Bank credit : a study of the principles and factors underlying advances made by banks to borrowers

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Preface

The purpose of this study is two-fold: to develop the principles of bank credit considered in the abstract and to set forth the main factors underlying the loans made, the credit extended, by banks to borrowers.

Part One is devoted mainly to an explanation of the way in which cash in banks becomes the basis of manifold loans and deposits, and to a statement of the relation of loans to the other principal items of the bank balance sheet.

The burden of Part Two is a consideration of the factors underlying and affecting the soundness of the contents of banks’ portfolios. It has seemed natural and logical to give a somewhat detailed account of recent changes in our bank credit arrangements, including the evolution of the form of the bank borrower’s obligation, the growth of the note brokerage business, the establishment of the bank credit department, and the rise of the new business department and its effects on the quality of bank loans. The work of note brokers acting as middlemen between borrowers and banks has been given what seems a deservedly large place.

The structure of Part One is built in part on old and familiar foundations, and in part on foundations newly laid. The main sources of Part Two are the Proceedings of the American Bankers’ Association, pro-

Vv vi PREFACE ceedings of the various state bankers’ associations, reports of the Comptroller of the Currency, and banking periodicals. Information embodied chiefly in chapters VII-XI and XVI, and unobtainable from the ordinary sources, was secured by extensive correspondence and interviews with bankers and note brokers, to whom my sincere thanks are due.

CuEsTER A. PHILLIPS Hanover, N. H.

TABLE OF GONTENTS

CHAPTER Paes EEN PROUCTION 4 fea 8c pie ald hen Ve eanath. Reve nails .

The Nature of Bank Credit. ...............0 0c eee 1

The Bank Acceptance as Bank Credit............. 1

Are Deposits Bank Credit... .....455 sduevie bec ccese 2

Bank Credit vs. Commercial Credit............... 3

The Legitimate Scope of Bank Credit Extension.... 4

Part I Quantitative Aspects Of Bank Credit

II. Toe Nature or CoMMERCIAL BANKING............. 13 Banking Transactions and Accounts.............. 13 Expansion of Loans a Prelude to Loss of Cash...... 20 PPGOCIVS LAA DT UIOR 6 bP ie en tis Re ORR EME Co's ns 22 Concealed Assets and Liabilities.................. 29

III. Tae PaitosopHy or BANK CREDIT..............04. 32 A Critical Analysis of the Traditional Theory...... 34 Loan and Deposit Expansion within the Banking MAM Looe Pid oy We wil IAN AN De meet NOD o's ay, 38 Primary and Derivative Deposits Differentiated.... 40 The Ratio of Derivative Deposits to Loans........ 44 Factors Determining the Ratio of Derivative De- AS TO DOR UA vob ci) Saas sot Yui e las 46 Aggregate Derivative Deposits Tend to Remain Constant in Amount) ods’ ai dowd tees... 52

Quantitative Determination of Individual Bank Loan Expansion Traceable to Acquisition of Prim- SOE MOAIER. Hiatt nek en Fete iik ed als 0 aes 54 viii TABLE OF CONTENTS

CHAPTER PAGE Qualifications of the Formula.................... 57 The Distribution of New Reserve as the Foundation of Manifold New Loans |... 45 seco dube nse ne 59 Relation of Loans to Deposits.................4-. 63

