CHAPTER XXI

THE CANADIAN BANKING SYSTEM

[147]Financially, Canada is part of the United States. Fully half the gold reserve upon which its credit system is based is lodged in the vaults of the New York Clearing House. In any emergency requiring additional capital Montreal, Toronto, and Winnipeg call on New York for funds just as do St. Paul, Kansas City, and New Orleans. New York exchange is a current and universal medium in Canada and is in constant demand among the banks. A Canadian wishing to invest in securities that may be quickly marketed commonly turns to the New York market for stocks and bonds. Yet the American banker visiting in Canada, if he is unacquainted with the history of banking in his own country, finds himself in a land of financial novelties, for Canada has a banking system unlike any in operation in the United States at the present time. Twenty-nine banks, known as the "chartered banks," transact all the banking business of the Dominion. They have 2,200 branches, and each may establish new branches without increase of its capital stock. [At the close of the year 1915 there were twenty-two banks with approximately 3,200 branches.] They issue notes without depositing security with the Government and in such abundance that no other form of currency in denominations of $5 and above is in circulation. Notwithstanding the fact that the notes are "unsecured," their "goodness" is unquestioned among the Canadian people.

THE SYSTEM NOT NEW

But to the student of the history of banking in the United States there is little that is radically new in the Canadian system. He finds in it many of the practices and expedients that were found excellent in the United States in the first half of the nineteenth century, and is almost persuaded that but for the Civil War what is now known as the Canadian banking system would everywhere be called the American system.

The fiscal exigencies of war, which have caused changes in the banking systems of most countries, have had no influence upon the development of banking in Canada. During the first half of the nineteenth century the commercial and financial interests of Canada and the United States were comparatively intimate and the financial institutions of both countries developed on similar lines. The safety-fund system, first introduced in the State of New York in 1829, found favor also in Canada and is still an integral part of the Canadian banking system. Branch banking, which was most successfully illustrated in this country by the State Bank of Indiana, and which now exists in some form or other in almost all countries except the United States, has always prevailed in Canada. The importance of a prompt redemption of bank notes as exemplified in the old Suffolk banking system in New England before the war, was fully realized in Canada and is probably better illustrated in the present Canadian system than in any other country. There bank notes and bank checks are treated as identical in nature, both being cleared with the same regularity and promptness. The so-called free banking system, which was first adopted in the State of New York in 1839 and thereafter adopted by eighteen other States of the Union, was tried in Canada in the fifties, but not on a large scale. This system, requiring that issues of bank notes should be secured by a segregated deposit of certain classes of stocks and bonds, has never met with approval among the leading bankers of Canada.

The Canadian system is a product of evolution. It has taken its present form because of the commercial and financial needs of the Canadian people. It was not created by lawyers or statesmen to meet a fiscal need of the Government, but has grown up gradually under the fostering care of experienced bankers, no changes having been made until experience proved them necessary or advisable.

The chartered banks transact the business which in the United States is divided among national banks, trust companies, private banks, and savings banks. They buy and sell commercial paper, discount the notes of their customers, lend money on stocks and bonds, make advances to farmers, and sometimes aid in the financing of railroads and industrial enterprises. To a Canadian the word "bank" means one of the twenty-odd "chartered banks," for the law prohibits the use of the word "bank" by any other institution.

OTHER FINANCIAL INSTITUTIONS

The only other financial institutions in Canada which possess much importance are the mortgage and loan companies. These usually operate under charters granted by the provincial legislatures and do a business similar to that of the farm and mortgage companies which once flourished in the United States, making loans to farmers for a term of years and taking farm mortgage for security. They also make loans upon urban and suburban real estate and thus aid in the upbuilding of the cities and their suburbs. The business of these institutions is made possible by the fact that the bank act does not permit the chartered banks to accept loans secured by real estate.

The Dominion Government maintains a double system of savings banks. One set is managed by the post-office department, every post-office receiving deposits. The other set is managed by the finance department. The post-office department also sells annuities and old-age pensions. The money received through the savings banks is regarded as a loan from the people and is used, like money obtained by taxation, in the payment of the Government's general expenses. The Government is required to carry a gold reserve of 10 per cent. against the savings deposits, but no assets are set aside for their security. The chartered banks pay the same rate of interest and get most of the business, for they offer facilities with which the Government does not attempt to compete. Most of the Government's deposits come from the poorest and most ignorant classes, people who in all countries are suspicious of banks. Some of the Canadian cities maintain municipal savings banks, but they are of relatively small importance.

Trust companies in Canada are not financial institutions. They are trust companies in fact as well as in name, their business being to act as trustee and administrator. A few of them accept deposits, although it is not certain that they have a right to do so. The bulk of the money they handle comes to them through the administration of estates and trust funds.

Private banking firms are almost unknown in Canada, there being only two or three in the entire Dominion, and these do a mortgage and loan business rather than a strictly commercial banking business.

Hence, if any one seeks to understand the financial or banking situation in Canada, he must devote his attention in the main to the chartered banks. These through their branches furnish the loanable capital necessary for the support of the Dominion's trade and industry and for much of its agricultural enterprise. To them the Government turns when funds are needed for internal improvements or when the exchequer faces a deficit. The promoters of street railways, steam railways, steam railroads, and other permanent improvements take counsel with the managers of these chartered banks before they issue their securities. The banks as a rule do not invest their funds in the stocks or bonds of new enterprises, yet their managers are the men most familiar with the world's money markets and their approval, therefore, of any financial undertaking is highly esteemed.

THE ESSENTIALS OF THE SYSTEM

A chartered bank in Canada is a bank of branches, not a bank with branches. The parent bank, technically known as the "head office," neither takes deposits nor lends money. All the banking business is done by the branches, each enjoying considerable independence, but all subject to the supervision and control of the head office. The law places no restrictions upon the number or location of branches. Canadian banks, therefore, have branches in foreign countries as well as in Canada.

