The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
332. -6 - Repurchase Paper Poe'ct Dis,unt Rates - Operations of FRBanks • The A B C of Bankers Acceptances By KNIGHT WOOLLEY Assistant Cashier, American Exchange National Bank,1 New York, N.Y. AMERICAN ACCEPTANCE COUNCIL 120 Broadway Nw York • The A B C of Bankers Acceptances By KNIGHT WOOLLEY Assistant Cashier, American Exchange National Bank, New York, N. Y. AMERICAN ACCEPTANCE COUNCIL 120 Broadway New York I Published by American Acceptance Council 120 Broadway, New York • Foreword Much has been written in recent years regarding the why and wherefore of Bankers Acceptances. Since the passage of the Federal Reserve Act in 1913, American financial institutions have been gradually learning the advantages such acceptances offer as short time investments, and the volume bought and sold each day in New York has now reached large proportions, probably exceeding today that of any other financial center with the exception of London. But the manner in which these acceptances come into being, and the way in which they may be used in practice to finance various transactions, seems still not to be fully understood by many of those who might advantageously make use of them. It is due rather to this fact, than because of anything new in connection with the subject, that this pamphlet has been written in non-technical language to show by practical examples how Bankers Acceptances originate. 3 The A B C of Bankers Acceptances CHAPTER 1 How Bankers Acceptances Originate in the Financing of Export Shipments. The Export Manager of a New England manufacturing concern, with an overseas clientele developed during the war, called at his bank to discuss possible ways of financing the foreign business of his company. What he said was this: "We are making regular monthly shipments abroad. Usually sight drafts with documents attached, drawn in Dollars on the foreign buyers, are turned over to your bank for collection. With these as security you advance us the face amount of each draft, less your collection charge and interest for the time which will elapse until the arrival of the proceeds in New York. Is there some way in which this business might be financed to better advantage?" The answer is that Bankers Acceptances can be utilized to finance such shipments and in many instances may prove more advantageous than 5 any of the various methods of borrowing against documentary drafts. To make this plain, let us compare the more familiar method of advances against documentary collections with the financing of a shipment by a "Bankers Acceptance Credit," examining in each case the banking costs to our friend, the manufacturer, on a typical exportation. For the sake of clarity, we shall suppose a shipment of merchandise to Buenos Aires, and consider first the steps taken by the Export Manager in obtaining from his bank a cash advance, collateralized by a sight draft in dollars with documents attached. When the goods have been placed on board ship, the manufacturer attaches the bills of lading and insurance certificates to a draft drawn in dollars on the buyer and turns over these documents to the bank to be forwarded to its correspondent in Buenos Aires for collection. Normally, the proceeds of this draft would not be received in New York for about two months, as the mail time to Argentina is usually, figured roughly, 30 days each way. However, as the needs of his business necessitate the use of the money while the merchandise is afloat, •the Export Manager arranges to have the bank advance the face amount of the draft less, of course, Its collection fee, which we shall call / 18 per cent, and interest at say 6 per cent for 60 days, the approximate time that will elapse before the proceeds of this draft reach New York. This is a common, though sometimes expensive, 6 method used by shippers for financing exports, and under certain conditions has proved an easy and satisfactory way to conduct business. From the banker's viewpoint, its greatest drawback lies in •the fact that it ties up the bank's funds. In times of stress there is no elasticity in this way of financing as there is nothing to rediscount, and a bank, when "loaned up," is unable to take care of the further needs of its customers. As we are particularly interested in observing the workings of an acceptance credit, let us now consider the manner in which this same exportation to Buenos Aires can be financed by the use of the bank's credit standing instead of by the use of the bank's cash. After shipment the dollar sight draft with documents attached is turned over to the bank for collection, as in the example above, and the same collection fee of V8 per cent is charged to the account of the exporter. Now, however, instead of receiving an advance from the bank, the Exporter, under the terms of the acceptance credit, draws on the bank a second draft for the same dollar amount as the first draft, which is now starting by mail to South America. This new draft, instead of at sight, is drawn at 60 days after sight, so that its maturity will correspond as closely as possible with the time of arrival in New York of the proceeds of the outgoing collection. On presentation to the bank, the word "accepted" is stamped or written across the face of the draft together with a notation 7 • of the maturity date, 60 days hence. This acceptance is signed by an officer of the bank authorized to do so, and changes the instrument from a simple draft to a bankers acceptance, which carries with it the bank's unqualified promise of payment at maturity. When the passage of the Federal Reserve Act gave the acceptance privilege to banks in this country, an open discount market for bankers acceptances came into existence and these instruments are bought by individuals, corporations, and commercial or savings banks having money to invest for short periods. A small but efficient and specialized group of acceptance dealers maintains the market, behind which stands the Federal Reserve Bank, ready at all times to red.iscount eligible bills. It is to one of these dealers that the Export Manager sells the accepted draft (which is classed as eligible for rediscount under the terms of the Federal Reserve Act, because at the time of acceptance it was drawn to finance an exportation of merchandise, as evidenced by the documentary collection). In payment, he receives the face amount of the bill, less a discount amounting to the interest for two months at 4%70 per annum, which we will assume is .the prevailing rate for the acceptances of prime banks. Stated in another way, by the use of the credit standing of his bank through an acceptance credit, our manufacturer is financing his exports by funds obtained from the discount market at 4% per cent interest instead of 8 by cash borrowed from his bank at 6 per cent. The bank has loaned its credit, and the money in reality has come from some unknown third party who has purchased the 60-day acceptance. Let us look back for a moment now and note the understanding between the bank and the manufacturer when the acceptance credit was first arranged. By the terms of the acceptance agreement (the formal contract between bank and customer) the Export Manager has agreed, among other things, to provide the bank with funds with which to pay the acceptance one day before maturity, whether or not the proceeds of the first draft reach New York as expected. The bank, in other words, is loaning its credit on the assumption that the financial responsibility of its customer, the manufacturer, insures the deposit of the necessary_ funds to meet the acceptance when presented by the unknown holder at maturity. For lending its name and assuming the credit risk, the bank charges a small acceptance commission, which we shall assume to be at the rate of per cent per annum, or Y4 per cent for the sixty-day bill in question. How, then, do the banking costs of these two methods of financing an Argentine shipment compare when viewed from the standpoint of the exporter? Looking back, we see that when the bank made an advance against the documentary collection, the charges amounted to interest for two months at 6 per cent and a collection fee of V8 per cent. Under the 1/2 9 bankers acceptance credit, the cost was a collection charge of Y8 per cent, interest for two months at 43/4 per cent, and an acceptance commission of M per cent. Disregarding the small Revenue Stamp charges and the collection fee, a comparison of the per cent per annum costs would appear as follows: Bankers Advance on Acceptance Credit Documents Interest for 2 months,. 6% Bankers Acceptance Commission — VA% PA% s% sg% Total The difference, M per cent per annum, may not seem to be much of a saving, perhaps; but nevertheless it may equal a sum in dollars and cents which in these days of intense competition, few can afford to overlook. In order to be concrete in our example, we have assumed certain charges and interest rates, but we must remember that all these are variable. The kind of merchandise, its destination, the credit standing and responsibility of the exporter and the foreign buyer, the volume of the business, and the prevailing interest rates will each have a certain bearing on the banker s charges. In figuring on the banking costs of an exportation, therefore, everything depends on circumstances, and it must not be assumed that the acceptance credit is invariably the cheaper of the two methods we have considered. Nevertheless, because of the variety of ways in which the bankers acceptance can be used to meet the particular needs of shippers, this in 10 strument is coming to be looked upon with greater favor and is increasing in volume as its possibilities become more generally understood. In the New York discount market today many millions of dollars' worth of bankers acceptances have their origin in the financing of export shipments. 11 • CHAPTER II How Bankers Acceptances Originate in the Financing of Import Shipments under Bankers Letters of Credit. In the first chapter we examined the way in which the export manager financed shipments of merchandise to foreign countries by means of Bankers Acceptance Credits, and as these proved satisfactory and economical, the president of this company decided to consult his bank concerning the possibility of using acceptances for financing importations of the raw material needed in his factory. Said the Manufacturer: "Quantities of Argentine wool are used each month in my plant, and in the past I have always purchased this from dealers in Boston. Recently I have arranged a direct connection with a reliable shipper in Buenos Aires who has quoted me a satisfactery price conditioned upon the opening of a bankers confirmed letter of credit in his favor. How will •this instrument finance my importations?" The illustrated diagram gives an answer to this query. With the help of this diagram, we shall briefly follow step by step the workings of a letter of credit and examine partictflarly the way in which 12 • a bank's acceptance is used to draw funds from the discount market for use in financing an importation. To be concrete, let us consider the shipment of wool from Argentina to our friend, the New England Manufacturer. When the selling price and other conditions have been fixed with the exporter in Buenos Aires, a letter or formal application is addressed by the purchaser of the wool to his bank requesting the opening of the credit and giving a concise resume of the terms governing the transaction. Provided the bank is willing to extend the accommodation to its customer, these terms are then incorporated in the letter of credit which is delivered to the Manufacturer, who in turn mails it to the Buenos Aires shipper. In addition •to reciting the terms upon which the bank will accept drafts, this credit, which is signed by authorized officials of the issuing bank and is not subject to cancellation, •bears a confirmatory clause which customarily reads somewhat as follows: "We hereby agree with the drawers, endorsers and bona fide holders of drafts drawn under and in compliance with the terms of this letter of credit that the same shall be duly honored upon presentation." This paragraph is important to the wool shipper in two distinct ways: Firstly, by transferring the financial obligation from the buyer to a bank, he is relieved of any responsibility regarding the credit standing and solvency of his 13 • customer, the New England Manufacturer; secondly, he is enabled to discount his documentary draft drawn in dollars with his local bank in Buenos Aires, at the best rate obtainable, which is lower than • if he were discounting a draft drawn direct on the Manufacturer. Thus, on shipping the wool the exporter receives immediately from his local bank the money due him in the form of the proceeds of the discounted draft, and if all goes well he ceases to be interested in the transaction. The documentary draft is now sent to the American correspondent of the Buenos Aires bank which presents it for acceptance at the office of the bank issuing the letter of credit. Here the accompanying documents are carefully scrutinized, and if they are found to conform strictly to the terms of the credit, the word "accepted" is stamped or written across the face of the draft together with a notation of the maturity date—in our example, 90 days hence. This acceptance (shown on the opposite page) is signed by an officer of the bank authorized to do so and changes the instrument from a simple draft to a 'bankers acceptance which carries with it the bank's unqualified promise of payment at maturity. The bank issuing the letter of credit is permitted customarily to hold the documents giving title to the wool, the accepted draft only •being returned to the presenting bank, which as we have seen happens to be the New York correspondent of the negotiating bank. 14 act • O ' 000.00 ,•- ., c ( 4 1.4& • eigbee,nei-d)c}&.€41,/la.v2,-,--6-x9.944 °75;;;40,ea:ckez' tfdie)a '*nAa.*,,k-J4/xwele 7a.',,p__;Z,M a CO„ea A, ti ,accow-teeL ,Po/y23 ;dakie-Srernie, /.9e)e Olt 0- -c- ./WiP g. _e cf e erS BANKERS ACCEPTANCE The draft of the Argentine wool shipper, after acceptance by the bank issuing the letter of credit, is shown above. In addition to the maturity date and signatures of two bank officers it bears a notation indicating that the acceptance had its origin in an importation of wool from Buenos Aires to New York. FINANCING AN IMPORT TRANSACTION BY BANKERS ACCEPTANCES FOREIGN EXPORTER FOREIGN BANK Ora, 1107.4 tio-•••• Jet a La XrPri Receives letter or Ueda. Orimal draft Naosi dun/ banks/4 presents draft to mis Own IlAnk tar ducoant , Discounts draft and for wards it to correspondent Americo bank in ACCEPTING BANK AMERICAN CORRESPONDENT OF FOREIGN BANK AMERICAN IMPORTER lo!MX,1111 Wirth.1.31 OtimnS Oa of told frpe tins rd IMO .1 to ellYttr "as a ay is • Presents Ira Sr =eats . , and Men was n tke market • SCCOptpa robins prior 3 lo matielly of 'work. 4cc.pr0( arsal AcCelffer. P°4 at matonty j'eittej ACCEPTANCt MARKET one, ' BROKERS AND DISCOUNT HOUSES E accepted draft . CTIPA,...s Buy and sell his The above courtesy of the Federal Reserve Bank of Philadelphia. chart is used through the LICENSE NO. FARMERS BONDED WAREHOUSE 2-10,000 ATLANTA. CA FARMERS WAREHOUSE Co.. PROPRIETORS INCORPORATED UNDER LAWS OF GEORGIA •••• — ORIGINAL — NEGOTIABLE a z VANCH(DUSE MEGEWT P'0172 ONE E-- -)ALE et1))77.0-g4 R ECETgarF; S 10M OF THE ONE BALE OF COTTON DESCRIBED HEREIN. STORED IN THE ABOVE-NAMED WAREHOUSE. FOR WHICH THIS RECEIPT IS ISSUED SUBJECT TO THE UNITED STATES WAREHOUSE ACT, THE REGULATIONS FOR COTTON WAREHOUSES THEREUNDER AND THE TERMS- OF THIS CONTRACT. SAID COTTON IS FULLY INSURED BY THE UNDEFtSiGNED WAREHOUSEMAN AGAINST LOSS OR DAMAGE BY FIRE AND LIGHTNING UNLESS EXPRESSLY STATED OTHERWISE ON THE FACE OF THIS RECEIPT SAID COTTON IS ACCEPTED FOR STORAGE FOR ONE YEAR ONLY FROM THE DATE OF THIS RECEIPT BUT UPON SURRENDER BY THE HOLDER THIS RECEIPT MAY BE EXTENDED OR A NEW RECEIPT ISSUED AS PROVIDED IN SAID REGULATIONS. THE UNDERSIGNED WAREHOUSEMAN IS NOT THE OWNER OF THE COTTON COVERED BY THIS RECEIPT. EITHER SOLELY. JOINTLY OR IN COMMON WITH OTHERS UNLESS OTHERWISE STATED HERE UPON THE RETURN OF THIS RECEIPT. PROPERLY INDORSED. AND THE PAYMENT OF ALL CHARGES AND LIABILITIES DUE THE UNDERSIGNED WAREHOUSEMAN. AS STATED HEPEIN. SAID ONE BALE OF COTTON WILL BE DELIVERED TO THE ABOVENAMED DEPOSITOR OR HIS ORDER. ISSUED AT ATLANTA. GA., ON 192.. GRADE MD WEIGHT DETERMINED BY A CLAS. MEIER AND WEIGHER LICENSED UNDER THE U. S. WARLI.,, ACT -49:19 No. 1 0 1 9 1 — LicENsE6 AND BONDED UNDER THE UNITED STATES WAREHOUSE ACT ••••• RECEIPT AND TAG FARMERS WAREHOUSE COMPANY LICENSED WAREHOUSEMAN BY THE UNDERSIGNED WAREHOUSEMAN CLAIMS A LIEN ON ,SAIO COTTON FOR I CHARGES AND LIA• BILITIES AS FOLLOWS I MARKS WEIGHT REWEIGHT STORAGE INSURANCE WEIGHING .STAPLE CUSSING TURNING our I CONDITION ussaiwcou s •AtcoRom, TO THE OFFICIAL COTTON STANDARDS OF THE UNITED STATES. 60.1.1unner paall.••110.8 Specimen of Warehouse Receipt issued by Warehouse Company licensed under the United States Warehouse Act. _ •ORADE S What now becomes of this acceptance? As shown by the chart, it is sold to the acceptance dealers or brokers, referred to in Chapter I, and the proceeds credited to the dollar account of the Buenos Aires bank. The draft having been accepted and discounted, this institution henceforth is only contingently liable. When the acceptance privilege was given to banks in this country by the passage of the Federal Reserve Act in 1913, an open market for bankers acceptances was created in which discount rates are stabilized and facilities offered for the purchase of these instruments by individuals, corporations and banks having money to invest for short periods. The returns are comparatively high in view of the self-liquidating character of the paper and the undoubted security offered, for in its assurance of eventual payment the acceptance of a prime bank is comparable to the certificate of deposit of that bank. In the background stands the Federal Reserve bank able to rediscount eligible bills at any time. Looking back we see that the seller in Buenos Aires in effect received payment when the merchandise was shipped; the bank in Argentina was credited with funds due it when the accepted draft was sold in the New York Market to the acceptance dealer; and although the merchandise has meantime reached its destination, still no cash has been put up by our friend, the Manufacturer, who is buying the wool, or by his bank which issued the letter of credit. The accepting 15 1 • bank, it is true, has loaned its credit but the actual money has come from some unknown third party, either individual, corporation, or bank which purchased the acceptance in the discount market. To complete the transaction, let us turn to the actual shipment of wool which probably reached New York on the steamer bringing the draft. The documents, as we have seen, were retained by the bank when accepting the draft and they are now turned over by the bank to the Manufacturer against a •trust receipt so that customs entry can be made and the wool delivered to the factory. In the formal contract between bank and customer, signed when the letter of credit was arranged, the Manufacturer has agreed to provide the bank with funds with which to pay the acceptance one day prior to maturity. As the arrival of the shipment in this country and the acceptance of the 90 day bill occur within, a few days of each other in the example we have been considering, it follows that our friend, the Manufacturer, has the best part of three months in which to prepare the goods for market before he is called upon to put up a single cent of real money. And for this extension of banking accommodation through the letter of credit, he pays the accepting bank only a small commission of a fraction of one per cent. To be concrete, we have considered the various steps in the importation of a shipment of wool, but it must not be understood that all im- 16 portations under letters of credit follow precisely the same lines. All the details will vary to a greater or less degree, depending on •the circumstances of each case, although the principles underlying such transactions remain always the same. Today in the New York discount market it is estimated that considerably more than half of the outstanding bankers acceptances have their origin in importations financed by letters of credit. 17 • CHAPTER III How Bankers Acceptances Originate in the Financing of Domestic Shipments and Goods in Warehouse In the preceding chapters we examined the way in which acceptances originate in the financing of export and import shipments under bankers credits, and we considered in some detail the various steps taken by a New England manufacturing concern in arranging and conducting its business so as to make use of bankers acceptances in obtaining from the discount market funds which otherwise would have been borrowed on the company's note. This instrument met the needs of the manufacturer so admirably in financing imports and exports that the president of this company called at his bank to discuss the method of using acceptances for domestic shipments of merchandise and for borrowing on goods in warehouse. Said he, "At a certain period of the year large quantities of cotton are shipped to me by rail or steamer from Texas, a part of this on arrival being used in my mill and the remainder stored in warehouse. How can I finance these shipments from the south by means of a bankers acceptance and how can I borrow from the dis 18 count market by a bankers acceptance secured by that portion of the cotton which is placed in warehouse?" Before examining in detail the aspects of an acceptance credit based on merchandise in storage, let us consider briefly methods by which this instrument can be utilized to finance the cotton shipment from Texas to New England. The Federal Reserve regulations classify as eligible for rediscount an acceptance drawn against a transaction involving "the shipment of goods within the United States, provided shipping documents conveying security title are attached at the time of acceptance." Conforming with this stipulation, there are a number of variations in the way our friend, the manufacturer, could use a bankers acceptance to finance his cotton shipment. For example, a letter of credit might be opened in favor of the shipper authorizing time drafts on the issuing bank (similar to the usual import credit); or a sight letter of credit might be opened in favor of the shipper, each transaction being refinanced by an acceptance credit at the time the issuing bank is called Upon to pay the sight draft. Still another workable way to accomplish the desired result is the following: Order bills of lading are attached to a sight draft drawn on the New England manufacturer and these by his instruction are mailed to his bank in Boston or New York. Should the manufacturer have insufficient funds to pay this draft on presentation, he may arrange to obtain the money by re 19 financing under an acceptance credit. To accomplish this, the manufacturer draws on his bank for the same amount as the sight draft drawn by the shipper, the usance of the bill being the approximate time taken by the cotton in transit from Texas to the warehouse in New England where it is to be stored. This draft is against the shipping documents just received by the bank and after acceptance and discount, the funds would supply the necessary cover for the shippers draft. Should the cotton arrive at its destination prior to the maturity of the acceptance, the shipping documents held by the accepting bank could be turned over to the manufacturer on trust receipt to permit the proper storage of the goods. Now let us turn to a more detailed study of acceptances drawn against warehoused staples. Before considering the per annum cost to our friend, the manufacturer, for obtaining money by means of bankers acceptances drawn against the stored cotton, we should examine the Federal Reserve regulations defining the conditions that must surround the transaction if the acceptance is to be eligible for rediscount at a Federal Reserve bank—a requisite to borrowing at the best rates from the open market. Condensing somewhat the phraseology of these rulings, we find that a Federal Reserve bank may rediscount a bankers acceptance bearing the endorsement of a member bank, Which has been drawn under a credit opened for the purpose of financing the storage of readily marketable staples, provided: 20 1. The bill is secured at the time of acceptance by a warehouse, terminal, or other similar receipt, conveying security title to such staples. 2. The receipt is issued by a party independent of the bank's customer. 3. The acceptor remains secured throughout the life of the acceptance. In the event that the goods must be withdrawn from storage prior to maturity of the acceptance or the retirement of the credit, a trust receipt or other similar document covering the goods may be substituted in lieu of the original document, provided that such substitution is conditioned Upon a reasonably prompt liquidation of the credit. A "readily marketable staple" within the meaning of these regulations may be defined as an article of commerce, agriculture, or industry of such uses as to make it the subject of constant dealings in ready markets with such frequent quotations of price as to make (a) the price easily and definitely ascertainable and (b) the staple itself easy to realize upon by sale at any time. Cotton stored in warehouse is classified as a readily marketable staple and assuming that the other circumstances conform with the stipulations of the Federal Reserve regulations, we may now consider in a little more detail the steps taken by the manufacturer in obtaining money by acceptances, and then compare the banking cost of this method of procuring funds with the more familiar ways of borrowing. 