How the Withdrawal of Cash from an Individual Bank Effects a Wide-Spread Contraction of Loans end Depasite iy i4s 2 an ee 64 Why Banks Compete for Deposits................ 66 The Assimilation of an Individual Bank to the SVSLEMG 5 fia cic EE Pe 68 The Essential Difference between the Old Theory and the News Aig, @, CO ee ea 72 Anticipated Criticism Answered.................. 74 IV. InteR-RELATIONS oF CasH, LoANS AND Deposits..... 77 Cash in Relation to Loan Expansion in Individual and: Collective Banking) x wie sistem ae eee 77 Regulation of Ratio of Cash to Deposits in Individual berber as ee ee a 79 Ratio of Cash to Deposits and to Loans in the Banking .Systena fey: SUR PRE ts eR ooo, 82 V. Surptus In Retation To Loans, Deposirs AND RE- BIORVIES 34-46 60s yi¥8 2a 9 se et ee i ti 84 A New but Erroneous Doctrine of Surplus......... 84 The Doctrine: Disproved 9 61; 2 0. Oe a Ee, 4 87 The Relation of Cash or Reserve to Surplus........ 94 . The Ratio of Cash to Deposits and of Surplus to Creditor Liabilities: wi ecnesdis ce PROPER Ot. 96 The Relation of Cash to Deposits vs. the Relation of Surplus to Creditor Liabilities.................. 102 VI. Banxers’ BANKS AND CREDIT EXTENSION........... 103 The Nature of Bankers’ Banks................... 103 Bankers’ Banks Dilute Cash..............0...... 104 ‘Federal Reserve Banks Illustrative............... 104. Future Credit Expansion under the Federal Reserve Systema iy yt, 661 PR | OS 112

The Rediscount Rate as a Factor in Credit Extension 114 Commercial Banks as Bankers’ Banks............. 119

TABLE OF CONTENTS 1X PART II

QUALITATIVE ASPECTS OF BANK CREDIT

CHAPTER PacE VII. Recent CHANGES IN OUR BANK CREDIT ARRANGEoid bp ke aha Ae be Ee a Seema a 123 Evolution in the Form of the Borrower’s Obligation. 123 The Growth of Note Brokerage......... NEAR ess 131 Seasonal Demands for Funds in Relation to the Growth of Note Brokerage.................. 138 Independent Banking and the Rise of Note Broker- GOI Pe Re shales aretha ek OR, 8 139 The New Attitude of Bankers toward Brokers’ BOP TEE SESS PEF d Soo EOC oo 141 The Rise of the Credit Department............... 142 The First Phase of the Development of Credit Re- BUGLE GPS 4 see. Gale Sat SU ay ao ee Tos 144 The Development of the Credit Department since POOR MPO Sea ney beet Lateran th oe 146 The Underlying Forees ye oe ee es 148 The Rise of the New Business Department and its Relation to the Credit Department............. 152 The Influence of the Federal Reserve System upon the Kinds and Quality of Bank Loans. .......... 156 VIII. Tae Bank BorroweEr’s STATEMENT: ASSETS. ........ 160 Cash 6n Hand.and m Banks... .woiyvaciel. eth. 0... 165 Accounts and Notes Receivable.................. 169 Merchandise or Inventory..........0. 0000000000 173 Real Estate, Machinery and Equipment........... 179 Rte macs cere wots Eatin mtelh 182 So Gece PINE | EDOTICRS 2 clay oa raved @ RRR GRR 183 Trade-Marks, Patents, Goodwill, etc............ 184 POL ERSUPADOE OOS RRS eT oe 186 IX. Tae Bank BorrRoweEr’s STATEMENT: LIABILITIES. .... 189 Bills Payable for Merchandise................... 189 Billa Payable to'own Banke it iderrloeidin. ccs 189

Bills Payable for Paper Sold................. ‘see. 190 x TABLE OF CONTENTS

CHAPTER PAGE Open ‘Aecourtten): 2e een cle Fincher Wier 191 Chattel: Mortgages! 1 O24 CoO Ot 192 Bonded Debt and Interest Thereon............... 192 Deposits of Money with Us...............0c0800 193 Other liabilities 44 Geib TR RO A 194 Capital and Surplus, Proprietorship Interest, or Net WV OMth seacat Gath duis he pie ee ee RE es Sane 196 Ratio of Quick Assets to Current Liabilities........ 197 Relation of Net Worth to Credit Worth........... 198

X. Toe Bank Borrower’s STATEMENT: THE INCOME ACCOUNT Ee Goel te 199 DRT ATIC C40 ascites i ee Ee ee 201 Salaries and Cash Withdrawals................... 201 Depreciation ses 0's. 4 AR, LR Te, 202 Sales. itech hae MAE a 204.