PROCESS OF INCORPORATION

The provisions of the bank act with respect to the organization of new banks are intended to guard against the entry of unfit or inexperienced persons into the banking business. The minimum required capital of a bank is $500,000, of which all must be subscribed and one-half paid in before a new bank can open. At least five men of integrity and good financial standing must agree to act as provisional directors and secure a favorable report on their project from the parliamentary committee on banking and commerce. These men must agree to subscribe for fairly large blocks of stock, otherwise the committee will be inclined to reject their application. They must convince the committee that their project is a well considered one, that there is need for the new bank. If they satisfy the parliamentary committee it will be granted. The bank, however, cannot yet begin business. Provisional directors now have merely the right to advertise and cause stock books to be opened. If inside of one year capital stock to the amount of $500,000 has been subscribed and $250,000 thereof paid in, the provisional directors may call a meeting of the shareholders, at which a board of regular directors shall be chosen. Before this meeting is held at least $250,000 in cash must be paid over to the Minister of Finance. The regular directors must then apply to a body known as the treasury board for a certificate permitting the bank to issue notes and begin business and the treasury board may refuse this certificate unless it is entirely satisfied that all the requirements of the law have been met. Delay on the part of the treasury board might prove fatal to the new enterprise, for if a new bank does not obtain a certificate within one year from the date of its incorporation, all the rights, powers, and privileges conferred by the act of incorporation cease. These requirements make it impossible to organize a new bank in Canada with any degree of secrecy.

NOTE ISSUES

Having obtained its charter, a new bank must open its head office in the place designated, and may then proceed to establish branches or agencies, upon the number and location of which the law places no restriction. Under its charter it has authority to issue circulating notes up to the amount of its unimpaired paid-up capital in denominations of $5 and multiples thereof. An amendment of the bank act passed July 20, 1908, gives the bank the right to issue what may be called an emergency circulation during the crop-moving season (October 1 to January 31). During this period the legal maximum of the circulation of a bank is its paid-up capital plus 15 per cent. of its combined paid-up capital and surplus or rest fund. This emergency circulation, which consists of notes in form and in other respects exactly like the regular issues, is subject to a tax at a rate not to exceed 5 per cent. per annum, the rate being fixed by the governor in council. If a bank's circulation does not exceed its paid-up capital, it pays no tax.

SECURITY OF NOTES

The law is silent on several subjects that seem of great importance to most bankers in the United States. For instance, it does not require that the banks shall deposit with a government official, or in any way set aside any kind of security for the protection of the note holder. It does not even require that the banks shall carry a cash reserve against either notes or deposits, nor does the law make the notes a legal tender for any payment. A bank need not accept the notes of other banks. The Government does not guarantee the redemption of the notes. Neither does it bind itself to receive them in payment of dues to itself.

Nevertheless the notes of the Canadian banks are everywhere acceptable at par, the people apparently not being at all concerned about their "goodness." And their confidence in the note has been well justified, for nobody since 1890 has lost a dollar through the failure of a bank to redeem its notes. Following are the legal requirements, which for twenty years have proved adequate protection for the note holder:

1. Every bank must redeem its notes at its head office and in such commercial centres as are designated by the treasury board. The redemption cities are the same for all the banks. They are Toronto, Montreal, Halifax, Winnipeg, Victoria, St. John, and Charlottetown.

2. Each bank must keep on deposit with the Minister of Finance a sum of lawful money (gold or Dominion notes) equal to 5 per cent. of its average circulation; the total so deposited is called the "circulation redemption fund." It is a guaranty or insurance fund for use, if need be, in the redemption of the notes of failed banks.

3. Bank notes possess first lien upon the assets of a bank.

4. Bank stockholders are liable to an assessment equal to the par value of their stock.

5. A bank must make to the Minister of Finance on or before the fifteenth of each month a detailed statement of its assets and liabilities on the last business day of the preceding month. This monthly return, the form for which is set forth in the act, must be signed by three general officers.

6. The Canadian Bankers' Association, an incorporated body of which each bank is a member, is given supervision by the bank act of the issue and cancellation of notes and of the affairs of a failed bank.

7. The notes of a failed bank draw interest at 5 per cent. from the date fixed for their redemption by the Minister of Finance, who may redeem them out of the assets of the bank or out of the "circulation redemption fund."

IMPORTANCE OF REDEMPTION

Each of these provisions of the law has its value and significance, but only the first is absolutely essential to the successful operation of the system. All the other provisions might be changed or abolished without impairment of the efficiency of the banking system. But the abolishment of this redemption system would at once give Canada a new banking system. The bank note is _almost the sole circulating medium_ in Canada, and the people have confidence in it because it is tested every day at the clearing houses and proves itself as good as gold. This daily test would probably not take place with the same regularity as now if the banks did not have branches or if they were obliged to deposit security against their issues. Canadian banks are national, not local institutions. All but a few of them have branches in every part of the Dominion, and these branches, as fast as they receive the notes of other banks, either send them in to the nearest redemption centre or convert them into lawful money--or its equivalent, a bill of exchange--through branches of the issuing banks located in the same towns. Each bank is seeking, through its branches, to satisfy all the legitimate needs of the people for a circulating medium. When the note of a bank is in circulation it is earning money for the bank, but when it is in the vault or on the counter of the bank it is an idle and useless piece of paper. Hence every bank always pays out its own notes through its branches and sends the notes of other banks in for redemption, thus increasing its own circulation and _strengthening its own reserve_.

Furthermore, if the banks were not allowed complete freedom of issue within the prescribed limit, but were required to deposit some form of security, as is required of the national banks in the United States, an investment or speculative risk would arise that would inevitably cause friction. If bonds were designated as security, bankers might often be tempted by high prices to sell their bonds and forego the profit on circulation for the sake of making a larger profit by the sale of the security. Thus the volume of bank notes might contract even at a time when the people needed more currency. In such case, of course, Canada would be obliged to import gold in order to fill the gap in the circulating medium.

