG ISLAND,
THE AMERICAN BANKING SYSTEM 1
Why banks are organized. How a city bank serves its country
correspondent. Supervision and Association.
THE FUNCTIONS OF A BANK 7
* Basic principles of banking. Deposits the proceeds of loans.
The discount function. The note issue function. The trust
TYPES OF BANKING INSTITUTIONS 14
/ National Banks. State Banks. Trust Companies. Savings
Banks. The work of a savings bank. Building and Loan
Associations. Growth of building and loan associations.
Safe deposit companies. Stock and bond brokers. Mortgage
companies. Individual bankers. Private bankers.
DEPOSITS AND INDORSEMENTS 27
Receiving teller. How to count money. Cash items. The de-
posit ticket. Transit numbers. Purpose of indorsement.
Forms of indorsement. Warranty of indorser. Charging
back unpaid checks. Checks to officers of corporations. Rub-
ber stamp indorsements. Coupons. Exchange. The name on
the ticket. The block system. Mail teller.
THE PAYING TELLER 48
The bank's cash. The bank's money supply. The paying op-
erations. The teller's opportunities. Paying Teller's duties.
Procedure in paying checks. Date. Words and figures.
Signature. Alteration. Identification. Is the balance suffi-
cient? Stop payments. How banks watch stop payments.
Causes of stop orders. Payment against uncollected funds.
Cancelling paid checks. Payrolls. Currency shipments. Clear-
ing house settlements. Paying teller's day. Overs and shorts.
Pay roll and petty expenses. Certifications. Other certifica-
tions. Checks of deceased depositors. Corporation checks.
Legal tender. Partnership accounts.
Reasons for protest. Rules for protest. Notice of dishonor.
How notices of protest should be sent. Time of notice. Pre-
sentment and protest may be waived.
BANK CHECKS 80
/ Checks displace money. Growth of the check system. The
problem of money. Checks transfer rights. Composition of
bank check. Why a bank collects its checks. Kiting checks.
THE WORK OF THE CLEARING HOUSE 89
/ The New York Clearing House. Non-member banks. The
clearing process. Making a clearing. Settling the balances.
City collections. Sent wrong and fines.
COLLECTING OUT OF TOWN CHECKS 101
Collecting through correspondents. Check collections through
the Federal reserve bank. Check collections at par. Federal
reserve collection system. Illustration of deferred credit. Gold
settlement fund. Work of transit department. Indorsement
of transit items.
r Costliness of exchange. Assessing exchange charges. Interest
delays. Controversy over exchange charges. Argument for
exchange. New York exchange. Charge for exchange. Col-
lection costs. Argument against exchange. Progress of par
collection. Opposition to par collection. State legislation.
Advantages of par collection. Cost of money transfer elimi-
nated. Par collections not malicious.
COLLECTIONS . 128
Classes of collections. Messenger. Collection process. .
Arrival drafts. Bill of lading. Duns. Collection records.
Settlement for collections. Special instructions. Messenger
force. Note teller. Timing notes. Days of grace. Collection
record. Notes payable through clearing house. Exchange
charges on collections. Coupons.
CREDIT AND CREDIT INFORMATION 147
Credit a broad subject. The three big C's of credit. The busi-
ness risk. Capital. The statement. Havoc of the war. The
strike of the buyers. Inventory. Accounts receivable. Quick
liabilities. Credit department. Sources of credit information.
Composition of credit file. Commercial paper checkings.
Purpose of credit information. Course of a loan.
The bank carries the load. Loans and discounts distinguished.
The master mind. Borrower should keep compensating balance.
Interest calculations. Loan records. Collecting maturing
notes. Collateral loans. Good delivery. Warehouse loans.
Loans on goods in transit. Loans on receivables. Automobile
loans. Wall street loans. The margin. Bookkeeping of the
loan. Loans for correspondents. Collateral must be mixed.
The loan card. The trust receipt. Calling loans. When the
interest rate soars.
COMMERCIAL PAPER AND ACCEPTANCES 191
Purpose of commercial paper. Financing through commercial
paper. Checking paper. Acceptances. Book credit. Ad-
vantages of the acceptance.
BANK ACCOUNTING 200
Corporate records. Minute book. Capital stock records.
Stock ledger. Stock book. Stock transfer book. Stock
control. Statement book. Ratio of reserve. General ledger.
For every debit a credit. Accounting records. Bond
NEGOTIABLE INSTRUMENTS LAW 351
Form and interpretation. Consideration. Negotiation. Rights
of holder. Liability of parties. Presentment for payment.
Notice of dishonor. Discharge of negotiable instruments.