Not Protitecwer sail al 2) esate ae oa as 205 Dividends ee eo AGS isi es aa ek 206 The Borrower's Capacity 3). bcs eee eA ee 207 Reciprocal Benefits of the Bank Borrower’s Statement 209 Significance of Refusal to Render Statement....... yAg XI. INVESTIGATING THE CREDIT RISK................05. 214 Handbooks as a Source of Information............ 215 The Mercantile Agencies...... GPT eh ced 215 The Trades Gat Ww, Ree eh eR AREA ee 216 Banks sec ovineska eek Mie toe ea eee os 219 hoe’ Interview... 6562 Re eee Ot Te ie 221 The Method of Investigation in a Particular Case.. 222 ALL. Secoken LOanee yc Oe ae ee ae nie? Warehotiie Loans) ute oleu Ce ad OW Bae sea 226 Cotton: Loana.6) 216k Gee a a a 229 Crop Loanws 6 68058 POO i Sa he 230 Real Estate Mortgage Security. ...............06. 231 Urban Real’ Mstaten. oe) Mate CE oan 231 Farm: Land as: Security: 4.49.0 Ae ea er 232 PALIT, OVMEDRARIS 5.66) MO A We a ee 235 Objectionable Features... .go8 oo 6.0 bee Cai oe es 237

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CHAPTER — PAGE Rules for Controlling Overdrafts................. 239 Depend upon Bank Supervision.................. 240 An Index of the Soundness of the Bank........... 241 XTV. Loans or Country BANKS... 2.2.0.0... ccc cece e eens 242 Distinctive Features of Country Bank Loans....... 242 Rules for Reducing Slow and Past Due Paper...... 248 Poneto Perse eae 249 pe. rate at (interes: coe how. okie walle Ma ek 250 2 6 SOANS OR BANKS. TO DANRB yet) d biiicewers dials Vele@as eats 253 Pe Old ORI ae a ay ae UN 253 Investigating the Borrowing Bank................ 256 Pear CMIAT CASE eth ook kok vad oa Deen 258 XVI. CommerctaL Paper Houses as INTERMEDIARIES BE- TWEEN BORROWERS AND BANKS...............-. 260 Characteristic Features. ..........0...0 ccc cee eeces 261 BUR ee aR le, Yue hc at os Lod shared Sa i ca ie Nats ANCOR & ci 262 The Volume of Note Brokerage Business.......... 264 EN OO ee aha hess eiaie eee slghelee se os 265 Mes Sy ho 2" 2 for 0 | 9a a Re 265 Advantages of the Note Brokerage System to Bor- PORTE ery tee Sinus wale hg 2G Aas Wikies wR sania ho 267 Disadvantages to the Borrower.................-. 270 Advantages of the Note Brokerage System to Banks 271 Disadvantages to the Bank... 0... e es comes ad Weaknesses of the System...................204. 277 MPPERCUINIR SCH OMe RMON ND Redan RPI 287 XVII. Bank SUPERVISION IN RELATION TO BANK CrEDIT.... 295 National Bank Supervision.................0206- 296 PRA LE TSAI OUPORVISION: jeia\ aainwcnds. Sond eaed wid a eo 2h 299 Clearing House Bank Examination............... 302 The pystem Deseribed ... 2... ee kee eae eens 304 Influence upon Loans of Small Banks........... 309 Effects upon Loans to “Double” Borrowers in Rr Ce hah iis cA aa Ae wr oe ean ee eines 311 Incidental Effects upon Loans.................. 312 Internal Bank Examination...................06- 315

