THE PRACTICE OF PAYING INTEREST ON DEPOSITS— SHOULD IT BE ENCOUR¬ AGED? s o o DELIVERED BEFORE THE KENTUCKY BANKERS ASSOCIA TION, A T LOUISVILLE, OCT. 22, 1891. SY E. C. BOHNE. PRESS OF JOHN P. MORTON AND CO LOUISVILLE, KY. nM r-; ^;s r-s ®yijj,'’ f'j I . - J ' ^ -LiLvi ' ^ \ T. *r ' TV^ Vi, t-x j iv:.'4' ADDRESS. Mr. President and Gentleynen of the Convention : The Committee of Arrangements has selected me to address you on the subject of “ The Practice of Paying Interest on Deposits, Should it be Encouraged? ” As an abstract question, I would answer unhesitatingly. No! If a simple edict of mine would abolish the practice, it would be unceremoniously, im¬ mediately, and forever done away with. Considering generally accepted custom, and sharp competition between different cities and among banks themselves, I am inclined to answer that the practice of paying interest on deposits should be exercised less liberally and more judiciously. The term “ deposit ” means money, or its equivalent, left in a bank for safe keeping, and subject to immediate with¬ drawal in whole or in part. The safety against theft and the elements offered by the banks for the keeping of such funds, the convenience of withdrawing them at any time and in such sums as suits the depositor, the record of the transactions, the legal safeguard as to evidence readily to be established with regard to their nature between parties at issue, and the neces¬ sity of keeping accurate book accounts of the same were, until quite recently, considered‘a fair and sufficient equivalent for the profit which a bank might earn by the temporary bal¬ ances in its hands. The desire to increase traffic by offering extraordinary inducements, more or less wise and business¬ like, caused some banks to offer interest on call deposits respectively on the balances in their hands. At first the rate of interest so allowed was low, while the rate of (interest received by the bank was high, leaving a handsome margin for profit on such tran.sactions. 2 ADDRESS. Gradually competition, thoughtlessness, and recklessness in management increased the rate paid for deposits, at the same time decreasing the rate obtained on loans, making the margin for profit more and more problematical, and in some cases actually working with loss. From the standpoint of an individual it may be nobody’s affair whether or not a business transaction is profitable; but if a bank manager loses sight of the fact that in handling his bank’s capital he is handling other people’s investments, he does not only fail in his duty to his stockholders by working without adequate profit, but he also demoralizes the business for other more conservative bank officers by working for nothing, and such practice should be frowned down. In order to demonstrate to you the correct¬ ness of my remarks as to the unprofitable nature of the inter¬ est-paying business, I will have to annoy 3^ou with a few cold figures, which will no doubt astonish those who have paid but little attention to the subject at issue. We will take for example an account averaging $ 20,000 dail}^ balances at 3 per cent interest, credited monthl3\ The interest charge per annum will be $616.70. The daily trans¬ actions of that account amount to, say $8,000. The cost (ex¬ penses and taxes) of transactions per $1,000 are about 5^ cents per da3^ Hence the cost for $8,000 transactions is 44 cents per day, or per annum $160.60, making total charges paid for that deposit $777-30. Of the $20,000 balance there is available for loans what is left after deducting the reserve held by the bank. The average reserve of all National Banks in the United States on July 9, 1891, was, in strictly reserve items, 22.63, actually, counting all immediately available items, 29.41. In the reserve cities the available items reached 35 per cent. ■ My own experience during the last five 3'ears shows a reserve of 29.14 actual reserve item, and 41.51 per cent of available items. Taking as norm the average of above ex¬ treme figures, it is safe to say that 32.67 per cent are at all times held by banks in reserve cities in such assets as are ADDRESS. 