Bills of exchange, form and interpretation. Acceptance of
bills of exchange. Presentment for acceptance. Protest.
Acceptance for honor. Payment for honor. Bills in a set.
Promissory notes and checks.
INDEX . . 383
In a study of the practical operation of a bank, we
must have in mind two types of banking institutions:
(a) The bank of moderate size, which may be termed
the "ordinary" bank; and (6) the departmental bank,
which may be termed the "city" bank. The former
will include banks whose assets run from a few hundred
thousand to several millions. In such banks the work
is done by a relatively few employees, each of whom
performs several functions in the course of the day's
work. For instance, in the ordinary bank, the book-
keeper will keep the general ledger and the loan records,
figure discounts, draw cashier's checks, and reconcile
the accounts with other banks. In the city bank
there will be a general ledger bookkeeper, a loan clerk,
and an auditing department, each with a corps of clerks
doing one particular part of the work. But in so doing,
these departmental clerks will do exactly the same work
as the one man. Again, the ledger clerks in the ordinary
bank will not only post the daily credits and debits,
but will also make up statements and write up pass
books; while in the city bank a department will be
organized to write up statements and pass books, as a
check upon the work of the bookkeepers.
In treating the work of a bank from its many angles,
I have endeavored to draw a picture of the ordinary
bank, supplementing this by reference to the practices
in the larger ones. But, to repeat, the same work, in its
fundamentals, is done in both. The difference lies solely
in the number of people and departments required to
carry on the fundamentally identical functions.
AMERICAN BANKING PRACTICE
THE AMERICAN BANKING SYSTEM
The American banking system will be most readily
understood if we start with the " country bank/' or, to
use a better term the " local bank." 1 In practically
every community numbering several thousand people
there is the home bank organized by the local citizens
to furnish banking facilities for the locality. It has
indeed been claimed with some justification that the
remarkable development of all parts of the United
States has been made possible by the assistance of these
local institutions which even the remote farm districts
of the South and West find profitable to maintain.
Why Banks Are Organized.
There are four principal causes for the establishing
First, the need for banking facilities, (a) As soon
as a small community develops, people feel the need
of a safe place to keep their money. Business men
and individuals find themselves in possession of money
1 In using the term "country bank" the author follows the National
Banking Act, which classifies banks in the national system into : central
reserve banks, reserve banks, and country banks. (For details of
this classification, see page 289.) But 'to use a' more dignified name, the
term "local bank" has been selected, to distinguish the banks in the
smaller places from those in the larger cities which act as reserve deposi-
tories for other banks. As they are found in practically all localities
whose population is sufficiently dense to form a community, the "local"
banks are in the great majority.
2 AMERICAN BANKING PRACTICE
for which they have no immediate use; and in offering
the protection of its vaults for the funds of the com-
munity, the bank fulfills its first and simplest function.
(b) There is the need of facilities for the transfer of
funds from place to place in the payment of debts.
Communities are not sufficient unto themselves; and in
their trade with the rest of the world, a medium of
payment is required for which the checking function of
the bank is admirably adapted, (c) There is the need
for currency or paper money with which to carry on
business which requires the use of cash as distinguished
from bank credit, (d) There is the need of loans for
local business purposes.
Second, banks are established by professional pro-
moters, or in many cases by a local promoter, often an
attorney, who sees an opportunity for a profitable busi-
ness both for himself and the stockholders. These pro-
moters select their field carefully and then take an
agreed fee, although the Comptroller of the Currency
will not now grant a charter where the new bank is so
promoted unless convinced that a real need exists, and
the fee for promotion is not excessive. In the case of
local promoters, the advantages which accrue come
naturally with the development of the bank. In these
two ways hundreds of banks have been successfully
started. A single case will illustrate the process.
A certain village of three thousand people had no bank.
The nearest institution was three miles away, making it
inconvenient for the people to transact their banking
business. A lawyer, becoming impressed with this
fact, proceeded to crystallize public sentiment, and
in due course enlisted enough support to organize a bank
with a capital of $50,000, all subscribed by local people
in small sums. He not only received his legal fees,
but was made counsel for the bank, which within a
THE AMERICAN BANKING SYSTEM 3
year had half a million in deposits, all gathered from the
local field. The bank proved a most desirable client
and a most beneficial institution for the development of
the community. This is typical of a large number of
banks that have been organized within the past quarter
Third, and the most unfortunate reason of all for
establishing a bank, is spite. In many instances the
organizers have been connected with other banks, or
as borrowers or depositors have been displeased with
certain transactions and have formed a bank of their
own. It is to be regretted that such banks were ever
chartered; but in many cases they too have had a fair
degree of success.
