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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.