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FEDERAL RESERVE BANK OF DALLAS December 6, 1924 CAPITALIZING PROSPERITY To the Bank Addressed: We have recently received requests from many of our member banks for assistance or advice in connection with the problem of keeping their funds profitably employed, a task rendered exceptionalfy difficult by the present money situation. Our members understand, of course, that we are always glad to assist them in any way within our power in connection with their investment operations. Our facilities are available for making purchases of government securities, and we endeavor to supply bankers’ acceptances to member banks upon request as long as our own supply is sufficient to enable us to fill their orders, as under the prevailing open market policy of the System we do not bid for bankers’ bills but purchase them only on offer. The rather light volume of bills now being offered us makes it difficult for us to maintain an adequate supply but we do our best to fill orders placed with us by our member banks, as we earnestly desire to encourage the investment of surplus funds, arising from a more or less temporary expansion of deposits, in prime bankers’ acceptances. There has been in the last four years an inflow of gold into this country of more than $1,500,000,000 and gold imports still continue though at a diminished rate. This inflow of gold, which has been due to monetary and financial disorganization in Europe, has been the principal cause of the exceptional ease in the money market in this country, at a time when in Europe there is a short age of credit and interest rates are high. A change in this situation can be expected to come about gradually as currency and credit conditions in Europe improve and as the international gold stand ard is re-established. In the meantime it is highly important that immediate consideration be given to the formu lation of correct policies without regarding the matter of present earnings as being a paramount consideration. For banks in an agricultural section like the Southwest, the issue resolves itself into a choice between three alternatives: (1) To expand loans and discounts by liberalizing credit pol icies, (2) or to invest funds in the best available securities, despite the unsatisfactory yield, (3) or to allow excess reserves to remain idle until needed to meet normal or seasonal demands for loans or withdrawals of deposits. The first mentioned course, stated in plain terms, simply means a letting down of the bars to undesirable credit risks or to the use of bank credit for capital purposes. The ex tent to which these policies will be indulged in will be largely determined by the extent to which the banks adopting them shall have forgotten the lessons of 1920. As these lessons are still more or less fresh in the minds of our member bankers, however, it is believed that conservative tendencies, now in evidence throughout the district, despite the present surplus of idle funds, will continue to dominate the policies of most, if not all, of our member banks. Of the banks that were caught in an over-extended condition in 1920, there are but few that failed to learn the age-old lesson that it is in times of prosperity, rather than during hard times, that most of the disastrous mistakes in extending credit occur. The second alternative, that of investing in open market paper and securities, is of course en tirely unobjectionable, assuming that due consideration is given to their convertibility into cash in case of need, which must include probable trend of prices and possible declines in the event of a sub stantial gold export movement. While it is true that this class of investments is not very attractive just now so far as rates are concerned, the wide range of maturities available appeal to the banks that desire to reduce their idle funds to a minimum and at the same time enjoy the assurance of being able to divert them promptly from investments to the regular channels of loans and dis counts as seasonal needs may require, or to meet either seasonal declines in normal deposits or This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org) thus shifting to the bank any impairment th a t may occur in their own capital assets and thus creating ultimately an impairment of the bank’s capital funds,— failing to recognize the immutable economic law th at sooner or later the com munity’s losses, whether liquidated at the expense of its banks, or not, must be ultimately recouped through a general scaling down of the community’s demands and a more intensive program of production. The resistance offered by borrowers to a suggested temporary program of frugality as a means of relief from financial distress is more pronounced in agricultural sections which have high productive and recuperative powers than is usually the case in other sections where productivity is low and crop failures are not infrequent. And yet the principle here involved remains the same. Where borrowers regard a bank as a sort of commissary, and feel entitled to come to the bank and withdraw cash against loans merely to meet living expenses, it is not likely that any concerted effort will be made in th at community to practice the necessary self-denial and economy when crop failures occur, particularly when the productive and re cuperative powers of its farms are such as to impose but little necessity for paying heed to the question of repaying borrowed money. In its final analysis the evil of over-extension of credit as the result of poor crop condi tions is the inevitable outgrowth of the failure on the part of the lending bank and its bor rowers to realize that a bank’s duty is not to supply capital deficiencies, but to maintain its own capital in tact; and th at its function is not to lend its own funds or resources, but to lend the resources of one part of the community to another part of the community. When a bank finds itself contributing to the community out of its own resources, instead of basing its extension of credit upon the present or prospective resources of the community itself, it is in evitable th at at some definite time in the future the credit supply (which is a fixed and measurable thing) will be greatly reduced or exhausted by the undue proportion of available resources tied up in “frozen loans.” While we recognize th at credit cannot be administered under any inflexible rule or policy, each application being entitled to treatm ent on an individual basis, experience has shown th at at least one generalization can be safely applied in formulating policies looking to the control of the volume of credit extended in the face of unfavorable conditions. If, as bank ing experience teaches, it is sound banking practice to expand credit judiciously from time to time during a good season, based on a favorable outlook for a large and profitable produc tion, then by the same process of reasoning credit should be judiciously conserved when the situation is reversed and the prospects for production are poor. This is the universal rule and practice in the administration of credit to all other lines of industry and business, and represents a principle th a t cannot be violated with impunity in the administration of agri cultural credit. Yours very truly, Governor.
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