GENERAL ARTICLES

Central Banking

HAROLD E. CROWLE July 1 1933
GENERAL ARTICLES

Central Banking

HAROLD E. CROWLE July 1 1933

Central Banking

HAROLD E. CROWLE

A MONETARY COMMISSION will in the near future investigate the desirability of a central bank for Canada. In view of the growing agitation for such an institution, the appointment of such a commission could not very well have been long delayed.

But our surviving banks are, and have been, in an apparently very strong position, and our banking system is everywhere lauded as one of great excellence and much superior to that of our southern neighbor. Our bank presidents have told us for several years, and still tell us with no uncertain voice, that we do not need a central bank. But the strength of the agitation indicates that somewhere there must be some radical defect in our system.

Does not the root of the trouble lie in this, that our entire banking resources and credit are split up among and under the absolute and individual control of ten privately owned banks, each necessarily pursuing its own essentially selfish objects on behalf of its shareholders; which objects are, on the one hand, to earn the maximum of profits and, on the other, to maintain the bank at all times in an impregnably strong financial position, no matter at what cost to business in general and no matter what else goes to the wall?

To cure this defect in our banking system we require a central bank controlling the whole of the national banking resources and credit now divided among the other banks, the prime objective of which institution would be the public and national good. In other words, a bank devoted to the service of the Canadian nation and people rather than to that of bank shareholders.

As a result of the exclusive private ownership of our national credit, we can hardly expect to escape some of the evils from which we have suffered. Some of these are the excessively high Cost of banking accommodation, a legal bank rate of seven per cent treated as a dead letter and interest at eight and nine per cent compounded several times a year, excessive and unreasonable demands for security on loans, despotic dictation to borrowers as to how they shall conduct their affairs, neglect of smaller interests and preferment of wealthier borrowers, excessive and unwise credit in boom times followed in times of depression by an unwarranted calling in of loans—in general, carrying on with a view to selfish interests rather than for the public and national good. Of course, it must be acknowledged that the banks do and have done just what any privately owned institution must do if it is to survive and prosper in a competitive system.

Usefulness of a Central Bank

IN CREATING and organizing a central bank, the I American Federal Reserve System might well be followed in several features. To make the scheme feasible and give the existing banks a stake in the new institution, they should be compelled to subscribe to a part of the stock of the central bank, but only to a part. To make the new bank representative of the nation, the rest of the stock should be subscribed in part by other institutions, in part by the public, and in part by the Dominion Government.

Representative control could be obtained by placing the whole scheme under a Government-appointed board something like the present Treasury Board; and the management of the central bank under a board of directors appointed in part by the Dominion Government, in part by the banks, in part from leaders in agriculture, commerce, and industry in the Dominion.

The profit motive could be taken away from the management. as it is in the Federal Reserve System, by providing that all profits earned on the stock of the bank over, say, five or six per cent shall belong to the Dominion Government. This would also have the effect of taking away all incentive to any moneyed group gaining control of the central bank.

A central bank in Canada could perform the following functions:

1. Act as a bank of deposit for Government funds and for the cash reserves of all other banks, thus creating a single reserve as in England.

2. By means of the resources which it will thus control,

provide money and credit not only to the other banks by way of rediscounting, but also if necessary to the public direct, SÍ) as to provide for all legitimate demands on acceptable terms.

3. Provide a banking institution of a public character to which resort may be made by a borrower who has any just cause of complaint regarding his treatment by another bank.

4. Have general supervision and some measure of control over credit provided by all the other banks.

5. Regulate in good and bad times the volume of money and credit, and thus

have some control over the internal price level.

6. Act as a Government bank for the deposit of Government funds and the issuing of

loans and for general Government financing.

7. Provide a new l'entrai bank currency, but not necessarily be given a monopoly of the issue of bank-note currency.

8. Generally to control and regulate the national banking resources and credit for the good ol the whole people.

Central banks create money and credit like other banks by the use of the resources they control. The chief resources of a central bank are its subscribed capital, its Government deposits and the cash reserves deposited with it by other banks. It was found necessary when the Federal Reserve System was being established to compel by law member banks to deposit their legal cash reserves with their Federal Reserve Bank. We have no such thing in Canada as a legal cash reserve; which means that our banks are not compelled by law to keep on hand any particular amount of cash as a reserve against their notes and the total amount of money they hold on deposit; but. without any such law, they do hold on hand a very tidy reserve of actual cash, being gold and Dominion notes to the amount of about two hundred million dollars. They also have about three hundred million dollars out on call loans in Canada and elsewhere, and they look upon this money also as part of their cash reserves.

