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F R P R IN T 3331 Circular No. 2 7 Series of 1 9 2 0 FEDERAL RESERVE B A N K OF D ALLAS Dallas, Texas, August 6, 1920. BAN KER S A C C E P TA N C E S TO THE MEMBER BAM ADDRESSED: There i s en closed herew ith f o r your p eru sa l and study a B ook let e n t it le d "Bankers A ccep ta n ces- P r in c ip le s and P r a c t ic e s " , p u b lish ed by the American Acceptance C ou n cil. This b o o k le t has been prepared through the c o lla b o r a t io n o f those p o s s e s s in g exp ert knowledge o f this^form o f c r e d it , upon a su g g estion o f the Federal Reserve Board to the American Acceptance C ou n cil, and t h e r e fo r e i t s con ten ts and p r in c ip le s are concurred in by that body. We b e lie v e that our mem ber banks w i l l welcome an op p ortu n ity to r e c e iv e in p r in te d form such a c le a r and f u l l d is c u s s io n o f t h is s u b je c t . In a d d itio n to what in t e r e s t may be awakened in an op p ortu n ity to extend acceptan ce c r e d it s to t h e ir customers by the ex ecu tion o f b an k ers’ a ccep ta n ces, a knowledge may be gained o f the f a c i l i t i e s a v a ila b le f o r in v e s tin g surplus or tem p ora rily i d l e funds in prime ban kers’ accep ta n ces by purchase on the open mar k et at a time when such funds are a v a ila b le . The F ederal Reserve Bank o f D allas w i l l , upon r e q u e s t, c h e e r fu lly purchase in the open market, b an k ers’ accep tan ces f o r the account o f i t s members a g a in st and on r e c e ip t o f a v a ila b le fu n d s, making no charge f o r t h is s e r v ic e e it h e r f o r telegram s or oth erw ise. The Federal Reserve Bank o f D allas w i l l a ls o r e c e iv e ban k ers’ accep ta n ces f o r c o l l e c t i o n f o r the account o f owners, making no charge f o r i t s s e r v ic e , and i t is w e ll to note that the p roceed s o f any ban k ers’ a c c e p t ances executed by any bank in any Federal Reserve c i t y , are a v a ila b le f o r c r e d it to the member banks' account at the Federal Reserve Bank o f D allas on the date such accep ta n ces mature and are p aid by the a c c e p to r . The Texas S tate Banking Law Amendment o f 1914 a u th o rize s s ta te banks to execute a ccep ta n ces on ly in tra n s a ctio n s in v o lv in g the im p orta tion or e x p o r ta tio n o f good s, to the exten t o f 50% o f the c a p it a l and surplus o f the a c c e p tin g bank. Membership o f s ta te banks in the F ederal Reserve System does not co n fe r a c c e p t ance powers upon such banks but an Amendment to the State Banking Law was p a ss ed by the l a s t S p e cia l S ession o f the Texas L e g is la tu re a u th o r iz in g tr u s t com p an ies w ith a c a p it a l s to ck o f not le s s than $ 5 0 0 ,0 0 0 .0 0 , to execute accep ta n ces in both dom estic and exp ort and im port tr a n s a c tio n s to the exten t o f f i v e times t h e ir c a p it a l sto ck and su rp lu s, and upon p erm ission o f the S tate Banking Com m iss io n e r, to ten tim es t h e ir c a p it a l s to ck and su rp lu s. This Amendment, how e v e r , d id not ca rry the emergency cla u se and does not become e f f e c t i v e u n t il n in e ty days a f t e r passage or about September 20. T ru stin g that you w i l l fin d a study o f t h is s u b je c t and a p eru sa l o f the en clo se d b o o k le t o f in t e r e s t and v a lu e , I am, R e s p e c t fu lly , Governor This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org) B a n k e r s Accefitc Principles and P rac ■ Chapter I. General Principles o f A cceptance Credit AM ERICAN A C C E P T A N C E 1 111 Broadway Bankers Acceptances Principles and Practices Chapter I. General Principles o f Acceptance Credits AMERICAN ACCEPTANCE COUNCIL 1 1 1 Broadway New York Published by American Acceptance Council 111 Broadway, New York May, 1920 ( Copies o f this pamphlet may be obtained or reprint arranged through application to the Executive Offices o f the American Acceptance Council) Foreword The preparation of a primer on bankers ac ceptances was suggested at a conference of Gov ernors 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 pre pared 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 to co-operate with officers o f the Council for this purpose. At a meeting of the joint committee of the Board’s appointees and the Publicity Commit tee 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 per mitted 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 distinction between bankers acceptance credits and money borrowed. At present there exists a serious lack of unanimity among both bankers and users of bankers accept ance credits with regard to the sound and proper use o f the acceptance facilities. As a result o f its experience, deliberations and inquiries, the Council is convinced that practices have in some cases de veloped— partly through lack o f experience and understanding, and partly from the exigencies of the war period— which, if uncorrected, might ulti mately lead to disastrous consequences and restric tive 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 arbi trary and rigid. The Federal Reserve Act is provided with a flexi bility to accommodate the needs o f business, in the wide discretionary regulatory powers o f 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 o f sound banking judgment, limitations hindering initiative and practice. 