The Banking Reserve

I DO not think I need apologise for calling your atten-
tion to this subject of the banking reserve. I say the
banking reserve, and not the Bank reserve, because,
as will presently appear, what I have to say does
not merely or primarily relate to the Bank of Eng-
land. It is of the reserve position of our banking
system as a whole that I desire to speak.

Now, considering that Mr. Goschen, in his memor-
able speeches of 1890 and 1891, nearly eighteen years
ago, regarded this matter as absolutely urgent, while
the difficulty of the position has certainly not dimi-
nished since that time ; considering that the present
Premier during the last two or three years has more
than once impressed on the banking community the
necessity of some action ; considering, too, that some
half-dozen of the most prominent practical bankers
in the City have in the most formal way called public
attention to this matter, it is pretty evident, I think,
that the question is one which presses for some

1 A lecture delivered by invitation to the Chartered Institute of
Secretaries, Feb. 24th, 1909.

practical solution. Bankers are, by habit and by
tradition, exceedingly cautious, and they would not
have spoken so strongly as they have on this subject
unless they felt that it was really imperative that
something should be done, and done without delay.

I do not think you could have a more favourable
opportunity for strengthening the reserve than we
have to-day. Money has never been more plentiful.
The gold yield last year was in the neighbourhood of
eighty-five millions sterling. Kates of discount were
very easy. Continental banks strengthened their
position by sixty to seventy millions ; the Bank of
France alone by over thirty millions. So far as I
can make out, in this market we did absolutely
nothing. The reserve at the Bank of England was
positively lower by about 1,800,000 odd in February,
1909, than in February, 1908. We lost an exceedingly
good opportunity.

This was not for want of due warning. Sir Felix
Schuster repeatedly insisted on the unique opportu-
nity which times of easy money offer for increasing
our gold holdings. But nothing was done in this
country, whilst in almost every other the great bank-
ing institutions, including the Treasury of the United
States, have made large accessions to their reserves.

Mr. Palgrave, in the Bankers' Magazine of February,
1904, tells us that " much of the legislation which
regulates banking in England is now altogether out
of date, and mischievous where it is not useless."
I would hardly have ventured, on my own unsupported
opinion, to put the matter so strongly. But this is
the verdict of a man who has long been one of the
highest banking authorities of this country, and who
is a director of one of the largest joint-stock banks.

If Mr. Palgrave is right in his estimate, and for
my part I should entirely agree, there is no reason
for that excessive reluctance to disturb existing
arrangements on which foreign observers often re-
mark. There is plenty of room for the revision of
our present methods, and for some new departure
in a system which has been untouched for sixty-five
years.

It cannot be too clearly recognised that this is
not a question that merely affects the money market.
The whole nation is intimately concerned in the
provision of an effective banking reserve ; and this
not merely because we are all of us in these days the
clients of banks. No doubt, anybody with 5 can
open a banking account, and is, therefore, interested
in the solvency of the institution with which he is
thus connected. But the poorest man in the country
is as greatly interested in this question as the richest
depositor. The question of unemployment is to the
front now. It has always seemed to me curious that
while in the many discussions which it has provoked
we get all manner of extravagant and Utopian solu-
tions proposed, from land nationalisation to a stringent
protective tariff, it does not seem to have occurred



138 PAPERS ON CURRENT FINANCE

to the majority of persons who are dealing with the
subject that the recent abnormal increase in unem-
ployment was consequent upon the banking crisis
in the United States. The argument post hoc propter
hoc requires to be used with great caution in economic
discussions. But I think it is beyond dispute that the
sudden increase in the rate of unemployment (the
percentage in 1908 was double that of 1907 1 ) was
due almost exclusively to the failure of the banking
organisation of the United States and the consequent
effect on the world's trade. I say, then, that the
whole nation is concerned in this question, and the
poor, perhaps, more than others, as they have
smaller resources to fall back upon at such times.

WHAT is BANKING RESERVE ?

Those who have addressed the public on this ques-
tion, though they all agree on its urgency, appear to
agree on little else. The solutions they propose are
most divergent. I think that is partly because
people have not come to terms precisely as to what
they mean by bank reserve. I must ask you to excuse
me, then, if I try to define the term " reserve." I
should be inclined to say that a reserve is " a public
provision of money, not required in the ordinary

1 Unemployment is the most notable and distressing of modern
social facts. Yet we have no adequate official returns of its fluctuations.
But, so far as the trade union figures show, it was not much above the
average in 1907. In 1908 the percentage rose from 3*7 to 7-8.



