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BULLETIN o f the National Association of Credit Men Vol. X V I. A P R IL , 1916 The Improvement of Credit Department Methods in and Reserve Banks *B y \ Chairman o f the Board o f Federal Reserve Bank o f St. Louis. Financial history can be divided into three eras— the era o f barter, the era o f money, and the era o f credit. W e are at present in the era o f credit, and at a time when the financial statement o f the borrow er is an absolute necessity. W hen we look at it now, it seems strange that twenty-six years ago there was no such thing in existence in this country as an organized credit department in a bank. F or many years previous to this, business houses, doing business on credit, had organized credit departments and were making a m ore or less successful effort in getting statements from customers, yet though banks were lending large sums o f money, and in some cases were getting what purported to be statements o f the borrowers, they had no credit departments, to which these state ments were sent, analyzed, and what we may call “ standardized” fo r comparison from year to year. I have been unable to find a record o f any bank that had a credit department prior to the year 1890 . About this time, some o f the large banks in the East, doubtless made uneasy by the ex pansion o f credit that preceded the panic o f 1893 , were led to establish credit departments fo r their protection. It is probably safe to say that the banks, which had taken this precaution, were in better condition to stand the stress when it came than those which had not so acted. Perhaps it was the panic o f 1893 that caused the awakening. A nyhow , from that time on, the develop ment o f organized credit departments in banks in large centers was comparatively rapid. They realized that the old way o f coming to a general conclusion as to the status o f a borrower, based on m ore or less haphazard statements and investigations, confirmed by the general knowledge o f the discount committee and board o f directors, was dangerous. They saw that definite, tangible inform a tion was necessary, and realized that it was well worth while to have men whose business it was to get this information and keep it up to date. The larger banks have realized the situation fo r a number o f years, but the smaller or country banks, have not yet com e to a complete realization o f the necessity o f credit records. ^Presented to Conference of Banking and Currency Committee of the National Association of Credit Men, January 20, 1916. 282 CREDIT M E N ’S BULLETIN Prior to the opening o f the Federal Reserve Banks on N ovem ber 16 , 19 14 , I had talked to many country banks throughout the United States and while as a rule they would agree that credit records were a good thing, they seldom seemed to think it was worth while making any effort to establish them in their banks. O f course, every bank that ever made a loan had something in the nature o f a credit department, but, in the m ajority o f cases, it was a nook in the cashier's brain, and it is self-evident that such a de partment was sure at times to have inform ation much too general. W hen the Federal Reserve Board issued the regulation, warn ing all members o f the Federal Reserve System that, in time, it would desire statements from the makers o f all notes offered for rediscount, a great step was made toward having all member banks, at least, establish credit departments. This first circular was issued by the board on November 10 , 19 14 . In its Circular No. 3 , Regula tion B, Series o f 1 9 15 , issued January 25 th, which superseded this circular, the following is contained: “ It is recommended that every member bank maintain a file which shall contain original signed statements o f the financial condition o f borrowers, or true copies thereof, certified by a member bank or by a notary public designating where the original statement is on file. Statements should contain all the information essential to a clear and correct knowledge o f the borrow er’s credit and o f his method o f borrow ing.” In an appendix to this circular is given the information that is desired in credit files o f member banks, as fo llo w s : “ The credit files o f member banks, referred to in the above regulation, should include inform ation concerning the following matters: (a ) The nature o f the business or occupation o f the b o rrow er; (b ) if an individual, information as to his indebtedness and his financial responsibility; ( c ) I f a firm or corporation, a balance sheet showing quick assets, slow assets, permanent or fixed assets, current liabilities and accounts, short-term loans, long-term loans, capital and surplus; (d ) All contingent liabilities, such as indorsements, guaranties, etc.; (e ) Particulars respecting any* mortgage whether there is any lien on current assets; debt and ( f ) Such other information as may be necessary to de termine whether the borrower is entitled to credit in the form o f a short-term loan.’’ This, at least, set up a standard, showing the character o f the information that it was thought wise should be carried on the credit records o f all banks. The first thing the Federal Reserve Banks had to do, when were established, was to open up credit departments, since they CREDIT DEPARTMENT IMPROVEMENTS 283 it was self-evident that they should not accept rediscounts without having credit information, at least concerning their member banks. Every Federal Reserve Bank found that it had two classes o f member banks to deal with— first, the banks in the large cities, all o f which had some kind o f credit departments, and some o f which had highly developed, credit departm ents; and second, the country banks, the m ajority o f which were operating under the old system o f having the entire credit department in the cashier’s brain. The problem before the Federal Reserve Banks then, w a s : first, to establish their own credit departments, knowing that the larger banks could furnish credit inform ation; and, second, to educate the country banks to realize the necessity o f and help them inaugurate the plan o f keep ing credit records. It seems strange that the requirement o f a Statement from customers should have been considered by many o f them as a hardship and caused the cry to go up that there was too much “ red-tape” in the system. H owever, it has not been so long ago that even a borrow er in a large city could be found, who, when asked fo r a statement, would draw himself up and act as if insulted, and this is still the attitude o f those in small centers, who have not been helped to a realization o f the need o f a statement by. their local banks. I might state here that, while the regulations o f the Federal Reserve Board, under certain conditions, waived state ments at the inauguration o f the system, the Federal Reserve Bank o f St. Louis felt that it could not do a higher service to the com munity than that o f requiring statements to accompany all notes offered to it fo r rediscount. It felt that the sooner this was the custom in its district, the easier it would be for the banks and the better fo r the district. The consequence is that we have never accepted a note fo r rediscount that was not accompanied by a state ment in regard to the maker or o f the party, such as an endorser, upon whose credit the local bank granted the loan. W e have tried to have a signed statement o f the maker o f the note, but where this was impossible, upon the theory that the local bank did not grant a loan without knowing something about the borrower, where necessary, have accepted a statement made by the bank on behalf o f the borrow er, giving approximately what he owned and what he owed. It is extremely gratifying to report that, with many banks, the trouble they anticipated in getting statements from farmers and other borrow ers was never realized. In fact, where the bank has asked fo r such statements tactfully, as a rule, they have succeeded in getting them. It is also interesting to find out from experience that the statement has frequently been o f even more benefit to the maker o f the statement than to the bank that required it.' I f there were time, interesting experiences could be told in regard to this. Reduced to their simplest terms, the problems have b een : F irst. T o get the large city banks, which already maintained credit departments, to require their customers, who in the main have very large businesses, to give more satisfactory statements. I think it is fair to say that, in the last year, many commercial houses have been taught to make better and more nearly uniform state ments o f condition than heretofore they have thought necessary. There is http://fraser.stlouisfed.org/ a decided tendency toward requiring an audited statement Federal Reserve Bank of St. Louis 284 CREDIT M EN ’S BULLETIN from commercial houses, and these interests, themselves, are be ginning to see the wisdom o f it. Second. It has been necessary to convince the country banks that general statements o f condition o f customers are dangerous, that from their smaller local business interests a signed statement from the books is necessary, and that it is as necessary fo r the farmer to give a statement as for any other business man in the community to do so. Finally, the Federal Reserve Banks have had to establish credit departments o f the very highest efficiency possible. There are certain essentials which it is necessary to know before a conclusion can be reached as to the credit standing o f anyone. They are as fo llo w s : F irst. It is necessary to know the man, his moral respon sibility, and his business methods. Second. The business, its character and relation to the com munity, whether the capital is sufficient under the circum stances; what proportion is fixed and what proportion circulating or liquid. Does it keep its liabilities well within its assets? Third. W ill the man, firm or corporation, plus that particular business, result in profits and the payment o f obligations? It is the duty o f any credit department to find out these things, not any one o f them, but all o f them. Its duty is to gather the data, analyze and systematize it, so that conclusions can be promptly reached. In order to get these essentials o f credit information, banks must get certain data, and I believe that all the information neces sary can be gathered from the follow ing sources: First. The record o f past experiences with the borrower, whether interest was paid promptly and principal met at maturity, the extensions asked for, etc.; Second. The average monthly balances o f the depositor who is a borrow er; Third. The statement o f condition furnished by the borrower. and; Fourth. The replies to inquiries made through correspondence in regard to the borrower and his business; the result o f personal investigation among the trade; clippings from newspaper, and agency reports. Sources one and two, above mentioned, are within the bank, and a good way to keep a record o f the loans and average monthly balances is by cards. The third source, is a statement o f condition o f the borrower, and the fourth source, is work o f the credit de partment, itself, acting as an investigator. This data should be systematized and kept up to date, so that whenever a loan is pre sented, the second time, it takes but an instant’s reference to the records fo r the bank to come to a conclusion as to whether it is a good loan or not. Statements o f condition that come to a bank are made by the business men o f the community, and when I say business men, I mean to include farmers. F