4 The American Acceptance Council feels that it would be most unfortunate if, through either ignor ance or abuse o f privilege, banks and business men should compel a change of attitude in the exercise of the regulatory functions o f 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 be fore its readers, the Council recommends the work to the careful attention o f its members and invites their hearty support in putting sound principles into actual practices. The ultimate fate o f 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. I General Principles o f Acceptance Credits Some general principles, as they apply to bankers acceptance credits, may be stated as corner stones in the foundation o f 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 short term 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 o f the underlying transaction should liquidate the bankers acceptance. That the banker, ordinarily and as far as practi cable, 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 o f 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 market ing, domestic credits may not be extended for financing the production of goods. In domestic transportation credits, against ship ping 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 ac cording to the terms o f the sale, but not to exceed six months. The period to be covered by an ac ceptance credit may not in any circumstances ex ceed six months. In domestic credits secured by “ readily market able staples in warehouse,” the bankers accept ance is designed to provide means for the carry ing o f staples, from the point o f completed pro duction 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 an article o f commerce, agriculture or industry of such uses as to make it the subject o f constant 7 dealings in ready markets with such frequent quo tations of prices as to make (a ) The price easily and definitely ascertainable, and (b ) The staple itself easy to realize upon bv sale at any time.” The extension of clean credit, that is, unsecured bankers acceptances, not related to any of the com mercial processes referred to above, is restricted under the Federal Reserve Act to the so-called dol lar exchange credit. This credit is designed to enable banks and bankers, in certain foreign coun tries, under the rules and regulations of the Fed eral Reserve Board, to provide exchange for re mittances in anticipation of the marketing and trans portation o f goods sold. While there is no limit prescribed by law as to the length of an acceptance credit a bank may ex tend, 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, ex clusive 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 not ordinarily discount his own acceptance. 8 The A ccepting Banker W e 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 busi ness to ascertain— 1. 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 cer tain 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 re quire beyond his customer’s obligation to provide the funds in case o f delay or failure in liquidating the transaction. He may thus require a guarantor or additional collateral. If the business is pro posed 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 busi ness. If the transaction involves dollar exchange credit, the acceptor may have placed with him, or lodged in satisfactory hands for his account, ac ceptable 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 ac ceptance agreement, and in due course will accept the bills, after seeing that the drafts and docu ments, 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 pur pose, he has entered upon an unqualified liability to the holder o f his acceptance to pay it at fnaturity. He has, moreover, undertaken to handle for his cus tomer a highly technical and specialized series of transactions involved in the business underlying the acceptance. The satisfactory outcome o f the trans action, 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 rela tion 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 con sidered 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 o f the acceptance, even in case the underlying transaction should not be liqui dated 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 accept ance 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 o f 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 o f his banker intelligent service and fair treat ment. 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 pro ceeds of the underlying transaction, and will stipu late 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 bor rowers of lesser financial strength and importance. They cannot perhaps afford to be quite so inde pendent, 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. Th e Guarantor o f Credit The guarantor o f 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 o f his custo mers, 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 o f 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 ful fillment o f the obligation o f the taker o f credit to provide funds but may include other obligations stipulated as an essential condition to the granting o f 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 a commission which may, or may not, include the acceptor’s commission. The acceptor’s commis sion, 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 collec tions, and the benefits accruing from having ex change for remittance. Or the guarantor may be a merchant or manufacturer desiring goods available through an importer or producer who for one rea son or another, without the granting of these ac ceptance 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 com mission or he may act without special compensa tion, 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 guar anteeing the contract o f the person that does con trol their disposition. Or there may be reasons of friendship or relationship that may form the motive for a guarantee o f credits. 