THE CIRCULATION REDEMPTION FUND

The 5 per cent. insurance fund for the redemption of the notes of failed banks is theoretically an important and prominent part of the system, yet practically it would seem to be of little consequence, for not once since 1890 has it been necessary to use a dollar of the fund. Banks have failed, to be sure, but the notes of these banks have always been redeemed either out of the assets or by recourse to the double liability of the shareholders. It is a mistake to suppose that the people of Canada have confidence in bank notes because of the existence of this redemption fund. The average business man knows nothing about the fund and if his attention were called to it as being a source of security for the bank notes, he would probably think a 5 per cent. reserve altogether too small. The real reason why the people have faith in bank notes is because the notes are always honored by the banks and never fail to stand the test of the clearing house. In other words, they believe that bank notes are good for about the same reason that they believe the sun will rise in the east every twenty-four hours, and do not bother themselves about reasons.

Nevertheless this redemption fund does contribute to the strength of the banking system. It makes each bank to a certain extent liable for the mistakes of other banks, and as a result gives rise to a spirit of mutual watchfulness and helpfulness. Other features of the system contribute to the same result, especially the fact that a Canadian bank accepts from a depositor without indorsement the notes of other banks. Since the banks have branches in agricultural and mining communities, often distant from the railroad by several days' journey, and these branches are accepting the notes of other banks and giving credit for them as if they were gold itself, it is evidently important that each banker should have all possible information with regard to the status and business of his competitors. As a result one finds among the bankers of Canada a surprisingly intimate knowledge of each other's affairs.

TWO NEGATIVE QUALITIES

The two negative qualities of the Canadian bank note--its lack of a legal-tender quality and of a government guaranty--at first sight may seem to readers in the United States a source of weakness. Yet Canadian bankers would doubtless all agree that nothing would be gained by making bank notes legal tender for any kind of payment or by making the Government in any measure liable for their ultimate redemption. Such measures would probably be rejected as likely to prove harmful. It would be like hampering a flying machine with unnecessary bars of steel. Bank notes, like bank checks, are mere promises to pay money and are more convenient than money because they can be created as need for a medium of exchange arises. When either has done the work that called it into existence, it should disappear from circulation and be redeemed. If it is made a legal tender like money itself, or if its redemption is guaranteed by a strong government, there is always the danger that ignorant classes of people will regard it as money itself and withdraw it from circulation.

The Canadian Government has nothing to do with the daily redemption of bank notes and does not guarantee that they shall be redeemed. It is custodian of the 5 per cent. redemption fund and is under obligation to redeem the notes of failed banks out of this fund, but if a series of bank failures should exhaust it the note holder has no guaranty that government funds will be used for his relief.

The possession by the note holder of a first lien upon the assets of a bank, including the funds that may be collected from shareholders on account of their double liability, gives rise to such general confidence in the ultimate convertibility of a bank note that the notes of a failed bank, on account of the interest they bear, sometimes command a premium. As a rule, the notes of such a bank are collected by the other banks and held until the date of redemption has been named by the Minister of Finance.

CANADIAN BANKERS' ASSOCIATION

The Canadian Bankers' Association is an incorporated body with powers and duties prescribed in an amendment to the Bank Act passed in 1900. Each chartered bank is represented in the membership and has one vote. The association is required by law to supervise the issue of bank notes and to report to the Government all over-issues, to look after the destruction of worn and mutilated notes, and to take charge of suspended banks. Its headquarters are in Ottawa. The expenses of the association are apportioned among the banks and do not apparently constitute a very heavy burden, for the secretary has an exceedingly small staff. All expenses incurred by the association on account of a suspended bank are, of course, a charge against the assets of the bank.

When the notes of a bank are so worn or mutilated that it wishes to replace them with new notes, notice is sent to the secretary of the association, a date is fixed, and in the presence of the secretary the old notes are duly counted and taken to a furnace, where they are consumed in the presence of the secretary and other witnesses. After this solemn operation has been performed and the signatures of all parties observing it have been duly attested, new notes are issued by the association to replace those that have been destroyed.

The clearing houses in the Dominion are subject to regulation by the association. It also has the power to establish sub-sections and to do educational work by providing for lectures, competitive papers, examinations, etc. The _Journal of the Canadian Bankers' Association_, a quarterly publication of excellent quality, is edited by the secretary and is at present the only educational force at work among bank employees.

ELASTICITY OF THE CIRCULATION

While the amount of notes that the chartered banks may issue is limited by the Bank Act to the amount of their paid-up capital, experience has proved that this legal limitation is only nominal and that the real and effective limit is imposed unconsciously and automatically by their customers and themselves. Each constantly seeks to increase its issue of notes to the legal limit, yet the combined efforts of all are never able to force into circulation more notes than the people need.

The reason why an excessive issue of bank notes in Canada is impossible is found in the two following facts:

1. Every bank must redeem its notes on demand in seven commercial centres in different parts of the Dominion.

2. The monetary circulation of Canada, exclusive of $1 and $2 bills, and "change" consists entirely of bank notes.

The redemption system is an automatic and effectual check against inflation. It is easier to get notes redeemed in Canada than it is to secure payment of checks in the United States, for the notes are redeemable at different points throughout the Dominion and no exchange is ever charged. If a country merchant accumulates more currency than he desires to keep on hand, he deposits it, together with his checks and drafts, in the local branch of his bank. This branch immediately sorts out the notes of other banks and treats them as it does checks and drafts upon other banks, either sending them to the nearest redemption agency or using them as an offset in the local clearing house if the issuing banks have branches in the locality. The branches of a bank are not obliged to redeem the notes of the parent bank, but must accept them at par in the payment of all dues. Thus each bank is doing its utmost to bring about the redemption of the notes of other banks. At the same time it is paying out its own notes to all customers who ask for cash, seeking to bring its circulation up to the limit. As a result of these operations, two powerful forces are constantly at work, one putting notes into circulation, the other retiring them, and the people of Canada always have on hand just the amount of currency they need and no more. It is the people, not the banks, who determine how much the circulation of the banks shall be.

