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61ST CONGRESS \

2d Session

)

QT?IVTATT?

/DOCUMENT

SENATE

N o . 569

NATIONAL MONETARY COMMISSION

Bank Acceptances
By
LAWRENCE MERTON JACOBS

f
Washington : Government Printing Office : 1910

NATIONAL MONETARY COMMISSION.

NELSON W. ALDRICH, Rhode Island, Chairman.
EDWARD B. VREELAND, New York, Vice-Chairman.
JULIUS C. BURROWS, Michigan.

JOHN W. W E E K S , Massachusetts.

E U G E N E H A L E , Maine.

ROBERT W. BONYNGE, Colorado.

PHILANDER C. K N O X , Pennsylvania.

SYLVESTER C. SMITH, California.

THEODORE E . BURTON, Ohio.

LEMUEL P . PADGETT, Tennessee.

H E N R Y M. TELLER, Colorado.

GEORGE F . BURGESS, Texas.

HERNANDO D. MONEY, Mississippi.

ARSENE P . P U J O , Louisiana.

JOSEPH W. BAILEY, Texas.

ARTHUR B. SHELTON, Secretary.

A. PIATT ANDREW, Special Assistant to Commission.

BANK ACCEPTANCES.
By

LAWRKNCE MERTON JACOBS.

The fundamental difference between European and
American banking has its origin in t h e dissimilarity
between t h e evidences of indebtedness which lie behind
t h e item of loans and discounts. I t is most strikingly evidenced in t h e fact t h a t time bills of exchange form a considerable proportion of t h e resources of t h e great banks of
London, Paris, and Berlin, whereas t h e assets of leading
New York banks are largely based on stocks and bonds.
Of t h e bills of exchange in which are employed, either
through loans or discounts, t h e funds of European banks,
an essential p a r t consists of w h a t are known as bankers'
bills—that is, bills drawn on bankers and accepted b y
t h e m on behalf of customers in accordance with arrangements previously made. They are bills in exchange for
which, b y sale t o a broker or b y discounting at a bank,
bankers' customers or those to whom they are indebted
m a y secure immediate credit. In some instances it is
arranged t h a t t h e customers themselves shall draw t h e
bills and in others t h a t t h e bills shall be drawn b y third
parties for their account. I n granting t h e accommodation
t h e obligation t h a t t h e bankers t a k e upon themselves is
t h a t they will accept t h e bills upon presentation. This
acceptance consists in t h e bankers writing across t h e face
of t h e drafts t h e word " A c c e p t e d , " adding their signature
and t h e date. I t is in t h e n a t u r e of a certification t h a t
t h e bills will be paid at m a t u r i t y — t h a t is, a specified

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number of days or months from the date appearing in t h e
acceptance, or three days later if grace is allowed, as in
England. When a banker grants accommodation t o a
customer b y means of an acceptance, he m a y secure himself in various ways. Ordinarily a banker accepts a customer's draft merely upon his general responsibility, t h e
banker's risk being much t h e same as if he h a d discounted
t h e customer's note running a certain length of time.
Where t h e customer is an importer, t h e banker ordinarily accepts t h e drafts upon t h e delivery to him of t h e
documents covering t h e shipment, which documents he
t h e n turns over t o his customer against a trust receipt.
When a credit of this kind is opened, t h e usual practice is
for t h e banker t o require t h e signature of a form containing
an agreement t o hold him harmless for accepting t h e bills,
t o place him in funds sufficient t o pay off t h e bills three
days prior t o their m a t u r i t y , and to p a y him a commission
on t h e transaction, this commission varying according to
t h e length of time t h e bills are to run and t h e financial
standing of t h e customer. The cost of the accommodation t o the customer is this commission plus t h e prevailing
r a t e of discount for bankers' bills.
I n the United States the national bank act does not
permit banks t o accept time bills drawn on them.
Although t h e act does not specifically prohibit such
acceptances, t h e courts have decided t h a t national b a n k s
have no power t o make them. This restriction has h a d
a very considerable influence upon t h e development of
banking in this country. For some time after t h e passage
of t h e national b a n k act, merchants and manufacturers
provided themselves with funds b y discounting their

