Bank reports alone would be insufficient to safeguard the interests of stockholders and creditors, for these statements are compiled by the banks themselves and are not verified by any outside agency. Moreover, mere figures fail to present a true insight into the condition of the reporting banks. To verify these statements and to investigate the actual status of the banks, several kinds of examinations are conducted. They may be external or internal, depending upon whether they are beyond or within the control of the bank. External examinations are public or quasi-public in nature, since they are made by the national and state governments and also by the clearing houses. Internal or private examinations are conducted by the directors or the stockholders of the bank.

The object of any form of examination is to determine the solvency and liquidity of the institution. In general, these factors are ascertained by an analysis of the bank's assets in relation to its liabilities. In examining assets, their actual existence must be proved and their true appraisal determined. An examiner must assure himself that the assets as stated in the general ledger are really in the possession of the bank and that it has complete legal title to them. He must also compare the book values of all assets with their true market worth on the day of the examination in order to discover any depreciation. An examination conducted by the government must also disclose whether the bank has observed the laws relating to capital requirements, reserve computations, and loan restrictions.

To attain these ends, the federal government maintains a staff of examiners under the direction of the Comptroller. The examination division was reformed after 1907, when the panic emphasized the need of more efficient supervision, and it was further reorganized after 1914, when the Federal Reserve Act revised the banking system of the country. The main office is located in Washington, and twelve branches corresponding to the Federal Reserve districts are also in operation. Each branch is supervised by a chief, who directs the work of the field examiners, and the operation of the entire service is unified by frequent conferences of the staff. Examiners are required to pass a sort of civil-service test to determine their knowledge of accounting, banking, and general business. The law forbids an examiner to derive any direct or even indirect compensation from banking institutions. He is no longer compensated by a fee from the bank which he is examining, but is now paid a fixed salary by the government.

The cost of an examination is carried by each bank in proportion to the amount of its resources on the day of the investigation. This plan is more equitable than to impose the same assessment on all banks, for such division would prove burdensome to the smaller institutions. The law requires at least two regular examinations every year, and in addition the Comptroller may order special investigations more frequently in the case of banks indicating an unsatisfactory condition. The duration of an examination may extend from several hours to several weeks, depending upon the size of the bank. A small bank can be examined within a day by a single official, while a large institution requires the services of several examiners and their assistants for a period of two or more weeks.

The primary object of the examiner is to verify the actual existence of the assets and liabilities as compared with the entries in the books of the bank: The examiner starts his investigation by counting the cash, for this item can be tampered with most readily in covering a defalcation. Money in the hands of the various tellers is verified first, and later the sums in the vaults, for they can be closed in the meantime with the examiners' seals to prevent any possible tampering with cash, securities, or other valuables. The counting of cash is not difficult, as the legal reserve funds are now maintained with the Federal Reserve bank, and the individual bank keeps relatively small sums in its own vaults. Even this money is not examined completely, for packages containing small denominations are checked merely in bulk, and only bills of large amounts are counted individually. Coin may be tested by weight in bags or, if necessary, by actual count.

Checks and other items which are to be forwarded for collection and payment may be verified by communicating with the banks on which these instruments are drawn. In the case of checks payable through the local clearing house, verification can be accomplished merely by inserting in the batch of checks on each bank a slip requesting that the total amount be verified to the examiner. In the same way the item "due from other banks" is reconciled by requesting from each of these correspondents a statement of the amount due to the bank on the day it is being examined.

Similarly the amount of loans and discounts may be ascertained by selecting a number of borrowers at random, sending them a statement of their obligations and asking for a confirmation of the amount.

It is highly important to know what persons are receiving loans from the bank. Are directors granting such accommodations to themselves? Are the officers securing credit from the bank? Is any one individual or corporation obtaining loans in excess of the limits prescribed by law? Large extensions of credit, although not excessive legally, are noted by the examiner on special sheets which indicate the direct liability of any borrower as the maker of notes, and show his contingent obligation as the indorser of some other person's paper. These liability records are filed in the office of the government examination department. At the next examination of the bank, similar data are secured, and if these relatively heavy lines of credit show no reduction, the facts are brought to the attention of the officers and directors, who are then called upon to remedy the situation.

The examiner also inspects the collateral which borrowers have pledged with the bank. This security should possess a satisfactory margin or excess value over the amount of each loan. Also the collateral should be readily marketable, so that the bank may recover the amount of its loans if the borrower should default in his payment. Advances based on real-estate mortgages especially are observed, as such collateral possesses only a limited market. An examiner also notes the maturity of the bank's paper and analyzes obligations which have been continually renewed or are long overdue. These he lists as slow, doubtful, or estimated losses.

In examining bonds and securities held by the bank as investments, their book value is compared with market quotations, and any discrepancy due to appreciation or depreciation is noted in the report. An appraisal is also made of fixed assets, such as the bank building, furniture, fixtures, and real estate.

The underlying problem in examining assets is to discover any tendency toward overvaluation. In scrutinizing liabilities of a bank the examiner must be watchful for any inclination to understate the extent of these obligations. A bank, as any other corporation, is exposed to the possible evil of an overissue of stock. An attempt to sell more shares than are authorized by the charter can easily be discovered by comparing the amount issued, canceled, and still outstanding, as entered in the stock-certificate book of the bank or in the records of the registrar of the stock.

Any misstatement of the liabilities due depositors can be ascertained by communicating with them directly. The amount due to banks as depositors is verified by the same method used in checking the amount due from other banks - i.e., by asking for a statement of these balances. This means cannot be applied very well to the accounts of individual depositors, who might receive the impression that the solvency of the bank was being questioned. So instead, the examiner may test the accounts as entered in the individual ledger by comparing them with any pass books which depositors have left with the bank for balancing.

Having checked all assets and liabilities, the examiner enters these accounts in his report of condition. Later this report is compared with the statement submitted by the bank itself, and if discrepancies arise they must be adjusted. The bank may be required to charge off losses on its loans or depreciation in its investments. These deductions may be large enough to impair the bank's capital, and in this event the stockholders may be called upon to make good the impairment.

After an examination of a bank has been completed, the results should be communicated to the directors to give them an opportunity of correcting any irregularities discovered in the operation of the institution. For this reason the Comptroller of the Currency furnishes the board of directors with a copy of the report filed by the examiners. In some states these findings are brought to the attention of the directors immediately by giving the examiner power to call a meeting of the board.

Officials of the state governments conduct examinations of banks in about the same manner as the federal examiners. The accuracy and thoroughness of these investigations have varied according to the economic development of the state. A dual system of bank examinations by both national and state governments existed when the Federal Reserve Act was passed. This statute provides for a third form of banking examination, as the Federal Reserve banks can examine any of their members and submit a report of their findings to the board. Under such conditions, state banks joining the Federal Reserve system faced the possibility of undergoing two sets of government examinations, and thus many were at first deterred from accepting membership. This disability has to a large extent been removed, for the Federal Reserve Board may accept the reports of the state banking departments in lieu of its own examinations. This policy has been followed in states which conduct efficient examinations, while in a few Federal Reserve districts it has been found necessary to conduct independent investigations of the member banks incorporated under the laws of some states. Assuming that the examination of the bank has disclosed irregular practices, the national Comptroller or the State Superintendent has certain means in their power of remedying the situation. Warnings can be issued to the delinquent bank, but its doors can be closed only when it commits certain acts which are legally regarded as indicating a state of insolvency.