BANK NOTES HAVE NO COMPETITION

The fact that the bank note has exclusive possession of the monetary field in Canada is most important. His ignorance of this fact is one reason why the average banker or business man in the United States has been unable to get a practical understanding of the Canadian system. Its significance is easily seen. If Canada, like the United States, had in circulation a lot of government notes in denominations of $5, $10, $20, the Canadian banks would be able to increase their issues of bank notes almost without limit, for their new notes would simply take the place of the government notes, the latter going into bank reserves. The people of Canada in making deposits would not discriminate against bank notes, but would deposit the government paper quite as freely as the bank paper. As a result, the amount of the government paper in circulation would gradually decrease and the amount of bank notes would increase. The volume of Dominion notes in the vaults of the banks would expand, and as these notes are redeemable in gold the banks would feel justified in larger extension of their credit, so that an increase in deposits and current loans would ensue. Under such circumstances such freedom of issue as is enjoyed by the Canadian banks would doubtless result in inflation.

But such conditions do not exist in Canada. All the paper currency in the hands of the people, excepting $1 and $2 bills, is in the form of bank notes. There is no chance to substitute bank notes for government notes. Hence, if at any time business relaxes and the need for money among the people grows less, an increasing tide of bank notes flows into the banks. The people who bring these notes do not ask for money in exchange, for to them the notes are money. They take bank notes to the banks just as people in the United States take greenbacks and silver certificates--to be exchanged for a deposit credit or account.

NO LIMIT OF ISSUE REALLY NECESSARY

Theoretically there is no reason why any limit should be fixed upon the amount of notes which a bank may issue. Even though a bank has a monopoly of issue in a country--like the Bank of France--it nevertheless is unable to expand its circulation beyond the people's needs. Such a bank, unless it should adopt a reckless policy of lending which would bring ruin quickly upon itself, can exercise very little influence upon the amount of currency in circulation. In a country like Canada, where several banks are issuing currency, no single institution can enlarge its issue of notes beyond the needs of its own customers. If it should endeavor to do this by lending freely to customers who promised to use its notes in different parts of the country, the effort would be futile. The notes would quickly find their way into the branches of other banks and be sent in for redemption.

Like most other countries, however, Canada has placed a limit on the note-issuing privilege, fixing it at the amount of a bank's paid-up capital. While there is no scientific necessity that such a limit be fixed in order to prevent the over-issue of notes, nevertheless there are other considerations which justify it. It is an indirect method of compelling banks to increase their capitalization _pari passu_ with the growth of their business. Inasmuch as the capital of a bank is the stockholder's contribution toward its assets, it is exceedingly desirable that this contribution be made as large as possible, for, other things being equal, the strength of a bank varies with the amount of its capital. It is not unreasonable, therefore, to require that banks in return for the useful note-issuing privilege should be required to keep their capital resources large.

When a Canadian bank has reached the limit of its note issue--which has rarely happened--it begins at once to treat the notes of other banks very much as if they were its own. Instead of going to the expense of sending them in for redemption, it uses them as counter money, paying them out to depositors in response to their calls for cash. If all the banks in Canada should issue notes up to the limit, as some of them did during the exciting months of 1907, and if the current rate of interest did not warrant the issue of the taxed notes provided for by the amendment of 1908, the note circulation would immediately lose its elasticity. As further expansion would be impossible, the banks would have to meet any increasing demand for currency by paying out gold and Dominion notes, thus depleting their reserves. Such a situation would doubtless lead to a sharp advance in the discount rate and to the importation of gold.

THE PRACTICAL LIMIT UNDER THE LEGAL

It should be noted that the practical limit of note issue is about 10 per cent. below the legal limit. The manager of a bank having a paid-up capital of $1,000,000 begins to get nervous when his circulation equals $900,000. His office may be in Montreal and his bank may have branches in the far East and in the far West and in the mining wilderness of the North. Some of these branches he can not reach by telegraph and some are distant a week by mail. He immediately sends warning to all the branches and cautions them against any large out-giving of notes and against entering into transactions which will be likely to lead to unusual demands for currency. On account of this situation, even in times of greatest pressure, the total issue of the banks is usually 10 per cent. below the authorized limit.

DEPOSITS

The liabilities of Canadian banks, like those of commercial banks in Great Britain and the United States, furnish a fairly correct index to the expansion of the country's credit. Since the Canadians, like other Anglo-Saxons, make free use of the check book in the settlement of both business and private accounts, any increase of bank loans and discounts is usually attended by a corresponding increase in deposits. When a Canadian business man discounts his note at his bank he almost invariably leaves the proceeds on deposit with the bank. As he makes his payments by check his own deposit account declines, but the bank accounts of his creditors increase, so that the net result of borrowing in Canada is an increase in the total of bank deposits. Consequently, in good times, when the banks are freely extending credit, the deposits grow, and in periods of dullness and liquidation they decline. A growth of deposits, therefore, is commonly accepted as an indication of business and industrial activity.

If a business man in Canada has temporarily a large balance in his bank and realizes that he will not need the money for several months, he will either arrange for its entry as a time or savings bank account, or for the payment of interest on his balance as a current account. Of course, the bankers do not encourage this practice, nor can it be indulged in by a depositor who is also a borrower. Depositors of the class who are paid a small rate of interest--usually 2 per cent.--by national and state banks in the United States, usually have savings department accounts in Canada and get 3 per cent.

SAVINGS DEPOSITS ALWAYS PAID ON DEMAND

On account of the fact that the time or savings bank deposits contain such a large proportion of money likely to be needed in business at any time, the banks regard both classes of deposit as being essentially the same form of liability. Practically all the deposit liabilities of a Canadian bank are payable on demand, although payment on two-thirds of them at the present time can not legally be demanded until after notice. Custom has made it imperative that a Canadian bank shall pay any and all of its depositors on demand. For any bank to refuse to let a depositor have his money when he calls for it would be regarded by the public as an acknowledgment of weakness. Certainly no Canadian bank would take the risk of making the experiment.