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promissory notes with their local banker. Gradually,
however, many concerns, finding that their needs were
outstripping the banking accommodation which they
could secure in their immediate vicinity, came to place
their notes in the hands of brokers who in turn disposed
of them to such bankers as possessed greater surpluses
than they could satisfactorily invest at home. It is this
method of borrowing which is now largely employed. In
other words, the prohibition of bank acceptances has led
to the creation of a vast amount of promissory notes
instead of time bills of exchange. The difference between
these two classes of instruments accounts to a great
extent for the difference between European and American banking. In the case of time bills of exchange
drawn on and accepted by prime banks and bankers there
is practical uniformity of security. In the case of our
promissory notes or commercial paper there is no such
uniformity, the strength of the paper depending on the
standing of miscellaneous mercantile and industrial
concerns.
It is this uniformity of security, on the one hand, which
makes possible a public discount market; it is the lack of
it in single-name paper which makes such a market
impossible. As a result, we have great discount markets
in London, Paris, and Berlin, and none in New York. In
European centers the discount rate is the rate upon which
the eyes of the financial community are fixed. In New
York it is the rate for day-to-day loans on the Stock
Exchange. The advantage in character of the one rate
over the other clearly indicates an important advantage
of European banking systems over our own. In the first

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place, the European discount rate bears a very direct
relation to trade conditions. Its fluctuations depend
primarily on the demand for and supply of bills which
owe their origin to trade transactions, as balanced against
the demand for and supply of money. If trade is active
the supply of bills becomes large, rapidly absorbing the
loanable funds of the banks. As these surplus funds
become less and less banks are unwilling to discount except
at advanced rates. If trade is slack, less accommodation
from bankers in the way of acceptances is required, bills
become fewer in number, the competition for them in the
discount market more keen, and the rate of discount declines. Low rates are an incentive to business and advancing rates act as a natural check. The New York call-loan
rate, on the other hand, bears only an indirect relation to
trade conditions. Its day-to-day fluctuations register
mainly the speculative and investment demand for stocks.
Low rates, instead of being an incentive to the revival of
trade, are rather made the basis for speculative operations
in securities.
The striking difference, however, between European
discount rates and the New York call-loan rates is that the
former are comparatively stable and the latter subject to
most violent oscillations. Foreign discount rates as bank
reserves become depleted advance by fractions of i per
cent. In New York the money rate advances on occasion
10 per cent at a time, mounting by leaps and bounds from
20 per cent to 100 per cent in times of stress.
There are two principal reasons for the stability of foreign discount rates. In the first place, trade expands and
contracts gradually, so trade bills multiply or diminish in

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number little by little, producing a gradual increase or
decrease in the demand for money. In the second place,
discount rates are steady because there is a free movement
of funds between the countries possessing great discount
markets. Between London and Paris money flows as the
balance of indebtedness changes, modified by the discount
rates at the respective centers. If France owes England
more than England owes France, money will tend to flow
from Paris to London in settlement of this balance of
indebtedness. If the London discount rate is higher than
that of Paris, the movement will be accentuated by the
movement of French funds to London for investment in
sterling bills of exchange—that is, in bills drawn on and
accepted by prime English banks and bankers. If the
Paris discount rate is higher than that of London, there will
be a natural offset to the tendency of funds to move to
London in settlement of this balance of indebtedness.
Briefly, money seeks investment in those centers where
the discount rates are highest. If the discount rate in
Paris is i>2 per cent and 2% per cent in London, Paris
bankers remit funds to London for investment in sterling
bills. This increases the supply of money competing for
bills in London and forces the discount rate downward.
At the same time the drain of funds from Paris results in
lessening the competition for bills in that center and the
Paris discount rate rises. Thus it is that funds freely
move to and fro between London, Paris, Berlin and Amsterdam, an exact equality in rates being prevented
largely by the fact that the discount markets in these
cities differ in size and that there is not in each an equally
free market for gold. For example, the Paris discount

