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make in real estate and mortgage securities, and in other cases the limits prescribed for such investments do not depend in any respect upon the capital, surplus, and savings funds which they possess. Indeed, in country towns these banks are encouraged to loan their funds to farmers on mortgage security and for the purpose of assisting them, not in the transfer of their crops to consumers, or in the transformation of seed into crops, but for the purchase of their lands, the construction of their buildings, the equipment of their farms with drainage, irrigation works, cattle, machinery, etc. Thus they are tempted, and in some cases almost forced, to transform investment securities into checking accounts.

Our reserve system contributes to the same end. It compels our banks to keep locked up in their vaults in cash a certain percentage of their deposit liabilities. A larger percentage is usually kept on deposit with banks in reserve cities, and since they must be held subject to call, these funds flow to New York City, where they are invested on call loans on the New York Stock Exchange. The fact that under ordinary circumstances the loans of a broker when called can be transferred from one bank to another, and that the securities deposited as collateral can be readily sold upon the stock exchange, has created the impression that these loans are really liquid. As a matter of fact they are not liquid in any proper sense of the term. The sale of a bond or of a certificate of stock on the New York Stock Exchange is not liquidation. It is merely a transfer of obligations from one person to another, and if the pressure for realization upon call loans is great, these transfers cannot be made in the ordinary manner, and crisis ensues.

The third part of our reserves takes the form of high-class bonds listed upon the exchanges. Banks call these their secondary reserves and ordinarily feel quite safe when they have large quantities of them in their vaults. In this case also they are deceived by the fact that ordinarily, when everything is running smoothly, such bonds can be turned into cash, and they are accustomed to call these securities liquid on that account, but they are no more liquid than are the call loans based upon them, and pressure to realize on this portion of our reserves, if it be great, is forced liquidation, and in extreme cases also results in crises.

So far as the danger of confusing commercial and investment loans is concerned, in many respects the worst of our banking practices still remains for discussion. I refer to the basis on which lines of credit

for ordinary bank customers are established and administered. It is customary for a business man to arrange with his banker for such a line, and too often in determining how much it shall be the bank takes into consideration the man's total possessions rather than the volume of commerce which he transacts. The line once determined, the customer expects that the bank will carry him for that amount and usually resents too close inquiry into the way in which he employs borrowed funds. Though the banker usually insists that his customer's paper shall be drawn for short periods of time, both expect that this paper will be renewed at maturity. Indeed both the customer and the banker are apt to regard the amount fixed in the line of credit as a part of the former's permanent working capital. The practice of demanding carefully drawn statements of a customer's business is fortunately growing, but it is still very far from common. The correct interpretation of these statements when they are drawn is even less common.

On account of this practice a banker rarely knows to what extent the paper in his portfolios represents commercial and to what extent investment processes. Until the test of forced liquidation actually comes, he does not know how large a percentage of his resources are really liquid. Under these circumstances it is not surprising that the line between investment and commercial loans is frequently crossed.1

33. THE CREDIT DEPARTMENT OF A BANK

The credit department of a bank is a development of the past twenty-five years. Today practically all of our large city banks have such a department, though in the country as a rule the work is not yet differentiated. The functions of a credit department consist of a systematic and judicious collection of data respecting the financial responsibility, character, antecedents, and business qualifications and abilities of the bank's customers, the classification of the data on each customer in chronological order, and their systematic preservation for future reference and comparison. A well-arranged file will disclose at a glance the entire career and present business standing of any customer.

The principal sources of credit information are as follows: (1) signed property statement from the borrower; (2) reports from competitors of the borrower; (3) reports from the trade, that is, from his

'Compare chap. xi, sec. 1.-Editor.

mercantile creditors; (4) reports from banks with whom he has dealt; (5) reports from commercial agencies; (6) reports from other departments of the bank that may have come in contact with him; (7) general "gossip" of the community.

The most important of these sources of information is by all odds the financial statement. It is an itemized exhibit of the resources and liabilities of the customer, usually at date of last inventory. A careful analysis of a statement will show the amount of cash that could be realized from the business if it were suddenly liquidated and its assets thrown on the market. Some of the largest banks now supplement this statement by an investigation of the factory or store conducted by the borrower. Expert appraisers and engineers are sometimes employed for the purpose.