21 • When the bank has signified its willingness to extend credit by accepting drafts drawn on it against merchandise in warehouse, the manufacturer is called upon to sign what is customarily called an "Acceptance Agreement," the formal contract between bank and its customer, and as this contains points of interest, the form used by one of the New York banks is given below. In signing this contract, the New England manufacturer pledges the merchandise as collateral security and agrees, among other things, to provide the bank with funds one day prior to the maturity of the bill. Acceptance Credit Agreement No For and in consideration of the acceptance by THE X Y Z NATIONAL BANK, of our draft (s) on them numbered dated payable at Dollars, for ), as part of the same transaction, we ($ hereby promise and agree, on or before the day prior to the due date of said draft to pay in New York funds to the Bank the amount payable by the said Bank thereon, and as collateral security for the due and punctual performance for such obligation, as well as for the payment of any and every debt or liability of every nature from the undersigned to 22 said Bank, we hereby deposit with and assign and transfer to said Bank the following property: with other additional collaterals as may from time to time be required by any of the officers of said Bank, and which the undersigned hereby promises to furnish on demand. And the undersigned hereby gives to said Bank, or its assigns, full power to sell, assign or deliver the whole or any part of said collaterals, or any substitute therefor, or any additions thereto, at any Brokers' Exchange or elsewhere at public or private sale, at the option of such holder, on the non-performance of any of the promises herein contained, and without notice of amount due or claimed to be due, without demand of payment, without advertisement and without notice of the time or place of sale, each and every of which is hereby expressly waived; and on any such sale, the Bank, its assigns or any of the officers of said Bank, may purchase on its own account, and withou.t further accountability except for the purchase price thereof, the whole or any part of the property sold free from any right of redemption on the part Of the undersigned, which right is hereby waived and released. It is further agreed, that any surplus arising from the sale of said collaterals beyond the amount due hereon, shall be applicable upon any claim of the said Bank arising directly or by assignment against the undersigned at the time of said sale, whether the same be then due or not due. And it is further agreed that any moneys or properties, at any time, in the possession of THE X Y Z NATIONAL BANK, belonging to any of the Parties liable hereon to said Bank, and any deposits, balance of deposits or other sum at any time cred23 • ited by or due from said Bank to any of said parties, shall at all times be held and treated as collateral security for the payment of any other obligation, indebtedness or liability of the undersigned to the said Bank, whether due or not due, and said Bank may at any time, at its option, set off the amount due or to become due hereon or any other obligations against any claim of any of said parties against said Bank. And it is further agreed that upon the non-performance of any of the promises herein contained, that any and all claims held by the said Bank at such time and arising directly or by assignment against the undersigned shall immediately become due and payable. It is also agreed that said collaterals may from time to time, by mutual consent, be exchanged for others, which shall also be held by said Bank on the terms above set forth, and may be applied to any other obligation now or hereafter to be incurred by the undersigned to 'said Bank, whether due or to become due. The rights given by this document to the said Bank are transferable by endorsement. New York .19 (authorized signature necessary) (Reverse Side) For and in consideration of One Dollar to me us in hand paid by THE X Y Z BANK, New York, the receipt of which is hereby acknowledged, we do hereby jointly and severally guarantee that , will on or before the due date of the drafts mentioned in the within agreement, duly pay to said Bank, the amounts payable thereon, and will duly and faithfully carry out and perform all of the other obligations assumed by said 24 And I do hereby expressly waive any demand we for payment upon said and notice of any default in connection with said agreement; and do consent to the substitution of any collateral referred to therein, and to the surrender and release of any such collateral, without ,substitution therefor. my In Witness Whereof, we have hereunto set our day of hands and seals this 19 • Witness: The manufacturer may now draw a draft on the bank for the agreed sum and this bill on presentation is duly accepted, a notation to this effect being written or stamped across the face of the instrument together with the authorized signature of a bank officer. For the sake of our example, we shall consider the bill to be payable 90 days after sight. It is then sold to one of the acceptance dealers, the manufacturing concern receiving the proceeds. The actual money which the manufacturer thus receives has come in reality from some unknown third party who purchased the acceptance in the open market, with the knowledge that it represented one of the best forms of short time investments with a comparatively high return. Although the bank has loaned the manufacturer its credit and not its cash, it nevertheless has assumed without qualification the responsi 25 bility of paying the acceptance at maturity regardless of the disposition of the merchandise in warehouse or the solvency of its customer. For loaning its credit and assuming this risk, the bank receives as compensation a small commission which may vary according to the credit standing of the bank's customer, the kind of goods in storage, the usance of the bill and many other factors. Let us consider this charge to be per cent for 90 days or at the rate of 1Y2 per cent per annum. To arrive at the banking costs, the rate prevailing at the time, which we will assume for purposes of illustration is 43470, must be added. Assuming that other methods of borrowing would cost the New England manufacturer 6 per cent, a comparison (disregarding stamp charges) would be as follows: Acceptance Other. Credit Borrowing Interest for 90 days Bankers Acceptance Commission 4T/4% P/2% 6% 534% 6% This illustrates a case in which it would be to the advantage of the bank's customer to utilize bankers acceptances, and this method of financing is being adopted by increasing numbers of merchants when borrowing on staple commodities in warehouse. 26 S • Bankers Acceptances Principles and Practices Chapter I. General Principles of Acceptance Credits AMERICAN ACCEPTANCE COUNCIL 1 1 1 Broadway New York i:4. • Bankers Acceptances Principles and Practices Chapter I. General Principles of Acceptance Credits AMERICAN ACCEPTANCE COUNCIL 1 1 1 Broadway New York • Published by American Acceptance Council 111 Broadway, New York (Reprint, January, 1921) this pamphlet may be obtained or reprint arranged through application to the Executive Offices of the American Acceptance Council) (Copies of • Foreword The preparation of a primer on bankers acceptances was suggested at a conference of Governors of Federal Reserve banks in March, 1919, when it was proposed that some experts other than Reserve bank officers should be employed for the purpose. After the organization of the American Acceptance Council, it was subsequently decided that it would be better to have the publication prepared and issued in collaboration with and under the auspices of the Council. In accordance with this plan a committee was appointed by the Federal Reserve Board in order tc co-operate with officers of the Council for this purpose. At a meeting of the joint committee of the Board's appointees and the Publicity Committee of the Council, held in July, 1919, the matter was fully discussed and it was then decided to issue such a primer serially and in pamphlet form, each pamphlet being devoted to some particular phase of the problem. Upon its completion, it was planned, the work should represent a careful study of the whole subject of bankers acceptances as permitted under the Federal Reserve Act and the Federal Reserve Board regulations. The present pamphlet is primarily devoted to 3 the principles of bankers acceptance credits and the 0 distinction between bankers acceptance credits and money borrowed. At present there exists a serious lack of unanimity among both bankers and users of bankers acceptance credits with regard to the sound and proper use of the acceptance facilities. As a result of its experience, deliberations and inquiries, the Council is convinced that practices have in some cases developed—partly through lack of experience and understanding, and partly from the exigencies of the war period—which, if uncorrected, might ultimately lead to disastrous consequences and restrictive legislation. The Council believes that it is preferable that restraints on banking and business be self-imposed in conformity with sound and tested practices and principles, rather than by legislative enactment, when to be effective they generally must be arbitrary and rigid. The Federal Reserve Act is provided with a flexibility to accommodate the needs of business, in the wide discretionary regulatory powers of the Federal Reserve Board. These powers the Board so far has used very moderately. It has consistently given in its regulations a liberal interpretation of the Act, emphasizing its desire not to impose, on the exercise of sound banking judgment, limitations hindering initiative and practice. 4 • The American Acceptance Council feels that it would be most unfortunate if, through either ignorance or abuse of privilege, banks and business men should compel a change of attitude in the exercise of the regulatory functions of the Federal Reserve Board. It seems appropriate, therefore, that the Council should prepare this study of the whole subject of American bankers acceptances. In placing it before its readers, the Council recommends the work to the careful attention of its members and invites their hearty support in putting sound principles into actual practices. The ultimate fate of the American bankers acceptance—whether it will be directed by self-imposed rules or by law and governmental regulations—lies in the banking community's own hands. 5 • General Principles of Acceptance Credits Some general principles, as they apply to bankers acceptance credits, may be stated as corner stones in the foundation of this study. They are: 1. That credit, not money, is loaned. 2. That, in general commercial use, the Bankers Acceptance Credit is designed to provide shortterm transactions in goods by supplying assured credit to carry goods, in process of production, transit and marketing. That it should be based on a specific transaction or a series of transactions of these kinds, rather than be permitted to provide borrowed general working capital. That the completion of the underlying transaction should liquidate the bankers acceptance. That the banker, ordinarily and as far as practicable, should retain control of the goods, receive and apply the proceeds to the retirement of the credit when due; accordingly, bills should be drawn to mature so as to synchronize with the prospective liquidation of the transactions. While the principles stated above would quite fairly and accurately describe the world's best concepts and traditions with respect to bankers ac- 6 • ceptance credits, not all of the commercial processes above named are permitted under the provisions of the Federal Reserve Act. Thus, while the law authorizes the granting of import and export credits to finance goods in production, transit and marketing domestic credits may not be extended for financing the production of goods. In domestic transportation credits, against shipping documents covering goods in transit, the bankers acceptance is intended to provide for the financing of goods during the period of transit; and of goods sold and shipped from the time of shipment until payment for the goods is due according to the terms of the sale, but not to exceed six months. The period to be covered by an acceptance credit may not in any circumstances excud six months. In domestic credits secured by "readily marketable staples in warehouse," the bankers acceptance is designed to provide means for the carrying of staples, from the point of completed production to the time when they are distributed. It is never to be used for speculation. In June, 1919, the Federal Reserve Board defined "Readily Marketable Staples" as follows: "A readily marketable staple may be defined as ar article of commerce, agriculture or industry of such uses as to make it the subject of constant 7 • dealings in ready markets with such frequent quotations of prices as to make (a) The price easily and definitely ascertainable, d (b) The staple itself easy to realize upon by sale at any time." The extension of clean credit, that is, unsecured bankers acceptances, not related to any of the commercial processes referred to above, is restricted under the Federal Reserve Act to the so-called dollar exchange credit. This credit is designed to enable banks and bankers, in certain foreign counies, under the rules and regulations of the Federal Reserve Board, to provide exchange for remittances in anticipation of the marketing and transportation of goods sold. While there is no limit prescribed by law as to the length of an acceptance credit a bank may extend, it may not accept any bill having a maturity beyond six months exclusive of days of grace drawn under any import, export or domestic credit, nor bills having a maturity beyond 90 days, exclusive of days of grace, drawn under any credit to furnish dollar exchange. By discounting the bill drawn under a bankers acceptance credit, the drawer or other holder may realize on it when desired, but the acceptor should rot ordinarily discount his own acceptance. 8 The Accepting Banker We shall now consider the application of these general principles from the different viewpoints of the several parties to a banker's credit as they apply under the provisions of the Federal Reserve Act. There is first the accepting banker, the grantor of credit who is asked by a commercial user of credit or another banker to lend his credit to finance a certain business transaction. If the customer is favorably known to him and one for whom he desires to extend a credit, he will inquire into the nature, conditions and terms of the proposed business to ascertain1. That, under the Federal Reserve Act and under the rules and regulations of the Federal Reserve Board, it is an eligible transaction. 2. That it will be completed within the period of the contemplated credit and is reasonably certain of itself at maturity to produce the funds with which to pay the obligation assumed by the borrower. 3. What further guarantee, if any, he should require beyond his customer's obligation to provide the funds in case of delay or failure in liquidating the transaction. He may thus require a guarantor or additional collateral. If the business is proposed by a, banker, in behalf of a customer, the acceptor will probably require the bankers' guar- 9 antee in addition to such securities as will come into his control in the ordinary course of the business. If the transaction involves dollar exchange credit, the acceptor may have placed with him, or lodged in satisfactory hands for his account, acceptable securities or bills for collection. He will also consider the scope of the credit desired with relation to his own resources, existing liabilities, and facilities for handling it, and whether the accepting commission is adequate, all things considered. If all these matters are satisfactory and he decides to grant the credit, he will issue his letter of credit on his customer's written request and guarantee, or the proper execution of an acceptance agreement, and in due course will accept the bills, after seeing that the drafts and documents, if any, are properly drawn, stamped, etc., according to agreement. While the accepting banker seeks to avoid any preventable risk and expects merely to lend his credit to his customer for a specified time and purpose, he has entered upon an unqualified liability to the holder of his acceptance to pay it at maturity. He has, moreover, undertaken to handle for his customer a highly technical and specialized series of transactions involved in the business underlying the acceptance. The satisfactory outcome of the transaction, for both banker and customer, depends upon the ability of the banker to perform his function skillfully and successfully. 10 The Taker of Credit The taker of credit has another and different relation to the transaction and views it from a different angle. He has business in hand or in prospect in which he believes he can advantageously use a bankers acceptance credit. He has carefully considered the matter; he has a definite belief that the turnover of the transaction will provide the funds to retire the bills before they mature. He has weighed the chances of failure through delays in transportation, through changed market conditions, etc., and is confident of his ability to provide the cover for the maturity of the acceptance, even in case the underlying transaction should not be liquidated in time. He decides he will do the business provided he can get satisfactory banking acceptance credit and service. He assumes that he can; that his character, standing and credit, his reputation for prudence and ability, entitle him to the credit required. Possibly several banks have solicited his business. It may be that the transaction is such that he will himself draw the bills or that he will desire to have the drafts issued by others on his behalf; in any event, he is going to obligate himself to provide funds in time to retire the banker's obligation to be created under the acceptance credit, which he is going to hire for a definite period. In normal times he will select his banker. The 11 • character of his business will partly determine his selection and he may use different bankers for different classes of transactions. He will be guided also in the choice of his bankers by the comparative costs, i. e., commissions plus discount at home or abroad, not forgetting that some names are better known than others in particular foreign markets and that a poor rate of exchange realized by a foreign seller will likely affect the price of goods. He will not take a weak credit—an acceptance that would not sell well—because he is well aware of the fact that by drawing on a weak firm he will jeopardize his own credit. He will require of his banker intelligent service and fair treatment. He will not desire to pay for credit longer than necessary; therefore, he will arrange to have the credit mature as soon as possible after the date on which he may safely expect to receive the proceeds of the underlying transaction, and will stipulate for the privilege of retiring the credit under rebate before maturity. What has been said here with reference to large borrowers applies with even greater force to borrowers of lesser financial strength and importance. They cannot perhaps afford to be quite so independent, but the same principles govern them and, if anything, their observance is more vital to them because any loss or excessive charge affects them so much more severely. They must try, therefore, 12 •to buy the very best service and credit available to them. If the taker of credit is a foreign banker he may be depended upon to be market wise and see to it that his business is in good hands. The Guarantor of Credit The guarantor of an acceptance credit may, or may not be, a banker. If he is a foreign banker, he may arrange for his clients' credits with his banking correspondents in foreign countries, facilities which otherwise they might not be able to secure. In such cases, on behalf of his customers, he will probably attend to proper preparation of drafts and documents, collections, etc. If he is a domestic banker, not himself in a position to accept in sufficient amounts to supply the entire needs of his customers, he will probably act as agent in procuring other acceptors and is likely to act for them in attending to the local details of the business involved, such as holding collateral, receiving and remitting proceeds, etc. He may also negotiate the paper for his customers, but his obligation as guarantor is to the grantor of the credit, generally the acceptor. His obligation, broadly stated, is to insure fulfillment of the obligation of the taker of credit to provide funds but may include other obligations stipulated as an essential condition to the granting of the credit, such as assurance that funds derived 13 from the credit will be applied only to the uses for which the credit was given, and that the proceeds of the underlying transactions when realized will be applied as agreed. In such cases the guarantor is paid by his clients commission which may, or may not, include the a acceptor's commission. The acceptor's commission, however, will probably be lower on a credit guaranteed by a banker than if it were not so guaranteed. There may be other profits accruing directly or indirectly to the banking guarantor such as proper charges for exchange and collections, and the benefits accruing from having exchange for remittance. Or the guarantor may be a merchant or manufacturer desiring goods available through an importer or producer who for one reason or another, without the granting of these acceptance facilities, could not swing the business in the volume required. Their own lines might be full or too large a margin might be required by their bankers unless they received additional guarantee against loss. Such a guarantor may stipulate a commission or he may act without special compensation, being primarily interested in getting the goods, or to control their market, and for these reasons he may be willing to assist in the financing by guaranteeing the contract of the person that does control their disposition. Or there may be reasons of friendship or relationship that may form the motive for a guarantee of credits. 14 S II When the Beneficiary of a Banker's Credit Makes It Available to a Third Party When the taker of credit makes it available to the drafts of a third party, (to illustrate, when the buyer of goods furnishes a bankers acceptance credit to the seller), different considerations arise than in cases where the seller takes an acceptance credit to extend credit to his buyer; or to carry his unsold goods. In the first case, goods have been sold and the seller is entitled to payment in the form of an approved bankers acceptance according to terms of sale. All sellers normally prefer cash payment as soon as practicable, but cash before or on shipment is not normally practicable. The most desirable and entirely usual course where cash payment cannot be had is to draw against documents for an agreed term on a responsible drawee. Such draft can be readily discounted by the seller in his own market. Such settlements,, through cOnfirmed acceptance credits, from long and satisfactory experience are to all intents and purposes regarded as the equivalent of cash in the markets of the world, and they serve their purpose equally well in the financmg of domestic sales and shipments of goods. If the seller is satisfied with the financial responsibility of his drawee he may consider his 15 contingent liability as drawer to be negligible, so also the buyer or discounter of the exchange may regard his credit risk as slight. But if the drawee is not so favorably known the purchaser of the bill may consider more carefully the credit and financial position of the drawer and the character and value of the goods, and possibly may limit the volume of drawings he will handle or may place restrictions on the delivery of documents. Therefore, when the credit of the drawee is for one reason or another considered as not beyond question, the seller's credit will prove a considerable factor in the terms upon which the bill may be sold and this will react unfavorably upon the buyer. Some importers are of such undoubted standing and repute that bills on these drawn by reputable sellers (i. e., foreign trade commercial bills) find a ready sale in foreign markets at good rates, but in the vast majority of cases a banker's credit is preferred. So also in domestic business; where goods are sold and shipped there are many opportunities for the buyer to provide a banker's credit with advantage to himself and the seller, rather than to lean too heavily on the credit of the seller or on his own bank for money borrowed. In dealing with credits available to a drawer other than the taker of credit, the ordinary procedure is for the banker to issue in behalf of the taker of credit, against his agreement to put the 16 0 banker in funds, etc., a commercial letter of credit, advice of which is forwarded and confirmed to the authorized drawer, who draws when his shipment is ready and presents the bill and documents to an exchange bank for sale. Such bank names a rate of exchange (based on the length and quality of the paper and current conditions of exchange) which it will pay for the bill. If sale is made it sees that the bill or bills are properly drawn in conformity with the terms of the credit, that the documents are in good shape and convey title and control of the goods to it. These being arranged the bill and documents are forwarded with appropriate instructions to the exchange bank's agent or correspondent at the place where the drawee is located for acceptance and collection at maturity, or for rediscount upon arrival or later, as may be desired. As in many cases documents are required to be delivered on acceptance, there then comes the time when the bill is not directly secured by the goods and the element of unsecured credits is injected. The drawer and first discounter of the bill have considered this in appraising the credit and standing of the drawee, to whom they look for payment of his acceptance at maturity. The drawee has considered it in granting the credit to his customer, the taker of credit, and as the documents covering the goods usually are surrendered by the holder of the bill to the drawee banker against his acceptance of the 17 bill, the latter may, before releasing the goods to his customer, require other collateral or payment. From the above it is obvious that a transaction in goods is being financed and that up to the time of surrender of the documents by the acceptor to his customer the goods have been under continuous control of one or another of the creditors. In these credits it is the drawer who must first be satisfied of the quality of the acceptance offered, then the exchange market in the place where the bill is to be sold. Therefore, the taker of credit will assure himself that the credits he secures will be acceptable to the seller and the bankers in the seller's market. When Taker of Credit Himself Intends to Draw The situation is different where the taker of a banker's commercial acceptance credit is intending to draw himself. This will probably be in cases where he desires accommodation to carry staples unsold or goods sold but not shipped, or to anticipate realization on sales in which he has extended credit. In either event there is no third party involved. The relation is directly between him and his banker. He is in a relation more like a borrower of money. He might get his accommodation through secured loans or rediscount of his receivables or perhaps on his unsecured promissory note. If he has the option between these and bankers acceptance credit, he will use the cheapest. 