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CHAPTER PAGE Apprnpix A. Questions, Exercises, and Problems........... 319

APPENDIX B. Borrowers’ Statement Forms Designed and Approved by the American Bankers Association, Including the Report of Committee on Credit

Foreword To Teachers

The main circumstance prompting the publication of this volume is the lack of any work well designed to familiarize the student with the theory of banking in both its abstract and concrete aspects. At a time when _ banking policy promises for years to come to be the continuing source of many of our most vital economic problems, the value of a mastery of banking theory becomes apparent and method of study important. The author believes that mastery can be gained most advantageously through the solution of questions and problems directly related to the text studied and accordingly presents extensive ‘‘Questions, Exercises, and Problems” in Appendix A.

Many of the questions, exercises, and problems are integrated with the text and the numerous teachers who rely chiefly on the Socratic method may profitably direct considerable attention to their solution, notably, in connection with chapters IJ, III, VI, VITI-xX. It would be conducive to thoroughness if chapters IT and III and the corresponding portions of Appendix A were broken into not fewer than five assignments, e. g., as follows:

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XIV FOREWORD TO TEACHERS

The method of handling other works used jointly with Bank Credit may be passed over without comment except that a preliminary study of the bank balance sheet and of clearing and collection facilities and methods would be desirable, although not essential. The familiar texts of Dunbar, White, Holdsworth, Scott, and Moulton contain suitable introductory or collateral material.

It is in place to say that the purpose of the sharp conflict of theory with theory in chapters III and V is primarily not to expose the fallacy of the false, but to demonstrate, clarify, and enforce the truth of the true.

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Introduction

The Nature of Bank Credit t

Bank credit, as the term is used in this volume, stands for credit extended by banks to borrowers. Bankers frequently use the term in the plural, meaning advances made to their borrowing customers. Whether the borrower withdraws the amount of the proceeds of his loan in cash at.once or leaves it on deposit with the lending bank, the loan in either case constitutes credit extended. Just as a merchant extends credit to the customer who pays for his purchase at a later time, so the banker extends credit to the business man who borrows money. Whether the money is taken from the bank at the time the loan is made, the next day, or ten days later, makes no essential difference; bank credit may take even the form of an overdraft.

The Bank Acceptance as Bank Credit

The bank acceptance, which is a draft or bill drawn upon and accepted by a bank, differs from a loan in the fact that the accepting bank makes no actual advance of funds; it meets its obligation at the maturity of the draft out of funds provided by the drawer. The accepting bank has faith in the willingness and ability of the drawer to provide the funds required to meet the draft when it matures, but the liability assumed is essentially contingent, the advance being made by the bank or discount house that buys the bill.

A bank with low reserves may be disinclined to make a loan, but quite willing to accept a draft that is payable at a future date out of funds provided by the drawer. The accepted draft, being the obligation of a bank, finds a market wherever banks have redundant funds. The bank acceptance, therefore, works in the direction of a more nearly complete equilibration of demand for and supply of the purchasing power that banks make it their business to lend. The accepting bank buttresses the credit standing of the drawer, who then secures the funds desired from a lending institution. An acceptance credit has an important direct influence upon neither the deposits nor reserves of banks; actual advances affect both items directly. Hence, from the standpoint of banking theory, the acceptance credit is comparatively unimportant.

Are Deposits Bank Credit?

It happens, also, that borrowers extend credit to banks, when either cash or the proceeds of loans are lodged with their banks. Deposits are obviously closely related to loans, both in an individual bank and in a banking system, but that close relationship scarcely justifies the application of the term bank credit to deposits. Whether arising from the lodgment of cash or of the proceeds of loans in a bank, deposits represent

INTRODUCTION 3 credit extended by the bank’s customers to the bank. However, partly out of deference to the reader who may insist that deposits also are bank credit, and partly because of the close relation of deposits to loans, a discussion of the deposit item in its relation to loans, surplus and cash is given in later pages.