Canadian bankers feel that 3 per cent. is too high a rate of interest to pay depositors. This rate is a matter of tacit agreement among the banks and no single bank can afford to lower it, for such action would cause it a loss of business. On the other hand, if any bank, hoping to increase its deposits, should offer to pay 3-1/2 per cent. or 4 per cent., its conduct would be looked upon with grave disapproval by its competitors. Some of the new banks in recent years have obtained business in this manner and have been severely criticised by the managers of the older institutions.

SAVINGS DEPOSITORS NOT PROPERLY REWARDED

To an outsider it would seem that the savings bank depositor in Canada is not generously treated. In the United States he gets 4 per cent. on his savings even in the large cities. In Canada, a country where real estate mortgages yield from 7 to 9 per cent. and the bonds of new corporations are selling at prices giving the investor a higher return than he can get in the United States, it is certain that a real savings bank could well afford to pay depositors 4 per cent. It is doubtless true that 4 per cent. is a higher rate of interest than most of the savings depositors in the chartered banks have a right to expect. A large part of these deposits are not savings deposits at all. Nevertheless it is doubtful if the banks would be justified in a reduction of the rate.

The right solution of the problem seems to lie in another direction, namely, in the making of a sharper distinction between demand and savings deposits. The funds received from both classes of depositors should not be treated alike. The money of savings bank depositors should be invested in bonds and mortgages and then could be made to yield a net return of over 5 per cent. If the depositors were not allowed to check upon their accounts they would be a source of such little expense to a bank that it could easily afford to pay them interest at the rate of 4 per cent. At the present time the banks are paying 3 per cent. interest on money which they are lending to commercial borrowers and for the care of which they are maintaining an expensive force of clerks. Depositors who have checking accounts might be allowed 2 per cent. on large balances, but out-and-out savings depositors, people who make no use of the check book, are certainly entitled to a 4-per-cent. rate in a country where investment capital is as fruitful as it is in Canada.

Strictly speaking, the savings departments of the chartered banks are not savings banks, for they do not pretend to devote their time funds to long-time investments. The amount of securities held by the banks is never equal to the amount of time deposits.

A thorough reorganization of the savings departments of the chartered banks, to equip them for the real business of a savings bank, would not be possible without an amendment to the Bank Act, which now prohibits them from loaning money upon real estate or upon the security of real-estate mortgages. It is generally believed that this prohibition is commonly evaded by the banks through the acceptance of such mortgages as "additional security" after loans have been made. A savings bank, of course, must have the legal right to accept such security.

NO BANKERS' BANK

The indebtedness of banks to banks is not large in Canada. The branch system makes it unnecessary for banks to carry balances in other institutions located in the financial centres. Nearly every bank has a branch in either Montreal or Toronto and in these branches carries the major proportion of its cash reserve, so that branches in the far West or in the maritime Provinces are always able to sell exchange on Montreal or Toronto. Canada has no bankers' bank. The Bank of Montreal, which is the largest bank in the Dominion, its assets being equal to about 25 per cent. of the total, is often spoken of as the government bank because it is the largest government depositary, yet it holds a very small amount of funds belonging to other banks.

AMOUNT OF THE RESERVE FIXED BY EACH BANK

It must not be supposed that the Canadian banks do not carry adequate reserves. On the contrary, every bank manager gives to this subject daily and most conscientious thought. To the Canadian banker the word "reserve" means a fund immediately available for the liquidation of liabilities. How much this fund ought to be depends altogether upon the amount and character of the liabilities to be protected.

A Canadian bank manager, having before him the amount of time deposits and demand deposits, respectively, knowing the probable future needs of the various depositors, being in constant touch with branch managers both by wire and by letter, and having back of him information born of many years' experience, easily determines how much his bank's reserve ought to be in order to assure its safety. The law neither helps nor hinders him; it simply requires that the bank shall satisfy the demands of depositors in accordance with the terms of the contract and that it shall redeem its notes on demand. The public by force of custom expects a bank to do a little more than the law requires, for its credit is bound to suffer if it take advantage of its legal privilege to delay payment upon time deposits. The manager is a hired man, sworn to do his utmost to protect the credit of the bank, trained for many years in its service, familiar with its history and its policy, anxious to guard his own reputation and character against criticism. Under these circumstances it would be remarkable if he did not fix the amount of his bank's reserve nearer the ideal figure--if an ideal banking reserve is possible--than could possibly be done by a body of lawmakers or of any other men outside the bank.

COMPETITION IS NOT LACKING

In many respects banking competition is quite as active in Canada as it is in the United States. Apparently there are only two things which the banks do not like to do in order to attract business--lower the discount rate, or advance the rate paid on depositors' balances. There is no express agreement among the bankers on these points, but every banker knows that he would become _persona non grata_ among his brethren if he should discount certain kinds of paper at less than 6 per cent., or pay his depositors on their monthly minimum balances more than 3 per cent. per annum. In Montreal and Toronto large borrowers can get money at 5 per cent., but the average merchant and manufacturer must pay 6. In Winnipeg borrowers can do almost as well, but farther west the usual rate is 7 per cent., and in some of the remoter districts merchants and farmers alike pay 8 per cent. Bankers do not believe in lowering the discount or interest rate unless they are compelled to do so in order to find a market for their funds.

Some of the older institutions would like to prevent competition from absorbing the minor profits which come from collections and transactions in exchange, but they are not entirely successful. The nominal or schedule charges for collections and exchange are frequently cut for the benefit of business men whose favor it is desired to propitiate.