18 O In this phase of the use of acceptance credit, we find limitations that perhaps are not so well understood and closely observed in practice as they are definite when tested by the application of our principles, and there are border line cases that only intelligent regard for principles and the spirit of the law will properly classify. Proper Use of Acceptances by Drawer Under Credit Taken by Himself There is a proper field for the use of bankers acceptances by the drawer under credit taken by himself in cases such as the following: When an importer has arranged to bring in goods under conditions that require longer credit than the usual terms or than the seller would wish to extend or to draw for. Frequently in such cases the terms stipulate payment on presentation or "sight against documents," whereas some further time is required for the sale of the goods that will furnish the funds to pay for them. A bankers acceptance credit may be used to finance the carrying of these imported goods during such an interval provided it was arranged for with the banker as a condition to engaging in the importation or the transaction which involved the importation. Or, where goods have been sold and exported and, instead of discounting the bills on the foreign buyers, these bills are lodged with a banker for collection and application of proceeds to liquidate 19 • an acceptance credit granted against the exports represented by the pledged bills and documents covering the exportation. Or, where bills are drawn by a shipper against documents in either export or domestic shipments, delivered to the banker for forwarding and delivery against cash, the latter, when received, to be applied by the banker in payment of the acceptance credit. Or, where there is a contract to export, to perform which goods must be manufactured or assembled, requiring use of credit before actual export can begin, or ocean or through bills of lading can be procured, but which the exporter has agreed to procure and deliver to the accepting banker. Or, where goods have been sold or contracted for export but are delayed in transit to port or are at port awaiting bottoms. Or, where staple commodities properly stored and insured are awaiting shipment or market or manufacture and are pledged to secure credit taken. Or if from some unforeseen cause or delay interfering with the prompt liquidation of the transaction a continuation of credit is required and an importer or exporter might properly wish to draw a new bill to retire one maturing. All of these cases, and possibly others, would fall well within the spirit of the law and principles. All are confined to certain transactions involving im 20 portations, exportations or domestic shipments, the proceeds of which will come into the banker's hands in due course to be applied in liquidation of credit, or are properly secured by pledge of staples. ( Improper Basis for Granting Acceptance On the other hand, goods sold in open account either at home or abroad are not a proper basis for granting bankers acceptance under the Federal Reserve Act; Nor is the pledge of goods other than readily marketable staples; Nor is the pledge of such staples out of control of banker or in owner's hands; Nor is the mere exhibition of a bill of lading or a copy of invoice by the shipper; Nor is a bill of lading in the hands of the consignee covering non-staple goods beyond the period when the goods represented by it are in transit; Nor are assigned accounts receivable, promissory notes, or other bills receivable. Such transactions, and the balances resulting from them, may be proper considerations for the loan of money. But each involves a use of credit in a way or to an extent not contemplated in the Federal Reserve Act as a basis for making eligible bankers acceptances. Acceptance credits in such cases would not be self-liquidating in the sense of our principles, nor 21 secured during their life by staple goods which might provide liquidation in case of need. They should be avoided so as not to bring reproach upon the bankers acceptance, the undoubted standing of which as the finest class of short investment paper should not be permitted to be affected. III Distinction Between Money Borrowed and Bankers Acceptance Credit Money borrowed is available only to the extent of a bank's loanable funds, but acceptance credits may be extended even where the bank has no funds to loan. The open market will provide the funds drawn from other banks and other sections, and from other countries where money is seeking an opportunity for investment. Money borrowed is frequently immobilized— By investment in plant or other capital investment; By employment in carrying non-liquid assets, such as unsold and unmarketable goods, and manufactures made up in anticipation of seasonal demand, old or over-due accounts; and By employment to replace proprietors' working capital sunk in ill-conceived business, but for which hope for recovery persists. 22 Money borrowed, either with or without security, is often considered and used as invested capital, the withdrawal of which would more or less seriously embarrass the borrower. Bank's loans to customers, except for seasonal requirements or specific purposes, are, therefore, as a class not always highly liquid. A bankers acceptance credit taken under provisions of the Federal Reserve Act must be of selfliquidating character; if a secured credit, it may in case of default be liquidated from realization on collateral enjoying a wide market, or, if unsecured, from completion of underlying transactions which, barring failure or fraud, will automatically yield in the banker's hands the funds for retirement. Such a credit, based on current commercial transactions, within limitations designed to minimize credit risks, may, therefore, be granted more freely, and with greater expectation of retirement at maturity than money might be loaned in ordinary course. In. loaning credit the underlying transaction should always be considered. Cautious regard for the acceptor's own reputation will require this. His obligation to accept for none but well-considered transactions of proper character is an obligation towards the whole money market, which scrutinizes with expert eye his acceptances sold in the market as evidences of his conduct of business. It is not 23 necessarily so with regard to loans of money— there the lender need satisfy none but himself, unless he seeks rediscount. Within legal limits and free from the scrutiny of the discount market he may lend on general belief and without specific knowledge of the purpose for which his assistance i$ sought. This may be seen by a comparison of the relafive requirements for eligibility at a Federal Reserve bank of commercial paper, including promissory notes given for borrowed money, and of bankers acceptances. As to the note, the use of its proceeds is the determining factor. That use must be commercial, i. e., in one or more of the steps in the process of producing, carrying or distributing goods. The evidence of such use, however, may be, and in practice is, the financial statement of the borrower, which must disclose a reasonable excess of quick assets over current liabilities. Such a condition, however, indicates no more than that, at the time the trial balance for the statement was taken, the amount of money borrowed, other than mortgage money or other long time obligations, was not invested in plant, equipment, or other capital investment. It may be assumed that the statement was prepared at not the most unfavorable period as it is given for the purpose of securing credit. Under existing conditions such a statement is per. 24 • • haps the most definite and precise information available to the lender of unsecured money, although, of course, good reputation and confidence based on personal acquaintance and knowledge of the character, habits and methods of the borrower form other and most important bases for extension of accommodation. But how different and how much more definite must be the banker's knowledge of the nature and details of the business which he assists by extending his acceptance credit. There are the documents, which in many cases he receives, covering actual goods in transit bought or sold; in other cases the contracts to export _must be disclosed, and the banker must be satisfied with regard to the value of the goods and the ability of the buyer to pay for them, and in some cases security by pledge of goods or staples is necessary. In granting acceptance credit, the banker, if he be prudent and has conscientious regard for the law, must have a more complete knowledge of the business to be financed than he ordinarily would have in the case of money borrowed from him, which, once borrowed, may be put to any use at the borrower's pleasure. It is the essence of commercial banking that money borrowed should be loaned on the general faith and confidence of the lender in the borrower, involving, nevertheless, a legitimate and unavoid- 25 able credit risk. It must not be assumed that there is an entire absence of such credit risk or even a smaller risk in granting acceptance credit. Indeed the hazards in extending acceptance credits are very real. Risks: What They Are and Hon) to Minimize Them Some risks are similar to those in lending money, others are of a different character. What are they and how are they minimized? The accepting banker has to take the hazard of relying on the strength and good faith of the taker of credit and of the buyer or consignee of the goods. In the first case he must depend upon the borrower's ability and desire to protect the banker, in case the underlying transaction fails to produce the funds necessary to meet the maturing acceptance. The accepting banker in this case is in a position very similar to that of a commercial banker relying on his customer's willingness and ability to repay borrowed money under adverse circumstances. The acceptor's risk should be appraised in the same way with this distinction, however, that even greater care should be exercised by him, first, because of his obligation to the discounters of his acceptance credit, and second, because the amounts involved are apt to be larger. The risk involved in having to rely upon the strength, ability and good faith of the buyer or con- 26 • signee of the goods sold by the taker of credit, is similar and may be more difficult to appraise, particularly if buyer or consignee is abroad. Time may be required to conduct inquiries. If there is doubt, suitable guarantees may be suggested or required which may result in the buyer providing credit instead of the seller extending it. It may be wise to decline to finance exports on seller's credit in cases where he is not abundantly able to stand a loss, if loss should occur. In this regard, the other class of risks must be considered, such as the nature of the goods and their value. Are they perishable or subject to material depreciation in quality in transportation? Is their market wide or restricted? Is their market value stable or liable to sudden decline? In case of delayed shipment or delivery at the other end, will they still hold their value? What facility has the banker for disposing of the goods in a foreign port if not accepted by the buyer or consignee? What expenses would this involve, and what loss might result? Expenses would include customs duties, transportation, storage, legal fees, commissions, etc. Loss might include these and also depreciation in quality through delay, loss on adjustment of insurance, etc., loss in value from a failing market, loss in exchange and interest. It is apparent, therefore, that the accepting banker must have wide and special knowledge of 27 goods and commodities, their values and markets; also of the special dangers and risks incident to their transportation, storage and sale. He must, if financing export trade on credit furnished by the seller, have special knowledge of foreign credits, foreign laws and business customs, or employ agents who have this knffledge. The American foreign trade banks, in which he possibly has a proprietary interest, can serve him in these regards in lieu of, or in addition to, other relations or correspondents, and by their specialized knowledge and facilities can greatly assist those acceptors who have not developed foreign departments or established satisfactory connections abroad. Many of the same risks in varying degrees surround acceptance credits in domestic shipments, but trouble in these may frequently be more quickly adjusted. In credits secured by warehoused staples, the applicable risks among those mentioned are very apparent, and there is another which should always be guarded against—the danger in lending on commodities held for speculation. Aside from the almost always ominous speculative hazard, bills drawn against speculative holdings are not eligible at Federal Reserve banks. As a precaution in these credits, as indeed in many others, an ample margin of collateral security in the commodity itself should be required, and the banker should inform himself as to the nature and 28 O extent of any prior liens on goods and the volume of similar credits taken from others. Credits against unsold goods ordinarily should be restricted to the period of time required to move the goods into channels of distribution through sale. Distinction in Banking Law The distinction between money borrowed and bankers acceptance credit is emphasized not only in prudent banking practice but in our banking laws. Section 5200 (U. S. revised statutes)* is the applicable section of the National Bank Act, and its limitations are partially and variously reflected in Sections 9, 11 (m) and 13 of the Federal Reserve Act where they affect national and state bank members in their rediscount operations. Thus, while with certain exceptions in Section 5200 with regard to money borrowed on the security of certain United States Government obligations, and also with regard to loans for limited periods secured under certain conditions by non-perishable staples, no person, natural Or legal, may be indebted to a national bank for borrowed money, secured or unsecured, for an amount in excess of 10% of the unimpaired capital and surplus of the bank. But there is no legal limit in either the National Bank Act or the Federal Reserve Act to the amount of accommodation that may be granted to one cus"For'text of Section 5200 sec Page 33 of Appendix. 29 tomer through discount by a national bank of commercial paper actually owned by him.* The philosophy of the limitations of and exemptions from the statutes may be briefly stated, viz., that while it may be, and frequently is, necessary and proper for banks to accommodate business with leans of money for employment more or less temporarily as working capital, or to finance capital operations, such advances should and must be confined within a maximum limit which no borrower may exceed; but nevertheless, it would be unwise and needlessly restrictive to limit by statute the extent of accommodation to business through rediscount of paper resulting from sales of goods on credit or arising in credit transactions against goods in being and presumably moving to or awaiting movement to market. These are the broad principles which, while subject to infinite refinement in particular applications, must remain broad to permit the essential elasticity to sound banking judgment required for it to function freely in its every day adjustment of and adaptation to business affairs and conditions. Bankers acceptance credit taken is not money borrowed either within the meaning of the law or in practice, but is immediately transmuted into money borrowed when the acceptor discounts or otherwise "The Federal Reserve Board's analysis of the loaning powers of National Banks under the amendment to Section 5200, as approved Oct. 22, 1919, appears on Pages 38, 39 and 40 of the Appendix. 30 • • acquires his own acceptance, before receiving the funds with which to retire it. This is because when acceptance credit is granted there is an obligation created or implied that the taker of the credit under which the drafts were drawn will put the banker in funds at or before their maturity. Such payment to the banker is the retirement of the credit by the taker. The debtor's obligation to provide cover for the payment of the acceptance is the banker's asset against which, by his act of acceptance he creates his liability for payment of the draft to its holder. If he subsequently becomes the holder of his own acceptance obligation at or before maturity, and before he has been placed in funds for its payment, his liability to pay has been extinguished, as he cannot be obligated to pay to himself, and he becomes in fact a lender of money against his customer's obligation to repay him. He I - in a similar position when his customer defaults iii providing funds before the banker is required to meet his obligation, i. e., pay his acceptance to the holder at maturity. In both cases, if the amount of such debt, which must be considered as an evidence of money borrowed, either by itself or added to other money loans to the same borrower, exceeds 10% of the capital and surplus of a national bank acceptor, such acceptor is in violation of Section 5200, and the excess over 10% is not eligible for discount by a Federal Reserve bank. 31 It is clear, therefore, that the acceptor's own acceptance, if offered by him to a Federal Reserve bank for discount or purchase, must be regarded as the promissory note of a drawer offered for rediscount, and as such is subject to the limitations covering rediscounts of single name commercial paper and does not take the preferred classification of commercial paper actually owned or bills of exchange exempt from the limitations of the Acts, as it would if the acceptance were held by some one other than the acceptor. In the latter case it would nowhere count against the line of the drawer; but as the obligation of the acceptor it would circulate either as commercial paper actually owned or as a bill of exchange against actually existing values, and without the limitations of Section 5200 and the relative sections of the Federal Reserve Act. 32 Appendix Section 5200, U. S. Revised Statutes [H. R. 7478.] An Act to amend Sections 5200 and 5202 of the Revised Statutes of the United States as amended by Acts of June 22, 1906, and September 24, 1918. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled, That section 5200 of the Revised Statutes of the United States as amended by the Acts of June 22, 1906, and September 24, 1918, be further amended to read as follows: SEC. 5200. The total liability to any association of any Person or of any company, corporation, or firm for money borrowed, including in the liabilities of a company or firm the liabilities of the several members thereof, shall at no time exceed 10 per centum of the amount of the capital stock of such association, actually paid in and unimpaired, and 10 per centum of its unimpaired surplus fund: Provided, however, That (1) the discount of bills of exchange drawn in good faith against actually existing values, including drafts and bills of exchange secured by shipping documents conveying or securing title to goods shipped, and including demand obligations when secured by documents covering commodities in actual process of shipment, and also including bankers acceptances of the kinds described in section 13 of the Federal Reserve Act, (2) the discount of commercial or business paper actually owned by the person, company, corporation, or firm negotiating the same, (3) the discount of notes secured by shipping documents, warehouse receipts, or other such documents conveying or securing title covering readily marketable nonperishable staples, including live stock, when the actual market value of the property securing the obligation is not at any time less than 115 per centum of the face amount of the notes se- • cured by such documents and when such property is fully covered by insurance, and (4) the discount of any note or notes secured by not less than a like face amount of bonds or notes of the United States issued since April 24, 1917, or certificates of indebtedness of the United States, 33 shall not be considered as money borrowed within the meaning of this section. The total liabilities to any association, of any person or of any corporation, or firm, or company, or the several members thereof upon any note or notes purchased or discounted by such association and secured by bonds, notes, or certificates of indebtedness as described in (4) hereof shall not exceed (except to the extent permitted by rules and regulations prescribed by the Comptroller of the Currency with the approval of the Secretary of the Treasury) 10 per centum of such capital stock and surplus fund of such association and the total liabilities to any association of any person or of any corporation, or firm, or company, or the several members thereof for money borrowed, including the liabilities upon notes secured in the manner described under (3) hereof, except transactions (1), (2), and (4), shall not at any time exceed 25 per centum of the amount of the association's paid-in and unimpaired capital stock and surplus. The exception made under (3) hereof shall not apply to the notes of any one person, corporation or firm or company, or the several members thereof for more than six months in any consecutive twelve months." SEC. 2. That section 5202 of the Revised Statutes of the United States as amended by section 20, Title I, of the Act approved April 5, 1918, be further amended so as to read as follows: "SEc. 5202. No national banking association shall at any time be indebted, or in any way liable, to an amount exceeding the amount of its capital stock at such time actually paid in and remaining undiminished by losses or otherwise, except on account of demands of the nature following: "First. Notes of circulation. "Second. Moneys deposited with or collected by the association. "Third. Bills of exchange or drafts drawn against money actually on deposit to the credit of the association, or due thereto. "Fourth. Liabilities to the stockholders of the association for dividends and reserve profits. "Fifth. Liabilities incurred under the provisions of the Federal Reserve Act. 34 • • "Sixth. Liabilities incurred under the provisions of the War Finance Corporation Act. "Seventh. Liabilities created by the endorsement of accepted bills of exchange payable abroad actually owned by the indorsing bank and discounted at home or abroad." Approved, October 22, 1919. What a Federal Reserve Bank May Discount for its Member Banks The limitations imposed upon the amounts of rediscounts which a Federal Reserve bank may make for a member bank, whether State or national, are determined by the provisions of the Federal Reserve Act and are not in any way affected by the amendment to Section 5200. Under the provisions of Section 13 of the Federal Reserve Act any Federal Reserve bank may rediscount for any member bank, whether State or national, the obligations of any one borrower to the extent of ten per cent. of the member bank's capital and surplus but it is expressly provided that "bills of exchange drawn against actually existing values" shall not be included in determining that ten per cent. limit. In the opinion of the Federal Reserve Board this phrase "bills of exchange drawn against actually existing values" includes "drafts or bills of exchange secured by shipping documents conveying or securing title to goods shipped" and "bankers' acceptances of the kinds described in Section 13 of the Federal Reserve Act" even though Section 13 (unlike the amendment to Section 5200) does not expressly state that those two classes of paper are bills of exchange drawn against actually existing values. In the opinion of the Board, however, accepted demand bills on which the drawer is released from liability are not "bills of exchange" within the meaning of Section 13 and must, therefore, be included in determining the limits on the amount of paper of any one borrower which a Federal Reserve bank may rediscount for any member bank. Under the terms of Section 11 (m), as amended by the Act of March 3, 1919, any Federal Reserve bank may, 35 • until December 31, 1920, rediscount for any member bank, whether State or national, the obligations of any one borrower to the extent of twenty per cent. of the member bank's capital and surplus, provided, however, that the excess over and above ten per cent, must be secured by bonds or notes of the United States issued since April 24, 1917, or by certificates of indebtedness of the United States. Special Provisions Relating to Rediscounts for Member State Banks The above discussion relates to the general powers of a Federal Reserve bank to make rediscounts for any member bank, whether State or national. It must be observed, however, that under the terms of Section 9 of the Federal Reserve Act, no Federal Reserve bank can rediscount for a member State bank any of the paper of any one borrower who is liable to such member State bank in excess of ten per cent. of the capital and surplus of that State bank but it is provided that the discount of bills of exchange drawn against actually existing values and the discount of commercial or business paper actually owned by the person negotiating the same shall not be included in determining the amount to which a borrower is liable to such member State bank. The provisions of this Section 9 are in no way affected by the amendment to Section 5200 of the Revised Statutes and the same test as to the eligibility of any part of the line of paper of any one borrower which is held by a member State bank is applicable now as before that amendment to Section 5200. Under the provisions of Section 11 (m) as amended by the Act of March 3, 1919, the Board has ruled that a Federal Reserve bank may, until December 31, 1920, rediscount for a member State bank paper secured by not less than a like face amount of bonds or notes of the United States issued since April 24, 1917, or certificates of indebtedness of the United States, without regard to the amount the borrowing bank may already have loaned to its customer under his regular line of credit, provided, however, that the aggregate of all rediscounts of the paper of any one borrower must in•no case exceed twenty 36 cent, of the capital and surplus of the metnber State Vi- per bank. In other words, if the regular line of credit of the borrower from a member State bank is not more than the ten per cent. limit fixed by Section 9 of the Federal Reserve Act, Federal Reserve banks may rediscount for State member banks to the same extent that they may for member national banks. If, however, the regular line of credit of the borrower from the member State bank is more than that ten per cent. limit, then the Federal Reserve bank cannot rediscount any of that regular line of credit but may rediscount that paper which is secured by Government obligations of the kinds specified Up to the limits described above. (See ruling of the Federal Reserve Board printed on pages 361 and 362 of the April, 1919, Federal Reserve Bulletin.) October 24, 1919. 