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market is broader than that of Amsterdam, and there is
consequently less risk in exchange in forwarding funds to
Paris for investment than to Amsterdam. That the Paris
discount rate should rule somewhat lower than that of
Amsterdam is accordingly natural. Sterling bills, moreover, are favored above German bills because London possesses a freer market for gold than does Berlin—that is,
a holder of credit in London can count on being able not
only to convert it into gold, but to withdraw the gold,
whereas artificial restrictions are sometimes placed on the
withdrawal of gold from Germany. In consequence,
apart from any consideration as to relative size of the two
money markets, there is a tendency for funds to remain
in or to move to London even when the Berlin discount
rate is slightly higher.
There are likewise two principal reasons for the instability of the money rate in New York. The first is that
the demand for loans for the purpose of speculative operations in stocks does not increase gradually. A few weeks
at most are sufficient for a large speculative movement to
develop. At the same time the profits in successful stock
speculation are so great compared with those in trade
that the matter of whether the call rate is 6 per cent or
10 per cent is relatively unimportant. So it is that only
very sharp and very considerable advances in the call
rate are effective in checking the demand for money.
The second reason is that an advance in the call rate
above the level of foreign discount rates does not serve
directly to attract funds from Europe. The continuance
of high rates can not be depended upon, and furthermore,
while London bankers, for example, may be willing to

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loan money to finance speculative movements at home,
t o make advances for similar purposes abroad is quite
another matter. In fact, the higher t h e call rate is the
less the European banker is inclined to lend his money in
t h e New York market. New York is in a class b y itself.
W i t h o u t bank-accepted bills it can have no discount
market. Without a discount market funds can not move
t o it as they do between the financial centers of Europe,
because there are no bank-accepted bills in which foreign
b a n k s can invest. Our commercial paper is not suitable.
Foreign banks will not purchase it because they are not
acquainted with or sure of the rating of miscellaneous
mercantile establishments and because such paper could
not be readily disposed of in case it became necessary or
profitable t o withdraw funds from New York for remittance elsewhere.
The weakness of our banking system as compared with
t h e systems of Europe m a y very certainly be attributed
in p a r t to t h e omission of the b a n k act to permit bank
acceptances. I t is a weakness, furthermore, which involves the country in serious economic loss. Without a
national discount market, the great majority of our merchants and manufacturers are compelled t o confine their
borrowings to American capital, either through the discounting of their paper with their local banks or through
its sale t o note brokers. All b u t the strongest and largest
are practically excluded from the benefits of foreign competition for their paper. Aside from the great concerns
with international ramifications, which are able to arrange
their own credits abroad, our merchants and manufacturers are not benefited b y low foreign discount rates,
85518—10

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except in so far as note brokers, who make it a practice
to borrow in Europe with commercial paper as collateral,
are better able to finance their purchases. What is more,
they receive relatively little advantage from an accumulation of funds in New York banks. Low call loan rates
have an indirect rather than a direct effect on the rate
which the mercantile community has to pay for money.
Low call rates, in other words, are an indication more
especially of stagnation in the stock market than of a
lack of demand for accommodation from merchants and
manufacturers. Such rates do not act as a stimulus to
trade in general any more than high call rates act as an
immediate check to overexpansion.
It is not only in our domestic trade that the country
suffers through the want of a discount market. Without
bank acceptances we are at a distinct disadvantage in
connection with our foreign trade. Our importers, unable
to open credits with their banks, as is done abroad, are
not in a position to finance their purchases upon as favorable a basis as the importers in other countries, as English
cotton spinners, for example. The English spinner about
to purchase cotton in America arranges for his bank to
accept sixty or ninety days' sight bills drawn on it by the
American shipper. The latter draws his bills on the
English bank and attaches the documents covering the
shipment, such as the bills of lading, insurance certificates,
invoices, etc. He then sells them to a New York bank,
thereby receiving immediate payment for his cotton.
The New York bank forwards the bills to its London
correspondent, which presents them for acceptance to the
bank upon which they are drawn. Upon the acceptance

