VII Recent Changes in Our Bank Credit Arrangements

123 124 BANK CREDIT One of the outstanding features of our banking practice during the last half century or more is the change of emphasis placed on the personal standing of the borrower. Fifty or sixty years ago single name paper was scarcely known. Banks refused to make advances on the security afforded by the borrower's signature alone and insisted upon one or more endorsers. The banker who loaned on single name paper without additional security was regarded as the reverse of conservative, if not positively reckless. In the country districts, where borrowed money was invested largely in fixed property and where the money was loaned on endorsed accommodation paper more extensively than in the large centers, borrowers sometimes became so involved as endorsers for one another that there resulted a situation, which, when pressure was brought to bear for payment) resembled a row of bricks standing on end so that if one were knocked down, it would fall on another until all were bowled over.1 The use of endorsed paper led to endorsing for accommodation. When a borrower had no more customers' notes he applied to one of his friends to exchange his note for his own and had it discounted at his bank. The friend did the same thing in his (a different) bank. Whenever one of these accommodation endorsers got into trouble the other was affected adversely, and heavy losses occurred yearly by what was called two-name paper.2 Endorsed accommodation 1 James B. Forgan, Evolution in Banking Thought during the Past Generation, Bulletin, National Association of Credit Men, Vol. XIX, p. 935.

s E. Naumburg, Annalist, Vol. Ill, No. 62, March 23,1914, p. 361.

RECENT CHANGES IN CREDIT ARRANGEMENTS 125 paper, with a heavy sprinkling of endorsed trade paper and acceptances, bulked large in bankers' receivables before the disturbing effects of the Civil War were felt. The evolution from this system of endorsed accommodation paper and endorsed trade paper, i. e., notes given by buyer to seller and endorsed by the latter, was to discount chiefly double name commercial paper representing bona fide business transactions and given for value received in merchandise. Under this system, which reached its culmination about 1880 accommodation paper was regarded as dangerous and was diligently eschewed. But in spite of the best efforts of the bankers, accommodation paper continued to be floated. Notes originally given for merchandise purchased became after several renewals the worst kind of accommodation paper because they enabled the borrowing customers of a bank to carry along delinquent debtors indefinitely.1 Then developed in trade the present discount system under which merchandise or manufactured wares are sold subject to a discount for cash or for a short term payment, goods being billed on open account. In order to take advantage of the liberal discounts offered for cash or early payment, merchants and manufacturers were under a strong incentive to borrow, and did borrow, from at first the bolder and later from even the most conservative bankers, on unsecured single name paper. The theory is that business concerns should buy their merchandise or raw materials as nearly for cash as possible and borrow directly or in1 Cƒ. James B. Forgan, op. cit., p. 936.

126 BANK CREDIT directly from banks to enable them to do so.1 This system developed until it has become so general a practice that we may profitably note the forces underlying its development. The Civil War with the greenbacks depreciated and fluctuating in value, and the demand for commodities outrunning supply, induced a marked shortening of the credit period, to thirty or even ten days. The system thus inaugurated became a settled trade custom in connection with which manufacturers and distributers began about 1880 to offer large discounts for cash payment. Competition in the eighties among our rapidly growing producing and marketing agencies resulted in the practice of selling through traveling salesmen and by sample. The buyer no longer found it desirable to visit the seller's store and to purchase from a stock of goods prepared in advance, and the old condition of "caveat emptor" gave way to the doctrine of implied warranties. In other words the risk and responsibility of the delivery was laid upon the seller instead of on the buyer, the buyer no longer consenting to fixing the price of the merchandise so firmly as to preclude the possibility of claims in deduction from the account. The doctrine of implied warranties and the open account came forward hand in hand. Once the practice of selling on open account was established, it was natural for sellers to stimulate promptness by offering liberal cash discounts. The introduction of discounts for cash, which took place in the early eighties, when growing competition among sellers tended to lengthen the credit period, impelled buyers to borrow i Ibid., p. 936.

RECENT CHANGES IN CREDIT ARRANGEMENTS 127 directly from their banks in order to take advantage of the discounts offered.1 The system of borrowing by the buyer on his own responsibility, which was a consequence of the introduction of cash discounts, has in the minds of many proved superior to the old methods of endorsed paper, which involved so many borrowers in complications and often led to the hiding of assets by endorsers to avoid the payment of obligations from which they had received no benefit. Although the introduction of the practice of financing trade by single name paper has been referred to as occurring in the eighties of the last century, it would be wrong to suppose that single name paper had not been employed here and there previously. Shortly after the crisis of 1873 banks in New York City began to discount single name paper for their customers, even though such notes had been sold to banks by brokers much earlier. The late president of the Importers and Traders Bank of New York, Mr. Buell, is frequently referred to as the pioneer in this field. He showed his customers the advantage of borrowing on their general credit standing in order to obtain cash prices on their purchases and thus show a margin of profit on their discount transactions.2 The first detailed classification of the loans of New York banks contained in the Reports of the Comptroller of the Currency is for the year 1874 and shows i Edward D. Page, Annalist, March 16, 1914, Vol. Ill, No. 61, pp. 324, 325.

*J. J. Klein, Commercial Importance of Single Name Paper, Annalist, Vol. Ill, No. 62, March 23,1914, p. 361.