37 Loaning Powers of National Banks, Under the Amendment to Section 5200, U. S. R. S., Approved October 22, 1919 The amendment to Section 5200 of the Revised Statutes which became a law on October 22, 1919, has made certain material changes in the loaning powers of national banks. For the convenience of national banks and others interested in the effect of those changes, there is submitted herewith an analysis of the provisions of Section 5200 now in force. The amounts which a National Bank may properly lend to any one person, company, corporation or firm (including in the liability of a company or firm, the liabilities of the several members thereof) under the various clauses of Section 5200, as amended by the Act approved October 22, 1919, are stated in terms of the percentage of the paid-up and unimpaired capital stock and surplus of the lending bank. CHARACTER OF LOANS (A) Accommodation or straight loans, whether or not single name. AMOUNTS LOANABLE Maximum limit, 10% of bank's paid-up and unimpaired capital and surplus. (B) "Bills of exchange drawn in good faith against actually existing values." The law expressly provides that this phrase shall also include: (a) Drafts and bills of exchange secured by shipping documents conveying or securing title to goods shipped. (b) De m a ri d obligations, when secured by documents covering commodities in actual process of shipment. (c) Bankers' acceptances of the kinds described in Section 13 of the Federal Reserve Act. No limit imposed by law. 38 • (C) CHARACTER OF LOANS Commercial o r business paper (of other makers) actually owned by the person, company, corporation or firm negotiating the same. AMOUNTS LOANABLE No limit imposed by law. (D) Notes secured by shipping documents, warehouse receipts or other such documents, conveying or securing title covering readily marketable non-perishable live staples, including stock. No bank may make any loan under (D), however, (a) Unless the actual market value of the property securing the obligation is not at any time less than 115% of the face amount of the note, and (b) Unless the property is fully covered by insurance, and in no event shall the privilege afforded by (D) be exercised for any one customer for more than six months in any consecutive twelve months. 15% of bank's capital and surplus in addition to the amount allowed under (A); or if the full amount allowed under(A) is not loaned then the amount which may be loaned in the manner described under (D) is increased by the loanable amount not used under (A). In other words, the amount loaned under (A) must never be more than 10%, but the aggregate of (A) and (D may equal, but not exceed, 25%. (E) Notes secured by not less than a like face amount of bonds or notes of the United States issued since April 24, 1917, or by certificates of indebtedness of the United States. 10% of bank's capital and surplus, in addition to the amount allowed under (A), or if the full amount allowed under (A) is not loaned, then the amount which may be loaned in the manner described under (E) is increased by the loanable amount not used under (A). In other words, the amount loaned under (A) must never be more than 10%, but the aggregate of (A) and (E) may equal, but not exceed, 20%. 39 (F) Notes secured by U. S. Government obligations of the kinds described under (1' the face amount of which is at least equal to 105% of the amount of the customer's notes. No limit, but this privilege, under regulations of the Comptroller of the Currency, expires December 31, 1920. Scme Examples of What a National Bank May Lend at Any One Time to Any One Customer Under the Amendment to Section 5200, Approved October 22, 1919, Expressed in Terms of Percentage of the Bank's Capital and Surplus Illustra- Illustra- Illustration tion tion 3 2 1 (A) Accommodation or straight loans (D) Notes secured by warehouse receipts, etc. (E) Notes secured by a like face amount of Government obligations 10% 5% . 5% 15% 20% 15% 10% 10% 15% Total (B) Bills of exchange drawn against actually existing values (C) Commercial or business paper (F) Notes secured by at least 105% of U. S. Government obligations 35% 35% 35% October 24. 1919. 40 No limit imposed by law. No limit imposed by law. No limit imposed by law. O Bankers Acceptances Principles and Practices Chapter II. Availing of Credit and Negotiation of Bills - AMERICAN ACCEPTANCE COUNCIL 1 11 Broadway New York Bankers Acceptances Principles and Practices Chapter II. Availing of Credit and Negotiation of Bills AMERICAN ACCEPTANCE COUNCIL 1 1 1 Broadway New York • Published by American Acceptance Council 1 1 1 Broadway, New York October, 1920 (Copies of this pamphlet may be obtained or reprint arranged through application to the Executive Offices ofthe American Acceptance Council) • 1 Foreword The following pages present the second instalment in the series on bankers acceptances prepared by the Acceptance Committee of the Federal Reserve Agents Conference in cooperation with the American Acceptance Council. The first was primarily devoted to the principles of bankers acceptance credits and the distinction between bankers acceptance credits and money borrowed. The present chapter deals with the procedure to be followed in availing of bankers acceptance credits and in negotiating bills drawn under such credits. Availing of Credit and Negotiation of Bills When a credit has been arranged and a transaction has advanced to a stage where the person who is authorized to draw on the banker is ready to do so, he may, of course, draw the bill of exchange and deposit it with his bank for collection, but he usually wishes to realize, in currency or local banking funds, the proceeds of his draft as soon after drawing it as possible. He avails of the credit when he draws under it in accordance with its terms, but the negotiation of the draft so drawn is not the same thing and it may be accomplished in various ways and through different channels, the choice of which will depend on the particular circumstances surrounding individual cases. If he is a foreign exporter drawing under a commercial letter of credit he will be careful to prepare his bills in duplicate or triplicate, as the case may be, and deliver them, with documents complete, and present the letter of credit to the bank or banker in his market who has bid him either directly or through an exchange broker the best price in local funds for his foreign bills. The bank or banker purchasing the bill indorses on the letter of credit the amount that has been drawn against it. 5 • If he is a domestic exporter drawing in a foreign currency the procedure may be practically the same, but if the drawer is not located in a center where foreign exchange is dealt in directly, the negotiation may be through the agency of his local bank. Similarly the drawer's local bank is the logical place for negotiation by the shipper located outside of the large centers of many of his bills drawn in dollars on accepting banks or bankers located in the large centers under their credits made available to the drawer in domestic as well as foreign transactions. The local bank may discount or purchase its customer's bills of exchange created in such transactions in the same way as the larger domestic institutions and branches of foreign banks, located in the large centers or at the ports, discount or purchase export bills received from their customers as well as brokers. Limitations of Section 5202 The local national bank may take both the export shipment bill and the bill drawn against domestic shipments of goods sold without regard to the limitations of Section 5200, which do not include such bills when drawn in current transactions against actually existing values. Regard must be had, however, for the limitations of Section 5202 in indorsing for rediscount, except to a Federal Reserve bank, or indorsing for resale bills payable in the United States. 6 S But within the limitations of Section 5202 there is a latitude for the proper extension by interior banks for a very considerable aggregate volume of valuable accommodation to their local shippers drawing under bankers acceptance credits. The development of this facility should provide a proper and profitable use of their own indorsement when they have occasion to realize in the open discount market on prime bills so taken; it would also supply to the open discount market a desirable class of domestically drawn paper now infrequently seen, i. e., three-name paper, two names on which are banking names, one the acceptor and the other the bank of first negotiation. Such paper is comparable to the three-name foreign drawn paper on American banks or bankers negotiated by exchange banks in the country of origin, drawn to their order and indorsed by them when offered for discount or sale in this country. This is the type of paper most preferred in this or any other discount market, as it represents only liabilities incurred in the transaction and financing of current, commercial operations involving transportation of goods, and on that account is generally and properly regarded as self liquidating. Procedure When Negotiating Sale or Discount of Large Amounts of Mills In cases in which the shipper or local bank is negotiating for the sale or discount of large amounts 7 of either foreign exchange bills or bills drawn on American banks under acceptance credits, it is usual for them to obtain by telegraph a firm bid from a bank or exchange dealer in New York or other port for the particular bills offered and to contract for their sale to such buyer for payment against their delivery in his market within a specified time. In such cases, also, the local bank of the seller may itself buy the bills of exchange from the seller, taking discount for the transit time to the purchaser, or may discount the seller's draft on the purchaser, drawn with the bills of exchange and documents attached for the number of (lays required, according to the contract of sale. Or an exporter may prefer to deposit his documentary export bills with an accepting bank for collection and draw his own bill in dollars on his bank under a credit granted him by it. It is to the advantage of the exporter to do this when the export bills he has to negotiate are not of the character to fetch prime rates as exchange, when the current rates offered for the export bills are unsatisfactory and probably a better rate of exchange will be realized when the bills mature and are paid abroad, and when the exporter does not wish to discount the entire amount of his foreign drawing or possibly does not wish to discount them for the full time to maturity. Formerly, American banks made money loans to exporters against their export bills for collection, 8 • usually with a reasonable margin and suitable guarantees, but now they may grant acceptance credit against the same collateral. Disadvantages of Former Lack of Open Markets If the exporter has drawn dollars against his export bills, he is in the same position as any other taker of credit availing of it by his own drawings. As a great many dollar credits are availed of by direct drawing of the taker of credit, it is desirable that the facilities for their negotiation should be well known and understood. Until an open discount market for bills was established, it was quite natural that the taker of dollar credit should look to his accepting bank for the negotiation of the bills drawn on it, and so it became quite the usual thing for the acceptor to discount for the drawer his bills on the acceptor, and this practice still continues to the detriment of a better and more proper development of the use of dollar credits and the open market. Through such discount by an acceptor of bills drawn on him, the anomalous condition is created that whereas the acceptor has contracted to loan his credit, he, in fact, makes a loan of money and in order not to have such loan conflict with other sums of money loaned to the same borrower or possibly increase too much the total money loans of the acceptor, he must of necessity dispose of the bill 9 himself—in other words, rediscount it for his own account. The effect of this procedure is not and cannot be to the best interest of either the takers of credit as a class, or the acceptors as a class, and must affect adversely the American bankers acceptance credit system of financing, the position of the dollar bill in foreign markets, and development of the American open discount market, for reasons that are readily discernible. Adverse Elements and Methods Important among these reasons are the tendency to create an artificial equalization of the value of different credits, which in the real market are appraised at different values—this through the fact that although the cost of credit and discount may be the same to one borrower from different acceptors, and so lead him to believe that one is as good for him as another, the difference in cost of rediscount, which is not apparent to the taker of credit, establishes a difference in value of the respective credits. The taker of credit could not remain oblivious to this difference if he sold his bills in the open market. Then there is the disturbing condition which is created in the discount market when an acceptor has accumulated a considerable volume of his own acceptances and, requiring funds, offers large amounts of them in the market. In the past, such offerings frequently came simultaneously from van - 10 •ous acceptors at times when money was tight and the market therefore unprepared adequately to absorb unusual amounts of particular names. Such names at such times naturally had to take rates somewhat inferior to those they would readily have commanded had the bills been marketed gradually in smaller amounts as created, and at the convenience of the drawers rather than to meet the requirements of the acceptors. Such operations tended to render market rates unstable and higher, to the disadvantage of holders of bills as well as users of acceptance credits. Similar if not more aggravated conditions arise when an acceptor, having a full legal line of money loaned to a borrower, also accepts and discounts for the same borrower. Then- the bill must be disposed of immediately to avoid carrying the excess loan in violation of law. The rate of discount obtainable may or may not be one that the drawer of the bill would consider reasonable, but must be accepted. This hazard of the market also tends to .higher cost to the borrower, i. e., commission and discount or flat sum to cover both, as allowance must be made for the hazard in market rate. Naturally such offerings occur more frequently with respect to bills drawn by very large borrowers and at times when, from an active demand for money or from an oversupply of such paper or both, the demand for bills does not quickly absorb the supply. 11 Cause and Effect ofMarket Congestion Such a condition and the resulting effects were strikingly illustrated in the autumn of 1918, when an important amount of grain-secured bankers acceptances was created almost over night under conditions that necessitated their immediate rediscount by the acceptors, and the New York market was deluged with offerings from interior cities in such volume that rates rapidly advanced to new high levels for those bills in particular, and all bills in general, to the inconvenience and cost of all holders of bills. If the distribution of that paper could have proceeded more leisurely, the congestion and disturbance would not have occurred, or at least would not have been so aggravated. In such circumstances instability is registered against the dollar bill of exchange in the exchange markets of the world, through the unsettlement of the American discount market and its consequent inability to make forward contracts for the discount of foreign-drawn dollar bills of exchange upon their arrival in this country, excepting at rates so advanced as to occasion unfavorable comment abroad. Also, at such times the Federal Reserve banks receive an undue proportion of long paper, which is lodged permanently with them, and is therefore bills unavailable to supply the market demand for has that again develops as soon as the convulsion are indeed, and, passed, when rates rapidly recede 12 apt to react downward below normal, only to advance again at the next recurrence of wholesale blundering. Avoidable Emergencies It may be asked, is not this inevitable when transactions of magnitude occur in times of emergency? To a degree, yes; but what creates the emergency? The abnormal administration of a normal function designed and, through generations of exercise under intelligent handling, proved adequate and fitted successfully to accommodate the needs of world commerce on a wojiderfully stable basis of cost for credit and discount. Under normal administration the emergency probably would be foreseen and provided against, or so mitigated that no ripple of disturbance would appear. The customs here deprecated must, if adhered to, themselves create from time to time the emergencies we should seek to avoid. They must lead to a wrong development in our discount market and react on the good acceptor and the taker of credit to their disadvantage. They are not now in any sense necessary and should be avoided. When Acceptances are Withheld from Market by Acceptor Some accepting banks have been adverse to permitting a drawer, to whom they have granted a credit, to market his own bill, and have required as 13 • a condition of accepting that the bill should be sold to them. Some such banks apparently did not care to have their acceptances appear on the market; others desired that they should be lodged only in certain quarters; still others sought to acquire their own obligations and exchange them outside of the market with friendly acceptors for their bills similarly acquired or for other bills that they had discounted for customers or had bought. In any such case the bills so handled were very apt to come into the local market or to be offered to Federal Reserve banks at inconvenient times, when their offering in addition to the current market operations would probably cause congestion and when an offering of a name infrequently seen was apt not to fetch a favorable price. The withholding of good paper from the market prevents its participation in the benefits resulting from wide distribution over the whole country which dealers and discount houses are constantly striving to increase. These are of real benefit to the acceptor in that they enlarge the market for his acceptances and so add market value to his name not only with the investor in his acceptances but also with users of bankers acceptance credit. Exceptions to Usual Practice It should not be assumed that an accepting bank or banker should never through discount or otherwise become the holder of his own acceptance before 14 its maturity. On the contrary, when his outstanding credit has been availed of to such an extent that the lawful limit of acceptance liability is exceeded, effort must be made at once to retire the excess. The natural and logical course in such case is to buy up in the open market the necessary amount of the paper, employing a broker or dealer for the purpose of locating and acquiring it if necessary. Again, if it appears that the market for any reason is not readily absorbing current offerings of any name at rates fairly stable in comparison with rates quoted for other names, the acceptor will be well advised if he reduce his outstanding line by purchase until such condition is corrected. Also, when a bank of deposit and discount which also accepts, having accepted for one customer, has that paper offered for discount by another customer (a depositor), the acceptor will properly discount that paper for his depositor at the best rate. Another case would be where a foreign branch of an American bank would protect by purchase bills drawn under credits issued by the American bank. But these exceptions are beside the practices referred to which have invited and aroused intelligent criticism and have caused the bankers acceptance when so used to be referred to merely as loans of money partly disguised. These critics argue that if a bank or banker wishes to lend money only he should not do so through the medium of his ability 15 to extend acceptance credit, and that if he desires to sell acceptance credit he should seek to make it as attractive to its users as possible. Real Value of Credit Our bankers should consider these questions and also ask themselves if it is good policy for the sake of a small additional profit, or even if the profit be so large as to amount to a double commission or more, to confuse the granting of bankers acceptance credit with loans of money. Would it not be better business to charge the borrower a proper commission for use of credit and then assist him if need be to realize its greatest advantage and best value? Our takers of credit also should inform themselves as to the real value of what they buy and pay for. In borrowing money through an acceptance credit they pay one price for the use of a credit, a name better known than their own, and another and different price for the temporary use of money which they can the more readily obtain by reason of their having first bought the use of a name additional to and other than their own. Having bought the use of the other name because of its supposed value to them in obtaining money on better terms than if that name were not bought, why should they not be free to sell what they have bought in the best market? Or if they seek merely to borrow money, why should they put their obliga- 16 tions in a form for rediscount by their creditor for his advantage and with their indorsement? Why should a borrower of money indorse for the lender? The situation so created seems rather topsy-turvy, and in extreme cases of relative financial abilities of the drawer and acceptor might even raise a question as to which would justly be entitled to be paid for the use of his credit. But there seems to be no valid reason now for the creation of such anomalous conditions. The open discount market is established and functioning. It is the acid test of credit and all credits may be tested in it, and their value to the user determined. Facilities for Doing Musiness in Open Market It is not difficult to do business in the open market. Dealers and discount houses that are thoroughly reliable specialize there in the purchase and sale of bankers acceptances. They are glad to bid on bills submitted by reputable parties. Keen competition for well-known names that are established in the market and for which the normal demand is greatest restricts their profits to narrow margins. Through their agency, more effectively than any other directly accessible to the merchants and manufacturers, are the surplus funds of all sections of the country made available wherever need for funds exist. They offer their services not only locally but wherever communication by mail or wire may be had. Bills may be sent to 17 • them direct or through banks and correspondents, either before or after acceptance, after suitable prior arrangement. They can accept deliveries and pay for them wherever banking facilities for transfers of funds and proper handling exist. Some of them have agencies or representatives in several of the more important interior cities. They perform services of great value on slender margins of profits and at considerable risk of loss through changing discount and money rates, and should receive the united support of all banks, bankers and others having dealings in bills. sills Should be Drawn in Readily Marketable Sizes Another very practical matter connected with the drawing and negotiation of bills is quite generally disregarded. It is the size in dollars of the individual bill drawn. Its disregard probably resulted from the direct negotiation of bills with the acceptor before the creation of a distributing market, when there was little or no thought given to the probability of resale. It is very important, however, that bills should be drawn in sizes that permit of their purchase by the largest number of investors. Obviously a $5,000 piece could be sold to anyone of a great number of buyers that might have idle funds, but a $100,000 piece would have a restricted market because of its size, and larger pieces at times are 18 almost unsalable and frequently must take a higher rate of discount on account of their size. It is desirable in large drawings, therefore, to divide them into pieces of marketable size. This is the practice abroad and it is quite usual to see in this market a great sheaf of bills drawn abroad aggregating a large amount, say the value of a cargo of raw silk, all drawn against the whole shipment but in convenient sizes for discount, say $10,000 each. In England the standard size has been £2,500. Here $50,000 is suggested as a proper maximum, with some smaller pieces to meet the requirements of buyers accustomed to commercial paper in pieces ranging from $2,500 to $10,000 and who, having Possibly larger aggregates to invest, prefer—or their regulations require—a wide distribution of risks over varying maturities and names and combinations of names. This class of buyer is rapidly increasing, and in the present disregard for their requirements their offered contributions of funds to the discount market, large in the aggregate and very constant, frequently must be declined. 