THE BANKING RESERVE 139

course of business, held available to meet excep-
tional emergencies."

Some will think this rather a strict definition, while
to others it may appear obvious ; but it rules out a
large proportion of what is commonly regarded as
reserve by bankers themselves, and even by the
legislation of some important countries. Let us go
into the point a little more fully. A banking reserve
is not merely sound assets. A bank may have the
soundest assets in the world, but it is impossible to
regard all assets which may be good in case of a
liquidation as necessarily good banking reserve.
Take the case of the United States. It is not too
much to say that when the banking system of the
United States suspended payment in 1907, the banks
held two thousand millions sterling of tolerably good
assets : it was not for want of assets that they sus-
pended payment. Nor can we admit that much of
the so-called liquid assets is properly banking reserve.
The term " liquid " is always a doubtful term.
Securities freely marketable to-day might be prac-
tically unsaleable to-morrow. The whole question
of the convertibility of assets is a very difficult one,
and we must allow very wide margins when we are
considering the price tolerably good assets will realise
at the time of stringency. Bankers will probably
include money at call, if not among their reserve
resources, at least among their liquid assets. But
many authorities are of opinion that the large



140 PAPERS ON CURRENT FINANCE

amount of money at call is the most dangerous
feature of our market. I suppose the bankers have
120 millions at call or at short notice. How much
of this could they get in in time of crisis ? A very
small proportion.

Mr. Pownall tells us, in an interesting paper on
Bank Reserves, what Viscount Goschen thought on
this subject in 1890. He says, " The last time we
had a crisis (in 1890) the then Governor of the Bank
of England and the Chancellor of the Exchequer
fixed on this point as the vital one. Their anxiety
appears to have been that the bankers should stand
solidly together, and not attempt, by individually
withdrawing money from the brokers, to protect
themselves at the danger of a general discredit.
There was undoubted solidarity of interest ; what
was needed, and was secured, was solidarity of action.
If the banks were unable or unwilling to lend, it was
of the highest importance that they should not de-
stroy the equilibrium of the short-loan market. To
do that would have been to force the brokers on to
the Bank of England, and thus risk a panic of incalcul-
able calamity. I fear that a Chancellor's letter would
have availed little." x

Holding these views, it is not surprising to find

1 Economic Journal, September, 1899. I may say that the late
Mr. Lidderdale was radically opposed to applying for a Chancellor's
letter. He told me more than once about that time that he could not
conceive circumstances in which he would feel justified in resorting to
this expedient.



THE BANKING KESERVE HI

Lord Goschen saying, at Leeds, in 1891, that " money
at call is a valuable asset, but it is not an asset which
constitutes a reserve useful to the general interests
of the community at large."

Cash, then, or what will at once be accepted as
money by those who have a right to demand money,
is the only real banking reserve ; and the cash must
be unemployed. Pressure in one part of the market
may be relieved by withdrawing short money lent
to another part : but such an operation causes new
disturbance, and only increases the general pressure.
An employed reserve is really a contradiction in
terms, if we are considering the market as a whole. 1

Coming now to cash, can all cash be counted as
banking reserve ? First we must notice that the
term " cash," as used by bankers, is extremely am-
biguous. Mr. Palgrave gives a list of seven different
things which are sometimes called cash by bankers.
Some bankers regard as cash their actual holdings
of metallic money in their own tills, others include
Bank of England notes, others notes of other banks,

1 Thomson Hankey has put this point admirably. " Ready money,"
he says, " is a most valuable thing ; it cannot, from its very essence,
bear interest ; everyone is therefore constantly endeavouring to make
it profitable, and at the same time to make it retain its use as ready
money, which is simply impossible. ... It is the constant attempt
to perform this miracle which leads to all sorts of confusion with respect
to credit.

" The Bank of England has long been expected to assist in performing
this miracle ; and it is the attempt to force the Bank to do so which
has led to the greater number of the difficulties which have occurred on
every occasion of monetary panics during the last twenty years."
The Principles of Banking, 1867, p. 25.