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of t h e bills t h e documents are delivered t o t h e accepting
bank, which then turns t h e m over to t h e spinner upon
whatever arrangement has previously been made. The
accepted bills are discounted b y t h e New York b a n k in
London and t h e proceeds placed to its credit there. The
New York b a n k can afford to pay a high rate for such
bills, as they are drawn on prime bankers, rendering certain their ultimate payment. The purchase of t h e bills
does not, moreover, necessitate any outlay of money, as
against t h e credit to be received through t h e discount of
t h e bills t h e New York b a n k can immediately sell its
checks on London.
Without such banking facilities—that is, t h e ability t o
arrange with his b a n k to accept time bills drawn on it by
a foreign shipper, t h e American importer is compelled t o
finance his purchases in either one of two ways. H e m a y
pay for t h e goods at once b y remitting funds direct t o t h e
shipper. This, however, ordinarily necessitates the negotiation b y t h e importer of a loan on his promissory note.
If he is not in a position to secure such an advance he must
shift t h e burden of providing funds to finance t h e shipment, from t h e time it is forwarded until it is to be paid
for, upon t h e foreign shipper, who is then in a position t o
exact terms more favorable to himself through an adjustm e n t of prices. The practice in connection with this
method of making p a y m e n t for foreign purchases is for t h e
shipper to draw his draft on t h e American importer and
t u r n it over t o his banker to forward for collection. Such
drafts, drawn as they are on individual importers and not
on banks whose standing is well known abroad, must be
sent for collection since there is no general market for

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them. Practically the only way in which a foreign shipper can realize immediately on bills of this character is to
dispose of them to his own banker or get him to make an
advance on them.
Either of these two methods of financing our imports is
expensive even when the time between the shipment and
the receipt of the goods is short. When the time is much
longer, as in the case of imports from South America and
the Far East, the cost is almost prohibitive—that is, so
great that we can not compete on an even basis with foreign buyers. In fact, we might be practically excluded
from these markets if a makeshift were not possible. Our
importer gets around our lack of banking facilities by
having his bank arrange a credit with its London correspondent. He receives an undertaking, called a commercial letter of credit, giving the terms of the credit—that is,
the name of the London bank upon which the bills are to
be drawn, the amount which may be drawn, the character
of the goods which are to be purchased, the tenor of the
bills, and the documents which must accompany them.
On the strength of such a letter of credit, the shipper in
South America, for example, is able to dispose of his bills
on London and thus receive immediate payment for his
goods. The local bank which buys the bills sends them
with the documents to its London correspondent, which
presents the bills to the barik on which they are drawn—
that is, the bank with which the credit was opened. Upon
the acceptance of the bills the documents are delivered.
They are then sent by the London accepting bank to the
New York bank which opened the credit and the latter
delivers them to the importer against his trust receipt.

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Twelve days prior to the maturity of the bills in London
the New York bank presents a statement to the importer
indicating the amount of pounds sterling which must be
remitted to London to provide for their payment at maturity or rather a bill stated in dollars for the amount of
pounds sterling drawn under the credit. In this purchase
of exchange the importer makes payment for his goods.
This method while workable is obviously cumbersome, yet
it is practically the only one which the American importer can follow in connection with such imports. It is
expensive for the importer, for not only must he pay his
bank a commission for arranging the credit, but there is
included in this commission a charge made by the London
bank for its acceptance. Further than that the importer
must take a material risk in exchange. At the time a
credit is opened the cost of remitting, say £10,000 to take
up the bills in London, might be only $48,600, or at the
rate of $4.86, whereas by the time the bills actually
mature exchange may have risen and cost him $4.87, or
$48,700.
As a result of the inability of our banks to finance imports through the acceptance of time bills, American
importers are, then, made dependent to a large extent
upon London, and are required to pay London a considerable annual tribute in the way of acceptance commissions. This practice not only adds to the importance
of London and militates against the development of New
York as a financial center, but it at the same time works
serious injury to our export trade. Since time bills can
not be drawn on our banks from foreign points against
shipments of goods to the United States, there are conse-

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quently in such foreign countries very few bills which can
be purchased for remittance to the United States in payment for goods which have been bought here. In other
words, under our present banking system our imports do
not create a supply of exchange on New York, for example, which can be sold in foreign countries to those
who have payments to make in New York. This means
that our exporters are also, to their great disadvantage,
made dependent upon London. It means that when they
are shipping goods to South America and to the Orient
they can not, when they are subject to competition, advantageously bill them in United States dollars. They
naturally do not care to value their goods in local currency—that is, in the money of the country to which the
goods are going—so their only alternative is to value them
in francs or marks or sterling, preferably the latter, owing
to the distribution and extent of British trade, creating
throughout the world, as it does under the English banking system, a fairly constant supply of and demand for
exchange on London. When we come to bill our goods
in sterling, however, it is at once seen that our exporters
are obliged to take a risk of exchange, which is a serious
handicap when competing with British exporters. Our
exporters who are to receive payment for their goods in
sterling must previously decide on what rate of exchange
will make the transaction profitable. If, in an effort to
safeguard themselves against a loss in exchange, they calculate on too low a rate for the ultimate conversion of
their sterling into dollars, their prices become unfavorable
compared to those made by British exporters and they
lose the business. If they do not calculate on a suflfi-