19 • Acceptances in Our Domestic and International Commerce by PAUL M. WARBURG Chairman, Executive Committee, American Acceptance Council AMERICAN ACCEPTANCE COUNCIL 1 11 Broadway New York Acceptances in Our Domestic and International Commerce By PAUL M. WARBURG Chairman, Executive Committee, American Acceptance Council AMERICAN ACCEPTANCE COUNCIL 1 1 1 Broadway New York I Published by American Acceptance Council I 1 1 Broadway, New York (Reprint January. 1921) (Copies of this pamphlet may be obtained or reprint arranged through the Executive Offices of the American Acceptance Council.) • Acceptances in Our Domestic and International Commerce* BY PAUL M. WARBURG Chairman, Executive Committee, American Acceptance Council HIS is the third time you have honored me with an invitation to address a Credit Men's convention, and genuine, indeed, is my appreciation of your generous willingness to listen to me again. All the greater, however, has been my embarrassment to write for you a new variation to the same old song, and to find a tune that would not sound stale to such patient friends. Barely a year ago it was my privilege to speak fo you at Chicago on the topic of trade acceptances, in the educational propaganda for which, from the inception of the movement, your Association had taken a leading part. Since then the Trade Acceptance Council has enlarged its name and scope into the "American Acceptance Council" whose widened field of activity now also embraces the "bankers acceptance." This was a natural evolution and followed as the logical consequence of our country's increasing interest in world trade and T • An address before the National Association of Credit Men, Detroit, Mich., June 10, 1919. 3 • world finance. The trade acceptance, in its most important aspects, relates to our domestic business; the bankers acceptance renders its primary service in financing foreign trade. What could have been more timely, therefore, than for the Trade Acceptance Council to adjust its gait so as to keep step with Uncle Sam's rapid strides into foreign fields? I need not assure you that this new departure could not possibly imply that the Council's interest in the development of the trade acceptance has lessened. No such thought could occur to anyone conscious of the fact that our domestic trade commands a position of vastly greater importance than our foreign trade, both as to volume and character. The enlarged program of the Council simply meant the inclusion of the bankers acceptance in addition to, not in substitution of, the trade acceptance, and the accession to the old Council of new members chosen from among the most prominent experts in foreign banking in the leading financial centers of the country. The American Acceptance Council, upon your invitation and in anticipation of this conference, held here yesterday an all day session, when both the trade and bankers acceptance were carefully discussed in highly instructive addresses and debates. Some of you were present at these meetings, and to all interested the speeches will be made available in printed form, so that it would be inadvisable for 4 • me now to go into a detailed discussion of the technique of the acceptance problem. I believe that you would prefer that I survey the field in broad outlines, with an incidental sketch of the future plan of operation of the Council. Trade Acceptances I shall touch only slightly upon the question of trade acceptances. You permitted me to go fully into that phase of the question about a year ago, and I have very little to add except that nothing has developed to alter the views which I then expressed, and that quite a gocd deal has happened to confirm them. A constantly increasing number of merchants testify that by adopting the trade acceptance they have simplified their operations, strengthened their financial security, and thereby their general ability to do business. It is true that a few opponents continue an antagonistic propaganda, but their attitude reminds me of the resistance encountered at the time when Federal Reserve banks were making their greatest efforts to secure the membership of State banks and trust companies. Old fashioned State bankers then used to sit up at nights figuring out to a nicety what they would lose by joining the Federal Reserve System. Detailed theoretical calculations were submitted and made the basis of their arguments. But while they were thus making out their hypothetical cases, those 5 amongst them who were capable of vision and of a more national point of view had joined the system. When, later on, groups of banks were invited for a discussion of the "pro's and con's" involved in membership, Federal Reserve officials were mindful to have represented some State bank or trust company that had joined. These new converts invariably reported the fact that membership had not only given them greater security, but that it had also resulted in their increasing their earnings through their new affiliation rather than suffering a loss. That always closed the discussion. On the one hand we had hypothesis; on the other we had facts. I am strongly inclined to believe that the trade acceptance discussion has reached a similar status. The hundreds of firms basing their evidence not on theory but on results actually achieved and benefits realized, tell their own convincing stories. Acceptance Council's Attitude When, as Chairman of the Council's Executive Committee, I recently addressed its first Executive Committee meeting, I tried to sum up its views in the following statement: "We are preaching the gospel of the trade acceptance for no other purpose than that we believe its use makes for sounder business and banking conditions. We do not say that single name paper is not good, or illiquid; but we may 6 fairly say that the trade acceptance is better and more liquid. We do not say that the trade acceptance serves all purposes and that all cash sales and all cash discounts ought to be avoided; but we do say that where business is not done on a strictly cash basis, the trade acceptance will be found the safer, sounder, and, in the long run, more economical method than the open accounts. "Indeed we believe that it is so much of an improvement over the open account that in some cases sellers, at present sacrificing a very heavy cash discount for the purpose of avoiding the dangers and inconveniences of open accounts, might find it to their advantage to consider the economy involved in the use of the trade acceptance when dealing with customers of strong credit. "We do not want to appear as wishing to force upon anybody the adoption of the trade acceptance, unless he considers it as serving his better interest. We do wish, however, those who can profit from the method to study it carefully and not to hesitate to adopt it. The American Acceptance Council's interest in the matter is that whatever makes for better morals in business and for better credit and banking conditions is a decided benefit to the United States." Anomalous Rate Structure It is true that during the last year the progress of the trade acceptance has not been as rapid as it might have been under ordinary circumstances; for 7 while it has gained new converts in large numbers, measured in volume its growth has been greatly retarded by the anomalous war structure of our discount rates. In normal times Federal Reserve banks would be expected to establish rates for bankers acceptances substantially lower than for single name paper, and about half way between these two there should be the discount level for trade acceptances. That was the original scheme of the Federal Reserve Board when formulating its principles with regard to the rate schedules for the various classes of paper. Our entrance into the world struggle intervened, and in order to facilitate the government's war financing, justly entitled to our very first consideration, rates had to be established favoring the so-called war paper; that is, bills secured by government certificates or bonds. This led to an incongruous rate structure resulting in the present abnormal condition when about 80% of all the bills held by the Federal Reserve banks—that is about $1,800,000,000., out of $2,150,000,000.—consists of war paper. The total loans and discounts of member banks amount to roughly $13,500,000,000. It is clear, therefore, that when engaging in rediscount operations with the Federal Reserve banks in order to provide for their commercial requirements, member banks primarily used their war paper, inasmuch as it commands the lowest of all rates. This ren 8 0 • dered illusory one of the main advantages originally intended to be derived from the ownership of trade acceptances and bankers acceptances—that is, a preferential discount rate. Indeed, the differential between Federal Reserve bank rates for commercial paper and bankers acceptances having shrunk to approximately one-half of one per cent., it no longer leaves between them an adequate space for a third and an effective intermediate rate for trade acceptances. The Normal Level for Discount Rates It has now become the country's very serious duty to liquidate as rapidly as possible the war paper and holdings of government bonds in the hands of banks and trust companies. This item. representing undigested government bonds amounting, it is estimated, to more than four billion dollars, constitutes one of the fundamental causes of banking inflation. In ord2r to promote their absorption by the savings of the people and in order to encourage thrift by compelling borrowers, if necessary, to reduce their loans, Federal Reserve bank rates for paper secured by government bonds in due course will have to be increased. They would have to approach more closely the then governing rates for commercial bills, while rates for bankers acceptances should be held at a rate sufficiently lower to provide for an ample margin in 9 their favor against single name paper. And between these two rates the trade acceptance should find its proper level. As this process of absorption takes place, and as the government reduces the volume of outstanding Certificates of Indebtedness, acceptances may be expected to regain their proper position as the most available and safest pass key to the facilities of the Federal Reserve banks. Ultimately acceptances are bound to become the main investment and rediscount field for Federal Reserve banks and this demand alone will create a large market for them at favorable rates. It may take a year or two before this course makes appreciable headway, but it is to be hoped that at an early date we may see the beginning of a definite policy pointing in that direction. British Discount and Gold Policies In determining the future level of our bankers acceptance rates, the British discount rate will play an important role. Sooner or later our rate and the British must be brought into a proper relation. It is impossible to predict exactly in what manner this will be accomplished. Our British friends at the end of the war have now established a gold embargo, while it may be expected that our gold embargo will be raised upon the signing of peace, if not at an earlier date. 10 England's future foreign exchange and discount policy is still undecided. At present there exist two divergent schools of thought: One, led by Lord Cunliffe, believing that foreign exchanges must be brought back to their pre-war levels by the establishment of a high British discount rate. That school holds to the old doctrine that high rates of interest will draw gold freely into a country enjoying a strong banking credit. If such a course were adopted, it might safely be followed by the lifting of the British gold embargo. The proponents of this policy are opposed, however, by another group of British political and financial leaders urging the maintenance of the gold embargo, preserving present artificially low interest rates under its protection, and allowing sterling exchange to remain at a discount in several foreign countries, particularly in the United States. It is difficult to see how such a policy, in the long run, may be expected to bring about a healthy cure. Whether or not it may be advisable for England to continue it as a temporary device is a matter that only British leaders can judge. My own belief is that sooner or later England, whose banking prestige and power have rested so largely upon the tradition of a free gold market, will adopt a course leading towards the lifting of the gold embargo, that is a policy of higher and effective discount rates. To me it remains a riddle how note issuing banks, on both sides of the water, 11 could hope to effect "deflation" unless they take steps not only to arrest a further increase in their investments, but indeed to decrease them. And this they can achieve only by placing their active official rates above those of the open market. Continued Inflation or Readjustment? It is an evil condition that prolongs the necessity for governments to issue billions of bonds or currency for the purpose of paying millions of people who idle. It intensifies the inflation of prices because it continues to swell the outstanding amount of money and credit, while, at the same time, idleness interferes with a proportionate increase of goods. But this state of things, bad enough in itself, is aggravated most viciously if, in order to place government bonds (issued for unproductive purposes) upon a low interest basis, the general level of rates of interest is artificially lowered and bonds. instead of being absorbed by savings, are carried by manufacturing new credit, be it through added bank loans or circulation. "During war the laws are silent," is an old Roman saying, which applies with equal force to economic laws. But the war, happily, is ended and we must now boldly face the question of whether we wish unconditionally to surrender to inflation and accept it as a finality—that is, sacrifice all services rendered in the past to the services of the future—or whether we are de 12 termined to work towards a readjustment in the direction, at least, of the pre-war level, though nobody expects us even approximately to reapproach it. It is a pathetic fact that peoples, like children, apparently can learn only from their own experiences, but not from the experience of others. We know that war prosperity usually ends in a crash; shall we be able to avoid it? Arrest Credit Expansion If such be our wish we must beware of booms based on a fake prosperity which has its roots in inflated credits and prices. It is an ungrateful and at present an almost superhuman task to stop the easy flow from our credit reservoirs that creates the enlarged foundation for our growing credit pyramid. While the Federal Reserve System proved our salvation during the war and while our imposing reserve power may be destined to play a most important role in meeting some of the grave problems that still lie ahead of us, I believe the moment is near at hand when we must not permit this reserve to be further encroached upon for the sake of increased credit expansion at a time when the healing process must be sought in contraction. To apply that remedy may be a harder task than to follow the lures of fictitious prosperity born of easy money, 13 but in the long run I believe it will be a more prudent and more charitable strategy. Such a course would not imply that we should be slackers in shouldering our full share in attacking and solving the world's burning economic problems. It means only that we must manfully and planfully husband our resources instead of squandering them by personal extravagances and headlong speculations— and that we must concentrate our efforts on doing the big constructive things with wealth bottomed upon solid production and saving, instead of resting it on the quick sands of further inflation of credit and prices. We cannot formulate any definite opinion as to what will be the future level of our own acceptance rates until we have a clearer picture with regard to the scope of our future government requirements, the amount and the terms of sale of United States Certificates of Indebtedness to be kept outstanding in the future, and until we know what England's discount policy will be. It is probable that in due course our discount rates for bankers acceptances will be on a par with (if not lower than) the English acceptance rate. Whether our rate will drop down to theirs, or theirs move up to ours, or whether possibly we shall meet half way cannot be prophesied until governments and note issuing banks have reached definite conclusions with respect to their future financial policies. 14 fo It appears, however, to be a reasonable expectation that (even though we should lift our gold embargo and England should not), we may hope to be in a position to maintain an acceptance rate which will enable us to meet the British rate in world markets, and on a level substantially lower than our commercial paper rate, whatever it may be at that time. Bankers Acceptances and Foreign Trade As a consequence of the war, the indebtedness of other countries to us has become such that if these foreign nations are to be kept in a position to buy our goods, we shall have to grant them credits or purchase their obligations, or other assets. We are not yet fully equipped for the placing of foreign securities on a large scale, moreover the credit of foreign governments in many cases is least well established in countries where the demand for our goods and credits is most urgent. But where government credit may be found inadequate, private credit may be of sufficient strength. People must eat and clothe themselves and certain industries in such countries may, therefore, well prove strong enough to warrant the granting of short credits involving the movement of our products to them or theirs to our shores. American bankers acceptances may play a most vital role in meeting this emergency and promote thereby the all important work of reconstruction, 15 which has been so much in the people's minds but has been so slow and elusive in taking tangible form. Our banking system has attained phenomenal strength within an unprecedentedly short lapse of time. There is a vast opportunity for American banking enterprise to go out all over the world and to enter into new relations, promoting not only our trade and industry, but at the same time rendering vital services to the countries at present sadly in need of our help. We may justly be proud of the spirit of enterprise shown by our banks in these new problems. The number of American branches and agencies opened in foreign lands exceeds seventy at this time, and is growing every month. They are now established in South and Central America, Asia and in Europe. In all these countries the dollar acceptance, and "dollar exchange" for which four years ago we modestly and prayerfully entreated a kind consideration, through force of circumstance have now been brought to a leading position. There are outstanding today, drawn in almost every part of the globe, approximately $500,000,000 in American bankers acceptances. But this is only the beginning. Some months ago I ventured the prediction that in the not too distant future we should live to see American bankers acceptances reach the billion dollar mark, and I have no hesitation in reaffirming that opinion. 16 '1 Growing Demand for Acceptance Facilities The growth of the American bankers acceptance business is likely to continue so fast that fear is expressed by some lest our available acceptance facilities may soon prove inadequate. It has been urged, therefore, that the limitations, placed by the Federal Reserve Act upon member banks of the Federal Reserve System, should be widened so as to enable these members to accept to a larger extent than the 100% to 150% of their capital and surplus, up to which limit they may accept under existing law. My own view is that we should be very careful not to overstrain the load of liabilities of our large deposit banks. Institutions often having deposits amounting to more than ten times their capital and surplus, and having invested a large portion of these funds in commercial loans involving credit risks, should consider very seriously whether it would be wise for them to add to their existing commitments acceptance liabilities in excess of the present restrictions of the law, unless, indeed, their general deposit liabilities were kept within very conservative limits. It would appear to be the dictate of banking prudence to preserve a certain safe relation between capital and surplus on the one hand and all liabilities, including those for acceptances, on the other. 