3 available for the immediate discharge of liabilities on deposit account. At this rate $6,414 of the $20,000 are held by the bank as reserve, and only $13,586 are available for loans. The average earning rate for discounts, according to my ex¬ perience of the last five years, was equal to 7.106 per cent, which is equal to a possible earning on the loanable surplus of $13,586 of $965.42, against $777.30 cost, leaving a profit of $188.12 on the $20,000 average deposit, equal to .94 per cent, and counting nothing at all for risk by theft, robbery or losses, nor for cost of exchange or interest, nor loss of time on foreign items sent by the depositor and taken for immediate credit. This small margin of profit increases and decreases with the percentage of reserve held by the interest-paying bank. The most reck¬ lessly conducted bank makes the most money out of such transactions, while the most conservative often actually loses money, if it attempts to do such business. Hence the practice of paying interest on deposits results in a premium on reck¬ less and a detriment to conservative banking, and .should not only not be encouraged, but, if possible, entirely abolished. The possibility of .so doing is, however, very remote, unless competition between the different interest-paying banks is re¬ moved, and concerted action with this regard is brought about. As it is, it would be detrimental for any one city to abolish paying interest as long as another neighboring city offers to do so, because interest-seeking depositors would leave the one and go to the other. But a correct understanding of the subject, and consequent thought upon it will certainly, at a future day, open the eyes of intelligent bank officers all over the country, and will lead to a considerable reduction, if not to entire abolition of the pernicious practice. So far for interest on call balances. We will now consider interest paid on time deposits. And right here at the outset I would state that, in my opinion, the word “ deposit” in connec¬ tion with these kind of transactions is a misnomer. A deposit left with a party for any specified length of time, with interest 4 ADDRESS. if left for that length of time, is a loan rather than a deposit. A bank receiving such time deposits, and claiming the right to pay them back at the time of maturity only, should consider such certificate or evidences of indebtedness issued by it as “bills payable” and not as deposits, and should enter them upon its books accordingly, and publish them as such in its statements. The practice of increasing deposits in that way is, strictly speaking, not sound banking, and under all circum¬ stances the statement of liabilities of the bank should show plainly the issue of “ bills payable,” and the bank should be ready to bear the odium connected with the fact of a more or * less great amount of that sort of indebtedness upon its pub¬ lished statement of condition. If the receiving bank chooses to put money received on time under the head of deposits, it should have the required reserve to meet same at all times if it proposes to pay them upon maturity only, it should put such funds under the head of bills payable, in which latter case it would not need to keep any money reserve whatever against such liability. If a reserve is maintained against amounts received on time deposits, the interest must be proportionately lower than if the liability is considered a bill payable and no reserve is maintained. The public is entitled to a clear under¬ standing of its rights and status in such matters, and I hope that the honorable Comptroller of the Currency and the State bank examiner, if such an ofiicer is created by law, will see that this point is definitely settled. Under the present custom the matter is much muddled, and conservative banks have to suffer under the odium caused by unbusiness-like proceedings of competitors, who, if it suits them, pay the certificates issued to the public for time loans upon presentation, and refuse to pay them until maturity, if that is more convenient. There should be some uniform and clearly defined principle of the matter between lender and borrower, which would operate so as to avoid any misunderstanding, or any conflict of interest, in justice to both public and banks. ADDRESS. 5 The question of time deposits, their nature and effect, and the want of uniformity of understanding, has caused a great deal of harsh censure, indulged in by the public against the banks, and is for that reason alone greatly to be regretted. In the present day, when the state of public sentiment is so de¬ plorably prejudiced against banks and bankers, it behooves us, as repsesentatives of that honorable and essential branch of the public economy, to do every thing in our power to clear the situation, and to bring about a better understanding of the relations between banks and the public, and it is particularly our duty to avoid every thing by which that unfortunate hos¬ tility against the corporations we represent might be increased or seemingly justified. The public mind is biased against financial institutions by many untoward circumstances, para¬ mount among which is the widespread publicity which news¬ papers seem to delight in giving to the defalcations occurring in banking circles, which are generally greatly exaggerated. I speak from personal knowledge when I say that there is nothing more deplored by bank officers than the laxity and perv^ersion of