14 II W h en the Beneficiary o f a {B anker’s Credit M a k e s It Available to a Third P arty When the taker o f credit makes it available to the drafts o f 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 o f 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 o f the world, and they serve their purpose equally well in the financ ing o f domestic sales and shipments o f goods. If the seller is satisfied with the financial re sponsibility of his drawee he may consider his IS 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 o f the bill may consider more carefully the credit and financial position o f the drawer and the character and value of the goods, and possibly may limit the volume o f drawings he will handle or may place restrictions on the delivery o f documents. There fore, when the credit o f the drawee is for one rea son 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 oppor tunities 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 o f 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 pro cedure is for the banker to issue in behalf o f the taker of credit, against his agreement to put the 16 banker in funds, etc., a commercial letter o f 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 o f exchange) which it will pay for the bill. If sale is made it sees that the bill or bills are properly drawn in con formity with the terms o f the credit, that the docu ments 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 cor respondent at the place where the drawee is located for acceptance and collection at maturity, or for re discount 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 credit is injected. The drawer and first discounter of the bill have consid ered this in appraising the credit and standing of the drawee, to whom they look for payment o f 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 o f the bill to the drawee banker against his acceptance o f 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 o f surrender of the documents by the acceptor to his customer the goods have been under continuous control of one or another o f the creditors. In these credits it is the drawer who must first be satisfied o f the quality o f 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. W h en Talker o f Credit H im self Intends to Draro 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 rela tion 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 o f 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 In this phase of the use o f acceptance credit, we find limitations that perhaps are not so well under stood and closely observed in practice as they are definite when tested by the application of our princi ples, and there are border line cases that only in telligent regard for principles and the spirit o f the law will properly classify. P roper U se o f Acceptances by Drainer Under Credit Taken by H im self 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 carry ing of these imported goods during such an in terval 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 o f discounting the bills on the foreign buyers, these bills are lodged with a banker for collection and application o f proceeds to liquidate 19 an acceptance credit granted against the exports represented by the pledged bills and documents cov ering 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 ap plied by the banker in payment of the acceptance credit. Or, where there is a contract to export, to per form which goods must be manufactured or as sembled, requiring use of credit before actual ex port 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 inter fering with the prompt liquidation of the transac tion 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 fo r Qranting 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 A ct; 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 con signee 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 Fed eral Reserve Act as a basis for making eligible bankers acceptances. Acceptance credits in such cases would not be self-liquidating in the sense o f 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 afifected. Ill Distinction Between M o n e y Borrow ed 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 invest ment; By employment in carrying non-liquid assets, such as unsold and unmarketable goods, and manu factures made up in anticipation of seasonal de mand, 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 custom ers, except for seasonal requirements or specific purposes, are, therefore, as a class not always highly liquid. A bankers acceptance credit taken under pro visions of the Federal Reserve Act must be o f 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 trans actions, within limitations designed to minimize credit risks, may, therefore, be granted more freely, and with greater expectation o f retirement at ma turity 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 o f proper character is an obligation towards the whole money market, which scrutinizes with expert eye his acceptances sold in the market as evidences o f his conduct of business. It is not 23 necessarily so with regard to loans of money— there the lender need satisfy none but himself, un less 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 is sought. This may be seen by a comparison o f the rela tive 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 o f its proceeds is the determining factor. That use must be com mercial, i. e., in one or more o f 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 state ment 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 un favorable 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 avail able to the lender of unsecured money, although, of course, good reputation and confidence based on personal acquaintance and knowledge of the charac ter, habits and methods of the borrower form other and most important bases for extension of accom modation. 