17 Acceptance Corporations It was in anticipation of these larger acceptance requirements that in 1916 an amendment was secured by the Federal Reserve Board authorizing national banks to invest in the stock of banks or corporations primarily devoted to the foreign acceptance business. Banks of this new type, under the Federal Reserve Board's regulations, are prohibited from taking demand deposits in the United States, and are required to keep their own resources, as represented by their capital and surplus, in liquid form, as a reserve, as it were, for the protection of their acceptance liabilities. In that case, it was held that it would be a conservative and logical policy to permit these institutions to have outstanding acceptances plus deposit liabilities equal to a liberal multiple of their capital and surplus. If, as I hope, the demand for American acceptance credits should continue to grow, the creation of additional acceptance banks or corporations would best meet the situation. Under the present rulings of the Federal Reserve Board, an additional $50,000,000. invested in acceptance corporations would easily provide further acceptance credits in excess of $300,000,000. Domestic Bankers Acceptances It is not, however, in foreign acceptances alone that bankers acceptances will occupy a prominent 18 • place. The domestic bankers acceptance, though not of equal portent, is also destined to play a role of great importance. Domestic bankers acceptances may be made for two purposes: first, to finance domestic shipments of goods, and second, to carry staples, provided that in the latter case the acceptor is secured by warehouse receipts (or similar documents) conveying title to standardized non-perishable staples having a wide market. The effective use of the domestic bankers acceptance is largely predicated upon the proper development of modern and safe warehousing facilities. Domestic acceptances are most important as equalizers of money rates all over the country. It will be easy for you to grasp the great economic service they can render in this respect if, as an illustration, you bear in mind how, during the cotton crop season, acceptances made by strong Southern firms, and secured by properly safeguarded warehouse receipts issued by warehouses independent of the borrower, would readily find their way into other districts either through the intermediary of the Federal Reserve banks or through banks, dealers, or discount companies. They would thus relieve financial pressure in sections where seasonal demands might otherwise be heavy. Moreover, if acceptance facilities in such sections should become exhausted, banks in other districts could readily accept against these warehouse receipts, pro- 19 vided the latter are issued by warehouses responsible beyond doubt, and surrounded by proper safeguards. Open Market for Acceptances Great headway has been made during the last year in developing a freer market for acceptances; the banks have reached a much better understanding of the proper principles to be observed in this respect. The pernicious habit, originally practised, whereby the accepting bank held its own acceptances, has generally been abandoned, and today acceptances are being placed in a larger measure through dealers, other banks or discount corporations. Mr. John E. Rovensky, Vice President of the National Bank of Commerce, New York, has given us the benefit of his wide experience in a paper on "The Acceptance as the Foundation of the American Discount Market." He emphasizes particularly the importance of the acceptance as an investment, both for commercial banks and savings banks, and explains how, after the redemptions of the bil, lions of United States Certificates of Indebtedness purthe banks in due time will be driven into the acceptchase of large sums of bankers and trade the most ances for the purpose of using them as reliable secondary reserve. very This short sketch can give you only a Amen in ed meagre outline of what has been achiev 20 can acceptance banking during these last four years; it is meant to stimulate your interest rather than to satisfy it with respect to the vast possibilities the future has in store both for the banker and the business man. Dangers to Be Avoided To point to the things to be done is, however, only one side of the Acceptance Council's functions: of equal importance is its duty to emphasize the things not to be done. In this connection, I am reminded of a story I once heard concerning a man belonging to a species now soon to be extinct and to be found by our children in Webster's dictionary only, the "bartender." A man of this profession, in prehistoric times, was abandoning his position and was turning over the cash-register to his successor. "Please show me how it works" said the newcomer. "I will show you how it works," said the other, "but I won't show you how to work it." The inference is clear. Those of us who have helped in paving the way for the Federal Reserve Act and have tried to formulate amendments for the purpose of enlarging the Act from time to time —so as to keep it wide enough to meet the country's continuously growing requirements—know how impossible it is to write banking laws tight enough to prevent abuses without at the same time 21 crippling highly useful powers, absolutely essential, indeed, if we are to compete in world markets with nations entirely free from legislative fetters. In these countries—I am thinking of England particularly—it is sound banking sense and conservative business prudence that constitute the unwritten, but none the less very effective, law, and it should be our endeavor to follow their example. We must have laws leaving some latitude; but within this latitude we must establish our own sound business usages that effectively prevent unwise abuses. Remedying Abuses With respect to bankers acceptances, permit me to give you just a few illustrations: it is clear that the Federal Reserve Act when authorizing domestic acceptances -contemplated two kinds of credits: one—acceptances secured by readily marketable staples—but not to be secured by any other kind of goods—and two, credits to finance the transportation of any kind of goods. In both cases the law prescribes that documents—warehouse receipts or bills of lading, respectively—are to be attached when the acceptance is made. Power, however, is given to accepting banks to release documents in order to facilitate the handling of the goods. But you can readily see that abuse is possible by presenting documents at the time the acceptance is 22 O • made and using these documents over again, after release, to secure another credit. You can easily imagine, moreover, how under the guise of financing a domestic transportation lasting only a week or two, a 90-day credit might be secured, which thus might serve to carry articles other than readily marketable staples. It is evident, furthermore, how easily, by this method, these acceptances may be turned into unsecured transactions and unsecured credits amounting in the aggregate to 20% of the capital and surplus of a bank may thus be granted to one single party instead of 10% as provided as the limit for similar loans under the National Bank Act. Should the law be amended so as to prevent such abuses, or should the Federal Reserve banks and the accepting banks get together and adopt measures to stop bad practices of their own accord? I do not think there can be any doubt as to which would be the better course. Principles to Be Observed Irrespective of what our laws permit or prevent, and without attempting to formulate too technical or too scientific a rule, or presuming to give any but my own personal views in the matter, we may, I believe, enunciate these principles as generally recognized sound banking ethics: These principles should not be understood, however, as applying to trade acceptances, or single 23 • name notes, which are instruments of entirely different character. A trade acceptance is the obligation of a purchaser to pay to the seller the price of goods bought; it represents, as it were, a loan of goods. The loan on single name paper might be held generally to represent a loan of cash; while the bankers acceptance is to be considered as a loan of credit. The bank granting an acceptance credit is not expected to advance cash; the customer is enabled to secure cash on the strength of the bank's credit, by the sale of the acceptance in the domestic market, or abroad as "exchange," and he is under contract to put the accepting bank in funds in ample time before the acceptance matures. No cash outlay on the part of the acceptor is thus involved. As compensation, the acceptor receives a commission commensurate with the length of the credit and the risk involved. Bankers acceptances ought never to be used in order to finance permanent investments, or for the purpose of furnishing working capital, or for providing funds for speculation in securities, staples, or other articles. Bankers acceptances are primarily designed to finance goods in course of transportation and in their various stages from origin to final distribution. 24 Staples in warehouses may properly be considered as constituting a temporary stage between production and distribution (but it is a dictate of banking prudence that such staples, to be the basis of domestic acceptances, either be under a contract of or awaiting reasonably immediate sale or delivery into the process of manufacture, and that they never be carried as a pure speculation). Goods in course of production in foreign countries under a definite contract for subsequent transportation, may be considered as offering a legitimate basis for bankers acceptances, even though the products may not yet be ready for shipment when the bill is drawn. But care should be taken in all these cases that the proceeds of the goods will liquidate the credit if the sale of the goods takes place before maturity of the acceptance. A reasonable number of renewals of acceptances are legitimate if, for good and valid reasons, disposal of the goods cannot be completed within the period of the first credit. Where documents are released, the title to the goods, wherever possible, should be preserved; in any case a moral hold, if no other, ought to be maintained to this extent at least that, before the acceptor is paid, title to the goods should not pass into the hands of other creditors and if the goods are sold 25 the proceeds should be applied to paying off the acceptor. Bankers acceptances drawn in certain foreign countries for the purpose of furnishing dollar exchange are justified where they are to be considered as anticipations of drafts expected to be drawn within a reasonable time for the purpose of the transportation of goods in course of production (e. g.: crops). The law provides that they may be drawn for the purpose of "furnishing exchange" in countries where the customary means of remittance is the 90-day bankers acceptance. Bankers acceptances ought to show by some reference on the face of the bill the nature of the transaction financed, as in England, where the bill generally refers to invoices, letters of credit, or bills of lading, as the case may be. Acceptance risks ought to be properly distributed; it is bad banking to grant too large an acceptance credit to any single party, no matter how good its standing. It is bad banking to grant unduly large acceptance credits on any single kind of collateral. Bankers acceptance credits ought to be taken only from banks and bankers of undoubted standing and of national reputation (and in the case of foreign drafts, of international reputation). 26 Acceptances ought to be made and sold for the benefit of the drawer, not for the accommodation of the acceptor. The acceptance business, in many respects, is similar to insurance business. There must be a proper appreciation and a wise distribution of the risks involved. There must be a premium corresponding to the risk, and a recognition on the part of the insured that he is taking a serious chance in dealing with companies that are weak, or disregard sound business rules. Voluntary Adoption of Sound Practices These are illustrations of principles that I believe the business and banking communities ought clearly to recognize, and firmly establish and enforce. There is no doubt about their ability to do so if the Federal Reserve banks, under the guidance of the Federal Reserve Board, co-operate. The power vested in the Federal Reserve Board to declare acceptances as eligible or ineligible for purchases or rediscounts by the Federal Reserve banks gives them a practically unlimited control over the practices to be encouraged or permitted in the development of the usages of granting, drawing and selling bankers acceptances. The field is new, however, and still unexplored in many corners. Unanimity as to the soundest principles and habits does not yet exist. Our problems 27 will require certain adaptations of European practices to our own needs, and the best methods will have to be developed by careful study and common council. The American Acceptance Council hopes to be able to do its full share in this work. It has established a relationship of close co-operation with a committee appointed by the Federal Reserve Board tilling the same ground. Together we hope to bring about a clearer understanding of the necessities of the case, to ascertain the best banking opinion, and then to make recommendations with respect to principles to be observed, usages to be adopted, rulings to be made, and, if required, legislation to be enacted. The sounder and the more effectual the unwritten law of good practices adopted and enforced by common consent, the less the necessity for the Federal Reserve Board or Congress to regulate business by rigid laws and rules. Individual and National Thrift In closing, I should like to suggest to you a thought closely related to this question of wise or unwise use of credit and very much in my mind. It has occurred to you, no doubt, how intimately connected at this time is the question of government financing and thrift with the problem of interest rates, safe banking and credit. Every substantial 28 I citizen of the Union has become the owner of government bonds, and contributes, somehow or other, to the gigantic funds flowing into the government in the form of direct or indirect taxation. No one can escape the most inexorable form of taxation to which today almost every country is subjected in the form of inflated prices. We all realize the determining influence that individual thrift will exercise in readjusting present abnormal conditions; individual economy must make up for the vast, and in war times unavoidable, waste of the government. But it is gradually becoming clearer and clearer to the country that now, at the end of the war, individual thrift must be accompanied by economy on the part of the government, and this leads to a growing recognition on the part of many that the financial methods of our government must undergo a thorough reform and reorganization. A body of expert credit men such as this understands more clearly than any other group of men what the lack of system in budgeting, accounting and auditing has meant in the past, and what benefits proper and advanced methods may secure for us in the future. How much credit would you grant to a department store that left it to each chief of a section, or even a sub-section, to enter into commitments obligating the corporation without any knowledge of 29 . what expenditures are being undertaken in other parts of the business, and without any single officer in the whole organization being conversant with the total commitments undertaken, or the revenues available to meet the obligations incurred? How much credit would you grant to such a department store if you knew that only by the joint action of two officers could payments be authorized, but that it was possible for one of them to close shop and go home without first having provided for the proper financing of the business? Or if you knew that one department could be prevented from securing most essential articles unless some salesman, entirely disconnected with the particular transaction, could secure favorable consideration for some particular transaction in which his own customers or friends at home were interested? A National Budget System That, substantially, is the condition of the United States. In the past the "department store" was in condition of such affluence that it did not seriously matter what each chief of a section committed himself to, or how extravagant he was. With a Federal budget, however, that now has reached unprecedented figures, and with the tremendous burden of taxation now resting upon the country, I believe that the time has come when the adoption of a national budget system is felt by all as a necessary 30 • reform to be undertaken without delay. We should have a permanent staff or board, whose business it would be to examine and co-ordinate the estimated income and expenditures of all departments and bureaus, to pare down, without fear or favor, whatever is unessential so as to bring the expenditures within the scope of what reasonably we may expect to be able to raise, and, finally, to oppose extravagances, no matter what political influence they might subserve. We need a non-partisan group of judicial and independent men constituting an element of continuity and expert knowledge, at the service of every new administration facing the intricate problems of taxation, amortization and governmental borrowing. I believe it would be most timely for this convention of credit men to devote its attention to this question of a national budget system. The keen interest taken in it by many prominent leaders in Congress makes us hope that it will be taken up in the near future. Both parties, as a matter of fact, stand committed to it. The danger, however, is that those influences in Congress, that have profited from the vicious practices of the past, will bend their efforts to emasculate any thorough legislation and to give us a budget system in name only, but not in substance. It is most important, therefore, that a group of men as here assembled, rcaching all parts of the country, should fully grasp the intricacies of the problem, that it should place itself behind the move- 31 ment and see to it that those representing them will hear, in no uncertain manner, what are the earnest wishes of the people. Greater economy in our financial administration is necessary in order to bring about a proper readjustment of prices and to bring back to a more normal scope taxation, which now endangers the further development of the country. Our future as world bankers offers opportunities which baffle the imagination. The grasping of these opportunities may mean relief to a large portion of suffering mankind, but these opportunities are so large that even our phenomenal banking strength may sooner or later threaten to become exhausted unless scientific economy is practised from top to bottom. Even the strongest is weak if he does not husband, or if he over-estimates, his strength! 32 1 The Creation of Acceptance Credits By WILBERT WARD, Assistant Cashier, National City Bank of New York; Chairman, Commercial Credit Committee, American Acceptance Council, Author of "American Commercial Credits.' ' AMERICAN ACCEPTANCE COUNCIL 120 Broadway http://fraser.stlouisfed.org/ I Federal Reserve Bank of St. Louis New York The Creation of Acceptance Credits By WILBERT WARD, Assistant Cashier, National City Bank of New York; Chairman, Commercial Credit Committee, American Acceptance Council, Author of "American Commercial Credits." AMERICAN ACCEPTANCE COUNCIL 120 Broadway New York Published by American Acceptance Council 120 Broadway, New York FOREWORD There is no lack of literature which sets forth the utility of the bank acceptance metho d of financing foreign and domestic trade. Howe ver, the merchant or banker who is for the first time consi dering the advisability of participatin g in the benefits of the acceptance method of finance will find little in the provisions of the Feder al Reserve Act to guide him in taking the practical steps necessary to avail himself of the privilege. The purpo se of this Pamphlet is to assemble and put into easily available form the working tools with which the banker builds up the credit transactions, as a result of which bankers' acceptances are created. CHAPTER I. GENERAL PRINCIPLES. The fact, that the use of the acceptance power by American banks is defined and limited by statute, brings into our acceptance practice an element from which the English banking traditions, to which we would naturally turn for guidance, is free. British and Continental bankers are under no legal restraint in selecting the character of the transactions which underlie the bills, of exchange they accept. Our banks, on the contrary, act under charters which bestow upon them certain delegated Powers. Prior to the passage of the Federal Reserve Act, the power to accept was not among the powers delegated to our national banks and it exists today only to the extent, and within the limits, defined by that Act. The Act has, in turn, been supplemented by regulations and informal rulings of the Federal Reserve Board, and by opinions of its counsel. It was appreciated by the draughtsmen of the Aldrich Act and the Federal Reserve Act that it would be inadvisable to bestow on American bankers without limitation the privilege of entering into 7 a phase of banking which was practically unknown in the United States. At the outset, consequently, the use of the acceptance power was closely circumscribed by statute and regulations, and even today our banks are not at liberty to exercise unlimited discretion in the choice of transactions to be put on an acceptance basis. There is no reason, however, to find the existence of the limitations of the Act and the Regulations an obstacle to the proper execution of acceptance credit arrangements. The Act and Regulations were drawn in sympathy with the best Continental practice, with the sole object of compelling, by legal pressure, adherence to basically sound principles until the growth here of a comprehensive but discriminating open discount market would supply the necessary curb to the creation of unsound acceptance credits. We have now reached a point in our development at which a comprehensive open discount market, capable of absorbing all the bills that are at present being created by the bankers which are availing themselves of the acceptance privilege, is a reality, and the time has come to learn how to exercise that discrimination which unerringly scents and avoids a bill which arises from a fundamentally unsound credit transaction, even though it may fall within the letter of the law. If we are to do that, then we must, while using the Federal Reserve Act 8 as our background, accquaint ourselves more intimately with international customs and practices in financing foreign trade. This is particularly true of transactions financed for account of the buyer, because in such cases the bank is likely to be called upon to issue to the seller, in advance of the actual acceptance, a written undertaking that the drafts to be drawn as shipment is made will be accepted on presentation. The instrument by which a bank evidences this undertaking is known as a commercial letter of credit; and, as a considerable part of the total volume of acceptances results from these commercial letter of credit operations, it will be necessary to consider their general nature. There are two outstanding reasons which make it imperative that our education in the intricacies of this department of international finance should proceed apace. In the first place, our position as the premier creditor nation of the world puts a duty on us to know how to use our wealth effectively for the rehabilitation of the world's trade. The bank resources of the United States exceed those of the rest of the world combined. In the international financial tug-of-war the preponderance of weight is on our side. Our end of the rope is anchored to the Federal Reserve System, which is nicely adjusted to pay it out under stress and take in the slack as the pressure diminishes. We have 9 not only become the world's creditor but bid fair to continue the process of selling more goods and services than we require in turn from others, to an extent limited solely by our willingness to lend the buyer the money to pay for them. So many are our advantages, that no one can successfully challenge our position as the reservoir of the financial power of the world. The shifting of this power to our shoulders from those of London, Berlin, Paris and the other capitals of Europe which previously bore it, brings a correlative responsibility. The benefits potentially to be derived from a project like the Muscle Shoals dam are enormous, but until the latent power has been harnessed and actually put to work to meet the complicated demands of modern industry the swift current serves simply as an impediment to navigation. So with our banking power. It is not enough to possess it; we must employ it to aid the trade which was formerly financed by European centers, or not we alone, but the whole world, will suffer. Secondarily, we can, if we are prepared to devote to it the necessary time and study, hold our supremacy as the financial center of the world, not simply in the broad sense of being the reservoir of credit, but in the narrower sense being the market to which the world will instinctively 10 turn to finance international merchandising by acceptance and discount. But to do this, our education in the business must progress to the point where it can be freed from governmental regulation, without fear of abuse. Only when that time comes, and we can meet British competition on an equal basis, without frightening our prospective customer with rules and restrictions, will the future of this country's acceptance and discount market be assured. We are not yet at that point. In spite of the fact that this country is the only free market for gold, the enormous weight of custom and tradition still brings to European centers even bills drawn against shipments of goods from foreign countries to the United States. To an extent, this results from the fact that the financing of these shipments is undertaken by branches or affiliations of European banks which have long ago entrenched themselves in the fields from which the Primary products of international trade originate. In part, also, it comes as the consequence of the feeling on the part of the merchants the world over that business of this sort is done better in London than in New York. It will do us no harm to hear some testimony on this point, given by a Belgian merchant who has dealt with both centers: "We have thousands of sets of bills of lading per annum, which go through the hands of experienced and 11 old-established British banks, in connection with letters of credit. "The reason why American bankers are as much as possible in Europe for such left alone the absolute and gross Ignorance of some business is officials as to the usances in such transactions, and the day when officials, who have gone through a first-c school and know the ins and outs of the lass British put at the head of the American banks, business, are will not occur and business with Americanthis trouble increase by leaps and bounds. This is the banks will reason why we give the preference to British banks, becaus e every time we have something to do with the Ameri can banks we have no end of trouble over items which are and clear as daylight to anyone versed in theas plain export business. "Please excuse us for making these observ we think they are in the interest of the Ameriations, but can banking world." It is not meant by quoting this comment to vouch for its fairness. The circle of international trade rs has widened immeasurably since 1914, and the newcomers have not altogether measured up to the high standard of commercial honor which characteri zed the merchants, merchant bankers and discount houses of the older regime. So English jurisprudence has recently, like our own, been introduced to a multitude of disputes arising out of commercial letters of credit and agreements to accept, which serve to indicate that there and here alike too much reliance must not be placed upon good faith, but these obligations must be drawn with more precision than was formerly deemed necessary, if controversies are to be avoided. 