Lastly, the desire on the part of one man for a bank
office, such as cashier or president, has led to the estab-
lishment of new banks. Many institutions have been
formed for the purpose of giving such a position to one
of the organizers. This is not so common a cause as
the foregoing, but it exists nevertheless.
From a banking standpoint, however, only the bank
which arises from a real need on the part of the public
has a right to exist and claim public support and con-
fidence. The other causes produce a multiplicity of
banks, just as a difference of opinion as to religion pro-
duces a surplus of churches.
But whatever the motive that prompts the organiza-
tion of a bank, as soon as it begins to function it reaches
out and connects with other banks, particularly in the
large cities. Inasmuch as the local bank must by law
keep part of its deposits in reserve, either in cash or in
other banks, and must collect the checks deposited by its
patrons, it establishes connections with the city banks.
To these it sends its surplus cash from time to time,
receives any needed cash in return, sends its checks
4 AMERICAN BANKING PRACTICE
daily for collection, and through it lends out its surplus
funds in the money centres.
How a City Bank Serves a Country Correspondent.
To show how a local bank links itself with a city bank,
the procedure of one bank will prove typical. Here is a
bank in a suburban village. It receives from its de-
positors about $50,000 a day, part in cash and part
in checks. It finds that it receives more cash than local
demands call for, and therefore ships by express from
$25,000 to $50,000 a week to its city correspondent.
The checks received on deposit are drawn on banks in all
parts of the country. To collect these with its own
machinery would be expensive and slow, and besides it
has no facilities for such country-wide 'collections.
Therefore it sends all its out of town checks to its
city correspondent, which in turn makes the collections
for it. When it needs silver or currency, it draws upon
the city bank. If it finds itself in need of funds, it may
borrow of the city bank. If it has surplus funds, as
most banks have at certain times during the year,
it will direct its city bank to loan the same for its account.
If it needs information about a borrower, the city bank,
through its credit department, will furnish it. More-
over, the local bank will draw interest on the balances
maintained in the city bank, for every day they are de-
posited. The large city banks thus have thousands of
bank clients whom they serve to the profit and satisfac-
tion of both. The network of bank connections spreads
all over the country, weaving the banks together into a
harmonious system, unorganized by law, but held to-
gether by the binding force of service.
Supervision and Association.
The next stage of banking development involves
questions of public administrative control and unifica-
THE AMERICAN BANKING SYSTEM 5
tion. In . every state there is a department of bank
supervision, by whatever name it may be called, such
as " Superintendent of Banks/ 7 " Commissioner of
Banking/ 7 etc., which supervises and examines the banks
within its jurisdiction, and enforces the state laws per-
taining thereto. The national banks are thus welded
together and supervised by the Comptroller of the
There are also to be mentioned the various bankers'
associations, as a rule found in each state, the American
Bankers 7 Association, and the various clearing houses,
which unify and harmonize the methods and practices of
the banks that become members. These associations
promote sound legislation and safe practices, develop the
personal equation among men, and in the case of clearing
houses, enforce rules that have the binding force of law.
Lastly, and most important, is the Federal Reserve
System, treated at length subsequently, which federates
all national and a large number of state banks and trust
companies into a harmonious system which has aptly
been termed the " greatest banking system of the
world." This is the great governor of our financial
engine. Being a bank of banks and a bank for banks,
it does not deal with the public, but with banks only.
< l It regulates interest rates, controls the supply of money,
checksjpjinics, standardizes banking methods and prac-
tices, and welds the country into a solid financial unit
that works for the good of all. (See Chapter XIX for
further treatment of the Federal Reserve Bank.)
As a matter of fact, all banks now enjoy the privileges
and protection of the Federal reserve' banks.. If the
bank is a member, it % deals with the Federal bank direct,
but if not a member, it deals with a city bank which
is quite likely to be a member and through the city
bank it receives indirectly many of the advantages en-
6 AMERICAN BANKING PRACTICE
joyed by direct membership. For instance: A non-
member bank is in need of funds. It may borrow of its
city correspondent; and if the latter were not in position
to lend, it in turn could borrow from the Federal reserve
bank. In other words, the city bank passes the load
along, just as the local bank passes its needs along to the
city bank. And only when the city bank has obtained
its full quota of loans from the Federal bank must it
fail in its service.
THE FUNCTIONS OF A BANK
In the terms of the economist, the functions of a bank
are those of deposit, discount and note issue. To the
uninitiated these terms are more or less meaningless
and can be understood more easily by a simpler treat-
ment. The institution we commonly know as a bank
performs many services for the public, all of which grow
out of the three basic functions above mentioned.
