The Theory of Money and Credit

Chapter 15. The Business of Banking

Money_201-300.indd 93 6/17/08 9:27:58 AM CHAPTER 15 The Business of Banking 1 Types of Banking Activity The business ofbanking falls into two distinct branches: the negotiation ofcredit through the loan of other people's money and the granting of credit through the issue of fiduciary media, that is, notes and bank balances that are not covered by money. Both branches of business have always been closely connected. They have grown up on a common historical soil, and nowadays are still often carried on together by the same firm. This connection cannot be ascribed to merely external and accidental factors; it is founded on the peculiar nature of fiduciary media, and on the historical development of the business of banking. Nevertheless, the two kinds of activity must be kept strictly apart ineconomic theory; for onlyby considering each of themseparatelyisitpossible tounderstand theirnatureandfunctions. The unsatisfactory results of previous investigations into the theory of banking are primarily attributable to inadequate consideration of the fundamental difference between them. Modern banks, beside their banking activities proper, carry on various other more or less closely related branches ofbusiness. There is, for example, the business of exchanging money, on the basis of which the beginnings of the bankingsystemin the MiddleAges were 293 Money_201-300.indd 94 6/17/08 9:27:58 AM 294 Money and Banking developed, and to which the bill ofexchange, one ofthe mostimportant instruments of banking activity, owes its origin. Banks still carry on this business nowadays, but so do exchange bureaus, which perform no banking functions; and these also devote themselves to such business as the purchase and sale of securities. The banks have also taken over a number of functions connected with the general management of the property of their customers. They accept and look after securities as "open" deposits, detach interest and dividend coupons as they fall due, and receive the sums concerned. They superintend the allotment of shares, attend to the renewal of coupon sheets, and see to other similar matters. They carry out stock exchange dealings for their customers and also the purchase and sale of securities that are not quoted on the exchange. They let out strong rooms which are used for the secure disposal of articles of value under the customer's seal. All of these activities, whatever their bearing in individual cases upon the profitability of the whole undertaking, and however great their economic significance for the community as a whole, yet have no inherent connection with banking proper as we have defined it above. The connection between banking proper and the business of speculation and flotation is similarly loose and superficial. This is the branch of their activities on which the general economic importance of the banks nowadays depends, and by means of which on the continent of Europe and in the United States they secured control of production, no less than of the provision of credit. It would not be easy to overestimate the influence on the organization of economic life that has been exerted by the change in the relation of the banks to industry and commerce; perhaps it would not be an exaggeration to describe it as the most important event in modern economic history. But in connection with the influence of banking on the exchange ratio between money and other economic goods, which alone concerns us here, it has no significance at all. 2 The Banks as Negotiators of Credit The activity of the banks as negotiators of credit is characterized by the lending of other people's, that is, of borrowed, money. Banks Money_201-300.indd 95 6/17/08 9:27:58 AM The Business of Banking 295 borrow money in order to lend it; the difference between the rate of interest that is paid to them and the rate that they pay, less their working expenses, constitutes their profit on this kind of transaction . Banking is negotiation between granters of credit and grantees of credit. Only those who lend the money of others are bankers; those who merely lend their own capital are capitalists, but not bankers. 1 Our use of this definition of the Classical School should not furnish any ground for terminological controversy. The expression banking may be extended or contracted as one likes, although there seems little reason for departing from a terminology that has been usual since Smith and Ricardo. But one thing is essential: that...