Bank Credit vs. Commercial Credit

The fundamental factors affecting the question of security or safety are essentially the same in mercantile and bank credit. The banker and the wholesaler and jobber are about equally concerned with such matters as the ratio of quick assets to current liabilities, net worth, the moral hazard, etc. Both the banker and the business man who sells on credit, tap substantially the same sources of credit information. Methods of investigating the credit risk are substantially the same. In collecting credit information the trade relies heavily on the banks and the banks rely heavily on the trade.

The essential difference between bank credit and commercial credit lies in the degree of certainty of payment. The banker’s percentage of profit is so small in comparison with the profit of the merchant or manufacturer who extends credit to his customers that the banker is compelled to take greater precaution concerning repayment of a loan than is the business man in regard to payment for wares sold.

The mercantile credit man considers himself fortunate if the losses of his house do not exceed 1/4 or 1/8 of 1 per cent of his total sales. The banker, whose discount is small in comparison with the profits of the merchant, regards as serious the loss of even 1/100 of one per cent of his turnover.! It was estimated in 1892, by Mr. E. 8. Lacey, a former Comptroller of the Currency, that the losses on loans and discounts made by national banks at that time amounted to 1/200 of one per cent.’

Another distinctive feature of bank credit is that a bank is commonly able to make loans in excess of the amount of cash received from shareholders and depositors. How much in excess is a question that is answered in chapter ITI.

The Legitimate Scope of Bank Credit Extension

It is not the most approved business of a bank to furnish the fixed capital of an enterprise. The fixed capital requirements of a business, as distinct from short time credit needs, must be met before banking accommodation can safely be extended, and borrowers should in general rely on banks for seasonal requirements only. What the banker may most legitimately furnish will be made clear by an illustration. A clothing merchant proposes to set up in business. He expects to carry a stock of goods worth on the average about $25,000. If he, without capital of his own, should make application for a bank loan of that amount, the application would in all but the most exceptional cases be refused, because the banker, who handles chiefly the funds of

1 Norman I. Adams, Credit Department, Analysis of the Financial Statement, A lecture delivered before the Boston Chapter of the American Institute of Banking, February 4, 1913, p. 4.

2K. S. Lacey, Some Phases of Modern Banking, Proceedings, Second Annual Meeting, Bankers’ Association of the State of Illinois, 1892, p. 50.

INTRODUCTION 5 others, cannot advisedly place those funds where so large a risk would obtain.

The merchant might secure his capital through the partnership form of organization or,conceivably, through the issue and sale of corporate securities. In any event the bank would have to insist that the merchant commence business with a capital approximately as indicated. With those requirements met, the merchant would be in a favorable position to apply for a loan to finance his somewhat extraordinary needs in the buying seasons, the spring and fall. The capital invested would stand as a buffer between any losses that might occur in the conduct of the mercantile business and the interests of the lending bank. It is plain that if a borrower fully repays his bank loans seasonally it is presumptive evidence that the banker is not being required to furnish a part of the capital fixed in the business. Many banks insist on a ‘‘clean up” at least once ayear,

The question naturally arises, why should the merchant,—and the same would apply to a manufacturer or other entrepreneur,—not have sufficient capital invested in the business to meet all needs, even those arising at the time of seasonal purchases or expansion? Relatively few concerns are so situated that borrowing from banks is unnecessary. The reason is that the possession of sufficient capital to enable a firm to follow that course would involve, ordinarily, an appreciable waste through loss of income on funds which, although available for use twelve months in the year, would be in active use only a fraction of that time.

