Appendix A: Question, Exercises, and Problems

APPENDIX A QUESTION, EXERCISES, AND PROBLEMS CHAPTER I 1. Define bank credit. 2. In what sense is a bank acceptance bank credit? In what not? 3. What circumstances, if any, justify the application of the term bank credit to deposits? 4. Indicate points of similarity and of difference between bank credit and commercial credit. 5. What is the legitimate scope of bank credit extension? 6. Compare or contrast the banking danger involved in investments in bonds and that involved in investments in frequently turned promissory notes. 7. Explain the increasing tendency of borrowers to rely on continuous bank loans. 8. Is continuously floating paper marketed by note brokers liquid? 9. What would failure on the part of a bank customer to reduce his loans to a low ebb at least once a year indicate with reference to permanent capital in the business? 10. Under what conditions are commercial banks justified in lending heavily to nonseasonal borrowers, e. g., tanners?

CHAPTER II 1. What is a balance sheet or financial statement of a bank? 2. Why is capital a liability? 3. Contrast the financial plan of a representative bank with that of a representative non-banking business corporation. Account for the difference. (By financial plan is 319 320 APPENDIX A meant the way in which capital is raised, whether by bonds, preferred stock, common stock, etc.) Would the business of receiving deposits argue against the issue of bonds by a bank? Why? 4. Why does the Fletcher American National Bank of Indianapolis keep balances on deposit with New York, Chicago and other banks? 5. Is "exchange" an asset or liability? An overdraft? Why? 6. What forces restrain the banker in executing a liberal loan policy? 7. Ought a reserve be required against United States deposits? Against amounts due to other banks? Cashier's checks? Why? 8. Define bank surplus. How does it differ from capital?

From undivided profits? Is surplus ever cash? 9. An applicant for credit at a bank was told by the cashier that the bank might lend him a part of its surplus. Criticise the cashier's statement. 10. If you were given a free hand in the examination of the affairs of a bank, how would you proceed to ascertain the amount of (a) capital, (b) surplus, and (c) undivided profits? 11. National and state banks and trust companies becoming members of the Federal Reserve system are required to purchase Federal Reserve bank stock equal to 3 per cent of their combined capital and surplus and to subscribe for an equal amount additionally. Are there any other items in the balance sheet as fixed in amount as capital and surplus? 12. A bank has a capital of $100,000, surplus and profits of $74,124.38. Its paid up stock in the Federal Reserve Bank of Chicago is $4,500. What is the amount of the surplus? 13. What is double liability? Illustrate.

14. Which of the national bank balance sheets here APPENDIX A 321 given represents the greater protection afforded depositors, assuming, of course, that the book values represent the actual values and that the shareholders are fully responsible for the double liability attaching to their stock? No. 1 Loans and Discounts. $1,000,000 Capital $ 25,000 Other Assets 200,000 Surplus 150,000 Cash 100,000 Undivided Profits.... 25,000 Notes, etc 100,000 Deposits 1,000,000 $1,300,000 $1,300,000 No. 2 Loans and Discounts. $1,000,000 Capital $ 100,000 Other Assets 100,000 Surplus 20,000 Cash 100,000 Undivided Profits.... 5,OOÖ Deposits 1,000,000 Notes 75,000 $1,200,000 $1,200,000 15. What is reserve liability? Why was the principle introduced? Is it superior to double liability from the standpoint of the shareholder? From the standpoint of the public? 16. The National Bank Act limits the loans of a national bank to 10 per cent of its combined capital and surplus (and to 30 per cent of its capital) to an individual, firm or corporation. A certain national bank having capital of $50,000, surplus of $75,000 and undivided profits of $10-, 685.20 desires to reduce the legal limit above referred to as a means of finding a pretext for holding certain "sick" borrowers in check. How can the limit be reduced through a bookkeeping operation?

322 APPENDIX A 17. What are concealed assets? 18. Cite methods of concealing assets. 19. Why are assets ever concealed? Why are liabilities concealed? Why are assets more likely to be concealed in banking than in non-banking business enterprises? 20. Items relating to the banks of Greenville, S. C, at the close of business September 12, 1919. Surplus and Tear Market Name of Bank Capital Undivided Deposits Organ-Value of Profits ized Stock American Bank $ 75,000 $256,203 $ 866,823 1890 150 Bank of Commerce 100,000 43,000 1,026,232 1906 135 Farmers & Merchants Bank 50,000 26,669 943,459 1907 145 Krat National Bank 100,000 148,997 2,121,260 1872 270 Norwood National Bank 250,000 358,967 3,657,684 1907 275 Peoples National Bank 200,000 209,799 2,112,391 1887 200 Assume capital, surplus and undivided profits to be accurate criteria of bank stock values and calculate which stock in the list given would represent the greatest investment worth at the price quoted. Which would be second choice?

Third, fourth, fifth, sixth? 21. The Hanover National Bank of New York has a capital of $3,000,000 and combined surplus and undivided profits of $18,000,000. If it pays dividends at the rate of 32 per cent per annum, at what price, roughly, ought the shares to sell in the market? 22. (a) A bank having a capital of $150,000 declares a six per cent semi-annual dividend. Title to 100 shares is the subject of litigation and the dividend thereon is unpaid. The remaining dividends are paid by cashier's checks. State the effect of the dividend payment on the balance sheet. (b) Ought a bank to be required to hold a reserve against all dividend checks outstanding? Why? 23. A bank having total resources of $975,000 is ambitious to overtop the million mark. How would its total resources and liabilities be affected if it borrowed $25,000 APPENDIX A 323 from a correspondent bank and then made an addition to its loans of $30,000, two thirds of the proceeds being drawn against by check and surrendered through the clearing house to other banks?