In their efforts to get new business, to be the first to open a branch in a promising new community, or to keep their regular customers from being dissatisfied, there seems to be the keenest kind of competition. Few villages of 500 people can complain that their banking facilities are less than they deserve, and many of them, with barely enough business to pay the expenses of one branch, are supplied with two. The recent rapid increase in the number of branches has been caused by the great expansion of the West and by the competition among the more progressive and energetic general managers, each desiring that his bank shall be the first in a promising field, even though his enterprise lead him to establish branches which at first do not pay expenses. In a new mining camp the first bank, like the first saloon or the first boarding house, usually begins business in a tent. Some of the more conservative bank managers in Canada think that new branches are being started in excess of the country's needs, but others are willing to take chances on the country's future and to charge considerable sums to the debit side of the profit and loss account in order to keep their institutions at the front in the great and developing West.

BANKING IN DIFFERENT PROVINCES

It is generally known that the Eastern branches get heavy deposits and are creditors of the head office, and that the funds they collect are forwarded to the Western branches, whose loans greatly exceed deposits. Bankers will admit that this transference of funds takes place, but there is considerable grumbling about it in the old communities of the East, and the bankers fear that a monthly or even annual publication of the facts would keep them perpetually in hot water. A glance at clearing-house statistics leaves no doubt as to the banking importance of the Western Provinces or as to the relative financial quietude of the East. Between 1900 and 1909 the total of Canada's bank clearings increased 227 per cent., but Halifax gained only 23 per cent., St. John only 90 per cent., and Quebec only 68 per cent. On the other hand, Toronto's clearings increased 179 per cent., Winnipeg's 600 per cent., and Vancouver's 524 per cent.

EASTERN PROVINCES HAVE SUFFERED

This transference of funds from sluggish to active communities is the inevitable result of a system of branch banking and is the cause of the tendency of the rate of interest toward uniformity in all parts of Canada. Whatever may be said against a system of branch banks, there can be no question that it does bring about a more even distribution of capital in a country than is possible under a system of independent local banks. Canadian bank managers are anxious to put out their money where it is most wanted, for there they get the best possible rate of interest and obtain paper of the best quality. No matter where a manager's headquarters may be, he is most deeply concerned in three questions: (1) Where is idle money accumulating? (2) How can he best draw it into his bank? (3) In what parts of the Dominion is money most needed? In localities of both kinds he establishes branches; in the one the branches accumulate deposits often much in excess of their loans, in the others the loans exceed the deposits. Thus it happens that the savings of the Eastern Provinces, where the growth of industry and trade is slow and the demand for new capital is not increasing, are sent westward and loaned out to merchants and manufacturers and farmers of the new territories. The people of the East supply the capital for the development of the West, though many of them perhaps are entirely ignorant of the useful purpose their savings are made to perform. In the western cities of Canada one hears no talk among business men about the scarcity of capital. A merchant or manufacturer in Manitoba gets the money he needs as easily as does the merchant or manufacturer in Toronto or Montreal.

Justifiable as the bank's policy is from a national point of view, one can not help believing that the branch banking system has really checked the development of business and industry in the maritime Provinces. If Canada during the last thirty years had depended, like the United States, upon independent local banks, there would have been a plethora of capital in the East, and Montreal, Quebec, and Halifax, like Boston, New York, and Philadelphia, would years ago have had 4 and 5 per cent. money, while Winnipeg and other Western cities, less populous than now, would still be paying 1 per cent. a month. The relative cheapness of capital undoubtedly helped build up the prosperous industries of Massachusetts. The same cause operating in the maritime Provinces of Canada would doubtless have led to the establishment there of industries of which the people under existing conditions have not ventured to dream.

LARGE USE OF DEPOSIT CURRENCY

It is sometimes assumed that a free and large use of bank notes tends to discourage the use of the check book and the growth of bank deposits. On the continent of Europe, for instance, where the notes of central banks supply all the currency the people need, the check book is comparatively little used. This fact is sometimes explained by the ease with which people can obtain bank notes for use in making all payments. Experience in Canada makes one doubt the validity of this explanation. The check book is almost as popular there as in the United States, and would probably be used still more than it is if the banks would adopt a policy as liberal as that in vogue in the United States. The Canadian banks not only charge exchange on checks and drafts payable in other localities, but even charge exchange on checks drawn on their own branches. The charge is a small one and probably has no great effect one way or the other, yet it certainly does not encourage the increase of deposits or the use of the check book. When a Canadian starts on a journey it is in a small way economical for him to fill his wallet with all the cash he expects to need. The notes of his bank will be taken at par everywhere throughout the country; his checks, even though he presents them at a branch of his bank, will be cashed only at a discount.

Notwithstanding this discrimination against the check, the deposits of Canadian banks have grown much more rapidly than the note circulation and the inference is that the volume of deposit currency has increased at the same rapid pace. Since 1900 the volume of notes has increased approximately 60 per cent., while the deposits by the public showed a gain of 155 per cent. These figures prove that business men in Canada appreciate the advantages of the check as a means of payment, and that the proportion of business transactions settled by it is steadily increasing.

BANKS SILENT PARTNERS IN INDUSTRY

A large part of the so-called commercial paper of Canadian banks is secured practically by title to goods in warehouses, factories, and wholesale stores. Such security is more saleable than stocks and bonds, and paper having such security back of it is therefore better banking paper than notes secured by stock-market collateral. So far as would seem possible the Canadian Bank Act makes merchandise of all kinds a sort of collateral security for bank advances. It assumes that if a bank advances capital for the conduct of a business it should have a claim upon all the assets of the business and upon all goods as they come and go in the course of trade. No matter how a merchant's stock may change in character, it all belongs to his bank in case he fails to take up his paper or meet his engagements. In the same way a manufacturer's stock of goods, the raw material and the finished products, no matter how they change from day to day and month to month, will become the property of his bank if he fails to pay his note. The law practically makes every bank a silent partner in many wholesale and manufacturing businesses and gives it many rights which no ordinary silent partner can acquire. It has the effect naturally of making bankers keep a close eye upon business conditions as well as upon the affairs of their individual borrowers. Canadian bankers are interested in the lumber market, in the prices of metals, in changes in the tariff, and in the acquisition of foreign markets for Canadian manufactures and products, even as the Wall Street banker is interested in the prices of stocks and bonds. He is in a sense the owner of merchandise of all kinds, and both trade and financial news has equal significance to him.

