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Now if Bank No. 3 pays the clearing house $2,000, the clearing house will pay Bank No. 1 $1,000 and Bank No. 2 $1,000 and all the obligations of all the depositors of each bank to the depositors of the others will be settled. There is a chance, however, that some of these checks are bad. A drawer may not have sufficient funds, a drawer may have stopped payment, one of the checks may be forged. Each bank has till 1 o'clock to examine its checks and pay. By 1 o'clock Banks No. 1 and No. 2 must have paid, and Bank No. 3 will be paid. If a check is bad it necessitates a slight readjustment of the accounts unless it is sent by runner to the bank which presented it for settlement. Thus it is that Bank No. 1 collects for A, B, and C all the checks they hold against the accounts of M, N, O, X, Y, and Z on Bank Nos. 2 and 3. If the accounts of each of the banks are well balanced, one is likely to owe about what is due it. $100,000 may be sufficient to pay balances aggregating several millions.

In the illustration used above how do the banks settle with the clearing house? The banks which owe the clearing house could take gold, gold certificates, or legal tender notes to the manager who in turn would settle with the creditor banks. To save transporting gold or other money about the streets at great risk and expense, clearing house certificates were devised. The member banks deposited gold in the clearing house or in a bank and received as evidence of the deposits clearing house certificates which were used in settling balances, and circulated only between banks.1

These forms of payment have given way to other methods. Since the establishment of the Federal reserve

1 Cannon, Clearing Houses, pp. 36-42. (D. Appleton and Co., New York, 1900.)

Holdsworth, Money and Banking, p. 213. (D. Appleton and Co., New York, 1918.)

system (see ch. 20) and the adoption of the law requiring member banks to keep all of their reserves in the Federal reserve banks, checks drawn on a Federal reserve bank make a satisfactory form of settlement. If the clearing house is located in a city which has a Federal reserve bank or a branch, the clearing house arranges for the reserve bank to make the settlement of balances. The manager of the clearing house sends a certified copy of his settlement sheet to the reserve bank. The reserve bank then debits or credits the accounts of the banks and the settlement has been made, without risk or expense to the banks.2 A bank which is a clearing house member, but not a reserve bank member, must arrange with a member bank to have its balances charged or credited through the account of the member bank. In some cities the clearing house manager pays the creditor banks by drawing drafts on the debtor banks. The bank which receives one of these drafts presents it to the creditor bank and requests payment in the manner it may prefer, money, draft on Federal reserve bank, or exchange on some city, or cities. In some cities the clearing house manager has an account at a designated bank. He deposits the checks received as payment from debtor banks and issues his checks in payment to the creditor banks. In some cities the debtor banks often borrow the balances of the creditor banks. When this is done the borrowing bank gets from the creditor bank an order on the clearing house for the amount and uses it to pay the balance due to the clearing house.

In some towns banks instead of clearing at 10 o'clock clear later in the day in order that fewer items may be carried over night. Where that is done the bookkeepers would be idle in the morning. To avoid this practical difficulty bank runners at 9 A. M. exchange the checks on other banks held from the night before for receipts which

2 L. H. Langston, Practical Bank Operation, vol. 1, p. 92. 'Ronald Press Co., New York, 1921.)

OLD METHOD OF COLLECTING CHECKS 95

are cleared later in the day. When the runner gets back he has bundles of checks on the depositors of his bank which are immediately distributed to the bookkeepers.

73. Old method of collecting out-of-town checks. — The growing practice of business men to settle all accounts with their own checks simplifies matters for them but it shifts the trouble to the banks. Here is the way these checks were formerly collected. Take the example of checks received by a large house in Chicago. Its customers in all parts of the country wanted to pay bills by their local checks. If they did not add the Chicago Clearing House fee for collection, the Chicago house would lose that amount when it deposited these items for credit. To avoid these charges for itself and its customers, this house carried bank accounts in several sections of the country. When it received a local check from a town in West Virginia it remitted it with others to its Philadelphia bank. The Philadelphia bank took these checks at their face, but it had the same task that the Chicago bank had. How did the Philadelphia bank get its money? The Philadelphia bank received checks and drafts from many parts of the country. It arranged with other banks to collect such items for a per cent for collection, or each collected for the other without any charge, or one collected for the other free on condition that remittances were to be made not immediately but at intervals or subject to draft. Now in the case of the West Virginia check, the Philadelphia bank had an arrangement with a Baltimore bank for collections in Maryland, Virginia, and West Virginia. It might have happened that the local West Virginia bank had an account in this Baltimore bank, making it easy to collect by charging the West Virginia bank's account. If it did not carry an account for this bank, but did carry an account with a Charleston, West Virginia, bank it forwarded this to Charleston and the Charleston bank

probably had an account, or if it had not it did what any bank could have done, mailed it direct and asked in payment either cash, or more often, a draft on Charleston or New York. It would have been more direct and quicker for each bank to send its check drawn on Bank A to Bank A and ask payment, but it was too expensive. It was cheaper to send a dozen items to a bank near the one on which it was drawn and the chances were that the receiving bank would have several other items on the same bank and thus much postage, stenographic work, and time was saved. If the Chicago house had made its deposits in the Chicago banks as nearly all Chicago houses do and did, the Chicago bank would have pursued the same methods the Philadelphia bank did.

Another reason besides the expense may be given for not sending each check direct to the bank on which it is drawn. The courts in some states hold that it is negligence of duty for a bank to select the drawee bank as its agent for collecting a check. Therefore, if it is practicable, checks for collection are sent to a neighboring bank. In Ohio a statute declares that it is due diligence to send checks direct.

How did the West Virginia bank pay the Baltimore bank? (1) It could ship the money each time but it was too expensive, and another method had to be devised. (2) The West Virginia bank in order to pay such items could keep a balance with some Baltimore bank, so it could pay by a check upon it. (3) Instead of a check upon a Baltimore bank, it could send a check upon a New York bank, which the Baltimore bank was glad to get on account of its preventing a shipment of money to New York in order to maintain a balance there. If the West Virginia bank remitted a check on Baltimore or New York it in all probability charged an exchange fee of 1/10%.

The above method is known as the bank correspondent

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method of collection. Since the establishment of the Federal reserve system it has been declining in importance. 74. The charge for exchange. If a merchant in southern Georgia sent his check for $1002.50 to a shoe house in Boston and that house deposited it for immediate credit in a Boston bank, the bank would charge 1/4% or $2.50 for expense of collecting it and loss of interest. If the check were on a New England bank no charge would have been made. Now if this Boston bank sent the check to a New Orleans bank and the New Orleans bank forwarded it to the payer bank for collection, the Georgia bank would send its check on a New Orleans bank for $1002.50 less $1. It charged 1/10% for exchange. What were the elements of expense in handling this check?

The Boston bank had the expense of handling itoverhead, clerk hire, stationery, postage, but chiefly interest. It gave the depositor immediate credit for the money. It waited for its return. It received less than face value when it did receive a remittance. It had in some way to make it worth while for the New Orleans bank to act as its collecting agent.

Why should the local Georgia bank charge for paying the check of a depositor drawn upon it? If it had been presented at its counter it would have paid the face of the check, $1002.50. It charged because of the expense and trouble overhead, postage, stationery, drawing and mailing a draft on New Orleans, and maintaining a balance in the New Orleans bank, built up either from the transportation of money to New Orleans, or by some other method. There are plenty of banks, however, who receive many checks on other places which it must collect, whose balances in the city banks would be maintained naturally. To such a bank the issue of a draft like the above, instead of being an expense, is an advantageous way to reduce the balance.