12 We have no need to seek to wean away the business which the British and Continental banks are doing, but we should do that large part of international short-time merchandise financing which is Properly ours with the same skill as our neighbors. It will doubtless aid us in acquiring facility in shaping up these transactions, if the various types of acceptance credits outlined by the Federal Reserve Act may be sketched in with a background of concrete and specific illustrations drawn from the propositions which are daily being submitted for consideration by merchants to acceptance bankers. In setting about to outline the steps by which buyer or seller, as the case may be, should arrange With his banker for the extension of credit on an acceptance basis, one finds that the logical basis foti a division of the subject into articles is furnished by the Federal Reserve Act, which grants the right to accept time drafts growing out of four separate varieties of transactions. These drafts may grow out of transactions involving the importation or exportation of goods; out of transactions involving the domestic shipment of goods; may be secured by documents conveying or securing title to readily marketable staples; or may be drawn by foreign banks or bankers for the purpose of furnishing dollar exchange. When they reach the bill market, these drafts look alike and demand the same rate, 13 but in the process of creating them there is little of the procedure in connection with a dollar exchange draft, for instance, which is applicable to a draft secured by domestic staples. Moreover, the procedure in the case in which the drafts arise from importation or exporation of goods differs greatly when the financing is done for account of the buyer than when it is undertaken for account of the seller. Although it reverses the order in which the privilege has been bestowed, we shall, in succeeding articles, consider, first, drafts secured by staples; secondly, drafts growing out of a domestic shipment of goods; thirdly, drafts growing out of importations or exportations; and last, drafts drawn to create dollar exchange. Before proceeding to a detailed consideration of these classes of acceptances, there should be pointed out, by way of preliminary, some considerations which are common to all classes of acceptances. The first of these is that a bank which is about to undertake the acceptance business, must set up accounts to reflect the liability it thereby assumes. It is customary to show this liability by crediting the amount of each acceptance, as made, to an account bearing some such title as "Our Acceptances under Commercial Credits." There is, of course, a correlative liability on the part of the 14 customer to put the accepting bank in funds to pay the drafts at maturity. This liability is shown on the asset side of the accepting bank's statement under some such title as "Customer's Liability under Commercial Credits." Another consideration which must be taken into account is that in accordance with sub-division (d) of Section B of Federal Reserve Board Regulation A, Series of 1920, accepting bankers must furnish satisfactory evidence of eligibility of every bill offered to Federal Reserve banks for purchase or rediscount. The following forms of certificate have been approved for insertion on the face of the draft, by rubber stamp or otherwise: Underlying Transactions Form of Certificate DOMESTIC SHIPMENTS: "At time of acceptance, this bill was accompanied by shipping documents, evidencing the domestic shipment of (name of commodity) from (point of shipment) to (place of destination). (Name of Acceptor)" IMPORT AND EXPORT TRANSACTIONS: "This acceptance arises out of a transac(importation) tion involving (exportation) of (name of commodity) from (point of shipment) to (place of destination). (Name of Acceptor)" 15 WAREHOUSE SECURED CREDITS: "This bill was secured at the time of acceptance by independent warehouse, terminal, or other similar receipt conveying security title to (name of readily marketable staple) stored in (country where stored) and the acceptor will remain secured throughout the life of the bill. (Name of Acceptor)" It must further be borne in mind that revenue stamps, at the rate of 2 cents per $100 or fraction thereof, are required on time drafts, pursuant to the provisions of the Revenue Act of 1918, and certain articles of Internal Revenue Regulations 55, unless the drafts directly cover exports to a foreign country and constitute an inherent, necessary, and bona fide part of the actual process of exportation. Because of express exempting legislation, the stamp tax does not attach to time drafts covering shipments to the Virgin Islands, Philippines and Porto Rico. CHAPTER II. CREDITS WHICH WILL PERMIT A BANK TO ACCEPT DRAFTS SECURED BY DOCUMENTS CONVEYING TITLE TO READILY MARKETABLE STAPLES. The first chapter has indicated that the power 16 of a national bank to accept time drafts exists only to the extent authorized and within the limits defined by the Federal Reserve Act. Consideration will now be given to the steps to be taken to set up a credit to utilize this power in one of the four general classes of transactions in which it is bestowed—by accepting drafts secured by documents conveying or securing title to readily marketable staples. It is the primary duty of the banker who is approached by a customer with a request for such a credit to satisfy himself that the commodity which Is offered as security is a readily marketable staple. The interpretation of this phrase has been somewhat simplified by defining it as an article of commerce, agriculture or industry of such uses as to make it the subject of constant dealings in ready markets with such frequent quotations of price as to. make (a) the price easily and definitely ascertainable and (b) the staple itself easy to realize Upon by sale at any time. This definition, it may be readily appreciated, includes such commodities as cotton, the grains, dried fruits, tobacco and oil, and excludes specialties such as dolls' heads, watch Springs and automobile repair parts. After it is determined that the commodity falls Within the category of readily marketable staples, 17 the next step is to consider the documents which must come in the banker's hands prior to acceptance. The Federal Reserve Act provides that any member bank may accept drafts or bills of exchange drawn upon it, having not more than six months sight to run, which are secured at the time of acceptance by a warehouse receipt or other such document conveying or securing title covering readily marketable staples. The Regulations, Series of 1920, amplify this language and further restrict the acceptance privilege by providing that the bill not only be secured at the time of acceptance by a warehouse, terminal or other similar receipt, conveying security title to such staples, but also that this receipt be issued by a party independent of the customer, and provide further that the acceptor • remain secured throughout the life of the acceptance. The receipt should preferably, though not necessarily, be issued by a public warehouseman. The Federal Reserve Board recognizes the separate entity of a corporation issuing a receipt, when such corporation is not itself the borrower, though it be an affiliated company. It has ruled, however, that such a custodian must be organized in good faith as an independent corporation, and administered by duly authorized officers and agents independent of the borrower. The custodian should, preferably, issue the receipt directly in the name of the banker, in straight non-negotiable form. However, if the 18 receipt has already been issued to a prior holder, it must be negotiable in form. In this event, the banker should either surrender the negotiable receipt to the warehouseman in exchange for a nonnegotiable receipt issued in the banker's name; or, if he retains the negotiable receipt, immediately add a restrictive endorsement. By endorsing upon the negotiable receipt the statement that delivery is to be made only upon the order of the banker, the risk of its abstraction and unauthorized negotiation is precluded. A further reasonable precaution for the banker to employ, in the case of a negotiable receipt, is to address a letter to the warehouseman advising him of the fact that the banker is the holder and instructing him not to make delivery unless so authorized in writing by the banker. By thus keeping the warehouseman advised •of the banker's interest in the commodity, the security is strengthened, and moreover, the warehouseman thereafter bills the banker for the charges as they fall due, and thus enables the banker to verify the fact that they are being paid, and not accumulating a prior lien against the commodity . The banker will also satisfy himself that adequate insurance coverage has been arranged against fire and any other risk arising from the nature or location of the commodity. An important consideration, sometimes overlooked, is that the endorsement 19 of fire insurance policies does not operate to vest any claim in the endorsee, unless the company has assented to the assignment, if there has been an actual transfer of ownership, as distinguished from a mere transfer for the purpose of security. Having satisfied himself of the character of his collateral, and the soundness of the security offered, the banker will next give his consideration to the period over which the acceptances will run. The Federal Reserve Board has ruled that no bill is eligible for acceptance unless the goods covered by the warehouse receipt are being held in storage pending a reasonably immediate sale, shipment or distribution into the process of manufacture and that therefore no acceptance should have a maturity in excess of the time ordinarily necessary to effect this object. It is the opinion of counsel that such an *acceptance must not be made subject to any renewals, and the extreme period over which it may run is therefore not more than six months. At the same time thought must be given to the procedure to be followed in the event that the sale is subsequently consummated sooner than was anticipated at the time of acceptance, and somewhat prior to the maturity of the acceptance. It is preferable that the release of the collateral should be effected in exchange for cash, which may be applied by the banker in anticipation of the customer's liability to 20 Place him in funds with which to pay the acceptance at maturity. For this anticipated payment, it is the custom of the banker to allow interest. If the bank could locate the holder of the acceptance in question, and he were prepared to sell it, the bank could buy it at the current rate and cancel it. Practically the same result could be obtained by purchasing any other of its outstanding acceptances. It is not often perhaps that the accepting bank actually applies the specific deposit to the purpose, but it is the possibility of doing so which fixes the rate, which is calculated at 72% below the selling rate for the bank's acceptances of corresponding maturity. If the release of the collateral against cash is not feasible, recourse can be had to permission afforded by the Regulations of 1920 to substitute a trust receipt or other similar document covering the goods, provided such substitution is conditioned Upon a reasonably prompt liquidation of the credit. To insure compliance with this condition, it should be required, when the original document is released, either (a) that the proceeds of the goods will be applied within a specified time towards a liquidation of the acceptance credit, or (b) that a new document, similar to the original one, will be resubstituted within a specified time. The following trust receipt is appropriate for this purpose: 21 To the Bank Date New York, N. Y. We have received the merchandise covered by the documents enumerated above, and agree to hold the same in trust for the account and benefit of the Bank, as its agent, with power to sell the same, and in case of sale to pay over to it forthwith the proceeds thereof as security for any sums due or to become due under the said Letter of Credit, and also as security for any other indebtedness from us to the said bank. The delivery of said merchandise shall not operate as a waiver of the ownership thereof, and the said bank, may, by its representative, at any time enter any place where the said merchandise is stored, and resume possession thereof. Until the sale of said merchandise, we agree to keep the same insured at our expense against loss by fire, in the name of said bank, and to deliver the policies of insurance to it. (Authorized signature of customer) With these matters understood, the transaction hits reached the stage at which it is appropriate to request the customer to sign a form of agreement to evidence his obligation to furnish the bank with cover with which to pay the accepted draft upon presentation at maturity. A brief form of agreement, adapted to that purpose, is here outlined, and it is further suggested that bank counsel, in formulating such an agreement for their clients, may find useful precedents in the relevant portions of the Commercial Letter of Credit Agreement which is contained in the American Acceptance 22 Council pamphlet on Standard Forms of Commercial Letters of Credit. Domestic Documentary Acceptance Credit No The Bank New York City. Dear Sirs: In consideration of your accepting for our account, such drafts as we may designate, not exceeding the total amount of $ , secured by Bills of Lading , Warehouse Receipts representing goods of a market value estimated by us at $ , we hereby agree to pay to you, ifl cash, the amount of each draft so accepted, at the maturity thereof, or prior thereto at any time you may request it; and we authorize you to charge our account with any amount, at any time owing to you hereunder. We further agree to deliver to you additional securities or .property or to make payments on account to your satisfaction on demand, should the market value of the said securities or property in your opinion suffer any decline. a. (Neither you nor any of your correspondents shall) b. (You shall not) be responsible for any loss arising from any difference in quality, quantity, or character of merchandise or goods shiPped or stored under any such bill of lading, warehouse receipt or other instrument, other than as stipulated and expressed in the invoice accompanying the drafts, nor for corr.ectness or genuineness of documents, nor for delay or deviation from instructions in regard to shipment or storage. Your compensation shall be per cent computed upon the face amount of each draft so accepted. .Merchandise or goods shipped or stored in connection with drafts accepted by you pursuant to this agreement shall be paid for, or approved security shall be lodged 23 with you, at your opinion, before surrender of the documents. All securities or property which shall be received by you hereunder may be held by you as security for and applied by you to the payment of all other indebtedness or liability existing, or which may hereafter arise, from us to you. All goods shipped to or stored for us under this or any other similar agreement between us, or their proceeds, whether the drafts against the same shall have been paid or not and whether the goods shall have been delivered to us or not, may be held by you as general collateral security for any and all indebtedness to you, arising at any time or times from credit extended to us, under which we may be entitled to ship or store goods. On the non-performance of any promise contained herein, or upon the non-payment of any of the indebtedness above mentioned, or in case of our insolvency, bankruptcy, or failure in business, then and in any such case, all our obligations and liabilities, direct or contingent to you shall forthwith become due and payable, without demand or notice; and full power and authority are hereby given to you to sell, assign, and deliver the whole of the said securities, or property or any part thereof, or any substitute therefor, or any additions thereto, or any other securities or property given to you or left in your possession by us whether for the express purpose of being used by you as collateral security, or for any other or different purpose, or in transit to or from you, by mail or carrier, for any of the said purposes, at any broker's board, or at public or private sale, at your option, without either demand, advertisement or notice of any kind, all of which are hereby expressly waived. At any such sale, you may purchase the whole or any part of the property sold, free from any right of redemption on our part, which is hereby waived and released. In case of any sale or other disposition of any of the property aforesaid, after deducting all costs, or expenses of every kind for collection, sale or delivery, you may apply the residue of the proceeds of the sale or sales so made, to pay one or more or all of the said obligations or liabilities to you, whether then due or not due, making proper rebate for 24 interest on obligations or liabilities not then due, and returning the overplus, if any, to us; and we agree to be and remain liable to you for any deficiency arising upon such sale or sales. We hereby authorize and empower You, at your option, at any time, to appropriate and apply . the payment and extinguishment of any of the obligato hops. or liabilities, hereinbefore referred to, whether now existing or hereafter contracted and whether then due or not due, any and all moneys now or hereafter in your !lands, on deposit or otherwise, to our credit or belonging to us. :This agreement can be withdrawn or cancelled only with your consent. Yours very truly, With all the preliminary arrangements thus completed, the customer then draws his drafts on the bank, which duly accepts them by subscribing, customarily across the face of the drafts, a dated statement to that effect. With revenue stamps and the certificate of eligibility affixed as indicated in Chapter I of this series, the drafts are ready for the discount market. .if the total of the credit extended is large, it Will render the acceptances more easily marketable to split them up into denominations of say twentyfive thousand dollars. At times the volume of credit required by a customer to finance oil, cotton or like commodities Which are dealt with in large units, may exceed the acceptance capacity of the bank, particularly as the Federal Reserve Act, while permitting banks 25 c.11 to accept with its approval bills not exceeding 100% of their paid-up and unimpaired capital stock and surplus, provides that the aggregate amount of acceptances growing out of domestic transactions shall not exceed fifty per centum. If for this, or any other reason, it appears to the banker advisable to distribute the business, he can secure the participation of correspondent bankers by arranging a syndicate. Whether this distribution shall be with several large participants or wholesale depends upon the size of the credit and geographic and business conditions. The initiating bank would, normally, act as syndicate manager, and in that capacity bear the main burden of carrying through the details of the operation, including the disposal of the drafts, their collection and discount, and the distribution of the proceeds. CHAPTER III. CREDITS INVOLVING THE DOMESTIC SHIPMENT OF GOODS. This article will consider the steps to be taken by a bank to set up a credit to exercise the power to accept time drafts growing out of transactions involving the domestic shipment of goods. The Federal Reserve Act and Federal Reserve Board regulations impose but one condition upon the 26 k use of this privilege—that shipping documents securing title must be attached at the time of acceptance. In determining how title is to be secured, the banker must keep in mind the fact that the Federal Bill of Lading Act, which governs the issuance of bills of lading incident to Interstate Commerce, Provides for the issuance of straight bills of lading in which goods are consigned or destined to a specified person, and order bills of lading in which goods are consigned or destined to the order of any person named. In the case of a straight bill the carrier is justified in delivering goods to the consignee named without production of the bill of lading. If a straight bill of lading is employed, therefore, the banker must be the consignee named in the bill of lading in order to insure that the goods Will not be delivered without his order. In the case of an order bill, however, the carrier is not justified in delivering goods except to a person in possession of the bill of lading which has been endorsed to him or in blank by the consignee. In such a case the carrier is liable to any bona fide holder for failure to take up and cancel the bill upon delivery of the merchandise, and in such case the bank is Protected by holding a negotiable bill of lading though it is not itself named as consignee. The credit arrangements, subsequent to acceptance, are left 27 largely to the discretion of the banker; but any experienced banker will appreciate that sound acceptance practice suggests certain limitations upon the exercise of that discretion. From the practical aspect, for example, it makes a great deal of difference whether it is the purpose of the transaction simply to finance an owner of goods during a period of domestic transit, rather than to finance a domestic sale of goods in which the extension of credit during the period of transit is incidentally involved. If it is proposed to finance a domestic shipment, in which no sale is involved, sound practice dictates that the duration of the drafts should not exceed the period of transit, and the bank should retain security title to the merchandise because the mere fact that the goods are moving from place to place does not alter its essential warehousing character and it should properly fall within the limitations fixed for warehouse credits, as outlined in Chapter II of this series. If, however, there has been a sale of the goods, the duration of the drafts may comprehend not only the period of transit of the goods to the buyer, but also the usual and customary period over which credit is thereafter extended in such sales. But even here, though neither the Act nor the Regulations touch on the point, it makes a decided difference whether the transaction is financed for seller or for buyer. Acceptance financing is at its best when it 28 is self-securing and self-liquidating. Let us see how Closely this principle can be applied in practice to domestic shipments. If the financing of a domestic shipment is done for account of the seller, he will draw his time draft on his banker, attaching to it a negotiable railroad bill of lading conveying security title to the merchandise and evidencing shipment to the buyer. The bank will accept the seller's time draft and either discount it or turn it back to the seller so that he may do so elsewhere, and thus place himself in funds. The seller will sign an agreement of the sort outlined in Chapter II of this series to Place the bank in funds with which to meet the drafts at maturity. The bank, must, however, relinquish possession of the bill of lading as it will be required by the buyer to obtain possession of the merchandise on arrival. The goods then pass irrevocably beyond the control both of the bank and of its customer, the seller. The transaction can, however, be made in a sense self-liquidating, by requiring the seller to supply the accepting bank with a second draft of corresponding maturity, drawn on the buyer. The bank may forward this draft, with the documents attached, for acceptance by the buyer, as the condition upon which he may obtain possession of the goods. The bank can hold this accepted draft as collateral and to that extent make 29 the transaction self-secured. The fact remains, nevertheless, that the possibility of control of the goods is ended, and the accepting bank is depending, in the first instance, upon receiving the proceeds with which to liquidate the maturing acceptance from a merchant who is usually a stranger. If the financing of such a shipment is, on the contrary, done for account of the buyer, the seller will draw his time draft on the buyer's bank, attaching to it a negotiable railroad bill of lading conveying security title to the merchandise, and the buyer's bank, after acceptance, will be in possession of documents controlling the goods which can be surrendered to its customer, the buyer, against valid trust receipt, or, if it prefers, warehoused and delivered to him against cash. In any event, the goods are controlled by the bank or its customer, and a practical opportunity exists to continue the selfsecuring, self-liquidating character of the transaction through until the maturity of the acceptance. This question of the advisability of lending aid to a seller by acceptance financing has another aspect. In a broad sense, the stability of any period of commercial activity depends, not on the amount of credit that sellers may be able to extend, but on the amount of credit that buyers may be able to liquidate. The bulwark against inflation is the careful evaluation of the absorptive power of buy 30 ers. The best judges of this situation are the buyers' banks. No one is in quite so advantageous a position to gauge the amount of credit a merchant should receive as his local banker. When the burden of financing a sale is placed upon the buyer, and he In turn is under the necessity of calling on the aid of his banker, a corrective, which is totally lacking When the seller is extending credit to the buyer, is Immediately set up against over-buying. And this Protection is at its highest degree of effectiveness When the selling terms require the buyer to arrange with his