A CUSTOMER'S LINE OF CREDIT

In Canada the banks are managed by men whose long experience in the business has taught them to avoid certain banking practices that are in vogue in other countries. Realizing how important is the relation between a bank and its customer, they believe that this relation should be made as intimate and helpful as possible. Among Canadian bankers, therefore, it is part of the law and gospel of banking that a bank is entitled to full knowledge of the financial condition and business operations and prospects of its customers. Hence a bank insists that its customers shall rely _entirely upon itself_, that they shall make a full statement of their affairs at least once a year, and that they shall begin each year with a clean slate.

As a result of this policy a business man in Canada deals exclusively with one bank. Once a year he arranges with his bank for a line of credit and learns exactly the amount of paper he will be able to discount. If he happens to need less than he anticipated, he will not exhaust the credit allowed by the bank and will pay interest, of course, only upon such portion of the bank's funds as he actually utilizes. If, on the other hand, his business is unexpectedly large, giving opportunity to make bigger profits and creating the need for more capital, he will find the bank ready to increase his line of credit, provided the manager is satisfied that business conditions and prospects warrant expansion. Under no circumstances, however, must the customer of a bank seek to raise funds elsewhere unless he first gets the consent of his bank. If he sells his notes in the open market, he must do it with the full knowledge of his bank or run the risk of being placed upon the "black list."

As one would naturally expect, there is very little commercial paper floating about in the Canadian money market. The bill broker is unknown. Wholesalers and manufacturers, unless shipping to foreign countries, do not draw upon their customers. If credit is granted, it takes the form of a book account or of a promissory note.

The promissory notes received by a manufacturer or wholesaler are deposited with his bank. The book accounts under ordinary conditions remain entirely at the disposal of the business, but in extraordinary cases, when the situation is not satisfactory, or if an additional credit at the bank is desired, an assignment of the book accounts to the bank may be required.

During the harvest season heavy drafts are made upon the resources of the banks to provide for the movement of the grain crops of the West. In its advance of money for this purpose the law makes it possible for a bank always to have abundant security. Under section 88 of the Bank Act the buyer makes assignment to his bank of the grain purchased. When the grain is delivered to a railroad, the bill of lading becomes the property of the bank. When it reaches Port Arthur, or some other distributing point, and is stored in an elevator, the bank receives a warehouse receipt in exchange for the bill of lading; and when shipment is made to New York, to Montreal, or to Europe, the bank receives on surrendering the warehouse receipt the shipper's draft on the consignee, the bill of lading, and other documents. Throughout the entire transaction, from the purchase from the farmer to the final sale to the Eastern consumer, the bank practically has title to all agricultural products which are being moved by means of its funds.

LOANS TO FARMERS

The branches of Canadian banks in agricultural districts quite commonly lend assistance to farmers. They do not make a practice of taking mortgages on farm property, but lend outright on the farmer's credit, depending for their security upon his character as a man and ability as a farmer, and often as well upon a neighbor's indorsement. Farmers' paper ranks high among the Canadian bankers and constitutes a considerable proportion of the assets of some of the banks. The banks, of course, do not undertake to supply the farmer with anything more than working capital. They do not help him pay for his land and buildings, but they do let him have at least part of the money he needs for tools, wages, seed, stock, etc. Despite the fact that these advances are unsecured by mortgage, the banks suffer very little loss on farm paper.

CALL LOANS IN CANADA AND ELSEWHERE

After "current loans in Canada" the next largest item among the assets is "call and short loans elsewhere than in Canada." The call loans outside of Canada consist mainly of loans in the New York market and are as a rule secured by collateral easily convertible into cash. These loans are regarded by Canadian bankers as equivalent to cash and are figured by them as part of their reserve. Only the larger banks make a practice of loaning on call in New York.

THE BANKS AS FINANCIAL INSTITUTIONS

That the chartered banks of Canada are financial as well as commercial institutions is evidenced by their holdings of stocks and bonds. These securities represent partly an investment carried as a secondary reserve and partly a business carried on for the benefit of their customers. In Canada the demand for long-time investments is not large, but whatever market there is for securities is mainly in the hands of the chartered banks. An investor seeks the advice of a bank manager and often is able to obtain from him securities which satisfy his needs. The banks do not publish a list of their holdings, but it is generally taken for granted that they carry only gilt-edge securities. If a customer desires to obtain second or third rate securities, being eager for a high rate of return, a bank can accommodate him, not by selling him out of its own stock, but by negotiating the purchase of the desired securities in New York or London.

As the wealth in Canada increases and idle capital accumulates in excess of its immediate needs, this financial side of the business of Canadian banks will doubtless expand. It may, indeed, during the next generation or two greatly expand and become an important feature of the chartered banks. They are in a position to take care of the business as it develops and will doubtless be able to prevent the establishment of any purely financial banking houses in Canada.

THE REVISION OF THE BANK ACT, 1913[148]

The Canadian Bank Act, as is well known, is subject to decennial revision. The last revision was due to take place in 1910; but owing to circumstances which it is not necessary here to describe, it was not until the present year that the work was finally undertaken. The leading features of the Canadian banking system are so well known that they may be passed over, and the nature and causes of the recent changes in the act alone described. There were many minor modifications, but the essential changes effected were: (1) provision for a shareholders' audit, (2) the creation of central gold reserves, and (3) the providing of additional facilities for making loans to farmers.

In the recent revision of the act the public was most deeply concerned with the problem of securing an adequate system of bank inspection. The immediate reason for this was the disastrous failure of the Farmers' Bank. This institution had gambled away its resources on the Keeley mine; and had, in its failure, brought many farmers as well as others to the verge of ruin. For several years previous, however, there had been an insistent demand for some sort of external bank inspection....