128 BANK CREDIT Pea CENT. 100 90 80 7O 60 SO 40 ÒO 20 10 V¦> o L 707S 7860 J885 t89O 189S tSOO Diagram 5 ill \ \ i / / ^^ENDOR¿ SlN<}LE, Secuee •—•—. NAME A ¤¿OAN y/ « z. / \ \ «—Pen CENTtoo 9O So 7o 60 SO 40 30 20 to O/sos røro rsrs that single name paper in that year constituted 9.8 per cent of the total, and endorsed paper, 57.8 per cent of the total. The relative importance of the main kinds of loans of the national banks of New York, 1875-1914, is shown by diagram 5, and of the national banks of the entire country, for the period 1880-1914, by diaRECENT CHANGES IN CREDIT ARRANGEMENTS 129 too 90 80 70 60 JO 40 30 20 10 A I (/ / \ •ENOOfå 'SINGLE -Secua¿ SEOfM* N*ME fì -¤¿OANÍ røe kP£R — !· too 90 eo 4O so 20 to ieeo teas reso re9s ta<×r taos ia*s Diagram 6 grain 6.x Changes in the classification of loans after 1914 render the extension of the curves beyond that year impracticable. 1 In drawing the chart of loans of all national baaka it has been 130 BANK CREDIT State banks and trust companies show a strikingly smaller percentage of both single name and of endorsed paper than do national banks. The ratio of single name paper to total loans of state banks and trust companies in 1910 was only a scant 10 per cent, and endorsed paper constituted approximately 15 per cent, of the total. Loans secured by collateral in the case of state banks and trust companies were 29 per cent of the total, whereas the same class of loans made by national banks was 36 per cent of the total. Loans on real estate combined with mortgages owned by state banks and trust companies, on the other hand, constituted 38.1 per cent of their total loans.1 The paper held by state banks and trust companies is even less strictly "commercial" and liquid in its nature than that held by national banks.

Closely related to the evolution of the form of the bank borrower's obligation is the rise and development of note brokerage as a system of buying and selling both secured and unsecured paper,—but payable alfound advisable, on account of classification changes made in the Reports of the Comptroller of the Currency, to estimate the amount of endorsed paper for the period 1880 to 1888. The margin of error, however, is almost negligibly small. For the period 1891 to 1914 the item "on demand, paper with one or more individual or firm names" was divided arbitrarily and equally between endorsed paper and single name paper. In the classification of loans of the national banks of New York City 1875 to 1890, loans classified as "payable in gold" and "all other loans," together amounting to approximately 4 per cent of the total, were discarded. For the period, 1891 to 1914, the item "on demand, paper with one or more individual or firm names" was divided equally as above between endorsed and single name paper.

1 Report of the Comptroller of the Currency, .1910, p. 55.

RECENT CHANGES IN CREDIT ARRANGEMENTS 131 ways on time, never on demand. As the following pages will show, the beginnings of the note brokerage system reached back far into the last century. The Growth of Note Brokerage The development of the work of note brokerage or commercial paper houses in the United States has proceeded a long way without having attracted much serious attention. Handling wares of little bulk in proportion to value, occupying relatively small and inconspicuous quarters, and seldom attempting to secure publicity through the medium of advertising, note brokerage concerns have come in large measure unobserved to occupy an important and unique place in our credit organization. For at least twentyfive years before the outbreak of the Civil War a small class of dealers handled trade acceptances and receivables chiefly on a commission basis. Mr. Henry Clews, whose banking and brokerage house was the first in New York City to introduce the practice of buying these obligations outright has given an account of the work of the ante-bellum dealers that is so pertinent and illuminating as to deserve reproduction.

At the time I visited Washington [in 1861] my firm was more largely engaged in dealing in mercantile paper than any other branch of Wall Street business. I had inaugurated the system at the time of my advent to the "Street" of buying merchants' acceptances and receivables out and out, the rate being governed by the prevailing ruling xate for money, with the usual commission added.

132 BANK CREDIT It was by this method that my firm soon became the largest dealers in mercantile paper, which business had formerly been controlled by two other firms for at least a quarter of a century, and whose old fogy methods were by my innovations easily eclipsed. The merchants at that time would go to these discount firms and leave their receivables, bearing their endorsements, on sale there, and only when sold by piecemeal could they obtain the avails thereof. The more expeditious plan that I adopted, which was to give these negotiators a check at sight, seemed generally to merit their approbation, and enabled me to command the situation in that line of business, very much to the chagrin of my competitors. In this way my firm had accumulated about five hundred thousand dollars in notes, which were hypothecated with various city and country banks. After coming to the conclusion ... in regard to the certainty of a ... prolonged and desperate war, I made quick steps back to New York to dispose of my paper. I went vigorously to work, and succeeded in unloading all but ten thousand dollars of short time notes made by Lane, Boyce & Co., and a note of $500 of Edward Lambert & Co.

I had no sooner accomplished this very desirable work of shifting my burden, and distributing it in a more equable manner on the shoulders of others, but at higher rates than I paid, than in less than a week after my return from Washington the exciting news arrived of the firing of the first hostile gun at Fort Sumter. The announcement of this overt act of war spread like wildfire, and the wildest scenes of excitement and consternation were witnessed in Wall Street and throughout the entire business community. The whole country was panic stricken in an instant. . . .

RECENT CHANGES IN CREDIT ARRANGEMENTS 133 The two firms whose paper I was unable to dispose of were about the first to fail, and before the maturity of any of the balance of the paper which I had successfully negotiated both the drawers and endorsers thereon, without an exception, all collapsed.1 The financial and trade disturbances of the Civil War did not end with its termination and the commercial paper business was of slender proportions during the period of the inconvertible greenback, 1862-1878. During the greenback period fluctuations in the value of irredeemable currency made the extension of credit for any considerable length of time extremely risky. The approach of the resumption of specie payments was the signal for resuming the practice of selling goods on long time, and as the volume of notes and accounts receivable grew under the influence of lengthening credit terms, business concerns were impelled either to borrow from banks or sell their own paper through note brokers.