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ciently low rate they get the business but lose money on
the transaction through a loss in exchange.
The prohibition of bank acceptances not only acts as a
hamper upon our domestic and foreign trade, but is detrimental to our banks as well. It is the small country
bank which is chiefly affected. The business of the country bank, so far as the employment of its funds is concerned, may be divided into two classes—that which relates
to advances to local customers and that connected with
the investment of its surplus. It is in respect to the latter
that the matter of acceptances is important. Under the
present limitations of the national bank act there are
three principal ways in which a country bank may render
its surplus funds productive. It may deposit them with
its reserve agent. This means a low interest return, too
low in fact to permit of only a relatively small amount
being thus employed. It may invest in bonds. In this
way an increased interest return can be secured, providing
a wise selection of securities is made, but it partakes of the
nature of speculation. The third way is to buy commercial paper. Such purchases give an ample interest return
and there is no savor of speculation. Even this method
of employing a bank's funds, however, is far from satisfactory. It means the investment in a security for the
strength of which the bank must depend on the word of
note brokers, the rating of the mercantile agencies, or the
opinion of some correspondent bank. It means, furthermore, the tying up of the bank's funds for a fixed period.
If national banks were permitted to accept time bills the
country bank could then invest its funds in paper bearing
the guaranty of some great bank with whose standing it

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is perfectly familiar. Risk such as now has to be taken
would be eliminated. What is vital, however, is that with
a national discount market an investment in a bankaccepted bill is one which could be realized upon immediately. Commercial paper and bank acceptances are both
discountable. The prime difference between them, as
affecting a country bank, is that they are not both readily
rediscountable. Herein probably lies the reason for the
strong prejudice against rediscounts which exists among
bankers in the United States. In this country when a
bank discounts a piece of commercial paper it is discounting something which for its security depends solely on its
maker. Should the bank desire to realize on this paper
it could do so by rediscounting it, but such a rediscount
would be practically equivalent to a loan to the bank on
the strength of its own name. In other words, to rediscount its commercial paper would affect a bank's credit.
To ask for a rediscount is to ask for accommodation.
This would not be the case with bank-accepted bills. If
such bills were discounted by a country bank as a means
of investing its surplus and it was desired to realize on
them such a rediscount would be made not on the name of
the country bank, but on the name of the accepting bank.
A rediscount in this instance would not constitute a loan
to the country bank and would have absolutely no effect
on its credit. It would merely indicate that some more
profitable business had arisen in which to employ its funds
or that it was desirous of increasing its reserve.
Since the reserves of interior banks are so largely concentrated with them and it is essential that they keep thenassets in an especially liquid condition, the prohibition of

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bank acceptances works injury to the banks at the country's financial center, New York, in a different way. It
deprives them of what London banks, for example,
have—that is, a mass of the soundest securities against
which to loan their money on call or in which they may
invest their funds for very brief periods—bills of exchange,
covering genuine commercial transactions, bearing the
acceptance of prime bankers. Unquestionably such securities as a basis for loans are preferable to stocks and
bonds, but without them New York banks must have
recourse to day-to-day loans on the Stock Exchange.
Moreover, when the demand for such loans is limited, New
York banks are forced into the keenest kind of competition, a competition which, as has been pointed out, is not
only of little benefit to trade but which, through the lowering of the money rate, actually stimulates speculation.
Furthermore, without a steady money rate such as exists
in countries possessing discount markets, New York
banks are left with no reasonable or satisfactory basis
upon which to fix a rate of interest to pay for the deposits
of country banks. In London interest on bank deposits
is fixed at a certain percentage below the Bank of England
discount rate, usually 1% percent—that is, a rate which
fluctuates with the value of money and normally leaves
a certain margin of profit to the London bank. The same
practice is followed in all the great financial centers of
Europe. With us, country banks receive a fixed rate of
interest for their deposits, usually 2 per cent, the year
around, regardless of fluctuations in the value of money.
The unscientific nature of such a rate is obvious. When
the call loan rate is high country banks do not receive