142 PAPERS ON CURRENT FINANCE

others cheques on other banks, others cash balances
at the Bank of England, others balances at their
London agents, others money at call and at short
notice.

It is plain that we want much more specific returns
before we can arrive at any definite knowledge of
what is meant by and returned under the heading
of " Cash."

When we get down to metallic money we seem
to have got to bedrock ; and there are persons who
would include every form of metallic money as bank-
ing reserve. But it is quite clear, I think, that we
cannot do this. A large portion even of the gold
held by the banks is necessary till money. At least
four leading joint-stock bank authorities admit that
till money cannot be regarded as reserve ; that is to
say, the money which a bank finds it necessary to
use to keep its doors open and to carry on its ordi-
nary business is not money available to meet emer-
gencies. It cannot be seriously reduced, otherwise
the bank would have to close its doors. All the
greatest authorities on banking are agreed on that
point. The problem, then, is, How much cash is
held by joint-stock banks other than what is neces-
sary on the average to carry through the ordinary
business of the bank ? It is very difficult for an
outsider to form any opinion on this point. We hear
representatives of banks sometimes speaking of
" hoards " which the banks are forming for them-



THE BANKING RESERVE 143

selves. On the other hand, Mr. Palgrave says very
definitely that practically there is nothing held by
the banks in an unemployed form. He tells us,
' The tendency of business is to leave no unemployed
money outside the Bank of England "; * that is to
say, that there are no hoards of any importance, of
any magnitude, which are not potentially in use,
and therefore no money to meet emergencies, outside
the Bank of England. Moreover, any such unseen
hoards, because their amount is unknown and their
existence uncertain, lose much of the power they
might otherwise have to steady the market. A true
reserve must be a public provision of money.

It must be remembered, too, that a large pro-
portion of our metallic money consists of silver and
bronze. Neither of these, since 1816, is full legal
tender, and, though silver might for many purposes
have been a good remittance before 1873, it cannot
possibly count as bank reserve here since that date.
Now, we were told yesterday by the Chancellor of
the Exchequer that against an estimated amount of
about 100,000,000 of gold in our currency, there was
about 24,500,000 of silver and 3,000,000 of bronze.
Thus, 27,500,000 of " cash," or, say, nearly twenty-
five per cent., is not gold and not reserve. How much
of this is in the hands of the banks ? According
to returns made in June, 1905, they held, say,
5,250,000 of silver, and their holding had increased

1 Bank Rate and the Money Market, 1903, p. 225.



144 PAPERS ON CURRENT FINANCE

750,000 since a previous return in 1892. We have
no return of the holdings of bronze, but the silver
and bronze together must be well over 6.000,000.
All this counts as part of the " cash in hand " held
by the banks. But it is certainly not reserve, from
the point of view of a foreign drain on our market,
and it can only be available to a very limited extent
to meet internal demands. The old device of " paying
in sixpences," resorted to by the Bank itself in 1720
and 1745, was effectually barred by the Act of 1816.
But, last of all, no resources, however good, not
even gold itself, can be counted as reserve unless
they can be used in an emergency. Locked-up money
is not reserve. That brings me to the case of the
United States. The national banks there have re-
serves of gold which would be an exceedingly valuable
asset if they went into liquidation. We know that
they are obliged to hold 25 per cent, reserve against
their liabilities in the larger or reserve cities, and
15 per cent, in the country towns. But that is not
strictly reserve as we have defined it, because they
cannot part with it. They cannot pay out any part
of this 25 per cent, without reducing their liabilities
i.e. their accommodation to the public by four times
the amount thus paid away. Hence, as their reserve
dwindles down to 26 per cent, and 25| per cent.,
panic seizes on the public, because they know that
the next step will be that the banks cannot pay out
any more. That is one reason why we can never



THE BANKING KESERVE U5

establish an effective banking reserve by regulations
that banks shall hold such and such a proportion
of gold against total liabilities. Gold held under
these conditions may be a good asset when the bank
goes into liquidation, but it is not a banking reserve,
and will not prevent the necessity of liquidation,
which it is the purpose of a bank reserve to avert.

