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 s ch 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.