The banks as a whole have been opposed to any change in the method of inspection. The reason they advance is that the keynote of the organization of Canadian banks has always been the centralization of responsibility; and they do not think it wise to divide that responsibility with any outside authority....

As far as the public is concerned it has no means of judging of the soundness of a bank except by examining the monthly returns which are required by law from each bank. These returns are fairly comprehensive, and have been made more so by the revision of the act this year. The Minister of Finance may call for supplementary information from any bank, whenever, in his judgment, such data are required to afford a fuller knowledge of a bank's affairs. Of course, these returns can be taken only for what they are worth. In the case of several failed banks the returns were made with every degree of falsification, because no independent checking of the figures was possible.

Nevertheless, in obedience to the strong demand for some sort of independent bank examination, provision was made in the recent revision of the act for a shareholders' audit of each bank's affairs. The auditors are to be chosen by the shareholders from a list of forty names selected by the whole body of the general managers of the banks. The list must be submitted to the Minister of Finance for his approval. If one-third of the shareholders of a bank are dissatisfied with the auditor appointed by the majority, they may appeal to the Minister for the appointment of another auditor.

The auditors must submit a statement of their findings to the shareholders at the annual meeting, or on any other occasion the necessity may require. In addition the Minister of Finance may require a special return to be made to him, the cost of the service rendered being paid for by the Government.

Canadians would be wise not to expect too much from this system of external examination. After all, it can do no more than verify a bank's statements and books.... In every large undertaking, the soundness of the transaction must depend, as before, upon the judgment of the general manager and the board of directors.

The establishment of central gold reserves is the most important feature added to Canada's banking system by the legislation of 1913.... Under the new act each bank may issue any amount of notes that it may desire, provided that it deposits with a board of trustees, at Montreal, gold or Dominion notes to the full amount of the notes issued. These notes are to be identical in form with the ordinary notes of the bank. The gold or Dominion notes deposited with the trustees shall be returned to the bank whenever the notes which the bank has outstanding do not amount to the paid-up capital of the bank together with the amount of legal-tender money deposited with the trustees. In other words, the banks can still issue their notes up to the full amount of their paid-up capital, and an additional amount from September 1 to the end of the following February, which may equal 15 per cent. of a bank's combined capital and surplus. It is only for notes issued in excess of these amounts that legal-tender money must be deposited with the trustees at Montreal. It should be observed, however, that the banks pay a tax of 4 per cent. on the extra issue during the crop-moving period, whereas there is no tax upon gold-reserve notes. And as Canadian banks are not required to keep a legal reserve against their demand liabilities, there is no reason why the idle gold in their reserves should not be sent to Montreal to form the basis of new note issues, especially when it is considered that the gold may be recalled at once when no longer needed to cover notes.

The ability to issue notes to any amount required, on a gold basis, will greatly strengthen the position of the banks.

The third important new feature in the revision of the act is the power given to the banks to make loans to farmers on grain which is stored on the farm and still in the farmer's possession.... The permission granted them to loan money to farmers on stored grain in the latter's possession is an attempt to extend to the farmers aid similar to that hitherto granted to manufacturers and wholesalers alone. It should not be thought, however, that the banks have not always granted loans liberally to farmers....

The possibility of making advances to the farmers on their grain is expected to be of especial benefit to the West.... It is hoped that, under the new legislation, the farmer will be able to hold his grain for higher prices; and in the meantime secure accommodation from the banks to meet his obligations. Many bankers, however, refuse to see any remedy for the situation in the new legislation. They maintain that it will involve too much risk to extend loans on grain over which the farmer continues to assert control. Only the operation of time will enable us to estimate the value of this feature of the act.

COMPARATIVE FIGURES OF CONDITION OF CANADIAN BANKS[149]

ASSETS

Nov. 30, 1915 June 30, 1914. Gold and subsidiary coin--

In Canada $41,831,732 $28,948,841 Elsewhere 29,527,921 17,160,111 ----------- ----------- Total $71,359,653 $46,108,952 Dominion notes 140,751,331 92,114,482 Deposit with Min. of Finance for security of note circulation 6,770,645 6,667,568 Deposit in central gold reserves 15,100,000 3,050,000 Due from banks 169,429,330 123,608,936 Loans and discounts 881,101,540 925,681,966 Bonds, securities, etc. 121,953,898 102,344,120 Call and short loans in Canada 83,203,787 67,401,484 Call and short loans elsewhere than in Canada 135,530,562 137,120,167 Other assets 76,993,424 71,209,738 -------------- -------------- Total $1,702,194,170 $1,575,307,413

LIABILITIES

Capital authorized $188,866,666 $192,866,666 Capital subscribed 114,422,866 115,434,666 Capital paid up 113,987,275 114,811,775 Reserve fund 112,718,473 113,368,898 ------------ ------------ Circulation 124,153,685 99,138,029 Government deposits 36,001,548 44,453,738 Demand deposits 538,764,279 458,067,832 Time deposits 714,219,286 663,650,230 Due to banks 30,973,072 32,426,404 Bills payable 5,081,059 20,096,365 Other liabilities 14,007,918 12,656,085 -------------- -------------- Total, not including capital or reserve fund $1,463,200,847 $1,330,488,683

NOTE.--Owing to the omission of the cents in the official reports, the footings in the above do not exactly agree with the totals given.

FOOTNOTES:

[147] Adapted from Joseph French Johnson, _The Canadian Banking System_, Publications of the National Monetary Commission, Senate Document No. 583, 61st Congress, _2d Session_.

[148] W. W. Swanson. _The Revision of the Canadian Bank Act_, American Economic Review, Vol. 3, December, 1913, pp. 993-998.

[149] _The Commercial and Financial Chronicle_, Vol. 102, January 1, 1916, p. 13.