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 busi ness 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 bor rower’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. In deed the hazards in extending acceptance credits are very real. R isk s: W h a t T h ey A r e and H otd to Minimize Them Some risks are similar to those in lending money, others are o f 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 o f 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 accept ance. 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 cir cumstances. The acceptor’s risk should be ap praised in the same way with this distinction, how ever, that even greater care should be exercised by him, first, because of his obligation to the discount ers 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 o f credit, is similar and may be more difficult to appraise, par ticularly if buyer or consignee is abroad. Time may be required to conduct inquiries. If there is doubt, suitable guarantees may be suggested or re quired which may result in the buyer providing credit instead o f 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 re gard, the other class of risks must be considered, such as the nature o f the goods and their value. Are they perishable or subject to material deprecia tion in quality in transportation? Is their market wide or restricted? Is their market value stable or liable to sudden decline? In case o f delayed ship ment 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 ex penses would this involve, and what loss might re sult? 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 insur ance, 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 o f foreign cred its, foreign laws and business customs, or em ploy agents who have this knowledge. The Ameri can 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 corre spondents, and by their specialized knowledge and facilities can greatly assist those acceptors who have not developed foreign departments or estab lished satisfactory connections abroad. Many o f the same risks in varying degrees sur round 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 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 L a w The distinction between money borrowed and bank ers acceptance credit is emphasized not only in pru dent banking practice but in our banking laws. Sec tion 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 o f 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 con ditions 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 o f 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 see Page 33 of Appendix. 29 tomer through discount by a national bank o f com mercial paper actually owned by him.* The philosophy of the limitations of and exemp tions 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 loans of money for employment more or less tem porarily as working capital, or to finance capital •operations, such advances should and must be con fined 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 re discount o f 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 sub ject to infinite refinement in particular applications, must remain broad to permit the essential elasticity to sound banking judgment required for it to func tion freely in its every day adjustment o f and adaptation to business affairs and conditions. Bankers acceptance credit taken is not money bor rowed 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 o f 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 o f 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 is in a similar position when his customer defaults in providing funds before the banker is required to meet his obligation, i. <?., pay his acceptance to the holder at maturity. In both cases, if the amount o f such debt, which must be considered as an evidence of money borrowed, either by itself or if added to other money loans to the same borrower, exceeds 10% o f the capital and surplus o f a na tional 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 ac ceptance, 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 o f single name commercial paper and does not take the preferred classification of commercial paper actually owned or bills of ex change 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. A ppendix Section 5 2 0 0 , U . S. R evised Statutes [H . R. 7478.] An Act to amend Sections 5200 and 5202 of the Revised Statutes o f the United States as amended by Acts o f June 22, 1906, and September 24, 1918. Be it enacted by the Senate and House o f Representa tives o f the United States o f America in Congress as sembled, That section 5200 o f the Revised Statutes o f the United States as amended by the Acts o f June 22, 1906, and September 24, 1918, be further amended to read at fo llo w s: S ec . 