24. Which balance sheet subjoined indicates the more liquid banking condition? No. 1 Unsecured Loans $400,000 Capital $ 75,000 (Average time 9Odays) Real Estate Loans.... Bonds of Foreign Governments Union Pacific Railway Bonds 50,000 Real Estate 50,000 Cash 50,000 Surplus 175,000 400,000 Undivided Profits.... 50,000 50,000 Deposits 700,000 $1,000,000 No. 2 $1,000,000 Unsecured Loans $800,000 Capital $ 50,000 (Average time 90 days) Surplus 25,000 Railway Bonds 50,000 Undivided Profits 25,000 RealEstate 50,000 Deposits 800,000 Cash 100,000 $1,000,000 $1,000,000 25. Arrange the following items as a balance sheet: Banking House $ 20,000 United States Bonds... 40,000 • vDue to Banks 23,626 ' Circulating Notes 40,000 Cash 17,818 Due from Banks 32,188 , Time Deposits 217,932 Other Assets $ 14,318 Loans and Discounts.. 285,408 Demand Deposits 56,660 Undivided Profits 1,514 Surplus 20,000 Capital 60,000 324 APPENDIX A Draw up a new balance sheet after the following transactions have been completed: a. Lend $2,000 for 6 months at 6%, one fourth in cash and three fourths in deposits.

b. Sell $2,000 worth of other assets for $2,500. c. Pay dividend of 4%, one half the amount being left on deposit; one half in cash. d. Assume a customer having a balance of $300 remits check for $310 to Cleveland, whence, after passing through a correspondent bank there, it is returned to this bank and honored. e. Buy a new vault for $3,000, giving in payment a New York draft. ƒ. Receive deposits of $10,000; $4,000 in greenbacks and gold and silver certificates, $1,000 in notes of this bank, $3,000 in checks on other banks, and $2,000 in checks on this bank. g. Pay by cashier's check a claim for damages of $225. h. Sell at a discount of 3 per cent $2,500 of six months paper, bought from a note broker and having three months to run, and leave the proceeds on deposit with a correspondent bank. i. Rediscount $5,000 eligible paper at Federal Reserve Bank, taking one fifth in Federal Reserve notes and four fifths as deposit credit.

26. Resources Liabilities Loans $ 800,000 Capital $ 50,000 Securities 50,000 Surplus 50,000 Real Estate 20,000 Undivided Profits.... 20,000 Due from Banks 30,000 Due to Banks, etc 80,000 Reserve 100,000 Deposits 800,000 $1,000,000 $1,000,000 APPENDIX A 325 (a) What would be the effect on the balance sheet given above if the bank to which it pertains, introducing more detailed and more exact accounting methods, discovered that the balance sheet was correct except that discount collected but unearned amounted to $2,000 and that interest earned but not collected amounted to $1,000? (&) Why is interest earned but not collected an asset? Why and to whom is discount collected but unearned a liability? (c) Would the discovery of an excess of discount collected but unearned over interest earned but not collected have the same effect on the item of undivided profits as would an actual loss of equal amount? Would such a discovery have the same effect on the economic interests of the shareholders as would an actual loss? Why?

(d) This bank institutes the practice of making an accounting allowance for taxes accrued, which amount to $138.00. Indicate the changes involved in the balance sheet. CHAPTER III 1. Would the deposit of checks on other banks be as acceptable to you, if a banker, as would the deposit of actual cash? Why? 2. What is the "riddle" of banking? 3. Explain the manufacture of bank credit as described by Horace White and others. 4. Why would the acquisition of a "cash" deposit of a million dollars by the Liberty National Bank of New York be an insufficient basis for a loan and deposit expansion of several times the amount? 5. Develop the formulas X=c-^~¾ and D=II R. 6. Distinguish between primary and derivative deposits. 7. A Vermont banker says, "We have a customer who 326 APPENDIX A keeps an average balance of $5,000, and makes deposits and checks out each day. He comes in and hires $2,000 because of a shipment of goods totaling this amount and pays invoice. As far as we know he used this $2,000, but he may have paid from the $5,000, leaving his promissory note to keep up the average balance." Would this kind of operation fly in the face of our conception of derivative deposits?

Why not? 8. Why does the ratio of derivative deposits to loans vary more widely from borrower to borrower than from bank to bank? 9. Enumerate the principal factors affecting the derivative depositloan ratio. 10. Why, in general, is the derivative depositloan ratio higher in the case of city banks than in country banks? 11. Draw asymmetrical derivative deposit curves representing loans of varying maturities to show that the volume of derivative deposits for a given bank tends to remain constant over a period of time. 12. "Some concerns," says a Chicago banker, "borrow very heavily for a short period of the year, say from four to not over seven months, during which time they not only use these loans, but every penny of available balance. On the other hand, during from five to eight months of the year they carry large balances and do not borrow. Such accounts will invariably show better than a 20% average balance against the average loan if taken over a period of twelve months, yet during the life of the loan the balance is nil."

Would it be legitimate to say, from the standpoint of one who is attempting to give an exposition of banking theory, that the derivative deposits in this case are simply zero and that, if all the bank's customers were of this type, the aggregate volume of primary deposits of the bank would tend to be uniform? 13. Some concerns customarily borrow "practically their APPENDIX A 327 own money; in other words, their balances would equal or perhaps exceed the amount they are borrowing, but they need such balances. ..." What is the derivative depositloan ratio maintained by such borrowers? 14. "A given concern feels that they need a balance of say $25,000.00 to care for the ordinary turnover of their business. They will keep that balance when they are not borrowing, and when the exigencies of their industry tend to deplete the balance they will borrow from time to time in order to maintain it constantly at approximately the predetermined figure."

What would the derivative depositloan ratio be in this case? 15. "Theoretically," says a California banker, "your diagram (Number 1) contains all the desirable points, but in practice you will find that it does not work out, for generally when a man borrows money he has incurred the indebtedness previously and to save interest would put off payment as long as possible, and then probably pay it out all in one sum. . . . Further, when a man borrows money, especially a business man, he anticipates the probable date when he will collect certain sums and so times his loan to take care of the period only; so he does not in practice, pile up money in anticipation of paying the loan." If the synchronism, or concurrence of events, here involved was imperfect or incomplete, would derivative deposits emerge? May we not truly say that complete or perfect synchronism would exist only theoretically, using "theoretically" in the sense in which the California banker uses it?

16. Why is ci, in connection with the formula for the determination of individual bank loan expansion traceable to additional primary deposits, equal to (1—k)x? Why is ci also equal to c—re—krx?

328 APPENDIX A 17. Memorize the formula x = —-—zL·. kr+l-k 18. A New York bank whose borrowing customers on the average leave 15 per cent of their loans on deposit has a reservedeposit ratio of 13 per cent. How great an addition to its loans can be made as a result of the acquisition of new deposit accounts of $500,000? 19. Under what conditions will the loan expansion rendered practicable by a primary deposit acquisition be equal to that acquisition? 20. What qualification of the formula, x = — -> kr+l-k is called for in connection with banks in one-bank towns? What circumstances minimize the importance of this qualification? 21. As a result of amalgamations London Clearing House banks have been reduced in recent years from almost a score to seven. Have the consolidations increased the amount that any one of the banks can safely lend as a result of acquiring additional deposit accounts?

Does bank amalgamation, by increasing size of bank, render a reduction in the reservedeposits ratio possible without impairing the power to meet deposit liabilities on demand? If a bank had only one depositing customer, how large a reserve would be needed? If bank amalgamation in England should continue until two banks of equal banking power had all deposit and loan accounts, how would that fact be reflected in the overflow cash of either bank? 22. If the nineteen chartered banks of Canada became completely merged, it would be as if the derivative depositloan ratio of the amalgamated institution were 100 per cent. Explain. Substitute 100 per cent for k in the formula for determi¤APPENDIX A 329 ing individual bank loan expansion on the basis of cash acquired through deposit and calculate the loan expansion of such a bank as mentioned above, using $1.00 for c and 10 per cent for r. 23. A typical American bank can ordinarily increase its loans by an amount approximately equal to an addition to its primary deposits on the basis of a new cash acquisition, but our banks taken in the aggregate, and without assistance from bankers' banks, would be able to increase their loans by approximately nine times the newly acquired cash. Explain and illustrate by diagram.

24. Illustrate diagramatically the way in which new cash becomes distributed as the basis of manifold loans and deposits in the banking system, assuming a reservedeposits ratio of 20 per cent and a derivative depositloan ratio of 25 per cent. 25. The multiplicative importance of reserves in relation to loans and to deposits in the banking system is not traceable to the fact that borrowers withdraw less than 100 per cent of the proceeds of their loans. Substitute zero for k, one dollar for c, and 50 per cent for r in the formula for determining the individual bank loan expansion on the basis of a deposited cash acquisition, and in accordance with your results draw a diagram, modeled after number 3, showing the way in which new cash, under homogenous conditions throughout the banking system, would be distributed and become the foundation of manifold loans and deposits. 26. Are the deposits of a bank the offspring of its loans or are its loans the offspring of its deposits, i. e., cash or its equivalent deposited?

Consider the same question in relation to the banking system. 27. A country bank, bank A, has $10,000 in cash and $100,000 in each deposits and loans. A neighboring bank, 330 APPENDIX A B, has $20,000 in cash and $200,000 in each deposits and loans. A depositor withdraws $10,000 in gold from bank B and lodges it with bank A. Would the cash of bank A now constitute potential support for $200,000 each of loans and deposits? Why not? 28. Would the purchase by a bank of newly issued bonds tend to swell the deposits of (a) that bank and (b) the banking system as would the extension of credits to customers? Explain. 29. Do deposits and loans tend to be equal in an individual bank because loans arise out of deposited cash or its equivalent? 30. Why are deposits and loans in the banking system approximately equal? Would a doubling of our bank capital in United States, with reserves assumed to remain fixed in amount and in percentage, tend to affect the volume of loans but not that of deposits? Explain.

31. Explain the way in which the withdrawal of cash from an individual bank effects a widespread contraction of loans and deposits. 32. Refute the contention that banks can afford to maintain expensive establishments, to supply stationery and render other services because they can lend ten dollars as a result of receiving one on deposit? 33. Describe the way in which an individual bank with relatively heavy deposits, large surplus reserves and small volume of loans becomes assimilated to the system. 34. Develop the formula x = - Would a given kr+l-k bank be able to lend more or less than the application of the formula would indicate if other banks in the system were expanding their loans, either as a result of additions to their reserves or as a result of a reduction in the reAPPENDIX A 331 servedeposits ratio? If other banks were contracting their loans? Explain. 35. Assets Liabilities Loans and Discounts.. .$200,000 Capital $ 50,000 Bonds 50,000 Surplus 50,000 Banking House 25,000 Undivided Profits 25,000 Other Assets 25,000 Deposits 210,000 Cash 210,000 Other Liabilities 175,000 $5IO>OOO $510,000 The bank whose balance sheet is given above normally maintains a reservedeposits ratio of 10 per cent and its customers on the average leave 10 per cent of their loans on deposit. What is the amount of its surplus reserve?

How much can it increase its loans without impairing its normal reservedeposits ratio? Draw up the balance sheet after the loans have been made and the proceeds drawn upon. c (1 - r) c 36. Apply both formulas, x = — ¯iandi= > kr+l-k kr+l-k in problem 35 and observe that the results are identical. 37. What is the three-fold process by which a normal ratio of reserves to deposits is reached in an individual bank? The twofold process, in the banking system? CHAPTER IV 1. Explain carefully why a given bank tends to retain its cash despite liberal lending, if all other banks are following an equally liberal lending policy. Substantially the same result would ensue if some banks 332 APPENDIX A in the system were investing in new banking houses or long term bonds, instead of increasing their loans. Why? 2. The banker regulates his cashdeposits ratio through his control over cash. If his cashdeposits ratio fell below the limits of law or prudence, would it be practicable to increase it by securing new primary deposits? By new derivative deposits?

3. Reserve and deposits in an individual bank are mutually determinative. Explain. 4. What force or forces impel the banker to contract his loans when cash runs low? What when cash is plethoric? 5. If, in the banking system as a whole, loans and deposits are a function of cash, why are the loans and deposits of an individual bank not a function of cash? 6. Comment upon whatever mutual determinism may exist between cash and deposits (and therefore loans) in the banking system regarded as an aggregate. CHAPTER V 1. Why would the accumulation of bank surplus, if that surplus were always matched by cash, result in weakening the protection of depositors in our national banks? 2. A new bank has reserves equal to its loans and to its deposits, and surplus reserves equal to its surplus. If it is brought, through an extension of its loans, into harmony with the system as to the reservedeposits ratio, would the new loans be several times the reserve or would the reserve become only a fraction of the new loans? What would be the relation of the surplus reserve to surplus after the new loans were made and the deposited proceeds drawn upon by check?

3. Why does surplus represented by cash in an individual but not isolated bank cease to be represented by cash when loan expansion founded on that cash occurs?

APPENDIX A 333 4. Show, by reference to a consolidated balance sheet, what takes place within a banking system when surplus is accumulated in relation to cash and creditor liabilities. 5. State and explain the causal relation between cash and deposits and between deposits and surplus. 6. Enumerate (a) factors or forces that admit of a reduction in ratio of cash to deposits without impairing the immediate convertibility of deposits and (b) factors that make for a lower ratio of surplus to creditor liabilities without reducing the chances of the ultimate payment of those liabilities. 7. In what sense is bank reserve "barren" ? 8. What are the facts in regard to the proportion of loss to the total deposits in national banks, 1881-1919? 9. Comment upon the relation of the protective items to deposits in our national banks January, 1914, and June, 1919, as shown in the subjoined table. January, 1914 June, 1919.

Capital Surplus and Undivided Profits $2,049,783,151 2,363,478,000 Deposits $ 8,393,372,772 15,924,865,000 10. The dependence of immediate convertibility of depositors' claims upon a cash reserve is of a different order from the dependence of the ultimate convertibility of creditors' claims upon surplus and other protective magnitudes. Explain. 11. Compare the first Bank of the United States, 1811, and the second Bank of the United States, 1829, as to (a) immediate convertibility of notes and deposits and (b) ultimate convertibiliijy of creditor liabilities, as below.

334 APPENDIX A First Bank of the United States (Incorporated by Congress in 1791 for 20 years) (In millions of dollars) Resources January, 1811 Ldabilüies Loans and discounts $14.6 Capital $10.0 U. S. 6 per cent and other Surplus 5 United States stock.... 2,8 Circulation 5.0 Due from other banks 9 Individual deposits 5.9 Real estate 5 United States deposits 1.9 Notes of other banks 4 Due to other banks 6 Specie 5.0 Unpaid drafts outstanding. .2 $24.2 $24.2 Second Bank of the United States (Chartered by Congress in 1816, for 20 years; renewal of charter denied; reorganized as a Pennsylvania corporation. The bank assigned in 1841, final liquidation taking place in 1856, when depositors and note holders were paid in full, interest and principal; the shareholders, however, receiving nothing on their investment.) (In millions of dollars) Resources Liabilities 1825 1829 1832 1826 1829 1SSÊ Lout and Discounts... $31.8 Í39.2 $66.3 Capital $35.0 $35.0 $35.0Stocks 18.4 16.1 Circulation 6.1 11.9 21.4RealEstate 1.5 2.3 2.1 Deposits 12.0 17.1 22.SBanking house 1.9 1.6 1.2 Due to foreign banks,Due from foreign bank-etc 2.4 1.4era .5 .1 Due to state banks.. 2.0Due from state banks.. 2.1 1.7 3.9 Other liabilities 8.0 3.4 1.6Notes of state banks... 1.1 1.3 2.2Specie 6.7 6.1 7.0 $63.5 $68.8 $82.8 $63.5 $68.8 $82.8 What was the comparative condition of the second Bank of the United States as to (a) immediate convertibility of notes and deposits and (b) ultimate convertibility of creditor liabilities in 1825, 1829, and 1832?

APPENDIX A 335 CHAPTER VI 1. What is the essential difference between a bankers' bank and a commercial bank? 2. How do bankers' banks dilute cash reserve? 3. Why is the term "reserve deposits" not a contradiction in terms? 4. (a) Why do reserve deposit liabilities tend merely to be transferred from the credit of one group of member banks to the credit of other member banks as a result of lending and checking operations and not to be withdrawn from the Federal Reserve banks when member banks expand their loans and deposits? (b) January 1, 1920, the Federal Reserve banks had surplus reserves of almost exactly .35 of a billion dollars. The same banks were required to maintain a 35 per cent reserve against deposits. How much paper could they rediscount without reducing their reserves below the legal minimum if the member banks took the entire proceeds in deposits? 5. Notes of the leading central banks (bankers' banks) of Europe are eligible for use as reserve by the commercial banks. How would an expansion of notes of those central banks differ in effect from an expansion of Federal Reserve notes?

6. Federal Reserve notes, through a monetary division of labor, make it possible for lawful money to be used in its most inflationistic capacity. Explain fully. 7. What determines whether proceeds of rediscounts or of loans will be taken by the member banks in Federal Reserve notes or in deposits? 8. Through what channels do Federal Reserve notes get into circulation? 9. Why would maximum bank credit expansion on the books of member banks take place if Federal Reserve note 336 APPENDIX A issues were kept at a minimum while deposits of Federal Reserve banks were extended to a maximum? 10. Draw a diagram showing the quantitative relation that would obtain between cash reserves in the Federal Reserve system and deposits of member banks if all loan expansion of the Federal Reserve banks took the form of deposits to the exclusion of notes. 11. Is the future credit expansion of member banks limited by existing surplus reserves of the Federal Reserve banks? Why?

12. What change or changes in the method of regulating the reservedeposits ratio of commercial banks did the establishment of the Federal Reserve system make possible? 13. Hold in mind the provision of the Federal Reserve Act that one Federal Reserve bank may rediscount for, i. e., lend to, another and point out the way or ways in which the ratio of cash to demand liabilities may be regulated in the case of an individual Federal Reserve bank, and the way or ways in which that ratio is regulated in the case of the twelve regional banks taken as an aggregate. "` 14. Compare the volume of bills discounted by the Federal Reserve banks for their members, as given in the table on page 115, with the volume of reserve deposits on the books of the regional institutions, as given in diagram 4, page 109. 15. Make a study of the application of the formulas c(l - r) c x - — — and x= to the operations of a Federal kr+l-k kr+l-k Reserve bank.

16. Why would a rediscount rate of 10 per cent be effective in checking over-extension of loans of member banks even when all banks were expanding their loans simultaneously? 17. Indicate the relation of the rate of rediscount to (a) APPENDIX A 337 volume of loans of member banks, (b) deposits on the books of member banks, and (c) the volume of trade. 18. What would be the effect upon general prices, if, during a period of rising prices and of great industrial and commercial activity, such as precedes a crisis or stringency, an addition of 10 per cent to the loans and deposits of commercial banks was offset by no perceptible expansion in the physical volume of trade, available productive energy having been almost fully utilized previously? 19. If during the early stages of industrial revival, after a depression following a crisis or stringency, with labor and capital only partially employed, a 10 per cent expansion of bank loans and deposits were matched by a corresponding expansion in the physical volume of trade, what would be the tendency in the course of general prices?

20. Which is the more nearly accurate form of statement: An expansion in bank loans and deposits causes a rise in prices, or that such an expansion makes possible a rise in prices? In answering do not overlook such considerations as the following: Any circumstance (e. g., additions to our stock of raoney metal, the issue of fiat money, a reduction in reserve requirements, increased use of checks), that tends to increase surplus reserves would tend temporarily to reduce the rate of interest, increase business profits, and stimulate business expansion. The increased demand for raw materials, labor and commodities, would result in higher prices and rising profits. Rising profits would give a further impulse to demand for goods and prices would rise still further. As prices rose a heavier and heavier demand would be made upon the banks for credit with which to finance the increased volume of trade. In time, as a result of increased bank loans and deposits, the reservedeposits ratio would become strained, interest rates would rise to a high point, and expansion be brought to a halt. The crest of a wave of prosperity would 338 APPENDIX A be reached and passed. (For an exhaustive treatment of the business cycle, see Wesley C. Mitchell's admirable work Business Cycles, The University of California Press, 1913.

Pages 571-579 contain a summarized statement of the theory there developed.) 21. What distinguishes the work of Federal Reserve banks from that of national and state banks acting as bankers' banks before 1914 ` CHAPTER VII 1. The use of endorsed paper led to endorsing for accommodation. Explain. 2. What was the composition of the American banker's portfolio contents in 1860? In 1880? 3. Give an account of the forces underlying the development of single name paper. 4. What main developments are shown in diagrams 4 and 5? 5. What are the facts concerning the note-brokerage business before the Civil War? 6. State the effects of the depreciated and fluctuating greenbacks upon the note-brokerage business 1862-79. 7. Describe the progress of note brokerage in the eighteen hundred and eighties. 8. Compare the method of handling paper before 1895 or 1900 with that of 1920. Under what circumstances do the note brokers perform a banking function?

9. Comment on the time and circumstances of the breaking down of the barrier that had previously prevented eastern capital from flowing to the West through note-brokerage channels. 10. Characterize the growth of the note-brokerage business after 1900. 11. The success of the brokers in weaning borrowers away APPENDIX A 339 from banks created a corresponding demand among banks for the paper purchased. Explain. 12. What degree of concentration marks the note-brokerage business? 13. Briefly describe the internal organization of a modern commercial paper house. 14. What is the causal connection between the seasonal demands for funds in United States and the growth of note brokerage? 15. Branch banking is opposed to the development of note brokerage. Explain. 16. State the comparative importance of the bill broker in England, France, and Germany. 17. What is the main purpose of the credit department?

18. Describe the progress made in credit research 18901900; since 1900. 19. What forces have underlain the development and spread of the credit department? 20. Sketch the rise of the new business department and indicate the relation between new business and credit departments. 21. How has the Federal Reserve system affected (a) the kinds of our bank loans and (b) their quality? 22. The Federal Reserve banks have been called the balance wheel of the open market for bank acceptances. What is the significance of the statement? 23. Our discount companies in New York frequently borrow in order to carry their holdings of paper. Their usual trading profit is said to be 1/16 of 1 per cent per annum. If a discount company is compelled at any time to pay 6 per cent for borrowed capital, call money, how long a time would be required to wipe out the profit of 1/16 of 1 per cent on a sixty day bill bought at 4 per cent discount?

24. The Guaranty Trust Company of New York has frequently bought its own acceptances in the open market.

340 APPENDIX A Why might an institution buy its own acceptances in preference to those of a competing bank if there was no difference in the discount rate? CHAPTER VIII 1. What is a borrower's credit worth? 2. Under what conditions may character become relatively inconspicuous as one of the pillars upon which bank credit rests? 3. Enumerate the principal quick assets appearing in the borrower's statement; the principal fixed assets. 4. Is the difference between quick and slow assets one of degree or of kind, or both? Defend your answer. 5. What amount of cash may be said to "balance" the borrower's statement? 6. How may the cash item be adulterated? 7. What is the imprest cash system? 8. Comment upon the relation of the size of the bank balance of the borrower to the season or seasons of his trade. 9. What is meant by "rigging" the cash? 10. Justify the requirement that a borrower keep a balance equal to 15 to 25 per cent of his loans.

11. How can the records of a bank be made useful in throwing light on the cash at times other than on statement dates? 12. In what trades does the note still hold its own against the encroachment of the open account? What would notes in other lines of trade indicate? 13. Discuss the relation of notes and accounts receivable to the volume of sales. 14. What questions are best designed to enlighten the banker as to the quality and value of the borrower's accounts receivable?

APPENDIX A 341 15. Why is the open account preferable to the note from the standpoint of taking quick legal action? 16. Why is it desirable to have an audit by accountants or special appraisers follow closely the annual or periodic inventory? 17. What is the banker's interest in the location of the goods inventoried? 18. Inventories vary widely according to the method of valuation. Illustrate. 19. What is the most approved basis of inventory valuation? 20. Why should the banker object to the omission of both goods bought and the liabilities therefor? 21. What is the objection to valuing unfinished goods at cost? 22. What are the main facts for the banker to bear in mind in connection with the valuation of real estate, plant and machinery? 23. For what should the bank credit man be on the lookout in scrutinizing the item stocks and bonds? 24. Lay down guiding principles in the appraisal of patents, trade-marks and goodwill.

25. What are deferred assets? Give examples. 26. Discuss life insurance as a contingent asset. CHAPTER IX 1. Classify the following liabilities as either current or slow: interest on bonds, reserves, sinking fund requirements, taxes, due from subsidiaries, dividends declared but unpaid. 2. What is the significance of a large amount of bills payable in lines of business in which open accounts ordinarily prevail? 3. What is the desirable relation between bills payable to banks and bills or accounts receivable?

342 APPENDEXJÀ 4. Why is it desirable for the lending banker to know the maximum amount borrowed from all sources during the previous fiscal year? 5. Why is the amount of "bills payable for paper sold" less likely to be understated now than in 1905 ? 6. Indicate the importance to the banker of discovering how the amount of accounts payable is ascertained. 7. If offsetting accounts payable by accounts receivable does not change the net worth, why is the practice objectionable? 8. What phases of "bonded debt and interest thereon" ought especially to engage the attention of the banker? 9. What is the significance of an overlapping mortgage? Of a thin equity? 10. (a) Why does the item "deposits of money with us" deserve close scrutiny? (b) What is the answer to the contention of those who urge that this item indicates additional security, as those closely interested are shown to be willing to entrust their money to the concern in question?

11. To treat contingent liabilities as current liabilities is very unfavorable to the borrower. Explain. 12. Give examples of accrued liabilities. How do they differ from deferred liabilities? 13. What importance, if any, is to be attached to the absence of accrued liabilities in the borrower's statement? 14. Distinguish capital and surplus from net worth. Why should the lending banker be interested in the size of the proprietorship interest? 15. Comment upon the proper ratio of quick assets to current liabilities. Cite cases in which variation from the usual ratio would be justifiable? 16. If you were a lending banker, whom would you require to keep the higher ratio of quick assets to current liabilities, a wholesale grocer or a wholesale milliner? Sugar APPENDIX A 343 planters or roasters and jobbers of coffee? Retailers of hardware or of groceries and green vegetables? Why? 17. A given firm shows the following condition: Feb. 1st April 1st Cash $20,000 $ 7,000 Bills Receivable 120,000 63,000 Merchandise 220,000 170,000 Total Quick Resources $360,000 240,000 Accounts Payable $110,000 $ 40,000 Other Current Debts 90,000 40,000 Total Current Debt $200,000 $ 80,000 Ratio of Quick Assets to Current Liabilities 180 per cent 300 per cent (a) How might the condition of April 1st grow out of that of February 1st?

(b) If the borrower submitted the figures for April 1st as a part of his statement to his banker, what additional information or maximum figures for the year would place the banker in a position to avoid lending, the condition of February 1st being normal? (c) Would this extreme case indicate that the ratio of quick assets to current obligations ought itself to be tested? 18. Statements of a given concern for two successive years show the same ratio of quick assets to current liabilities, but the ratio of merchandise to receivables is 3 to 2 the first year and 2 to 3 the second. If merchandise is carried at cost and receivables at their face value, which includes profit on merchandise sold, which year's statement is the stronger from the standpoint of the lending banker? 19. Working capital is quick assets minus current liabilities. Why might a period of depression have very adverse 344 APPENDIX A effects upon a concern whose ratio of working capital to fixed assets was low?

Would an examination of the yearly changes in this ratio throw light on whether the concern was gradually converting quick into fixed assets? 20. What is a proper or safe relation of net worth to credit worth? CHAPTER X 1. What is the effect upon profits of capitalizing repairs and maintenance? Of charging additions and betterments to repairs and maintenance? 2. What is the advantage to the banker of comparing the borrower's income accounts over a period of years? 3. What advantage in analyzing the income account has the large bank with several customers in the same line of trade over the small bank whose customers are few? 4. On what grounds does the lending banker object to the borrower's failure to insure fire risks adequately? 5. What is the banker's interest in salaries paid and cash withdrawn? 6. How may "depreciation" conceal "unearned" profits? Mention other methods of concealing losses or slender earnings?

7. Characterize the financial and accounting policy of the New England cotton mills. 8. Compare or contrast the following lines of industry as to proper charges for depreciation: clothing manufacture, shoe manufacture, lumber manufacture. 9. Why is the item of sales important to the lending banker? 10. Five years ago firm A had receivables of $150,000 and sales of $900,000 per year, terms being 60 days net; this year, receivables are $120,000 and sales $1,000,000, terms APPENDIX A 345 being 30 days net. In which case, presumably, is the quality of the receivables the higher? 11. What would be your interpretation of increasing sales from year to year coupled with a declining ratio of sales to merchandise? 12. Where sales terms are sixty days net, how would the sales to receivables ratio stand if the statement were as of a date representing the peak of the selling season? (Reminder: Sales relate to a period of time; receivables to an instant of time.) 13. If sales terms of a given firm having sales of $1,800-, 000 are two per cent discount in ten days and 30 days net, at what amount, roughly, ought the receivables to stand?

14. Why ought the credit man of the bank look carefully into the ratio of net worth to sales? What is overtrading? 15. One manufacturer of brushes has a capital investment of $100,000, sales of $300,000 and net profits of $20,000. Another has a capital of $100,000, sales of $500,000 and net profits of $20,000. If the moral risk and other factors are equally good in the two cases, which manufacturer has the higher credit worth? Which is the more important from the standpoint of the lending banker, the ratio of net profits to sales or the ratio of net profits to capital investment? 16. Why should an unbroken symmetrical gain in net profits put the banker on his guard? 17. Illustrate the importance of collateral information in regard to earnings. 18. Under what conditions may dividends be much less than earnings and still be improper? 19. Outline three or more reflex benefits of bank borrowers' statements.

20. Why do some borrowers refuse to render statements? 21. A wool house has the following assets and liabilities: 346 APPENDIX A cash $189,000, accounts receivable $382,500, inventory $1,236,550, marketable securities $353,500, advances on wool bought $298,500, real estate $20,000, equipment and machinery $16,000, other fixed assets $9,000, bills payable $722,325, acceptances (payable) $216,510, accounts payable $831,550, reserves $294,000, deposits of money $64,500. What is the ratio of quick assets to current liabilities? What is the net worth? 22. The following statement is that of a wholesale grocery house and is taken at a representative date: Liabilities Cash S 406,826.32 Bills Payable $1,100,000.00 Accounts Receivable 1,806,715.14 Accounts Payable. 206,530.45 Merchandise 1,783,945.60 Money on Deposit 723,942.19 Real Estate 1,643,000.00 First Mortgage Machinery, Trucks, Bonds 1,500,000.00 Wagons, etc.... 157,435.00 Preferred Stock... 1,500,000.00 Goodwill 1,000,000.00 Common Stock... 1,000,000.00 Surplus 767,449.42 $6,797,922.06 $6,797,922.06 Sales $19,448,860.00 (a) What is the ratio of quick assets to liabilities?

(b) What evidence is there that the concern discounts its bills? (c) What would the turnover indicate as to the quality of the merchandise? (d) How much could be realized on goodwill in the event of failure? (e) The indenture covering the bonds overlaps from real estate to merchandise and other quick assets, but the assets back of the bonds are sound and saleable. Is the overlapping feature a weakness? What items in the stateAPPENDIX A 347 ment might cause a banker to suspect an overlapping indenture? Are there any other elements of weakness in the statement? (f) The moral risk being sound, what is the amount up to which you would be willing as a lending officer to extend further credit? 23. Draw up the financial statement of a corporation engaged in the manufacture of edge tools with a capital stock of $100,000 and other items of such magnitude and in such proportion as to give the concern a credit worth of $100,000, the moral risk being sound.

24. Calculate the credit worth of the American Agricultural Chemical Company whose certified balance sheet and income account are subjoined, assuming the moral risk to be excellent. BALANCE SHEET, JUNE 30, 1919 INCLUDINQ SOBSIDIABY COMPANIES Assets Capital Assets: Land, Buildings and Machinery $16,918,681.18Equipment and Floating Property 4,369,278.60Mining Properties 19,487,800.85Other Investments 6,411,621.15Brands, Trade-Marks, Patents, GoodWill, etc 1.00 Total Capital Asseta $ 47,187,282.68 Sinking Fund:For Redemption of Bonds $ 3,513,111.22Less Bonds Purchased, Interest and Premium 3,512,076.05 S 1,038.17 Deferred Assets: Unexpired Insurance, Taxes, Licenses, etc $ 379,345.60Guaranteed Accounts Receivable, incomplete newconstruction, expenditures chargeable to futureoperations, eto 2,351,686.31 Advance Payments, Merchandise Purchased 163,206.38 S 2,894,238.29 Ourrent Assets: Accounts Receivable $26,168,066.54Notes Receivable 10,217,338.27Inventories (Merchandise and Supplies) 19,514,430.45Cash in Banks, on hand and in transit 2,526,184.44ü. 8. Bonds and Notes 2,225,000.00 Total Current Assets t 60,681,019.70 $110,733,575.84 348 APPENDIX A LiabilitiesCapital Liabüitim:Preferred Stock $50,000,000.00Less Uniasued 21,615,800.00 — $28,384,200.00Common Stock $50,000,000.00Less Unissued 18,344,800.00 $31,655,200.00 Total Capital Stock Outstanding $ 60,039,400.00 First Mortgage:b% 20-Year Convertible Gold Bonds, due Oct. 1,1928 12,000,000.00Less Bonds Purchased for SinkingFund $ 3,415,000.00Less Bonds Converted into PreferredStock 1,142,000.00 4,557,000.00 Total First Mortgage Bonds Outstanding $ 7,443,000.00 Debenture Bonds:5% Convertible Gold Debenture Bonds, due Feb. 1,1924 $15,000,000.00Less Bondä Converted into Common Stock $ 3,739,900.00Less Unissued 5,900,000.00 $ 9,639,900.00 Total Debenture Bonds Outstanding $ 5,360,100.00 Deferred Liabilities:Reserve for Doubtful Debts and Contingencies. .. .$ 532,832.64Reserve for Property Depreciation 1,241,126.96Reserve for Property Renewals 276,739.92 $ 2,050,699.52Current Liabilities:Accounts Payable and Accrued Taxes $ 2,855,011.03Notes Payable 12,887,500.00Notes Payable (secured by U. S. Bonds and Notes).. 2,030,000.00Accrued Freights and Discounts 782,680.58Accrued Interest on Bonds 204,706.25 Total Current Liabilities $ 18,759,897.86 Surplus, June 30, 1919 17,080,478.46 $110,733,575.84 INCOME ACCOUNT FOR THE YEAR ENDED JUNE 30, 1919 Surplus at June 30, 1918 $16,394,829.80Income (including profits of subsidiary companies)after deducting operating charges, Plus Taxes($2,123,836.05) which include Federal Taxes forthe Calendar Year 1918 $ 8,035,854.30 Income from Other Sources 170,274.07 Total Inoome $ 8,206,128.37 Deduct:Interest on Mortgage Bonds $ 404,001.36Interest on Debenture Bonds 380,784.34For Freights, Losses and Contingencies 968,463.06For Factory Depreciation and MiningDepletion 2,294,209.52 $ 4,047,458.28 Net Profit for the Year $ 4,158,670.09 APPENDIX A 349 «auct:Dividends on Preferred Stock ( 1,659,896.33 Dividends on Common Stock 1,813,125.20 * 3,473.021.63 Surplus for the Year 886,848.M Surplus June 30, 1919 117,080,478.46 Profits and Dividends Since Organization, Ì8ÕS Total Profits to June 30, 1918 $53,679,003.68 Profit for the year ended June 30, 1919 4,158,670.09 Total Profits, June 30, 1919 *57,S37,673.78 Deduct: Dividends on Preferred Stock $25,752,923.12 Dividends on Common Stock 7,047,692.37 $32,800,615.49 Deductions to June 30, 1919 7,956,579.80 $40,757,195.29 Surplus, June 30, 1919 $17,080,478.46 25. Read carefully Appendix B and note any important considerations not dwelt upon in chapters VIII-X.

CHAPTER XI 1. Of what use would the Textile Trade Directory be to a credit man about to investigate the credit standing of a prospective customer engaged in the manufacture of woolens? 2. In what respects are the reports of mercantile agencies of value to the bank credit man? 3. Why is the class of firms from which a house buys goods a good index of credit standing? 4. Why does the mercantile credit man not begrudge time spent in being interviewed by the bank credit man? 5. What are the most important questions the investigator representing the bank credit department can ask? The most important single question? 6. In what ways may the banker avail himself of the advice of the trade expert? 7. State the main facts concerning banks as sources of credit information stressing (a) the reciprocal value of in) 350 APPENDIX A quiries, (b) the credence of the banker's testimony, (c) the difficulty of obtaining first hand information.

8. Formulate interview questions bearing upon the following aspects of the bank customer's business: Profits, dividends, business experience, reserves, life insurance, accounts receivable pledged, rate of interest paid on "money on deposit with us," proportion of capital paid in by notes, outside interests of partners, minimum bank borrowings, other bank accounts, sales and sales terms, contingent liability. 9. Describe the way in which the credit department of a metropolitan bank would investigate the credit standing of the Turnbull Wagon Company located at Defiance, Ohio. CHAPTER XII 1. What are the principal classes of secured loans? 2. Compare the interest of the New York banker in securities offered as collateral with the interest of a banker at Baltimore, Indianapolis or El Paso. 3. Comment on the importance of safe or full margin in connection with collateral loans. 4. Why are life insurance policies superior to stocks and bonds as security?

5. What was the probable origin of loans on warehouse receipts as security? 6. What are the chief factors affecting the safety of loans on warehouse receipts? 7. What is the advantage to the banker of using receipts based on one bale lots in connection with cotton loans? 8. What rules may well guide the banker in making crop loans? 9. On what valuation ought an urban real estate loan to be made?

APPENDIX A 351 10. Why are vacant properties dangerous as security for loans? A costly property in a poor neighborhood? 11. Enumerate and appraise the most important circumstances affecting the value of farm land as security. 12. Why are loans on high-priced land likely to be sounder than those on low-priced tracts? CHAPTER XIII 1. How does the " cash credit " of Scotland differ from the American overdraft? 2. Classify overdrafts with reference to the offenders. 3. What is the relation between bank competition and overdrafts? 4. Why are overdrafts an objectionable form of credit advance? 5. Compare national and state banks as to ratio of overdrafts to loans; trust companies and private banks. 6. Which rules given for controlling overdrafts would be of greatest value to a newly established bank? Which to an old institution? 7. Cite evidence that overdrafts are a function of bank supervision.

8. Would a bank examiner finding a customarily large overdraft item on the books of a bank under examination be justified in reversing his usual benevolent assumption that loans are sound? CHAPTER XIV 1. Why is the country banker justified in giving more consideration to character and capacity and less to the capital of the borrower than would the city banker? 2. Compare the selective power exercised in the choice of customers by the First National Bank of Boston and the First National Bank of Wahoo, Nebraska.

352 APPENDIX A 3. Why does the balance of the typical country bank borrower run low as compared with the same in city banks? 4. Characterize the country banker's demand loans against collateral. 5. What are "sleepers?" Why are they more common in the country than in city banks? 6. Under what conditions might a country bank have no loans in its financial statement? 7. Under what conditions ought the banker to renew paper? 8. Why is single-name paper less productive of past-due paper than is double-name? 9. In what way is the note ledger a spur to prompt retirement of loans? 10. What other measures can you mention as conducive to prompt payment? 11. Under what conditions ought loans to tenants prove advantageous to the banker? 12. Is the country banker justified in charging higher rates than the city banker? Why? CHAPTER XV 1. State and explain methods by which one bank may lend to another.

2. If unrated paper is that the maker of which is not rated by the mercantile agencies, why does it compare favorably with rated paper as collateral security in the estimation of the lending banker? 3. What is non-liability paper? 4. Along what lines does the representative of a metropolitan bank attempt to secure credit information at bankers' conventions? 5. The way in which a borrowing bank handles its acAPPENDIX A 353 eount with the city correspondent is a significant indication of the character of the borrowing institution. Amplify. 6. Give an account of the method of investigation employed by a bank in New York preparatory to making a loan to one of its correspondents. CHAPTER XVI 1. Account for the prevalence of the partnership form of organization among note brokerage houses. 2. The resourcefulness of the note broker is as important as his resources. Explain. 3. What are the principal kinds and relative proportions of paper passing through the hands of our note brokers?

4. What are the usual denominations of broker's paper? Why? 5. Explain fully what is meant by buying paper on seveD or ten days' option. 6. What is the broker's commission? Why may he make more or less than his commission? 7. What is the significance of the fact that the broker's commission is without respect to the time the note has to run? 8. Analyze the advantages of broker's paper to borrowers. 9. What are the disadvantages of broker's paper to the borrower? 10. Analyze the advantages of broker's paper to buying banks. 11. How high a premium does the banker have to pay for broker's paper as compared with "straight" paper? 12. Explain carefully the control exercised by the note brokerage houses over our banks. 13. Why is the note broker at any given time under an inducement to depress money rates? How has he attained this end?

354 APPENDIX A 14. The note brokerage system has tended to equalize discount rates territorially. Can as much be said of the system in relation to periods of time? 15. Under what conditions during a period of tight money would the proceeds of bank loans made directly to borrowers returning from the brokers' fold "go straight into the reserve" of banks in other communities? 16. If money rates were high in the St. Louis district and low in the Cleveland district, would the purchase of St. Louis paper by banks in the Cleveland district tend to set up a flow of bank reserves from Cleveland to St. Louis? Explain in detail, assuming that the paper passes through a note brokerage house of Chicago. 17. Why is the note brokerage system favorable to overexpansion? 18. How was it possible for the H. B. Claflin Company to borrow so heavily and so widely? 19. Describe and appraise methods designed to correct the weaknesses inherent in the note brokerage system.

CHAPTER XVII 1. Contrast internal and external bank examination as to purpose or object. 2. Characterize our national bank supervision prior to 1907. 3. What have been the main improvements inaugurated in the system of examination since 1907. 4. Along what lines has improvement been effected in state bank supervision. 5. To what extent is cooperation the rule among our supervising agencies? 6. What was the origin of clearing house bank examination? 7. What are the main features of the system of clearing house bank examination?

APPENDIX A 356 S. What merits are peculiar to the clearing house system of bank examination? 9. What has been the effect of clearing house examination upon the loans of small banks? 10. How has clearing house bank examination reduced double or multiple borrowing? 11. What incidental effects on loans and on banks may be traced to clearing house bank examination? 12. What are the weaknesses of the various forms of internal bank examination? 13. Describe the system of examination by accountants for banks in Group 1 of the New Jersey Bankers' Association. 14. Why ought bank examination by directors be welcomed by state banking departments?