It is apparent that out of these two classes of reserves alone there would be available a very large amount of money for dej)osit with the central bank. But we can pretty well take it for granted that they will not leave their casi» reserves with the central bank unless compelled by law to do so.

Control of Money and Credit

ONE OF THE chief arguments used by the heads of our banks against the establishment of a central bank is that, as one of the chief uses of a central bank is to act as a bank of rediscount of securities for the other banks, we have no need for it because we already have all such facilities fully provided in Canada under the Finance Act.

Let us grant the point at once and agree that if our central bank is to be chiefly a banker’s bank of rediscount and it is to be left to the other banks to make what use of it they see fit, wre certainly have no need of it at all. as it is almost a certainty the banks would make little use of it. Since 1914, when the Finance Act came into force as a war measure, the banks have been enabled to take their securities to tht

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Treasury Board at Ottawa and, after pledging them, receive their approved value in Dominion notes. If we had a central bank they would take them to that bank and receive either Dominion or central bank notes. Some of the banks have made no use of these facilities at all, and it was only during war years and in boom periods that any extensive use of the Finance Act was made by any of the banks. The American Banks made so little use of rediscounting at their Federal Reserve Banks for the first few years after that system was established that it became doubtful whether the Federal Reserve banks would ever pay a reasonable return on the amount of their capital investment.

The Canadian banks also claim that the Federal Reserve System did not save the American people from a panic, while on the other hand there has been no panic in Canada. We can also grant this point. Our banks seem strong enough and their reserves ample enough. There is not much fear of a banking disaster in Canada, and we are certainly not clamoring for a central bank on that account.

The point which our bankers seem to miss is that what the Canadian people want in a central bank is not to supply the other banks with rediscount facilities which they already have or to save us from future panics, but they do want an institution that will effectually control the whole of the money and credit of the nation, now under the control of the other banks, and which will

somehow be able to make that money and credit available in sufficient volume wherever and whenever legitimately needed, and on terms much more fair and equitable than at present.

The difficulty which will confront a central bank in Canada is this: that, whereas in England and other European countries having central banks there is excellent co-operation between the central banks and the other banks to provide ample money and credit, such co-operation can hardly be expected to develop at once in Canada between a central bank and the other Canadian banks. A merchant in England takes his bill of exchange to his bank and there discounts it and receives the money. That bank takes the same bill of exchange to the Bank of England and rediscounts it and receives Bank of England money. Thus new money is brought into existence and then retired as required, the only actual limit to such expansion being that to which the Bank of England will go in rediscounting customers’ paper brought to it by the other banks.

We can hardly expect that the creation of a central bank in Canada would produce immediately as excellent a money manufacturing system as they have in England, which has been the outgrowth of over a century. What the central bank in Canada will have to do if it is to accomplish what we say is required of it, is to attempt in some way to provide money and credit without expecting much friendly assistance from the

other banks, for a very considerable time at all events. How may this be done?

Prices Could be Stabilized

THE BANKS would have a just cause for complaint if we allow the central bank to compete with them, as they will no doubt be compelled to contribute to its capital and also to deposit with it their cash reserves, and we would thereby be compelling them to create a powerful competitor.

Let the central bank be an institution to which resort may be made by any borrower who has been refused credit or who alleges unjust or unfair treatment by his bank. We will give such borrower the name of Smith. Smith goes to the nearest branch of the central bank with his complaint. The central bank examines his position and requirements, and reports back to Smith’s bank that it considers him entitled to certain credit on terms that he can meet. In such case it would seem hardly likely that Smith’s bank would then refuse the credit on the terms approved by the central bank, as the latter’s approval would enable the former to take Smith’s paper to the central bank and rediscount it there. If things worked out this way in the main, we would soon have a very up-to-date and effective moneyand credit-creating banking system, and the public would be able to get its just and legitimate needs supplied.