Dun's and Bradstreet's reports furnish a great amount of valuable historical data as well as collateral evidence bearing on the present status of the borrower. They collect information with reference to business houses and give them a "rating" in their reports. They aim to cover the entire field and include every individual business man, but with new enterprises and even new cities springing up daily it is impossible in practice for them to furnish recent information on all mercantile concerns. A serious handicap to reliable information lies in the fact that the agency reporters are not always treated with the greatest freedom and confidence. Moreover, the reporters are poorly paid, and hence many of them are poorly qualified for the work in hand. There is also, in many instances, an evident desire on the part of the firms concerned to strengthen their "rating" by deliberate deception. Nevertheless, the service performed by the agency reports is an invaluable aid.

The remaining information is obtained by correspondence and interviews, and it usually furnishes much collateral evidence on the financial and moral responsibility of the borrower.

It is not a function of the credit department of a bank, however, to analyze the information collected and pass judgment upon the loan. It merely supplies the information to the loan officers of the bank, who render the decision and assume all responsibility for the loan.

34. A FINANCIAL STATEMENT

The following is a form of financial statement recommended by the American Bankers' Association. The statement proper is

followed by a long list of questions as to the character of the individual items.

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35. COMMERCIAL PAPER HOUSES AND NOTE BROKERS The business of note brokerage arose in response to a very definite economic need. Banks in a given community frequently find that they cannot fully utilize their resources there, and wish in consequence to make loans in a wider market. Similarly, it frequently happens that borrowers in a given community are unable to procure adequate accommodations for the reason that the banks there have already made loans to their full capacity; in consequence borrowers often wish to procure funds in a wider market. The opportunity thus afforded in bringing together the banks and borrowers of different localities has given rise to a distinct type of financial middleman. A remunerative business was early developed by individuals in taking notes of merchants in one town and selling them on a commission basis to banks in another town. This business has become so important today, however, that in place of the individual note broker we now usually find the commercial-paper house, an institution quite as important in the financial world as the banks themselves. Some of these houses purchase and sell commercial paper amounting to hundreds of millions of dollars annually. Their operations are nationwide in extent; they sell the paper of New England dealers to banks in California, and that of merchants in Portland and Seattle to the bankers of Chicago and New York. The commercial-paper broker thus serves the important economic function of adjusting or equilibrating the demand and supply of loanable funds.

The commercial-paper house may either buy the paper outright and then sell it to the bank, or it may merely offer the paper for sale

with the knowledge that it can be obtained on request. The former method is usual nowadays among the larger houses. In either case, however, the brokerage house is a mere middleman, for it is not a part of its business to loan funds; it always buys to sell on a commission basis. It may be added that the house guarantees the genuineness of the signatures to the paper, though it does not indorse the paper and thereby assume a secondary liability.

Where the commercial-paper house buys the paper outright there is much more likelihood that the broker will investigate the financial standing and general character of the borrower than if he merely secures the paper upon request, for he may find himself unable to sell the paper. This is regarded by many as an important consideration, for the banker is at a disadvantage in investigating business firms at long range. With a local customer the bank as a rule deals with persons who have been known to it for many years and whose business standing is a matter of record in the files of the credit department. But in the case of paper bought in the open market, unless the name of the borrower is particularly well known, the bank has to deal in the main with an abstract proposition in the form of the borrower's statement. The commercial-paper house, through its investigation, may therefore serve as an additional check on credit on the principle that two investigations are better than one. There is a possible danger here, however, in that each investigation may be less rigid than would be the case if the responsibility were not divided.

Where the paper is of an unknown name, it is the usual custom for the bank to buy the paper on an option of seven or ten days, during which time it may make an adequate investigation of the firm or corporation offering the paper. Such an investigation must be conducted chiefly by means of letters of inquiry to the banks and business men in the town where the borrower is located, to those in the trade who have sold goods to the party in question, and to bankers in great commercial and industrial centers where the paper is likely to be placed on the market. If the paper is not acceptable after investigation, it is returned to the commercial-paper broker, the bank of course keeping the interest earned while the paper was in its possession.

The term "commercial paper" as used in the financial world often refers, not to all paper arising out of commercial transactions, but only to paper that is handled by the commercial-paper houses. Such paper has its own special quoted rate, which often varies materially from the rate on direct loans of banks to their customers.

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