5200. The total liabilities to any association o f any person or o f any company, corporation, or firm for money borrowed, including in the liabilities o f a company or firm the liabilities o f the several members thereof, shall at no time exceed 10 per centum o f the amount o f the capital stock o f such association, actually paid in and unim paired, and 10 per centum o f its unimpaired surplus fund: Provided, however, That (1) the discount o f bills o f exchange drawn in good faith against actually exist ing values, including drafts and bills o f 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 o f shipment, and also including bankers accept ances o f the kinds described in section 13 o f the Federal Reserve Act, (2 ) the discount o f commercial or busi ness paper actually owned by the person, company, cor poration, or firm negotiating the same, (3 ) the discount of notes secured by shipping documents, warehouse re ceipts, or other such documents conveying or securing title covering readily marketable nonperishable staples, in cluding live stock, when the actual market value o f the property securing the obligation is not at any time less than 115 per centum o f the face amount o f the notes se cured by such documents and when such property is fully covered by insurance, and (4 ) the discount o f any note or notes secured by not less than a like face amount of bonds or notes o f the United States issued since April 24, 1917, or certificates o f indebtedness o f the United States, 33 shall not be considered as money borrowed within the meaning o f this section. The total liabilities to any asso ciation, o f any person or o f 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 o f indebtedness as described in (4 ) hereof shall not exceed (except to the extent permitted by rules and regulations prescribed by the Comptroller o f the Currency, with the approval o f the Secretary o f the Treasury) 10 per centum o f such capital stock and surplus fund o f such association and the total liabilities to any association o f any person or o f any corporation, or firm, or company, or the several members thereof for money borrowed, including the lia bilities 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 o f 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 o f any one person, corporation or firm or company, or the several members thereof for more than six months in any consecutive twelve months.” S ec . 2. That section 5202 o f the Revised Statutes o f the United States as amended by section 20, Title I, o f the A ct approved April 5, 1918, be further amended so as to read as fo llo w s: “ S ec . 5202. N o national banking association shall at any time be indebted, or in any way liable, to an amount ex ceeding the amount o f its capital stock at such time ac tually paid in and remaining undiminished by losses or otherwise, except on account o f demands o f the nature follow in g : “ First. Notes o f circulation. “ Second. Moneys deposited with or collected by the as sociation. “ Third. Bills o f exchange or drafts drawn against money actually on deposit to the credit o f the association, or due thereto. “ Fourth. Liabilities to the stockholders o f the associa tion for dividends and reserve profits. “ Fifth. Liabilities incurred under the provisions o f the Federal Reserve Act. 34 “ Sixth. Liabilities incurred under the provisions o f the W ar Finance Corporation Act. “ Seventh. Liabilities created by the indorsement o f ac cepted bills o f exchange payable abroad actually owned by the indorsing bank and discounted at home or abroad.” Approved, October 22, 1919. W h a t a Federal R eserve Bank M a y Discount fo r its M em ber Banks The limitations imposed upon the amounts o f redis counts which a Federal Reserve bank may make for a member bank, whether State or national, are determined by the provisions o f the Federal Reserve A ct and are not in any way affected by the amendment to Section 5200. Under the provisions o f Section 13 o f the Federal Re serve A ct any Federal Reserve bank may rediscount for any member bank, whether State or national, the obliga tions o f any one borrower to the extent o f ten per cent, o f the member bank’s capital and surplus but it is ex pressly provided that “ bills o f exchange drawn against actually existing values” shall not be included in determin ing that ten per cent, limit. In the opinion o f the Federal Reserve Board this phrase “ bills o f exchange drawn against actually exist ing values” includes “ drafts or bills o f exchange secured by shipping documents conveying or securing title to goods shipped” and “ bankers’ acceptances o f the kinds described in Section 13 o f the Federal Reserve A ct” even though Section 13 (unlike the amendment to Section 5200) does not expressly state that those two classes o f paper are bills o f exchange drawn against actually exist ing values. In the opinion o f the Board, however, ac cepted demand bills on which the drawer is released from liability are not “bills o f exchange” within the meaning o f Section 13 and must, therefore, be included in determin ing the limits on the amount o f paper o f any one bor rower which a Federal Reserve bank may rediscount for any member bank. Under the terms o f Section 11 (m ), as amended by the A ct o f March 3, 1919, any Federal Reserve bank may, 35 until December 31, 1920, rediscount for any member bank, whether State or national, the obligations o f any one borrower to the extent o f twenty per cent, o f 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 o f the United States issued since April 24, 1917, or by certificates o f indebtedness o f the United States. Special Provisions Relating to Rediscounts fo r M e m b er State Banins The above discussion relates to the general powers o f a Federal Reserve bank to make rediscounts for any mem ber bank, whether State or national. It must be observed, however, that under the terms o f Section 9 o f the Fed eral Reserve Act, no Federal Reserve bank can redis count for a member State bank any o f the paper o f any one borrower who is liable to such member State bank in excess o f ten per cent, o f the capital and surplus o f that State bank but it is provided that the discount o f bills o f exchange drawn against actually existing values and the discount o f 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 o f this Section 9 are in no way affected by the amendment to Section 5200 o f the Revised Stat utes and the same test as to the eligibility o f any part o f the line o f paper o f any one borrower which is held by a member State bank is applicable now as before that amendment to Section 5200. Under the provisions o f Section 11 (m ) as amended by the A ct o f March 3, 1919, the Board has ruled that a Federal Reserve bank may, until December 31, 1920, re discount for a member State bank paper secured by not less than a like face amount o f bonds or notes o f the United States issued since April 24, 1917, or certificates o f indebtedness o f 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 o f all rediscounts o f the paper o f any one borrower must in no case exceed twenty 36 per cent, o f the capital and surplus o f the member State bank. In other words, if the regular line o f credit o f the bor rower from a member State bank is not more than the ten per cent, limit fixed by Section 9 o f the Federal Re serve 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 o f credit o f the borrower from the member State bank is more than that ten per cent, limit, then the Fed eral Reserve bank cannot rediscount any o f that regular line o f credit but may rediscount that paper which is secured by Government obligations o f the kinds specified up to the limits described above. (See ruling o f the Fed eral Reserve Board printed on pages 361 and 362 o f the April, 1919, Federal Reserve Bulletin.) October 24, 1919. 37 Loaning P ow ers o f National Banks, Under the Am endm ent to Section 5 2 0 0 , U . S. R . S ., A p p rov ed October 2 2 , 1 9 1 9 The amendment to Section 5200 o f the Revised Statutes which became a law on October 22, 1919, has made cer tain material changes in the loaning powers o f national banks. For the convenience o f national banks and others interested in the effect o f those changes, there is sub mitted herewith an analysis o f the provisions o f Section 5200 now in force. The amounts which a National Bank may properly lend to any one person, company, corporation or firm (in cluding in the liability o f a company or firm, the liabili ties o f the several members thereof) under the various clauses o f Section 5200, as amended by the A ct approved October 22, 1919, are stated in terms o f the percentage o f the paid-up and unimpaired capital stock and surplus o f the lending bank. C h a ra c te r of L oan s A m o u n t s L oa n ab le (A ) Accommodation or straight loans, whether or not single name. Maximum limit, 10% o f bank’ s paid-up and unimpaired capital and surplus. (B ) No limit imposed by law. “ Bills of exchange drawn in good faith against ac tually existing values.” The law expressly provides that this phrase shall also include: (a) Drafts and bills of ex change secured by shipping documents conveying or securing title to goods shipped. (b) D e m a n d obligations, when secured by docu ments covering com modities in actual pro cess o f shipment. (c) Bankers’ acceptances of the kinds described in Section 13 o f the Fed eral Reserve Act. 38 A m o u n t s L oa n ab le C h a r a c te r of L oan s (C) Commercial or business paper (o f other makers) actually owned by the per son, company, corporation or firm negotiating the same. No limit imposed by law. (D ) Notes secured by shipping documents, warehouse re ceipts or other such docu ments, conveying or secur ing title covering readily marketable non-perishable staples, including live stock. No bank may make any loan under (D ), however, (a) Unless the actual mar ket value o f the prop erty securing the obli gation is not at any time less than 115% o f the face amount of the note, and (b) Unless the property is fully covered by insur ance, and in no event shall the privilege afforded by (D ) be exercised for any one customer for more than six months in any c o n s e c u t i v e twelve months. 15% o f bank’s capital and sur plus in a d d i t i o n t o 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 l i k e f a c e a m o u n t of bonds or notes o f the United States issued since April 24, 1917, or by cer tificates of indebtedness of the United States. 10% of bank’s capital and sur plus, in a d d itio n 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 de scribed 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. Gov ernment obligations of the kinds described under (E ) the face amount of which is at least equal to 105% o f the amount o f the cus tomer’s notes. No limit, but this privilege^ under regulations of the Comp troller of the Currency, ex pires December 31, 1920. Some Examples o f W h a t a National Bank M a y L en d at A n y O ne Time to A n y O n e Customer Under the Am endment to Section 5 2 0 0 , A pproved October 22, 1 9 1 9 , Expressed in Terms o f P e r centage o f the B a n k ’s Capital and Surplus Illustra- Illustra- Illustra tion tion tion 1 2 3 (A ) Accommodation or straight loans (D ) Notes secured by warehouse receipts, etc. . (E) Notes secured by a like face amount of Government obligations .......... 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 October 24, 1919. 40 10% 5% 5% 15% 20% 15% 10% 10% 15% 35% 35% 35% No limit imposed by law. No limit imposed by law. No limit imposed by law.