But it may happen that Smith’s bank will not even then grant the credit to Smith, or will not do so on the terms approved by the central bank. There seems no reason why in such case the central bank should not itself provide credit direct to Smith. Briefly, this means that the central bank should be able to provide direct to the borrower all demands for credit which it approves in cases where such credit is refused by any of the other banks or will be granted only on unacceptable terms.

To enable the central bank to carry out such a programme, it would have to be given a large measure of control of the whole of the national banking resources and credit now administered by the banks. The central bank should have supervision and control of all credit which the banks themselves provide. Just how this could be made effective or workable is a question not easy of solution. For one thing, it should be possible to require the approval of the central bank to all the larger loans of the other banks. To supply the central bank with the necessary resources with which to provide credit, additional reserves of the other banks could be required to be deposited with the central bank.

Any such measures would result in placing enormous powers of control in the central bank system, and would, of course, be regarded by the other banks as a fearful encroachment upon the rights and privileges they now enjoy. But if they wish to avoid coercive measures they should pay special heed to the direction in which the wind is blowing. They should cease active opposition to the creation of a central bank for one thing, and, when it has been established, give it their fullest assistance in providing the Canadian people with their reasonable and just requirements.

The central bank should also be able to regulate the volume of credit and thus keep the price level from fluctuating too greatly. When times are prosperous and money is easy, it could employ means similar to those used by other central banks to prevent unwise and excessive extensions of credit —by raising the rate of discount and by other effective means. In times of depression it could perform a notable service by continuing to provide money when it is most needed instead of calling it all in and

shutting up like a clam, as the other banks generally do. In times of panic, for example, the Bank of England has many times been known to take its very life in its hands and continue to advance money under desperate conditions—with the result that the country’ as well as itself was saved from disaster.

Excess Profits Revert to Government

“THE SUBJECT of governmental financ-

I ing by means of a central bank, to which reference has been made, is outside the scope of this article because this is concerned with central bank dealings with other banks and with the public. In passing, it might be observed that the central bank—being under a board appointed by the Government and itself, in turn, controlling the national banking credit—will become a ready and efficient vehicle for carrying out national policies involving the expenditure of public moneys. At present the Government is not master in its own house so far as financing is concerned but must go hat in hand to the banks and obtain their gracious permission, on their own terms, before it can use that national credit which does not belong to the banks but to the people.

It would also seem that, instead of having to pay the banks for the use of that national credit, the Government will be able to finance through the central bank at little or no cost, if the provision above referred to is adopted providing that all central bank profits over, say, six per cent are paid back to the Government.

There seems to be a very considerable demand that the central bank issue all the bank-note currency, and thus be given a monopoly of bank-note issue like that of the Bank of England or the Bank of FYance.

This seems to be hardly necessary, as we now have a safe, elastic and everywhere acceptable bank-note currency, capable of being expanded under the Bank Act and the Finance Act to cover all our own needs. A central bank would, of course, issue its own bank notes and would take the place of the Finance Act. but our real need is not some new machine to issue more paper currency. What we want a central bank to do for us is to render new credit available in adequate volume. It makes no real difference whether that credit is given to us in the form of bank notes or in the form of a credit in a bank book against which we may issue cheques. In either case we put new money into circulation, and that is what will set the wheels of commerce moving.

It makes little difference whether the central bank issues all the currency or the other banks are also allowed to issue bank notes. This is proved by what has happened in England and Scotland since the Bank of England was given the monopoly of banknote issue in England but not in Scotland. In England it resulted in the other banks providing credit in the form of deposits in bank books, against which customers issued their cheques, and bank notes went largely out of use. In Scotland, on the contrary, the other banks continued to issue bank notes, and bank-note currency continued in active use. Who can say that the prosperity of either England or Scotland was affected by these opposite developments? The truth of the matter probably is that both countries prospered or failed to prosper through causes quite other than having or not having in circulation ample bank-note currency.

What we want in a central bank is not something to provide us with currency inflation in the nature of a liquid stimulant, but something to provide us with a sound credit inflation more like a diet of healthgiving, body-building food.

While it is obvious that a central bank will naturally face the same problems the other banks face and cannot perform impossibilities. nevertheless, with the credit of the nation more or less under its control and with a fully national outlook, it should in time become the source and regulator of national prosperity.

Editor's Note— In a subsequent issue, Maclean's will publish an article outlining the attitude of the banking community toward the proposal for the establishment of a cent ral bank.