It is important that emphasis be placed on the distinction between fixed capital requirements and those credit requirements of a business which recur annually or seasonally. Separate and distinct methods ought to be observed in meeting each class of requirement. Business men should first provide for the capital requisite to start business on a sound basis; then, should have banking accommodation adequate to enable them successfully to carry on that business.}

A maximum of profit to the borrower of funds and a minimum of risk to the lending bank,—these frequently represent conflicting considerations, and it would not be in harmony with the facts to suppose that business concerns confine their borrowing operations to strictly seasonal or temporary needs. The practice of business concerns selling notes through note brokers, described in chapter XVI, and the practice of maintaining more than one bank account militate, along with other circumstances, against the ability and disposition of bankers to limit the extension of credit to the satisfaction of seasonal needs only. It is well known that many wholesale, jobbing and manufacturing concerns now keep large amounts of paper afloat continuously. That is, banks are supplying not only their short-time or seasonal needs, but a part of their long-time capital needs as well,—a circumstance that danger attends unless the proportion of liquid assets is kept ample.’

1Cf. Charles Hall Davis, The Davis Plan of Rural Banks, Proceedings, Seventeenth Annual Convention, North Carolina Bankers’ Association, 1913, pp. 29-32.

2 Professor Harold G. Moulton has thrown a, flood of light on the liquidity, or rather lack of liquidity, of American bank loans. See his articles on Commercial Banking and Capital Formation, Journal

INTRODUCTION 7

It is also true that commercial banks customarily invest a part of their funds in long-time securities, especially bonds, a practice that carries with it a danger of shrinkage in value due to changes in the long-time rate of interest. Large cash holdings and other liquid assets in ample amount are designed to obviate the danger arising from advances made on renewable paper, _ even though the proceeds are invested in fixed form, but only large capital, surplus, and undivided profits will meet the situation if the prices of bonds held by banks shrink, as shrink they do, when long-time funds become scarce and the interest rate rises.

The disposition of borrowers to rely increasingly on continuous loans as against those of short and certain maturity is traceable in part to two facts or tendencies. In the first place the demand for ‘‘seasonal’’ loans of short-time duration, has fallen off relatively, owing to our improved facilities for distributing and storing. As it is almost always possible to obtain promptly any article needed for the consumers’ trade there is no great advantage in heavy seasonal buying under ordinary conditions, and the need of seasonal borrowing is accordingly rendered less imperative.

A second circumstance that has caused the demand for seasonal funds to decline relatively to that for fixed capital has been the tendency to use more and more capital in relation to labor in both production and disof Political Economy, Vol. 26 (1918), particularly article III, pages 705-31.

1 Cf. Asael E. Adams, As to the Efficiency of our Present System, Proceedings, Twenty-fourth Annual Convention, Ohio Bankers’ Association, 1914, pp. 44, 45.

tribution. Every new labor saving device introduced has involved an increase in capital needed in the line in which that device is used, relative to the amount of liquid or short time funds required.?

In one sense continuously floating paper, when marketed by note brokers, is liquid, and in another it is not. From the standpoint of an individual bank it is ordinarily very liquid, although in times of crisis the makers might experience difficulty in meeting their obligations. From the standpoint of the banks taken as a whole this paper, put on the market by brokers wherever buyers among banks can be found, is distinctly non-liquid. From the standpoint of the borrowing concern the floating of paper continuously in the market is almost tantamount to the issue and sale of bonds. From the standpoint of the banking system the floating of such paper is also almost equivalent to the sale of bonds to the banks; but from the standpoint of the individual bank the short time paper is liquid and mobile. In an ideal bank credit situation continuously floating paper would not be outstanding and borrowers would completely pay their obligations to banks at least once a year. The business or trade that has a season longer than a year is rare, perhaps non-existent.

At the same time some lines of business, like that of the tanner, whose vats, always filled, impel him to borrow money ‘‘every day in the year,” are non-seasonal and yet make heavy demands upon the loanable funds of banks. There is no good reason in such cases why banks should not lend, provided the ratio of quick assets to current liabilities is adequate, the

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INTRODUCTION 9 capital or net worth of the borrower ample, and the other elements in the situation favorable.