More tersely stated, these services are : (a) The receipt
of funds for deposit and safe keeping. Out of this func-
tion grows what I like to term (6) the checking function,
sometimes called the " exchange function." By this is
meant the disbursement of the deposit funds as the
depositor directs when he draws his checks. When a
deposit is made in a bank, a credit is created on its books,
and the bank is debtor to the depositor in the amount
deposited. The depositor has the right to withdraw
this deposit, or in other words, have the debt repaid him,
on demand. But this demand more often takes the
form of a transfer of the credit than it does the withdrawal
of the cash itself. To illustrate: I have a deposit of
$1,000 in a bank. The bank owes me that amount.
It also owes other depositors, let us say, $99,000, or
$100,000 in all. I therefore am entitled to Koo of the
total deposits. I draw my check to another depositor
in the same bank, in the sum of $500. He deposits the
check and the bank takes away half my credit and
transfers it to him, and he is now entitled to that much
8 AMERICAN BANKING PRACTICE
more of the bank funds. I have simply transferred my
right. If the check were deposited in another bank, my
bank would owe depositors that much less and the
other bank would owe that much more. And so this
checking function is merely the transfer of rights against
banks; which rights, when redeemed in cash or its
equivalent, are canceled.
When a deposit of cash is made in a bank, the owner
of the cash takes a bank credit in place of his money;
which credit he can more easily and more safely transfer
than the cash itself. The use of the bank check has
grown enormously of late years, particularly in this
country, and it may now be said to be the most common
and most perfect medium of exchange known to finance.
It is cheap to create merely the cost of the paper. It is
elastic, in that the amount varies to suit the needs of the
maker. It is safe to carry or transport, since it is a
negotiable instrument and as such must be indorsed to
make good delivery. It has " earmarks" and can be
traced from its inception to its extinction, which is not
true of money funds. When finally returned to the
maker it becomes a perfect evidence of payment.
Inasmuch as the loaning function follows the deposit
function, the bank must have adequate funds before it
can make loans. When a bank starts business it has
merely its capital and surplus with which to work. But
with this as a basis, it attracts other funds, called depos-
its; and these three capital, surplus and deposits
are the loanable funds. Upon the faith that the bank
has a capital and surplus fund, contributed by the
stockholders, and is well managed and successful, the
public will entrust its funds to the bank, which it in turn
loans to borrowers, thus increasing its earning power,
and enabling the bank to fulfill its discount function,
mentioned under (c) page 11.
THE FUNCTIONS OF A BANK 9
The Basic Principles of Banking.
It will be well for the student at the very beginning to
understand the two basic principles underlying banking
operations, and these are: (a) JThat a dollar in money
will support from four to ten dollars in credit; and (6)
that a great part of bank deposits arises out of the pro-
ceeds of loans. In the first place, it has been found by
long experience that only a certain portion of the de-
positors will demand that their funds be returned to
them or transferred to others at a given time. And
moreover, while some withdraw, others will deposit,
so that there is a daily inflow and outflow of funds.
And a little money goes a long way in clearing the
transactions. For instance, in a bank of $2,000,000
deposits, it has been demonstrated over a series of years
that $50,000 cash on hand and $150,000 in reserve and
payable on demand in other banks will be sufficient to
clear all the daily transactions. Therefore, if the bank
keeps a reserve ofJJUper cent, it is safe. On the other
hand, it may safely lend out 90 per cent, of all its depos-
its; or, to put it differently, for every dollar in money in
hand it may expand its debts about ten times.
Deposits the Proceeds of Loans.
When a loan is made, the proceeds are credited,
as a general rule, to the depositor as a deposit would be,
and he draws checks against the credit. Only those
loans made to persons not depositors in the bank are
paid in cash or by bank draft. The vast majority are
treated as a deposit to be drawn against.
It is a rule of banking, quite generally recognized,
that preference should be given to depositors in respect
to loans. There are several reasons for this, among
which are: (a) Inasmuch as the proceeds of the loan are
as a rule credited to the depositor's account, it increases
10 AMERICAN BANKING PRACTICE
the deposits, (b) The bank has intimate knowledge of
the borrower's affairs and can lend intelligently, (c)
Having done the bank a favor as a depositor, the
borrower has the moral right to expect favors in return,
which may be stated in more dignified language thus:
The deposits arise by virtue of those who have idle funds
depositing them in the bank. The deposits of the public
are thus " pooled" and from the pool the borrower draws
when in need of loans. Those who have a surplus loan
to those who can use the funds; and unless the borrower
contributes to the pool and helps create and maintain it,