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The Selection Of Loans And Discounts

The problem of the reserves is vitally connected with that of the
selection of loans and discounts. As was shown in the preceding
chapter, the chief business of a commercial bank is to conduct
exchanges by a process of bookkeeping between individuals, banks,
communities, and nations. This process consists primarily in the
converting of commercial bills and notes into credit balances and
bank notes, in the transfer of such balances and notes between
individuals and banks, and in the final extinguishment of such
balances and the return of such notes at the maturity of the
commercial bills and notes in which the process originated.

In this process there is little need for cash, provided the
arrangements between banks for clearing checks and for the interchange
of notes are complete and efficiently administered. But when a bank
accepts investment in lieu of commercial paper, its need for cash at
once increases, because the demand obligations created by the credit
balances or the bank notes into which this paper was converted are not
extinguished by payments for goods purchased, but must be met by cash.

To distinguish between commercial and investment paper is, therefore,
one of the chief problems confronting commercial bankers. For its
solution an accurate knowledge of the business operations of customers
is necessary. An inspection of the paper presented and a general
knowledge of their wealth and business capacity are important, but not
sufficient. The forms of the paper employed in both commercial and
investment operations may be the same, and the possession of wealth
does not ensure the payment of the paper at maturity.

The chief means available for the acquisition of this knowledge are
the requirement from customers of frequent statements of their
operations, on properly prepared forms; the use, wherever possible, of
the documented commercial bill of exchange; and the maintenance of
credit departments equipped with the means of accurately studying
commercial, industrial, and agricultural operations, and of diagnosing
economic conditions. The study of carefully prepared statements of
customers made at frequent intervals reveals to the banker not only
the nature of the operations represented by the paper presented for
discount, but the trend of the business of his customers and, through
them, of the entire country. With such knowledge, he is not only able
to protect his institution against improper loans and discounts, but
to give valuable advice to his customers, advice which no one else is
in a position to give so accurately.

By a documented bill of exchange is meant a bill drawn by a seller
upon the purchaser of goods, accompanied by documents evidencing the
transaction; such, for example, as bills of lading, warehouse
receipts, and insurance policies. The names on such bills guide the
banker in his efforts to trace the transaction in which it originated
and the documents enable him absolutely to identify it, and constitute
security for the loan.

Instead of such bills, promissory notes made payable to banks are
commonly used in this country, greatly to the disadvantage of the
banking business. Such a note reveals nothing to the banker concerning
the purpose for which the loan is made, while a commercial bill, even
without documents, reveals the names of the principals of the
transaction in which the banker is asked to participate. Acquaintance
with these men and knowledge of the business in which they are engaged
at once suggests the probable origin of the bill and furnishes the
clue needed for subsequent investigation.

A properly equipped credit department will keep on file and at all
times available for use the data requisite for the information of the
officers upon whom the responsibility of selecting the loans and
discounts rests. Such data will not only concern the character and
business of each customer and the bank's previous dealings with him,
but general economic conditions, the operations and experiences of
other banks, other business institutions, governments, etc.

Next: Rates

Previous: The Supply Of Cash

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