What the commercial banker ought assiduously to avoid, even where loans are based on time deposits, is the unliquid condition of the loan item that exists when his funds are invested heavily in fixed form, in real estate, equipment, etc. Repayment then becomes a matter not of days or months, but of years, and may be extremely uncertain.

In succeeding chapters we shall consider in detail the nature of the process involved in the manufacture of bank credit, the relation of loans to other magnitudes in the balance sheet in both individual and collective banking, the recent evolution of our bank credit arrangements, the bases of bank loans, and the influence of certain institutions and practices upon the quality of the contents of the banker’s portfolio. A brief study of banking operations and accounts, designed to make clear the nature of commercial banking, is given in the next chapter as an essential preliminary to the development of principles attempted in the pages that follow.

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PART I

QUANTITATIVE ASPECTS OF BANK CREDIT

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CHAPTER II THe NATURE OF COMMERCIAL BANKING

The lending functions of a commercial bank are so radically different from those of the money lender, putting out only his own funds, that it will be desirable at the outset to consider carefully the nature of banking, the essence of which consists in the practice of extending loans far in excess of either the capital or cash holdings of the bank in question. A glimpse of the difference between bank loans and the loans of a money-lender will be gained if we examine the balance sheet of a bank as the institution expands on the basis of the cash paid in by the shareholders in exchange for shares of stock.

Banking Transactions and Accounts

Following the customary practice of setting down the assets and liabilities on opposite sides of the balance sheet, we note first that the payment of, say, $100,000 capital stock, one thousand shares of $100 each, will result in the creation of assets and liabilities as follows:

Assets Liabilities

The balance sheet shows cash as an asset,—debt paying power,—and capital stock as a debt. Sometimes ‘‘capital stock” is shortened to ‘‘capital,’’ in which case the reader may have difficulty in bearing clearly in mind that capital really means, not the cash paid in by the shareholders, but what the bank as an institution owes the shareholders on account of their cash contributions to the enterprise. Capital stock or capital is always a liability of the bank.

It would be natural for many of the shareholders to transfer their accounts from older banks to the new, and we may suppose that cash amounting to $50,000 is deposited by shareholders. The balance sheet or financial statement will then read:

Local business men, friendly to the promoters of the new bank, also open accounts, depositing $5,000 in cash and $20,000 in checks on other banks. Our statement will now show:

During the early history of the bank, connection will have been established with one or more metropolitan banks, and a deposit balance created. The primary reasons for the maintenance of balances on deposit with banks in centers to which the locality of a given bank is commercially tributary are (1) that the local bank may be‘able to sell drafts on those centers, for the accommodation of its customers who may desire to remit drafts as means of payment, and (2) that the local bank may have agents in the centers to handle and collect drafts drawn by dealers or manufacturers who have shipped goods to distant markets, and (38) that the local bank may have collection agencies for the stream of checks deposited daily by its customers.

It would be reasonable for a bank having a capital of $100,000 to place $25,000, more or less, on deposit with one or more banks in commercial and financial centers to which the locality of the bank with which we ‘ are concerned is tributary. Cash would then be reduced $25,000 and ‘‘due from banks’”’ would be increased to $45,000. The statement would stand:

Assets Inabilities RESIS St wart bs onye clos SPO. O00) Capital rw. oye deeo is $100,000 Due from Other Banks. 45,000 Deposits............. 75,000 $175,000 $175,000

Applications for loans amounting to $20,000 are received and approved. The average time is 90 days and the rate 6 per cent; the discount amounting to $300. The proceeds, $19,700, are left on deposit to be drawn against by check. This lending transaction introduces into the statement some new items. Loans and discounts, being valuable instruments in the possession of the bank, will take a place on the asset side of the statement; deposits will be increased by the amount of the proceeds of the loans; the discount, which is profit undivided and belonging to the shareholders, will be recorded as a liability under the head of undivided profits. Assets and liabilities have grown to the following proportions: