2: Commercial Banking
Returning to the author's earlier definition: a commercial bank is primarily concerned with the storage and movement of money: safekeeping the money of depositors, processing transfers to those its depositors wish to pay, and coordinating lending of deposited funds.
Commercial Paper
At the author's time, there were many small businesses in need of funds to finance their operations, which would be repaid when the operations yielded revenue. In an agrarian society, the farmer serves as an example: he must borrow money to purchase supplies and pay labor to plant his crop and tend his field, and he can repay what he borrowed when his crop is harvested and sold. The same may be said of any business (the tailor borrows to buy cloth and repays when he has sold clothes).
Commercial paper are the promissory notes written by such producers. They sign a contract guaranteeing repayment when they take a loan - and this contract represents the entitlement to collect this payment. The banker may hold this certificate and collect the payment himself, or he may sell the certificate (and the right to collect payment) to someone else. Commercial paper is often traded as if it were money among banks and large organizations.
Bills of exchange are also used in the same manner, as they also represent the right to collect money from a party that has received goods or services. There's a bit of fussy detail about how a bill is created and guaranteed, but since it is the functional equivalent of a promissory note, it seems incidental.
Discounting Values
In general, a sum of money to be received in the future is seen as less valuable than a sum of money that is presented right away - so any instrument that represents a right to collect a sum in the future is sold at less than the amount to be collected to compensate the buyer for the inconvenience of waiting. The difference between the amount paid and collected is the discount. The further in future the payment is due, the deeper the discount.
The party who discounts a bill is willing to accept less money in order to have a payment right away, even though the contract is not due for some time. They buyer of a discount is not in a rush to have money and is willing to bide his time if he is paid for the inconvenience of not having it.
The term interest is often used, and the difference is technical. Interest is an amount paid on top of the principal amount that is loaned, so when the bill is redeemed the holder receives more than the face amount; whereas a discounted bill is redeemed at its face value, but the buyer of the note paid less.
Checking Accounts
A check is a note from the owner of an account, compelling the bank to give a sum of money from that account to the bearer. Most often, a check is made out to a specific individual and only that person may withdraw the money, but a check may be made out to enable any bearer to cash it.
Originally, the recipient of a check was required to travel to the issuing bank to redeem it, but as the number of banks increased it became inconvenient to do so (if a merchant had checks from multiple banks) - so most banks began the service of redeeming the check for their clients. The merchant would deposit a bundle of checks to bank A, and the bank would present these checks to bank B, C, and D for payment.
In many instances, the transfer of actual money is minimized by exchanging checks: two banks that have checks in equal amounts drawn from one another's accounts need not push the coin back and forth across a table, but merely exchange the checks. Clearing Houses were established to manage the complex web of checks from one bank to another to minimize the transport of currency.
To facilitate exchange, a bank guarantees the validity of its depositors' checks - such that if a check exceeds the balance of the account the bank pays it and collects the difference from its own client. (EN: This practice has changed since the time the book was written - banks refuse to honor checks and return them to the recipient, who must collect from the person who presented the check, unless the accountholder has backed his account with a line of credit.)
There's some note about the timing of checks and the way that banks and clearinghouses provide a grace period to account for instances in which a check that has been deposited fails to clear before a check that must be paid. (EN: This was a more significant issue before electronic processing, when the speed of communication was much slower.
Bank Notes
A bank note authorizes the bearer to receive a sum of money from the bank's own reserves, whether immediately or on a specific date in the future. Functionally, it is the same as a check written by the bank that can be cashed y any bearer. Banks generally produce notes in bulk in fixed denominations rather than on demand and at variable denominations. These notes are circulated and function as money. (EN: At the time this book was written, the federal reserve had not yet been established, so most paper money was in the form of notes issued by banks that represented an amount of coin or specie.)
Bank notes are generally used in the community of the bank itself and tend not to travel to remote markets. They also tend to be issued in small denominations for use in day-to-day transactions by individual consumers. For larger amounts and greater distances, checks are preferred for both convenience and security: a single check replaces a bundle of notes or a large number of coins, and its restriction to a specific recipient protects it from theft and redemption by unauthorized persons.
Collections
To cash a check or note, the recipient must present it to the bank from which it was issued, which is a considerable inconvenience for merchants and tradesmen who may have received checks from customers who use several different banks. To address this issue, most banks provide collection services to their depositors. The depositor can present a check from another bank and their bank will collect the funds on their behalf and credit them to the customer's account.
The fastest and easiest way to do this is by courier: a bank will send a person to another bank where he will redeem a check and bring the cash back to the bank. This is expensive (the couriers must be paid) and insecure (a courier may be robbed).
To make the process more convenient, banks in a local community would arrange a daily meeting where they would redeem checks with one another - and it was quickly discovered that there was a lot of mutual exchange (Bank A would receive cash for checks from Bank B, then hand back the cash when B presented checks drawn on A). It was simpler, and required less physical money, to simply exchange checks.
This practice became institutionalized through clearing houses, a joint venture of several banks to exchange checks and notes among themselves, back and forth and in complex webs of exchanges. Checks from out-of-town banks could be transported to regional clearing houses for processing, and regions could send checks to the national clearing house.
All of this allows banks to do a great deal of their business on paper, rather than transporting cash.
Domestic Exchange
The payment accounts of bank customers are subject to an ongoing flurry of transactions, with money coming and going. The ledgers of the bank are an important record of exchanges between individuals - proof that money was paid with specific details of payer, recipient, amount, and date.
With the growth of banking, it is also common for money to be in transit between one bank and another on a constant basis. Even with clearinghouses, it often happens that the balance of credits and debits requires the movement of money from one bank to another - or more often from one community to another when the citizens of one town import more goods from another town than they export to it.
The cost of all this business is not always paid by the bank from its own profits, but is sometimes passed along to its customers, either as a direct charge or as a discount upon the redemption of checks from other banks. It is generally cheaper for an individual to pay his bank's rate of exchange than to hire a courier to move paper and cash back and forth to banks in remote locations.
In towns where there is a lot of domestic trade, the exchange rate becomes a means of competition among banks, as merchants who routinely trade with parties in other towns may find the exchange fees to be a significant business expense, and a small difference improves their profitability.
(EN: More is said on this topic, but domestic exchange fees are a thing of the past. With electronic communications and central banking, the cost is minimal and is taken by the bank as a business expense so that checks are redeemed at face value and no additional fees to the depositor regardless of their point of origin.)
Foreign Exchange
The business relations between banks in different nations do not differ greatly from the relations between domestic banks. The distance of travel makes transactions slower, and the fluctuation in currency values adds another dimension of risk, but that aside there is little difference to the customer or to the bank in depositing a check from the next town or the far side of the globe.
During the author's time, all currencies represented a weight of metal and most countries were on the gold standard, so exchanging dollars for any currency was simply a matter of calculating the value of each currency in grains of gold to find the exchange rate between them.
While exchange rates fluctuate, the telegraph enables arrangements to be made in seconds to minimize the fluctuation in values that might occur over time. Additionally, banks maintain reserves of foreign currency and have accounts at overseas banks to facilitate exchanges.
There's also a brief mention of purchasing futures and options in foreign currency to mitigate the risk of dramatic fluctuation.