We ought to be quite clear, I think, on that point.
Mr. Lawson, always witty and incisive, says :
" Perhaps the American idea of creating money
simply to lock it up as bank reserves was borrowed
from the railway stations in Germany, where there
must always be one cab on the ranks." Well, it
seems to me that that cab might as well be in the
stables. The reserve, then, must be available, other-
wise the gold may as well be in the mines. 1

THE PRESENT POSITION.

What is the actual position in this country, taking
reserve as above explained ? The total liabilities
of the banks of the United Kingdom may be put at
about 1,000 millions sterling. In this sum I do not
include liabilities on account of capital and reserve,
which are liabilities to shareholders, not to outsiders.

1 Since these remarks were made, the reserve ratios mentioned
have been altered, and the whole reserve position in the U.S. enor-
mously improved, by the Act of December 23rd, 1913, and its subsequent
amendments, creating the Federal Reserve System. The argument,
however, still holds as against any attempt to legislate for reserve on
the basis of a fixed ratio to liabilities.
F.C.F. K



146 PAPERS ON CURRENT FINANCE

Nor have I included anything on account of the
liabilities of Foreign and Colonial banks, which it
would be very difficult to assess for this purpose.
Savings banks' liability, which seems to me of a quite
different kind, is also excluded ; as well as insurance
and other liabilities, which may at times cause a
very real disturbance of the market.

What is the reserve held against this 1,000 millions
odd of liabilities ? I will take first the returns made
by the banks themselves, and we can afterwards con-
sider how much these returns must be discounted if
we take a strict view of what is really effective reserve.
The Bank of England has for over twenty years kept
considerably over 45 per cent, reserve against its
banking liabilities, the note issue being otherwise
provided for. The exact average rate for the years
1884-1903 was 46'6 per cent. During the last fifteen
years the great joint-stock banks publishing returns
show a ratio of something like 15 per cent., tending
of late years to rise somewhat. The average for
1904-6 was 15*5 per cent. ; last January's return
stands at 17'4. For the smaller and country banks
we have no complete returns ; but the other day I
noticed a return by one of the most important of
the English country banks, one with most ancient
and honourable traditions. The proportion of re-
serve to liabilities was 6*2 per cent. I do not think
we could put the general average holding of this
class of banks as more than 5 per cent, of liabilities.



THE BANKING RESERVE 147

Thus the banks may be divided into three orders,
holding respectively about 5 per cent., 15 per cent.,
45 per cent, of reserve, the proportion trebling
as you pass from one order to another on your way
from the country bank to the Bank of England.
Remembering that reserve is dead money, and makes
no contribution to dividend, these figures should be
noted. Whatever value they may have as indicat-
ing the proportion of effective reserve on which we
may rely, they are unimpeachable evidence of the
relative sacrifices made by different elements in the
banking community towards the burden of maintain-
ing dead or unprofitable resources.

But when we come to examine these returns in
the light of the exceptions we have been considering,
we find that very little is left as really effective
reserve, and that little is mainly confined to the
holding of the Bank. I put it as twenty millions, or
twenty-five millions at the outside 2J per cent, of
the total liabilities. Mr. Palgrave said, in 1902, that
there was little unemployed money (other than till
money) outside the Bank. We hear that some un-
known amount has recently been accumulated by
the joint-stock banks. On the other hand, as Mr.
A. C. Cole justly remarked, in his address to the
Institute of Bankers in Ireland (1905), some of the
reserve at the Bank must be regarded as till money.
That reserve, during the last fifteen years, has
averaged about twenty-five millions. Mr. Cole



H8 PAPEKS ON CURKENT FINANCE

considers that we can only count two-thirds of this as
true reserve. Add four millions for outside reserves,
and you get about twenty millions, say, twenty-five
millions as an extreme figure.

Is this reserve adequate ? The arithmetical pro-
portion is small, but no conclusion can be drawn
merely on that ground. It is a question mainly of
what the insurance companies call experience. It
depends on the probable emergencies to be met. One
can conceive a banking situation in which a reserve
of one per cent, might be adequate. If we had to
consider nothing but internal liabilities, and cheques
were universally used, it is almost conceivable that
we should want no reserves at all, especially if the
process of amalgamation had been carried so far
that there was only one bank. Every internal pay-
ment might be made by a cheque on that bank.
In this sense the banks are perhaps justified when
they urge that a large mass of their liabilities cannot
fairly be regarded as involving any serious necessity
for the holding of gold reserves. But we must deal
with the situation as it is ; and we must note that
the actual liabilities are of very different kinds, some
of them involving very serious possibilities.

