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The Conduct Of Checking Accounts








A checking account is an ordinary book account on which are credited
the cash deposited by a customer and the proceeds of collections,
loans, and discounts made on his behalf, and on which are debited
payments made to him in cash or on his behalf to other people or to
the bank itself. These payments are made on orders signed by the
customer and known as checks.

The ordinary customer of a commercial bank every day brings to the
bank the cash he receives as the result of the day's business, and the
checks received, drawn on his own and other banks, and is credited
with the amount on the books of the bank as well as on a passbook
which he himself retains. If he needs cash during the day, he presents
to the bank a check payable to himself for the amount needed, and
receives the kinds and denominations wanted; and if he wants to make
payments to his creditors in other forms than cash, he sends them
checks on his bank payable to their order, or a check drawn by his
bank on some bank in another place, usually called a draft, which he
has obtained by exchanging for it a check drawn to the order of his
bank. To the amount of these payments his account at the bank is
debited, and from time to time his passbook is left at the bank for
the entry therein of the debits made to date and its subsequent return
to him.

The customer must take care that his account is not overdrawn, that
is, that the debits on his account do not exceed the credits, since
overdrafts, except by accident or for very short periods and small
amounts, are not allowed in this country, and in other countries,
where they are allowed, they must be provided for in advance by a
special agreement between the bank and the customer, which usually
involves the deposit with the bank of ample security. In order to
avoid overdrafts, the customer in this country agrees with his banker
on what is known as a "line," that is, a maximum amount of loans or
discounts to be allowed. Whenever his credit balance falls to a
certain minimum, also established by agreement with the bank, the
latter discounts for him the paper of his customers, that is, bills of
exchange drawn on them or their promissory notes in his favor, or his
own promissory notes. The proceeds of these discounts are credited on
his account like deposits of cash or of checks for collection.

So long as the discounts are confined to commercial paper the bank's
part in these transactions consists almost exclusively of bookkeeping
between its customers and between itself and other banks. Ordinarily,
what is debited on one man's account is credited on another's, the
cash received nearly balancing that paid out. To the extent that the
cash receipts and payments do not balance, the bank either has a
surplus or is obliged to provide for the meeting of a deficit. The
means available for this latter purpose will be explained in
subsequent sections, as well as some of the details of this
bookkeeping process. For the present it is important to note precisely
how the discount of commercial paper is related to this bookkeeping
process.

As explained in Section 1, commercial paper is an essential part of
the process of exchanging goods through credit. A person buys on time
and sells on time and expects to pay for his purchases by the
proceeds of his sales. So long, therefore, as the processes of
commerce and industry proceed in a normal fashion, the paper
discounted by a bank will be paid at maturity and the credit balance
created by means of such discounts offset by corresponding debits.
Ordinarily the credits created through discounts during a given
period, say a day or a week, in favor of one set of customers will be
balanced during this same period by the payment of notes previously
discounted for other customers. Within a complete trading area this is
certain to happen, since purchases and sales of goods are equal and
what is credited to one man is debited to another.

The result is very different if a bank discounts investment paper,
that is, credit documents which represent the unproductive consumption
of individuals or of public and private corporations, or which
represent the purchase on time of the instruments of production rather
than the production of goods through the use of such instruments and
their transfer from the producer to the consumer. The means of payment
of such documents can only be created gradually by the application of
the profits of the enterprises in which the investments were made, or
by taxes spread over a series of years, or by a slow process of
saving. If a bank issues its own demand obligations in exchange for
such documents, it cannot make its books balance and it will be
constantly exposed to the danger of forced liquidation. If it attempts
to protect itself by requiring that the discounted paper shall mature
in a short period, the necessity of liquidation will be forced upon
customers who are responsible for the payment of the discounted paper;
that is, such customers will be obliged to sell at such prices as they
can command the property in which the investments were made, or some
other property. Such liquidation always results in forced
readjustments of prices and business depression, and sometimes in
commercial crises.





Next: The Issue Of Notes

Previous: The Operation Of Discount



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