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interest in proportion to the value of their deposits.
When it is low the New York banks pay more interest
than the deposits are worth. In the latter instance the
New York banks are forced into injurious competition
with one another. They are in much the same position as
competing railroads were earlier in our history, with
results similarly baneful. With the railroads it was
worth while to secure traffic even at a losing rate, as no
matter what the return it helped if only a little toward
meeting fixed charges. Oftentimes with the New York
banks to-day any rate which they can secure for their
money whether losing or not is acceptable as helping to
meet this fixed interest charge on bank deposits. To pay
2 per cent for deposits and to keep a 25 per cent reserve a
bank must loan its money at 2 ^ per cent to come out even,
taking into consideration the actual expense of making and
recording the transaction. It is better to loan at i ^ per
cent, however, than to let the money lie idle. It is better
to lose 1 per cent than to lose the entire 2 ^ per cent, as
would be done in case no loans at all were made, clerk-hire
being just as much a fixed charge as interest. With the
amendment of the national bank act, to permit the acceptance of time bills, such ruinous competition would cease.
The funds of the banks would come to be principally
invested in trade paper and stock-exchange loans would
be relegated to a position of secondary importance, as in
London and on the Continent. The field for the investment of their deposits would be greatly broadened, to the
benefit both of the banks and trade in general.
To remedy this primary defect in our banking system,
to make possible the financing of our domestic and foreign

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trade along the lines which have proved so advantageous
in other countries, to provide negotiable paper of a character suitable to the investment of foreign funds, paper
which can not only be discounted but rediscounted, to give
trade the advantage of bank surpluses accumulated both
in the country at large and in New York, to lessen the evils
of speculation, to afford a reasonable basis for the calculation of interest rates on bank deposits in central reserve
cities, to bring New York into the circle of those financial
centers between which funds move naturally as discount
rates rise or decline, to secure the advantage of the competition of foreign capital for our trade paper, can be put in
the way of accomplishment by the insertion of a paragraph
or two in the national bank act.
To permit bank acceptances would not require the
revision of the entire bank act. To remove the barrier to
scientific banking, as it is known abroad, no complicated
piece of legislation would be necessary. Time only would
be required for the development of a great national discount market.
The establishment of a central government bank is not
a prerequisite to the legalization of bank acceptances nor
to the giving of utility to such acceptances. The chief
value of such banks lies in their great resources, which
enable them to rediscount bills and make loans against
bills or other securities without practical limit at all times,
thus enabling other banks temporarily to realize upon
their assets should occasion require. That is the function
of a central bank. If any bank is sufficiently powerful to
do this and is willing to content itself with small profits
through the keeping of a large reserve it can come to exer-

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cise the functions of a central bank. There is no necessity of such a bank being the Government's sole financial
agent. It is not this which gives the Bank of England its
power. It is rather the knowledge that the Government,
realizing the size of the burden which the Bank is bearing
and how important its safety is to the whole financial
fabric of the country, stands ready to assist it in case of
need. Past crises have been met by the Government
authorizing the Bank of England to make an extraordinary
issue of notes. Certainly our Government can be counted
upon to render like assistance to a national bank similarly
placed. In fact, we already have a law providing for an
issue of emergency notes under the sanction of the Government.
If, moreover, we are to judge by the Bank of England,
provisions for an elastic currency are not essential to the
existence of a central Bank. It is true that the Bank of
England has a large amount—£56,327,085 notes—outstanding, but of these £37,877,085 are on account of the
Government—that is, they are nothing more than paper
representing an equivalent amount of gold, being exactly
similar to our own Government gold certificates. Of the
remainder, £11,015,100 are based on £11,015,100 government debt. The balance, £7,434,900, is based on " other
securities." This balance, however, is not subject to
periodic fluctuation. From day to day the only way the
Bank of England can increase its note issue is by receiving
into its vaults an equal amount of gold.

Full text of Bank Acceptances

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