During the eighties great progress occurred in the development of note brokerage. Before the close of the decade of the eighties paper dealers doing an extensive business had been established as far west as Chicago, Milwaukee, Kansas City, St. Louis, St. Paul, and Minneapolis. Over thirty millions of paper was sold by one western house previously to 1887, before a single default in payment occurred.2 Prior to 1895 or 1900 handling paper on consign1 Henry Clews, Fifty Years in Wall Street, Irving Publishing Company, 1908, pp. 78, 79. • W. H. Baker and H. N. Kingman, Commercial Paper, Proceedings, American Bankers' Association, 1887, pp. 46, 47.

134 BANK CREDIT ment was very common. Since that time the practice has fallen increasingly into disfavor. The volume of paper handled on a commission basis has dwindled and almost disappeared. Commercial paper houses now buy paper outright almost invariably, and to the extent that they hold it, whether through choice or necessity, perform a banking function. Dealers in paper now have a livelier sense of responsibility for its soundness and liquidity than when they worked for a commission. The intersectional activity of the paper dealers was slow in developing. As late as 1887 eastern banking funds were still confined to investment in eastern paper, even though the dealers of the West were floating trade paper that proved attractive to the banks of that section at a time when accommodation paper was growing rapidly in volume in the East. Eastern banks preferred "accommodation" paper to the receivables of the expanding West.1 The year 1890 marks in a rough way the breaking down of the barrier which had previously prevented eastern capital from flowing to the West through the channels afforded by the note brokers. Just at the time when there seemed to be an opportunity for bankers in the West, the Iowa group of states, to dispose of idle funds at profitable rates, the "festive"

note broker made his presence felt in banking circles, disturbing with his eastern capital the harmonious relations between banker and borrower.2 It was natural 1 Op. at., p. 47. * J. K. Deming, Modern Methods of Soliciting Business, Proceedings, Sixth Annual Meeting, Iowa Bankers' Association, 1892, p. 21.

RECENT CHANGES IN CREDIT ARRANGEMENTS 135 that the first brokerage connections established between the East and the West should have resulted in a flow of capital westward. As potential borrowers from banks in any particular locality sold their paper more and more through note brokers, surplus funds in that locality accumulated, and gave birth there to a demand for broker's paper. The more paper the brokers obtained through solicitation or otherwise, the greater became the buying demand of the banks. The situation was and remains a peculiar one and goes far to explain the rapid spread of the note brokerage system. Although the volume of paper placed by the dealers had reached large proportions before 1900, the growth of the business both in point of volume and territorial ramifications since that date has overshadowed its previous development. The following tabular statement throws light on the expansion of the operations of paper houses into sections whose economic development has occurred largely in our own time, and shows how in certain representative localities the solicitation of the buying departments of note brokerage concerns paved the way for the paper salesmen in the same localities.

Approximate date of Approximate date of City first sale of paper first sale of paper by local concerns by brokers to local to brokers banks Akron, Ohio 1902 1906 Columbus, Ohio 1907 1912 Joliet, Illinois 1908 Dallas, Texas 1910 1910 Portland, Oregon 1906 1908 Spokane, Washington 1911 1911 136 BANK CREDIT The a priori notion that the purchase of paper by brokers must have created a demand for paper on the part of banks whose borrowing customers were induced to dispose of their obligations through brokers, tallies with the contention, based in part on the table given, that the market for the wares of the paper dealer was the inevitable product of his own buying effort and power. There were of course many exceptions. Banks in localities having a widely diversified commercial or industrial development with few or no concerns of sufficient size and importance to borrow through brokers might naturally buy broker's paper long before customers of local banks were led to place paper in the open market. Banks in thrifty towns in the East may have found a natural outlet for their surplus funds in the purchase of broker's paper, even though local borrowing concerns never utilized the services of the note broker.

ïn some instances local borrowing demands were in excess of the local supply of short time funds and borrowers placed paper in the open market long before the banks were in condition to buy outside paper. St. Joseph, Missouri, affords an illustration. The jobbing houses located there sold their paper in the Eastern market for many years before the St. Joseph banks began, about 1900, to purchase commercial paper offered by brokers. The bank credit demands of the jobbing business of St. Joseph have always been in excess of the lending facilities of the local banks, and jobbers using a great deal of money have secured funds through the sale of notes placed with brokers, and have also opened accounts in New York and other cities in order to obtain larger accommodation.

REGENT CHANGES IN CREDIT ARRANGEMENTS 137 The situation in the country as a whole was, nevertheless, one where the solicitation of paper by the brokers had almost unique results: their success in weaning customers away from banks was productive of a corresponding demand for the very paper acquired by solicitation. The extraordinary growth in the work of the commercial paper houses during the last quarter century has been accomplished without a corresponding increase in the number of houses. The tendency has been for the stronger houses to build up an extensive system of branches and correspondents covering wide territory, as opposed to extension through an increase in the number of individual brokerage concerns. In some cases the branch principle has developed to a point where the branches participate in buying, and there is a general trend toward concentration of the entire business in a few hands. Experience has led some houses maintaining few branches, or none at all, to favor distribution through correspondents rather than through branches.

Boston has at present six local houses and four or five branches of concerns located in other cities. New York has a total of twenty-three houses, many of which, as elsewhere, are not engaged exclusively in the purchase and sale of commercial paper, but handle stocks, bonds, foreign exchange, etc. The modern commercial paper house is a somewhat complex business organization. Buying, credit, and selling departments contribute to efficiency and soundness of operation. The buying department is charged with finding desirable concerns from which the house 138 BANK CREDIT may buy, but it is only after the credit department, employing methods and having interests similar to those of the bank credit department, has approved an advance of funds, that the paper is bought. The selling department sells both "by list" and through personal solicitation. A large proportion of the paper handled is now sold by traveling representatives, who work in regularly assigned territory.

The depleted sales-forces of war-time had the volume of their sales affected adversely by the demands of the government upon the loanable funds of the banks, and many of the salesmen might have retired from the field but for the rediscount facilities afforded by the Federal Reserve system, which have tended to increase the amount of money available for the purchase of the note broker's offering. Seasonal Demands for Funds in Relation to the Growth of Note Brokerage The rise of commercial paper houses has an intimate connection with the seasonal character of the demand for funds in large sections of the country. As regularly as seed tune and harvest occurred bankers in the agricultural sections of the country found it desirable to be in a position to withdraw or secure funds from other than local sources in order to meet the local demand. In other words, it was the business and duty of the banks in the agricultural sections so to time their loans and so to make their investments of surplus funds as to meet these recurring seasonal demands with certainty and without disarrangement of local credits.

No form of investment filled the requirements of the RECENT CHANGES IN CREDIT ARRANGEMENTS 139 case so well as selected notes of distant concerns. Twenty years ago when loans were almost entirely local, surplus funds of country banks were invested largely in high class bonds and similar securities, which were held with the idea of sale when the local demand for funds outran the local supply. A bank holding such securities, however, had no disposition to sell them until money became scarce. But it was at just such times that the security market became unfavorable and restricted. Banks, having found the extensive holding of securities for such purposes unprofitable and undesirable, invested their surplus funds more and more in paper offered by note brokerage houses. The demands upon commercial banks which necessitated their carrying increasingly large amounts of loans the payment of which could be counted upon with certainty was long one of the chief sustaining forces of the note brokerage business.1 Independent Banking and the Rise of Note Brokerage The growth of the note brokerage business and the prominent role now played by the note broker as an intermediary between banks and borrowers in the United States are closely related also to our system of independent banks without branches. American banks having loanable funds in excess of local demands found it natural and profitable to purchase the paper of borrowers in other communities where local banks were unable to meet the demands of their customers. This 1 Cf. Jos. T. Talbert, Commercial Paper, Proceedings, Nineteenth Annual Convention, Minnesota Bankers' Association, 1908, pp. 42, 44.

140 BANK CREDIT persistent disparity between the lending power of local banks and the effective demand for bank credit has constituted the note brokers' opportunity, and the brokerage houses have been keenly responsive in affording facilities for putting banks having surplus funds in touch with distant borrowers in need of short time capital. Had we developed a system of branch banks the supply of bank credit and the demand for funds would have been equated without any needed intervention of other agencies. The branch banking system as seen in England, France, Germany and, even more strikingly, in Scotland and Canada, not only furnishes the mechanism for connecting communities widely different in their credit needs but also is capable, by reason of the large resources of the individual banks, of meeting the demands of heavy borrowers, leaving thereby no place for the activity of paper dealers.

Commercial paper houses as intermediaries between banks and borrowers and working as an adjunct to our banking system promote the flow of funds from one point or section where the demand is slight to other places where the need is pressing, distributing loanable funds in a manner analogous to that of a system of branch banks. There is, however, one important point of difference. Branch banking so equates demand and supply that every part or unit of the system bears its proper share of strain when strain comes. The note brokerage system, operating as an adjunct of independent banks, fails thus to equalize the pressure or strain. Under our system of note brokerage and independent banking those banks holding a minimum of local loans and a RECENT CHANGES IN CREDIT ARRANGEMENTS 141 maximum of broker's paper are relieved of strain in a stringency, while others with less paper and heavier local loans meet the demands of their borrowers with less ease. The branch banking system may be likened to a system of reservoirs with inter-connecting pipes always ample and unobstructed; whereas the note brokerage system, while always constituting channels for the inter-flow of short time capital from section to section, fails to function efficiently during periods of tight money and crisis. Then the flow of the currents of short time funds becomes impeded and disturbed.

The eight Scotch banks with their branches numbering approximately thirteen hundred, and the nineteen chartered banks of Canada with their thirtyfive hundred branches serve adequately as collectors of cash and distributers of credit. The paper dealer is of no importance in the distribution of credit in France, and plays only a negligible part in Germany. The English bill brokers and discount houses perform a function similar to that of our note brokers, but are concerned pretty largely with bills used to finance international transactions. Wherever branch banking develops widely the work of note brokers is excluded as supplementary and unnecessary. There is, on the contrary, a natural fitness between the note broker and independent local banking. The service of our own note brokers is not supplementary to that of the banks, but complementary and economically justifiable. The New Attitude of Bankers toward Broker's Paper The attitude of our bankers toward broker's paper has undergone a radical change since the note broker 142 BANK CREDIT first came prominently forward with his wares twentyfive years ago. Previously to the panic of 1907, which subjected commercial paper marketed by the brokerage houses to a crucial test, bankers were inclined to shake their heads. The crisis of 1907 and the events of 1914, however, demonstrated strikingly the convertibility of broker's paper, and bankers have been increasingly friendly to it. Probably a large majority of our banks as measured by resources now resort to the commercial paper houses with much regularity, and many continually, in order profitably to utilize idle funds, to enhance the convertibility of their loans, and to scatter their risks beyond local range.

The Rise of the Credit Department The credit department of a bank is one of prime importance. It is the clearing-house for credit information, the headquarters for analysis of credit risks, a storehouse of facts relating to borrowers of the funds of a bank. Men in charge of the department are watchdogs of the bank's loans and the guardians of the investments made for correspondents. "The department must be manned by our most faithful, reliable, intelligent, tactful men, who must be capable of infinite pains, of inexhaustible patience, and of absolute loyalty. Their ears and eyes must be open to every contingency that no sign may go unheeded. They are compelled to walk in the ruts of routine and yet be pathfinders constantly. No man who works mechanically will develop into a successful credit man. The credit department should have an equipment comRECENT CHANGES IN CREDIT ARRANGEMENTS 143 mensurate with its importance. It should be the inner chamber in all respects. ... Its mechanism of blanks, files, vaults and office fixtures should be perfectly adapted to its service, and every means that ingenuity can devise should be utilized to assist its work."1 .

A high state of development of the credit department has been reached chiefly in our leading cities, but with the growth of commercial and industrial centers credit departments are being organized in smaller and smaller places. Many country banks keep elaborate credit files without maintaining a credit department as a distinct unit in their organization. The ordinary credit system is elastic and forms multiply as needs expand until facts may be easily gathered from many sources, summarized and digested for ready use. The credit department of the metropolitan bank may utilize the services of upwards of a hundred persons. Some of them devote their time to indexing and filing information, while others do nothing but keep the folders in proper shape, with the paper fastened into the folder so that it may be handled and read like a book. Investigators who are employed to gather information from local houses in specific fines of business assigned to them develop into specialists and become repositories of facts and gossip for the whole trade. The results of their work are turned in to members of the office force who have been engaged on other phases of the same investigations. The whole is then digested 1J. G. Cannon, Bank Credits, Bankers' Magazine (New York), Vol. LXX, May, 1905, p. 587.

144 BANK CREDIT for the use of the bank or dictated as a letter to an inquiring correspondent, as the case may be.1 The First Phase of the Development of Credit Research The establishment of credit departments in American banking institutions dates from about 1890. The exact date of the establishment of the first department as a distinct entity in the work of a bank is not known to the writer but it took place somewhat previously to 1892. On November 17, 1892, Mr. James G. Cannon delivered an address on "Bank Credits" at Drexel Institute, Philadelphia,—probably the first practical discussion of the subject—in which he stated that there were then not more than a half dozen credit departments in as many banks in the United States. Mr. E. S. Lacey testified also in 1892 with reference to the rise of the credit department. He pointed out that large city banks were then regarded as not abreast of the times which did not possess "complete credit bureaus." Time and money were being spent freely and increasingly "by progressive institutions in our larger cities" with results demonstrating that no expenditure brought larger returns.2 Mr. Cannon was an earnest advocate of the advantages of a credit department in the work of a bank and was very active and effective in spreading his knowl1 Freas Brown Snider, The Development of the Credit Department of the Bank, Bulletin, National Association of Credit Men, Vol. XIX, p. 948.

2E. S. Lacey, Some Phases of Modern Banking, Proceedings, Second Annual Convention Bankers' Association of the State of Illinois, 1892, p. 49.

RECENT CHANGES IN CREDIT ARRANGEMENTS 145 edge and enthusiasm. The subject of bank credits was discussed before many state bankers associations during the mid-and late nineties, and the close of the last century witnessed the successful operation of a growing, if not large, number of well organized credit departments. The Fourth National Bank of New York, of which Mr. Cannon was for many years vicepresident, and which was later absorbed by the Mechanics and Metals National Bank, was the first, it appears, to establish such a department. The Chase National Bank and the National Park Bank were also pioneers, followed by the National City Bank in 1898, the National Bank of Commerce about 1900 and the First National Bank of New York two years later. The movement seems to have had its inception in New York. That it did not acquire extraordinary momentum during the last decade of the last century is attested by the fact that such leading Boston banks as the National Shawmut and the First National Bank of Boston did not institute credit departments until 1903.

Several leading banks in Philadelphia established regular and well equipped departments in the opening years of the present century. Coincident with the rise of the credit department was the agitation carried on concerning the rendering of signed statements of condition by borrowers. The executive committee of the New York State Bankers' Association adopted resolutions recommending to its members "that they request borrowers of money from their respective institutions to give them written statements over their signatures of their assets and liabilities, in such form as the committee on uniform 146 BANK CREDIT statements of the various groups might recommend.'* Nearly all of the groups of the New York State Bankers' Association adopted uniform statement blanks and the example thus set was followed by many associations in other states.1 In 1898 the National Association of Credit Men, even then a powerful organization of nearly three thousand members, adopted, after a year's investigation of the subject, uniform statement blanks which were widely employed from the outset.2 Only a year later the American Bankers Association, in a convention assembled at Cleveland, adopted a uniform property statement blank to be supplied to members. As if to place the full stamp of its approval on credit departments for banks, it instructed its secretary to set up in his office a model department, and to furnish members information in regard to the working of the same.

These efforts constitute what may be called the first phase of the development of credit research. The close of the last century witnessed firm foundations laid and conditions that were highly favorable to the extension of the work of careful investigation of borrowing concerns and systematic recording of the information secured. The Development of the Credit Department since 1900 Since 1900 there has been a steady and enormous growth in the number of credit departments in banks, in the volume of their work, and in the thoroughgoing 1J. G. Cannon, Bank Credits, Bankers' Magazine (New York), May, 1905, Vol. LXX, p. 586. * Ibid.

RECENT CHANGES IN CREDIT ARRANGEMENTS 147 and really scientific character of the work of investigation. The way in which the importance of adequate and systematically recorded credit information has been recognized geographically and chronologically since 1900 may be made plain by the following tabular statement: Year When Credit Department Name of Bank Was Recognized as a Distinct Unit in the Bank's Organization Com Exchange National, Chicago 1900 First National, Denver, Col 1903 Tootle-Lacy National, St. Joseph, Mo 1904* National Bank of Commerce, St. Louis 1905 Whitney-Central National, New Orleans 1906* First National, San Francisco 1907 Fourth National, Atlanta, Ga 1908 Southwest National Bank of Commerce, Kansas City, Mo 1909 Merchants-Mechanics First National, Baltimore, Md 1910 Seattle National Bank, Seattle 1910 Mississippi Valley Trust Company, St. Louis 1911 United States National, Portland, Ore 1912 Lowry National Bank, Atlanta, Ga 1914 National Reserve Bank of Kansas City 1915 Atlantic National of Jacksonville, Fla 1917 The period before 1900 was essentially one of pioneering. Since that date the frontier of the advancing movement has disappeared, and we may now expect an intensive development of the credit department and its methods throughout the entire country.

* Date is approximate.

148 BANK CREDIT The Underlying Forces The conditions or forces that underlay the rise and development of the bank credit department have been numerous. First, perhaps, in point of time, was a gradual change of method employed in the buying and selling of commercial paper. Borrowers were discovering that it was disadvantageous and frequently impracticable to confine themselves to one bank or to one place. Merchants and manufacturers went away from home to borrow and bankers went away from home to procure investments. Bankers feeling that it would be inadvisable to break the rate locally would send to the large money centers and buy from note brokerage houses the paper of even their home customers at a lower rate than that at which they felt they could discount the note directly. A small fraction of one per cent was sufficient to take many business men from home for their accommodation. The practice grew for banks in the larger cities to buy or "check" commercial paper for their country correspondents and it became more and more imperative for the larger city banks to be well informed in the widest possible manner with reference to the credit of borrowers, especially of sellers of commercial paper through the note brokerage houses. A well equipped credit department, in short, became essential to the profitable operation of a large number of metropolitan and other banks having numerous connections with smaller institutions whose credit ascertaining facilities were purely local in scope.

The service rendered by the city banks was practically gratuitous. Charges were seldom, if ever, made.

RECENT CHANGES IN CREDIT ARRANGEMENTS 149 But the ability and willingness of the city bank to furnish the desired information to its country correspondents was a magnet attracting new accounts and holding old ones against a growing competition.1 It must not be understood that the work of commercial paper houses led to the establishment of credit departments by only those city banks whose customers were in large part made up of correspondent banks. Banks like the Fourth National of New York, whose customers were chiefly merchants and manufacturers, early found the need of improved credit methods imperative in passing upon outside paper. Paper buying banks maintaining well organized credit departments have a distinct advantage in being able to act both quickly and advisedly. When the money market is dull and paper, for the time being, comparatively scarce, names of the first rank are secured by those buyers able to give immediate acceptance. As a broker acquainted with the individual demands of his constituents can at times easily dispose by telephone of a million dollars in choice paper in a few minutes, the value of a quick decision is evident.2 1 Banks in the larger cities are asked at times to purchase paper for the account of their correspondents. More frequently they are requested by their correspondents in the country to secure lists of offerings from note brokers and to check the names that are considered good. The lists after being checked are sent to the inquiring banks which generally buy the paper selected directly from the brokers. Ordinarily detailed reports are not given in connection with the names checked, as is true, commonly, when paper is bought outright by the city bank for its correspondent.

•William Post, The Loan and Credit Department, Bulletin oi American Institute of Bank Clerks, Vol. Ill, p. 137.

150 BANK CREDIT With the rapid growth of our cities and the growing disposition of an increasing number of borrowers,— merchants, manufacturers, contractors, promoters, capitalists, and banks themselves,—to use borrowed funds, the borrowing demands upon banks became so heavy that an individual officer, unaided by facilities for collecting, systematizing and preserving credit information, was incapable of meeting the requirements of his bank. The cashier or other officer could no longer carry "in the head " the multiplicity of details touching the credit standing of borrowers. Not only did it become more and more difficult to know each borrower personally as population grew hi numbers and density, but his affairs became less and less exposed to view. It was natural under these circumstances that well equipped credit departments should have been instituted and placed in charge of men specially qualified for credit work.

Another factor underlying the establishment and growth of the credit department was the spread of the •corporate form of organization during the nineties and in later years. As the growth in the number of corporations and the increased size of the business unit, whether firm or corporation, took place, the lending capacity of the relatively small individual bank was outstripped. But the growth in the size of business corporations prompted a corresponding increase in the lending capacity of banking institutions in order that each bank might have sufficient capital and surplus to enable it legally to meet the needs of its more prominent customers. In many places banks found that the provision of the National Bank Act which limits indiRECENT CHANGES IN CREDIT ARRANGEMENTS 151 vìdual lines of credit to onetenth of the paid-up capital and surplus hampered their activity in such a way as to suggest an enlarged capital and surplus as the legal basis of lending capacity adequate to meet the needs of their biggest borrowers. Growth in the size of banks and in the volume of their loans prompted the systematic collection and handling of credit information.

Relief from the restrictive loan requirements of our banking laws was found in many cases in bank consolidations which still further promoted the credit department movement. In numerous cases of consolidation the need of a credit department was felt in order that credit information, indifferently gathered and filed previously might be focalized and handled systematically and efficiently in accordance with the newer and larger needs. In another and quite different way the corporate form of business organization has contributed to the establishment of elaborate means and methods of obtaining and handling credit information. The rise of the corporation at once eliminated in large measure the personal and friendly element between debtor and creditor and afforded a screen for personal credit and personal honor. As the soulless corporation supplanted the partnership, men struggled less energetically to keep their family honor and name from the records of the bankruptcy court. Stockholders and managers of corporations had less incentive to pay their debts in full, and the lending bankers were subjected to greater labor and compelled to scrutinize more closely in order to protect themselves from loss.1 1J. G. Cannon, Credit, Credit-Man, Creditor, Bankers' Magazine (New York), Vol. LIII, p. 34.

152 BANK CREDIT There is no doubt that actual losses occurring under the old system, or lack of system, have been an immediate and inciting cause of action taken with a view to the installation of complete credit files. "Losses under the old system," says one banker in the Northwest, "proved the absolute necessity of accurate and complete credit data." In some instances improved facilities for the procuring of credit information have themselves been more or less favorable to the installation of credit departments, while the requirements of the Federal Reserve Act that all paper eligible for rediscount must carry a statement of condition of the maker has been decidedly important. The installation of modern bank credit methods has been advocated by bank examiners from their points of vantage, in and out of season. The Rise of the New Business Department and its Relation to the Credit Department The aggressiveness with which both new deposit and loan accounts are sought marks an innovation in American banking. A large number of new accounts are to-day obtained by energetic personal solicitation.

A former generation regarded this beneath the dignity of the banking profession, but a new day has dawned. The custom of sending traveling representatives to secure new accounts and to strengthen old ones dates back fifteen or twenty years. More recently, since about 1912, new business departments have been established by banks in the large cities, where one or RECENT CHANGES IN CREDIT ARRANGEMENTS 153 more officers are charged with the duty of building up the business, and to this end call, or have representatives call, upon existing or prospective customers and correspondents, presenting their claims, describing their methods, equipment and facilities. At the same time valuable information is acquired as to the resources and business of the communities, banks, and business concerns visited. A capable representative systematically collects a vast amount of highly valuable information which is recorded in the credit files of the bank.

The work of the new business department dovetails with that of the credit department. It has been natural for the bank management in many instances to utilize effectively information in its possession concerning the credit worth of a firm or corporation that gave promise of becoming a profitable customer. As the names of desirable prospective customers are discovered through the activity of the credit department of the bank in the larger center, steps are taken by the new business department toward enrolling those names on the ledgers of the bank. If some banks have resisted the temptation to utilize the credit department in the compilation of information for the solicitation of new business, allowing that department to focus its entire attention on the standing of makers of paper under discount in the particular institutions, others have not. It sometimes occurs that new accounts are secured by banks through the offer of lower rates of interest than those paid to competing banks by the concerns solicited. Eastern banking institutions have been able frequently to offer the western borrower lower dis154 BANK CREDIT count rates than prevailed in the West because of the greater abundance of money in the Eastern banking centers. Banks in New York City, in particular, are said to resort to lower rates as a means of securing new accounts, except in periods of stringent money.

Again, the offer of a more extended line of credit than that granted by rival banks has been used as a leverage in breaking relations already established between borrower and competing bank. A house having a maximum credit of $40,000 at a local or even metropolitan bank is not unlikely to be receptive with reference to an offer of a line of credit of $50,000 coming through the new business department of another bank whose facilities may be superior, and whose name may be one of greater prestige. Reference need scarcely be made to advertising as a means of obtaining new accounts. Suffice it to say that in recent years banks have advertised in the daily press, monthly and other periodicals, trade journals, bankers' journals, financial publications, by signs in street cars and even by bill board posters. Books and booklets, blotters, calendars, and cards have been distributed with a freedom that would have scandalized bankers of the old school.

Competition among commercial banks is keen, although not unrestricted. It would not conform with the facts to say that the new business department solicits accounts without careful discrimination as to the banks with which the prospective customers already have established dealings. The checks of possible or desirable customers passing through a city bank bear the names of the respective banks with which customers RECENT CHANGES IN CREDIT ARRANGEMENTS 155 do their banking business and enable the city banks to pass by, as if undesirable, the customers of friendly institutions and to seek out depositors of banks for whose goodwill the soliciting bank has no special concern or regard. The activity of the new business department, through which competition finds vent, tends to place in the possession of each borrower whose account is sufficiently important to attract wide attention, a line of credit in keeping with the decision of the credit manager and lending officer whose findings and judgment are, of all the soliciting banks, most favorable to the borrower, and the accounts of big borrowers, therefore, tend to gravitate toward the bank with a liberal policy of credit extension.

The work of the bank credit department in apportioning available banking funds among the most prudent and capable borrowers is of almost incalculable social value and the new business department extends the field to which the beneficial results of the work of the credit department enure. But in the process of extension, as we have just seen, there arises a tendency to grant credit more freely than would other banks that are also eagerly striving both to hold old accounts and to obtain new. Thus the constraining and conserving influence of the credit department of one bank is qualified and impaired by the activity of the new business department of another. While there is complete harmony in the aims and work of the two departments in ah individual bank, cross purpose appears when they are viewed from the standpoint of the banks considered as a system.

