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 e ery 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.