The usefulness of checks

Bank deposits may be obtained in several ways

With cash

1 The term "draft" is used broadly.

The question naturally suggests itself, why should a bank care to exchange for cash a right to demand an exactly equivalent sum? The answer to this question can be more satisfactorily discussed somewhat later. Here it will suffice to say that there is no profit to the bank in the mere receiving of cash deposits.

The deposit of checks and drafts is really an exchange of credit. The check when legally drawn on a given bank is a valid order on the bank to pay the sum specified to the person named on the face, or to his order. The payee simply by writing his name in the proper place across the back of the check may transfer it to someone else, and title may thus continue to pass from one to another by the process of indorsement. Thus a mere order to pay money which constitutes in the hands of the legal owner a right to demand the sum specified may serve the purpose of money itself. About the same may be said of the draft, whether drawn on a bank or on an individual. When, therefore, a check or draft is transferred by indorsement to a bank, and is then deposited in such bank, it is equivalent, if the instrument is good, to a cash deposit. The only difference is that the depositor can immediately draw his check against a deposit of cash, whereas, ordinarily, the bank will not honor a check drawn against other checks and drafts until they are collected. But in essence the transaction represents an exchange by the depositor of an embodied right to demand money from an individual or from a bank for an unembodied right to demand from his own bank an equivalent amount, less possible collection charges. Since actual money does not pass at all in the transaction, and since only "rights to demand" are involved, it is apparent that the transaction throughout is purely one of credit.

With checks and drafts

1 The story is told that some of the bankers in Germany kept a careful record of the actual coins deposited by their peasant clients and saw to it that exactly the same denominations were returned. This was done because the peasants nourished the fond delusion that the banker simply locked away in his strong safe the moneybags that they brought to him, and that the bags were subsequently returned to them intact. They would not have intrusted their money to bankers had they believed otherwise. It was obviously to the banker's interest to preserve this delusion.

Examining the process still more closely we can consider each case separately. Suppose that a depositor A in bank No. 1 draws his check in favor of B, who is also a depositor in bank No. 1. We already understand that A by drawing his check simply embodies the whole or a part of his right to demand money from bank No. 1 and transfers to B the proportion so embodied. In the great majority of cases, B does not exercise his newly acquired right to demand cash, but he takes A's check and "deposits" it. That means simply that he indorses it and surrenders his claim against the bank to the bank itself. The bank then cancels on its books to the amount of the check so deposited A's further right to demand, and at the same time it makes an equivalent credit entry in B 's favor, increasing thereby his right to demand exactly to the extent that A's was curtailed. That is to say, the transaction between A and B was settled, without the use of actual money, through two simple book entries.

Somewhat more complicated in method but analogous in principle is the case where A and B are not depositors in the same bank. B, let us assume, is a depositor in bank No. 2. A's check representing an embodiment of some proportion of his right to demand money from bank No. 1, is now deposited by B, in whose favor it is drawn, in bank No. 2. In this case B, by indorsing the cheek and by surrendering it to bank No. 2, transfers to his own bank the right to demand money from A's bank, namely bank No. 1. Bank No. 2 credits B's account with the sum so deposited, and then presents the check for payment to Bank No. 1, which pays the check and which then debits A's account, that is to say, curtails to the extent of the check his further right to demand. In paying the check, Bank No. 1 may employ cash, but in most cases, through the clearing house system, these payments are balanced against similar collections that are to be made, and differences alone are settled in terms of cash. The transaction here then involved simply a transfer by A to B of a right to demand from Bank No. 1 and a retransfer of this right by B to his own bank, which gives in exchange an equivalent right to demand from itself.

The process one of exchange of rights

Between depositors in the same bank

Between depositors in different banks

Still more complicated would be the process involved in the acceptance as a deposit subject to collection by a bank of a note, draft, etc., against third parties, who pay the claim by means of a check on some other bank. But it is not necessary to consider all the possibilities in detail. In principle they are alike even though in practice they may be both complex and elusive.

Lastly, we have to consider deposits growing out of dis-counts and loans. Here too we have virtually an exchange of credit.

Discounting in general involves the present evaluation of (and the possible provision for) some future contingency. When we are "making allowance" for a prospective situation in any field of human interest we are said to be discounting this situation. The future contingency that a banker evaluates is a right to collect money. The promissory note may be taken as an example. A promises to pay B a specified sum of money at some future time say three months - and embodies that promise in a written note. This promissory note is a "credit instrument" that at the time of execution has a definite and calculable value.