the law which permits criminals in banking circles to escape just punishment. What, among fair-minded people, simply reflects upon the deficiencies of the criminal statute and the indolence of the law in this State is charged by the public at large to the banks, who, apparently above the law, are consequently duly hated and proposed to be downed by unreasoning people. Every honest banker feels how per¬ nicious to the interest of banks, and how hurtful to the repu¬ tation of bankers as a class, such cases of dishonesty are, and consequently feels particularly aggrieved at the want of retri¬ bution and the failure of the law to punish dishonest men, and by those means to stop knavery, or at least to adequately punish it. Considering the number of persons engaged in banking, considering that over ninety-five per cent of all financial transactions of the people are made through banks, and considering the temptations to and offered facilities for 6 ADDRESS. dishonest}^ I venture to say, without fear of successful contra¬ diction, that there is not another class of men whose integrity is so intact and whose honesty ranks as high as that of bank¬ ers. Because of the knowledge of that fact in the mind of our fraternity we should guard that reputation with the great¬ est jealousy, and we are particularly severe upon financial un¬ faithfulness and criminality. Hence we are, more than any other class of men, aggrieved when notorious wreckers and criminal abusers of confidence escape punishment upon tech¬ nicalities. Yet the people, who are primarily responsible for the faults in the law, instead of having such faults remedied, abuse the banks and cast unkind reflections upon thousands of honest men who are every day occupied in serving the public in important fiduciary functions. Another great cause of the unpopularity of banks is the necessity of adhering to strict business rules in performing their functions, caused by the exacting position of responsi- bilit}^ of a person taking care of other people’s money, which position necessitates that minuteness and apparent austerity in a bank’s dealings with the public, and which causes the people at large, unjustly and unreasonably, to consider banks unnecessarily obstinate, ceremonious, and constrained. It behooves us to counteract these adverse circumstances b}'' in¬ forming the public of the position and functions of a bank, of its general usefulness, and of its absolute necessity to the commercial, industrial, and agricultural interests of the pres¬ ent day, by dwelling upon the faithful and honest work which banks do in the interest of all members of the communit}^ in augmenting the functions of money and in increasing its powers for utility. We should show how banks represent the accumulated savings of the people and are run for the benefit of the people, and we should especially clearly demonstrate and impress upon the public mind the fact that the banks are the only successfully available safeguards of the people against the aggressions of large capital, and that they, by helping ADDRESS. 7 the mass of people with moderate means, act against the de¬ plorable tendency of the times, which seems to be in favor of a rapid accumulation of wealth in the hands of the few, and that the banks are hence the people’s best friends. You will kindly excuse this digression from my subject. I # was led to these reflections by an inexorable chain of thought, and, since they are down upon the paper, will let them go for what they are worth. Every thing tends to show that only in approved business methods, conservatively administered with regard to interest in deposits as well as to every thing else, lies the good of stockholders and public both, lies the safet}^ of the banks, and the successful refutation of the unjust adversity of public opinion. In conclusion, I would answer the question put to me by the Committee of Arrangements, after considering it in all its aspects, that the practice of paying interest on call balances is certainly unprofitable to a conservatively managed bank, and that it .should be the aim of all good banks in all parts of the country to abolish it, or at least to materially reduce the rate of interest paid. As to interest on funds left with banks on time, I have shown that they are not really deposits, but par¬ take of the nature of bills payable, and that, in my opinion, such funds should be treated as such a liability, principal being payable only at maturity, and interest at such rate as may be profitable to the borrowing bank, and that where such loans are payable on demand the same remarks as made with regard to interest paid on call loans hold good. V • v: • » T > S 3 ' 4 i ' i?' I \ y y V ^ » t 4 « , ^ ■' <1 ;. > t t ■/. I • . • 4 _:« 4 t-« K /•' \*rn ■f > . I ' f'’ ^ } / n f I