156 BANK CREDIT The Influence of the Federal Reserve System upon the Kind and Quality of Bank Loans The Federal Reserve system also has had a marked influence upon the kind and quality of our bank loans. The establishment of the system has had a strong tendency to increase local loans with a corresponding reduction in the volume of funds placed on deposit by banks in correspondent banks. Under the old system a manufacturer desiring to buy raw material to be fabricated into goods for the market and out of the proceeds of their sale pay off his loan would in applying for a loan for, say, ninety days, get some such response as: "We would like to make you the loan, you have always paid your obligations promptly, we know the condition of your enterprise would warrant the extension of the credit you desire. But we are sorry that our own probable needs are such as to make it inexpedient for us to make the loan except on demand." The reply of the manufacturer was: "That is entirely out of the question. As it will require at least ninety days to place the goods on the market, a demand loan might prove very embarrassing." The result has been that the manufacturer has not taken the loan and production has been curtailed. The banker probably had to be satisfied with two per cent paid by his city correspondent.

Under the Federal Reserve system with its facilities for rediscount, the banker can feel safe in lending, even if extraordinary needs loom in the future. Making a loan for commercial purposes to borrowers of good standing no longer necessitates the tying up of RECENT CHANGES IN CREDIT ARRANGEMENTS 157 funds for the currency of the loan. Instead of lending to his correspondent on demand at two per cent, the banker may now lend to his customers at a higher rate, but with as great freedom from apprehension concerning the future.1 It is easily seen that this circumstance, by enlarging the power of banks to make local loans, and by curtailing the deposits of city bankers, must tend to relegate the call loan to a less conspicuous place in our financial system.2 A second effect worth noting is that in certain quarters, as on the Pacific Coast and in the St. Louis district, the operation of the Federal Reserve banks has favored the discontinuance of the practice of discounting paper having no definite maturity. Years ago, before active economic development commenced on the Pacific Coast, when merchants needed little accommodation, the most important outlet for the bankers' funds was to loan to property owners, who were naturally encouraged by the banks to keep the funds over long periods. Under these conditions it was expedient to make the notes payable one day after date with the understanding that the notes were so drawn in order to enable borrowers to pay at their convenience, and one-day paper in California means paper with an indefinite maturity. Borrowers still assume that they may pay when they like, while bankers flatter themselves that the paper, past due, is sub¯ 1 Cf. W. McC. Martin, Rediscount Facilities and Methods, Proceedings, Nineteenth Annual Convention, Indiana Bankers' Association, 1915, pp. 125, 126.

*Cf. Charles S. Hamlìn, Proceedings, Nineteenth Annual Convention, Indiana Bankers' Association, 1915, p. 118.

158 BANK CREDIT ject to call on demand. Both may be disappointed. The growth of the Federal Reserve system in magnitude and influence, and of the practice of rediscounting at the regional banks, must tend to eliminate paper of the kind described and to put two kinds in its place: paper that is payable on demand with collateral back of it that can be readily sold to enforce the demand, and paper that has a definite maturity.1 A third effect of the Federal Reserve system has been to improve, or tend to improve, the quality of bank loans through the requirement that paper eligible for rediscount be accompanied by a statement of the assets and liabilities of the borrower, except where a bank's own depositor borrows not more than $5,000 in amount. The introduction of the trade and bank acceptances, under the operation of the Federal Reserve Act, has also worked in the direction of sounder and more liquid bank loans.

A trade acceptance is a time draft drawn by a seller of goods on the buyer for the price thereof, and bears on its face the signature, i. e., acceptance, of the buyer with the date and place of payment. The introduction of this instrument of credit into many lines of trade after 1913 has given the banker a distinctly liquid portfolio item. Based on the current needs of the acceptor, this two-name paper is a secondary reserve that can be converted at once into primary reserve through the easy process of rediscount. Open accounts are looked upon by many bankers as "frozen." 1 Stoddard Jess, Probable Changes in Banking Methods under the Federal Reserve Act, Proceedings, Twentieth Convention, California Bankers' Association, 1914, p. 96.

RECENT CHANGES IN CREDIT ARRANGEMENTS 159 A bank acceptance differs from a trade acceptance in that the bank acceptance is executed by a bank, or other corporation, firm or person engaged in the business of granting acceptances. Whatever its foundation, whether domestic or foreign trade, the bank acceptance affords a superior medium for investing bank funds which are to be held liquid, inasmuch as such paper can be converted into cash through sale in the open market which has grown up since 1914 or through rediscount at the Federal Reserve or other banks. For funds only temporarily available, the bank acceptance is a most satisfactory investment. The revised banking law of New York State conferred authority upon institutions organized under its provisions to accept for payment at a future date drafts drawn upon them by their customers, without limitation as to the nature of the transactions involved, and numerous houses have pursuantly become extensive acceptors and dealers in bills. With the rise of these institutions national and other banks have adopted an increasingly liberal attitude toward incurring acceptance obligations, and the number of banks now engaged in the business runs well into the hundreds.

In the open market for bank acceptances the Federal Reserve banks have been the most important buyers, at most times overshadowing the commercial banks and other acceptors. During our participation in the Great War and for a short time previously money rates were tight and bank acceptances would have been a drug on the market but for the liberal acceptance buying policy of the regional institutions. In the er160 BANK CREDIT ratic market following the cessation of hostilities the same banks were heavy and stabilizing purchasers. The growth of the bank acceptance market has been little short of phenomenal, but the trade acceptance has had a hard struggle to gain recognition. Commercial paper houses have opposed resort to the trade acceptance by their customers on the valid ground that buying banks prefer the paper of concerns whose borrowings are in only one kind of paper. Furthermore, the market has been narrowed by the unwillingness of the larger banks to investigate the credit worth of houses offering trade acceptances when the denominations have been small. The development of the trade acceptance as a factor in our open market lies chiefly in the future.