banker for the extension of this credit at the time the order is placed. Such a situation is brought about by selling terms which require the buyer not only to finance the credit by arranging that the seller may draw a time draft upon the buyer's bank, but also stipulate that the buyer's bank immediately issue a written instrument authorizing the seller to draw on it, and stipulating in legal form that all such drafts will be accepted by it. Such an instrument is what has come to be known as a commercial letter of credit. It is undoubtedly in the development of this field of financing through the medium of bankers' acceptances credits issued for account of the buyers, that the bestowal of the power to accept the drafts in Connection with domestic shipments has its justification. The commercial letter of credit, though it is 31 41 !I \A, probably as old as the bill of exchange, was little used here prior to 1914. In that year the Federal Reserve Act gave our bankers for the first time the opportunity to use it effectually, through the exercise of the power to accept; and the outbreak of the War brought on a demand for its use in foreign trade. The volume of American commercial letter of credit business grew with astounding rapidity, and the extension of the acceptance privilege to domestic shipments of goods brought about its use in domestic as well as foreign trade. Naturally, so rapid a growth was accompanied by problems and difficulties which were accentuated by the slump of 1920. The lessons of these times were carefully studied by the American Acceptance Council, in cooperation with interested mercantile and foreign trade organizations. The results have been embodied in a report of its Commercial Credit Committee. This report outlines standard commercial letter of credit forms which afford even those who deal only occasionally with commercial letters of credit a comprehensive set of instruments and agreements. A buyer who desired a bank to finance a domestic shipment on an acceptance credit basis would first make application for a commercial letter of credit on the form provided for that purpose. The bank would, in turn, issue to the seller one of the standard 32 forms of commercial letter of credit, and require the buyer to sign the commercial letter of credit agreement. The shipper would then draw on the buyer's bank, in accordance with the terms of the commercial credit instrument, which would require him to accompany the draft with his invoice and a negotiable railroad bill of lading. The draft would be accepted and returned to the shipper for discount, thus financing the transaction, while the bill of lading would be surrendered, either to the buyer against a trust receipt of the kind outlined in Chapter II or to the bank's forwarder for the purpose of being warehoused in the name of the bank. CHAPTER IV. CREDITS TO FINANCE THE EXPORTATION OR IMPORTATION OF GOODS. While, as we have seen, the power to accept Is given in four general classes of transactions, by far the majority of our bank acceptances grow out of the class involving the importation or exportation of goods. These drafts may be drawn under credits opened for the purpose of conducting or settling accounts resulting from transactions involving the shipment of goods between the United States and any foreign country, or between the United States and any of 33 its dependencies or insular possessions, or between foreign countries. The language of the Federal Reserve Act is broad, and vests a wide discretion to determine the precise stage in such a shipment at which the use of the acceptance power may begin, the moment at which it should properly cease, and the closeness of the connection between the drafts drawn and the shipping documents. These are the practical considerations which must first engage the attention of a banker to whom prospective business is offered. Let us say that his customer is a cotton exporter, who has, from year to year, made large sales to English, Italian and Czechoslovakian spinners. The customer finds that for the coming year the English spinners will expect him to draw ninety day sterling bills on them, with shipping documents (ocean bills of lading and marine insurance, in negotiable form, with invoices) attached, to be surrendered to the drawee upon acceptance of the drafts. The Italian spinners propose to remit him the amount of his invoices, in dollars, by cable transfer, upon presentation of his sight documentary drafts to them in Genoa. The Czechoslovakian spinners have, in past years, purchased their cotton in Bremen, and they desire to continue that practice by paying for it by dollar check and taking delivery ex warehouse, Bremen. 34 (k). The capital employed by the exporter in his business is sufficient to accumulate but a portion of the cotton which must be in transit before the proceeds of any of these sales are due. The customer believes that cotton is lower and sterling is higher than either is likely to be at the peak of the season. So, he suggests, though his English contracts for the year have not yet been closed, might not the bank with propriety arrange a credit by which he could immediately draw at six months sight on its London office! The paper thus created could, upon acceptance, be discounted in the London market and the proceeds immediately converted into dollars, thereby not only giving him the advantage of the Present level of sterling, but also providing him With funds with which to accumulate the cotton he proposes to sell and ship. It needs little reflection to appreciate that this Proposition is premature. Sound principles dictate that the financing must not precede the consummation of the sales. Once, however, that the exporter has entered into specific and bona fide contracts for the sale and shipment of the cotton within a Specified and reasonable time, the foundation is laid for self-securing, self-liquidating transactions. Similarly, sound principles require that the life of the financial arrangement should coincide with the duration of the underlying sale. The life of the 35 arrangement may, therefore, extend through but must not exceed the usual and customary period of credit reasonably necessary to finance the sale. In the case at hand, the proper duration of the credit may be arrived at by totalling the time required to assemble and ship the cotton, say thirty days, the transmission and presentation of the documentary draft overseas, say fifteen days, and the life of the draft, ninety days. If the credit provides then that the exporter can draw at 120 days sight on the London office of the bank, he can immediately draw and negotiate this bill, and put himself in funds to buy the cotton. The bill will reach London and be accepted within fifteen days, and at maturity will be paid from the proceeds of the documentary bill, which, having reached London a month later, will mature simultaneously. The banker will have no difficulty in placing a well coordinated plan of this sort on a self-securing, self-liquidating basis. At its inception, he will require his customer to sign an agreement to furnish the bank with funds with which to pay the acceptance at maturity. Such an agreement can take the general form of the Domestic Documentary Acceptance Credit agreement outlined in Chapter II, but, as the acceptances are payable in pounds sterling, the first paragraph must be altered. Such alteration can be made substituting the pertinent 36 Portion (paragraph 2) of the Standard Commercial Letter of Credit Agreement recommended by the Commercial Credit Committee of the Council, reading "We agree . . . . (b) in the case of each acceptance, to furnish you, at your (New York), office, on demand, but in any event in time to reach the place of payment in the course of the mails not later than one business day prior to maturity with first-class bankers' demand bills of exchange to be approved by You for the amount of acceptance, payable in the currency of the acceptance and bearing our endorsement, or, if you so request, to pay to you, at your (New York) Office, on demand, the equivalent of the acceptance in United States gold coin at the rate of exchange then current in (New York) for cable transfers to the place of payment in the currency in which the acceptance is payable." Having executed this agreement, the customer will draw a 120-day sight draft on the London branch or correspondent of the American bank. The American bank will immediately negotiate this bill, thus giving the exporter funds with which to purchase the cotton as well as fixing the rate at which the sterling Payments will be converted into dollars. The bank Will then forward the bill to London for acceptance, and after acceptance it will probably find its way into the discount market. The customer will also agree to deliver the shipPing documents to the American bank in due course. To these documents the exporter will attach his ninety-day sight draft on his Manchester buyer, 37 which will be forwarded by the bank to its London office or correspondent. This institution will deliver the documents to the drawee against acceptance of the draft, hold the draft until maturity, again present it for payment, and utilize the proceeds to meet the exporter's 120-day sight draft in it, which will be presented at maturity by the holder who has purchased it on the discount market. Having thus undertaken the financing of the customer's English business, the banker will find it a somewhat simpler matter to finance the Italian sales. As the Italians have contracted to pay in dollars, the exporter can draw directly on the American bank, in dollars, for acceptance. The duration of this draft will be shortened to include simply the time necessary to assemble and ship the cotton, say thirty days, plus the time necessary to transmit the sight documentary draft, drawn by the exporter on the Italian importer, to Genoa, by mail, and to transmit the proceeds by cable, say an additional fifteen days. The documentary acceptance agreement printed in Chapter II will do very well, and the delivery of the shipping documents to the bank, for forwarding to its Genoa correspondent, with instructions to deliver them against a cable transfer of the full dollar amount of the invoice will make the transaction self-securing and self-liquidating. The financing of the Czechoslovakian business 38 differs from the Italian only in detail. The duration of the acceptances cannot be so nicely calculated, but they must not exceed the time estimated necessary for a reasonably swift sale of the cotton, either during transit or after arrival. In the interim, the Shipping documents should come into the hands of the bank, which will make arrangements with a Bremen correspondent to warehouse the goods upon arrival, and, as its agent, hold the receipts and make delivery against payment by satisfactory dollar cheques. Revenue stamps, at the rate of 2c per $100, must be affixed to the drafts drawn upon the banks in these cases, although the underlying trade drafts, constituting an inherent, necessary and bona fide Part of the actual process of exportation, escape the tax. Now let us introduce a Danish spinner, who Proposes to purchase cotton from the American exporter, and pay for it by establishing in favor of the seller an American bank acceptance credit. He will initiate this arrangement through his local Copenhagen bank which will instruct its American bank correspondent, either by cable or mail, to issue to the exporter a commercial letter of credit—preferably Commercial Credit Conference Form D-A, Which would read: 39 Confirmed Irrevocable Straight Credit. New York, January 2, 1923. All drafts drawn must be marked: Drawn as per advice No. D-A 1324. American Exporter, New York City. Dear Sirs: We are instructed by the Scandinavian Bank, Copenhagen, Denmark, to advise you that they have opened their irrevocable credit in your favor for account of Danish Importer, Copenhagen, under their credit No. 1578-W for a sum or sums not exceeding a total of Ten Thousand Dollars available by your drafts on us at ninety days sight, to be accompanied by full set ocean bills of lading, to order blank endorsed, insurance certificates, and commercial invoice evidencing shipment of 800 bales of cotton at 25c per pound, c.i.f. Copenhagen. Marine and mine-risk insurance to be effected by seller. Each of the provisions on the back hereof, except so far as otherwise stated, is incorporated as a part of this credit. The above mentioned correspondent engages with you that all drafts drawn under and in compliance with the terms of this credit will be duly honored on delivery of documents as specified, if presented at this office on or before February 1st, 1923; we confirm the credit and thereby undertake that all drafts drawn and presented as above specified will be duly honored by us. Yours very truly, American Bank. The exporter would draw on the American bank at ninety days sight, surrendering the stipulated documents to it against acceptance. The accepted draft would be returned to the exporter who could, if he needed funds, discount it at the preferential rate which prime eligible bank acceptances command. 40 • The documents would be forwarded to the Scandinavian bank, which would be under the duty to provide the American bank, at the maturity of the draft, With the dollars with which to pay it. There is no essential difference between an import and an export credit, as every foreign shipment is both export and import and the use of either term simply indicates the point of view. However, it may be helpful to consider the steps to be taken by an American merchant to finance his importations on an acceptance basis. For this purpose he would customarily establish a commercial credit in favor of the foreign seller. The American merchant will, if possible, seek to arrange payment in dollars, as he is thus freed both from the exchange problem and the commission charged by a foreign bank for making an acceptance in foreign currency. He will Sign the Application for Commercial Letter of Credit and Commercial Letter of Credit Agreement already referred to. The bank will issue for him, in favor of the foreign seller, an irrevocable credit,—preferably Commercial Credit Conference Form B, which would read: Irrevocable Credit No. 140. New York, January 2, 1923. Far Eastern Export Company, Calcutta, India. Dear Sirs: We hereby open our irrevocable credit in your favor for account of American Importer, New York, for a sum 41 or sums not exceeding a total of ten thousand dollars ($10,000) available by your drafts on us at ninety days sight to be accompanigd by consular invoice,—on board bills of lading drawn to the order of the American Bank of New York,—and commercial invoice evidencing shipment of Jute. Marine insurance to be effected by shipper. All drafts so drawn to be marked "Drawn under American Bank Credit No. B-73, dated January 2, 1923." There must be forwarded by early mail to California Bank at San Francisco, California, a copy of the consular invoice, commercial invoice and one bill of lading. All remaining documents must accompany the draft. The amount of any draft drawn under this credit must, concurrently with negotiation, be endorsed on the reverse hereof, and the presentment of any such draft shall be a warranty by the negotiating bank that such endorsement has been made and that documents have been forwarded as herein required. This credit must accompany any draft which exhausts the credit and must be surrendered concurrently with the payment of such draft. Each of the provisions on the back hereof, except so far as otherwise expressly stated, is incorporated as part of this credit. We hereby agree with the drawers, endorsers and bona fide holders of drafts drawn under and in compliance with the terms of the credit that the same shall be duly honored on due presentation, and delivery of documents as specified at our New York office, if negotiated on or before March 1, 1923. Yours very truly, With such an instrument in his hand, the seller can negotiate his draft drawn in accordance with its stipulations with any Calcutta bank, receiving payment either in local currency or, if he prefers, can usually arrange to receive a dollar bank check 42 on New York. The bank negotiating the draft would forward it to its New York correspondent for presentation to the American bank for acceptance and ask its New York correspondent to dispose of it after acceptance in the discount market, if it desired to make the proceeds immediately available. In either event the draft would be again presented to the American bank at maturity and at that time the obligation of the American merchant to make payment would have matured. The documents would be detached from the draft by the American bank at the time of acceptance and thereafter delivered by it to the American importer, either against cash or against trust receipt as the bank preferred. The degree of security afforded by the trust receipt varies in the different state jurisdictions in this country, but generally speaking it affords a degree of protection against the claims of general creditors provided the bank, by advancing the purchase price, obtains security title to the merchandise. Such a legal situation is created by the form of credit in question which stipulates that the bills of lading are to be drawn to the order of the bank, thus giving it title to the merchandise. Revenue stamps are not required in connection with the draft drawn under the Copenhagen credit because in that instance the bank acceptance is the only draft drawn in connection with the transaction 43 and, as an integral and inherent part of the exportation, is protected against taxation by the constitutional provision against the laying of any tax or duty on articles exported from any state. The draft drawn in connection with the importation from Calcutta on the other hand is not protected from taxation by the constitutional provision and stamps must therefore be affixed at the rate of 2c per $100 or fraction thereof. The use of the acceptance privilege, particularly in connection with the issuance of commercial letters of credit, is capable of so many adaptations to fit the requirements of particular cases that it is impossible to even indicate the variety of operations which may be undertaken. In fact it is this circumstance, that there is no variety of export or import operations which cannot be arranged upon a reasonable business basis which will make possible the utilization of the acceptance power, that has givenl the vogue to this method of financing, and which makes it the most useful weapon at the command of American bankers and merchants in doing our fair share of international trading and banking. 44 CHAPTER V. CREDITS DRAWN FOR THE PURPOSE OF CREATING DOLLAR EXCHANGE. The acceptance of drafts drawn for the purpose of creating dollar exchange constitutes the fourth, and last, general class of acceptance credits. In the dollar exchange credit the documentary connection with an underlying mercantile transaction, which is essential during the life of an acceptance secured by staples, but required only at the moment of acceptance in the case of domestic shipments, and merely in due course in case of an exportation or importation, is permitted wholly to disappear. This relaxation of the visible contact between the acceptance and the mercantile transaction is, however, in no sense intended to countenance the creation of "finance bills," drawn virtually for the purpose of procuring a loan from the American money market. It results simply from the impracticability of requiring a tangible connection between the underlying trade bills, and the banker's time bills drawn for the purpose of creating or recovering the funds invested in them. To prevent the abuse of the privilege, the Federal Reserve Act has imposed upon its use restrictions of a somewhat different character than those which have already been dealt with. The most important of these restrictions is that which requires that the 45 bills emanate from foreign countries or dependencies or insular possessions of the United States for the purpose of furnishing dollar exchange as required by the usages of trade therein. The Federal Reserve Board makes the determination whether the usages of trade require the granting of the acceptance facility, upon application made by a member bank setting forth the usages of the country in question. At the present time, the Federal Reserve Board has authorized the acceptance of drafts drawn for the purpose of creating dollar exchange in Australia, Argentine, Bolivia, Brazil, British Guiana, British Honduras, Chile, Colombia, Costa Rica, Cuba, Dutch Guiana, Dutch East Indies, Ecuador, French Guiana, French West Indies, Guatemala, Honduras, Nicaragua, Panama, Paraguay, Peru, Porto Rico, San Salvador, Santo Domingo, Trinidad, Uruguay, Venezuela, New Zealand and other Australasian dependencies. A second requirement is that these drafts shall have not more than three months sight to run, exclusive of days of grace. A third requirement is that the drafts must be drawn by banks or bankers located in one of the approved countries. The development here of a market of the broadest character for this class of bill, when drawn to supply a legitimate demand for 46 dollar exchange, will aid American banks, established in foreign fields, to supply American banking service to American business, and more successfully to compete with foreign banks which operate in other currencies. To understand the practical purpose served by this class of acceptance, let us consider a typical situation. A steamer from the United States arrives at a Central American port with cargo and mail, including documentary sight dollar drafts drawn by the American sellers on the Central American buyers. In the course of a day or two these documentary drafts are presented, simultaneously bringing all the drawees into the exchange market as buyers of dollars. The total of their requirements is likely to exceed the supply of dollar exchange which local bankers have accumulated from local exporters of products to the United States, or otherwise, and which are either already available as dollar deposits in accounts with bankers in the United States, or else in course of transit for cellection and credit to these accounts. If these drawees must compete for the inadequate supply of dollars on hand, it is obvious that the result will be a sharp rise in the cost of dollar exchange without any augmentation of the supply, to the detriment of all, and naturally also to the detriment of further trade with the United States. If the local banks 47 (it have, however, arranged acceptance credit facilities with their United States correspondents, the situation is simplified. They can sell their dollar cheques on the United States to the drawees, thus furnishing them funds with which to take up the trade drafts, and they can simultaneously draw for equivalent sums at ninety days sight on their American bank correspondents. The cheques and time drafts will arrive here in the same mail. The time drafts will be immediately accepted and discounted and the proceeds credited to the accounts of the Central American banks and thus utilized to cover the cheques. During the ninety days that will elapse before the time drafts mature, the Central American banks can as opportunity affords, and without forcing the market, accumulate and remit the dollar exchange with which to pay the drafts when presented for payment. The arrangements between banks for the creation of such a credit are usually perfected by means of an informal exchange of cables or letters, and dependence is customarily had upon custom rather than any form of agreement to define their duties, one to another. This customary obligation has been cast into legal form in the Standard Commercial Letter of Credit Agreement recommended by the Commercial Credit Committee of the American Ac 48 ceptance Council, the pertinent paragraph (paragraph I) reading: "We agree ... (b) in the case of each acceptance, to pay to you at your (New York) office, in United States gold coin, the amount thereof, on demand but in any event not later than one business day prior to maturity, or, in case the acceptance is not payable at your (New York) office, then on demand but in any event . in time to reach the place of payment in the course of the mails not later than one business day prior to maturity." Due to the fact that the most comprehensive open discount market for American bankers acceptances exists in New York City, a major part of these bills reach the New York market even though they bear the acceptance of a bank in some other city. Some of the banks in the smaller centers have taken cognizance of this fact, and sought to aid the marketability of their acceptances by accepting them, payable at the office of their New York correspondent. If the bills are so drawn, this provision may be helpful; but it is the opinion of eminent counsel that unless the bill as drawn so stipulates, an acceptance by a New Orleans bank, for instance, payable at the office of its New York correspondent, constitutes a material variance, and thus operates to discharge the drawer. If so, the bill at once ceases to become prime eligible paper, and its ready marketability is destroyed. Drawers of such bills should be instructed in advance of the intention to 49 accept, payable in another place, so that they may word their drafts ir conformity. This pamphlet has, of necessity, illustrated but a few of the many ways in which credits may be arranged for the proper utilization of the acceptance power. It will have served its purpose, however, if it has demonstrated that the limitations and regulations, properly appreciated and understood, do not hinder, but rather assist, the inexperienced banker in building up his acceptance credit arrangements upon a fundamentally sound basis. 5o
@FedFRASER