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2. The Banks as Negotiators of Credit
The activity of the banks as negotiators of credit is characterized by the lending of other people's, that is, of borrowed, money. Banks borrow money in order to lend it; the difference between the rate of interest that is paid to them and the rate that they pay, less their working expenses, constitutes their profit on this kind of transaction. Banking is negotiation between granters of credit and grantees of credit. Only those who lend the money of others are bankers; those who merely lend their own capital are capitalists, but not bankers.1 Our use of this definition of the Classical School should not furnish any ground for terminological controversy. The expression banking may be extended or contracted as one likes, although there seems little reason for departing from a terminology that has been usual since Smith and Ricardo. But one thing is essential: that activity of the banks that consists in lending other people's money must be sharply distinguished from all other branches of their business and subjected to separate consideration.
For the activity of the banks as negotiators of credit the golden rule holds, that an organic connection must be created between the credit transactions and the debit transactions. The credit that the bank grants must correspond quantitatively and qualitatively to the credit that it takes up. More exactly expressed, "The date on which the bank's obligations fall due must not precede the date on which its corresponding claims can be realized."2 Only thus can the danger of insolvency be avoided. It is true that a risk remains. Imprudent granting of credit is bound to prove just as ruinous to a bank as to any other merchant. That follows from the legal structure of their business; there is no legal connection between their credit transactions and their debit transactions, and their obligation to pay back the money they have borrowed is not affected by the fate of their investments; the obligation continues even if the investments prove dead losses. But it is just the existence of this risk which makes it worthwhile for the bank to play the part of an intermediary between the granter of credit and the grantee of it. It is from the acceptance of this risk that the bank derives its profits and incurs its losses.
That is all that needs to be said here about this branch of the business of banking. For as far as money and monetary theory are concerned, even the function of the banks as negotiators of credit is of significance only so far as it is able to influence the issue of fiduciary media, which alone will be discussed in the rest of the present work.
- 1. See Bagehot, Lombard Street (London, 1906), p. 21.
- 2. Knies, Geld und Kredit, (Berlin, 1876), vol. 2, Part II, p. 242. See further, Weber, Depositen-und Spekulationsbanken (Leipzig, 1902), pp. 106 f.; Sayous, Les banques de depôt, les banques de crédit et les sociétés financières, 2d ed. (Paris, 1907), pp. 219 ff.; Jaffé, Das englische Bankwesen, 2d ed. (Leipzig, 1910), p. 203.