Liabilities on current account are probably the least
dangerous of all to the banking system as a whole.
They represent the till money, if I may so speak, of
the general public, other than their pocket money.
It has often been pointed out, as by Mr. Palgrave,



THE BANKING RESERVE 149

that a man cannot very well withdraw his average
holding on current account. He may move it to
another bank, but he cannot well do without it in
this form, otherwise he would invest it. When we
come to what are called distinctively " deposit "
accounts, we have a quite different kind of liability.
The money is placed there because it is not wanted
at the moment. It only lies there till a better in-
vestment offers. True, it is nominally under some
condition of withdrawal subject to notice. But I
gather that under the stress of competition the con-
dition of notice tends to vanish, and I am often
assured that customers can practically move their
deposit moneys at will. High authorities have held
that the greatest danger the Scottish banks have
to provide for is a sudden withdrawal of such deposit
moneys, which form a large proportion of their
liabilities. We had a memorable object lesson as
to this risk in the Australian bank failures of 1893.
No doubt the difficulty was originally caused by an
undue inflation of land values, at a time when general
prices were steadily falling. But the crisis was pre-
cipitated by the fact that these banks held large
amounts of money, mainly British, on deposit
account. There was a rush on the part of the de-
positors to move their money, and the banks were
wrecked, a large part of the total loss of fifty-five
millions falling on this country.

Observe that these deposits, from the Australian



150 PAPERS ON CURRENT FINANCE

point of view, were foreign deposits. It is the
external liabilities that constitute the really serious
strain upon well-constituted banking systems like
our own. In 1826 Mr. Huskisson, comparing the
relative dangers of a foreign drain and an internal
panic, put the latter as by far the more serious.
Nobody, I think, would say so to-day. There is no
country in the world, I suppose, where banking busi-
ness is so thoroughly conservative, and takes so few
industrial risks, as in England. Our modern banks
are so well organised and so admirably managed
that I can hardly imagine any panic or run setting
in on the ground of distrust of a particular institu-
tion. It is, unfortunately, much easier to imagine
a general collapse of the market as a whole. Our
market works under very special and peculiar diffi-
culties. We are, of course, a free gold market not
the only free gold market, for I understand that
neither Amsterdam nor New York puts any obstacle
on the export of gold but still we are the most
important free gold market, and the one to which
resort is most generally made. There can hardly
be a monetary stringency in any part of the com-
mercial world which is not felt in London. This
market is also a kind of clearing-house for inter-
national payments. It follows that we hold large
deposits on foreign account as a basis for these
payments. These deposits have been steadily in-
creasing. I was astonished to find last year that



THE BANKING RESERVE 151

the Australian banks alone had in January twenty-
five millions sterling in this country. Germany,
again, has large deposits abroad, a great part of
which are in this market ; and it is curious that
one of the effects of the passing of their Exchange
Act of 1896, which considerably hampered dealings
on their exchanges, was that additional German
money was held in London, to facilitate dealings
on German account in our speculative markets. Per
contra, I believe that our deposits in foreign markets
are relatively small, and that we have little hold on
these markets, otherwise than by the general balance
of trade and the interest due on our foreign invest-
ments. Mr. Hansard has often insisted upon this.
He says that we hold few bills on foreign places,
and that the kind of securities our banks keep, though
very good, are usually not of the special class,
nor in the easily negotiable form, which foreign
markets prefer. There have been times, he says,
when it was easier to sell Turkish bonds than Consols
on foreign markets. The question for the London
banker is often not how good a security is intrin-
sically, but how easily it can be turned into cash,
or sold to check a foreign drain of gold. In 1907
the President of the Bank of the Netherlands, in his
annual address, pointed out that, in consequence of
the stringency in the United States in the autumn
of 1906, a considerable demand for gold had been
made on Amsterdam. " We met that demand,"
he said, " without the export of a single florin of
metal." They simply handed over bills on London,
thus transferring the pressure to this market. These
bills had been a good investment for the Dutch bank,
for rates were high. How many bills do we hold
that we could use in a similar way ?