or some reason, the latter have too long been considered in a class by themselves, when, in reality, the operation o f a farm, to make a living, is as much o f a business as CREDIT D E P A R T M E N T IM P R O V E M E N T S 285 the manufacturing o f steel. These statements should not be so long as to be burdensome to the one making them out or to the one who has to analyze them, but it is necessary that they be thorough and give the essential information. They should also be as nearly uniform as is practicable. A great step towards uniform ity o f statements was made by the establishment o f the Federal* Reserve Banks. F or instance, the Federal Reserve Bank o f St. Louis, in order to have uniform statements used throughout its district, has with great care prepared three form s o f statements, which are be lieved to be applicable to all characters o f business arising in this district. Since in agricultural communities particularly, the getting o f statements was in the nature o f pioneer work, our farmer's statement is in as simple a form , and still thorough, as we know how to devise. It contains no such words as “ credit” and “ debit” or “ quick assets” and “ current liabilities,” but simply asks that the farmer put down what he owns and what he owes. Our second form o f statement is for use by merchants, whether in dividuals, corporations, or partnerships. Our other form o f state ment is fo r use by manufacturers, miners, quarriers and other producers. These last two statements are very nearly the same in wording, but the latter statement asks for a little more inform a tion than the former, such as raw material, machinery and fixtures used in the business, and one or two other items. These statements also include the profit and loss account, not in the usual form , but asking fo r the debits and credits in this account, so that the way the profit and loss is arrived at is shown by the figures. In the mer chant’s statement, we also ask fo r merchandise purchased since last statement and merchandise sold. This gives us the “ turn-over” and also serves as a check on the profit and loss statement. I do not mean to say that our statements are the best that can be devised, but, as they are furnished free to all member banks o f the St. Louis district, which in turn distribute them to their cus tomers, we are getting established uniform statements in this district. As the system develops, it would seem that it might be advisable for the twelve Federal Reserve Banks to com e together and agree on uniform statements to be used f o r the different characters o f busi ness. This is a practicable way by which uniform statements can be introduced throughout the United States; fo r non-member banks that wish to keep themselves in safe condition will see the wisdom o f also requiring statements from customers, and I believe will follow the standards suggested by the Federal Reserve Banks. As I have intimated, in my judgment, it is necessary that the Federal Reserve Banks have established what may be called model credit departments. They should be as nearly perfect as possible^ in every detail. These departments have to analyze two types 6t statements— first, the statements o f the makers o f the notes, which’ come through the local bank to the Federal Reserve Bank; and second, the statements o f the member banks, which endorse the paper offered for rediscount. These credit departments have to know tw o things about the offerings— first, is the paper eligible commercial paper under the Federal Reserve A c t; and second, is it safe? B efore the paper can be accepted for rediscount by a Federal Reserve Bank, it must be both eligible and safe. T w o factors are looked fo r in all state 286 CREDIT M E N ’S BULLETIN ments— current liabilities and quick assets, and any statement o f condition to be in satisfactory form , must give sufficient information to allow the credit department to arrive at these tw o items with accuracy. Those who are familiar with credits, know the contro versies that arise in such business as the lumber business, the min ing business, etc., as to what constitute quick assets. I f you do not wish to have the miner count coal in the ground as a quick asset, you must have a line in your statement so worded that he will not include this, or, if he does include it, the statement must be clear to that effect. The statements o f customers, which come into a bank, should, o f course, be standardized on form s which the bank uses, so that a statement o f one year can be compared with the statements o f other years. This standardization will be much easier when the state ments o f customers become more uniform. The Federal Reserve Bank, also, has to analyze and stand ardize, fo r comparison, the reports o f condition that come in from member banks. Federal Reserve Banks receive copies o f reports o f condition as called for by the comptroller o f the currency. Since the method in use by the Federal Reserve Bank o f St. Louis, for analyzing and standardizing the statements o f member banks through one operation, is, as I believe, absolutely new and not in use in any other place in this country, I am going to describe it somewhat in detail. This method I think I can say was invented by T . C. Tupper, vice-chairman and deputy federal reserve agent o f the. Federal Reserve Bank o f St. Louis, who is in charge o f our credits. In order to put it into effect, he uses a Burroughs standard statement machine. The blanks are printed in size 1354 inches long and io y i inches wide. They contain four columns, so that inform a tion gathered from four separate reports o f condition can be in serted. These blanks contain thirty-one items, set out under each other as follow s: q u ic k 1. 2. 3. 4. 5. 6. assets: Cash and Exchange Loans and Discounts Overdrafts United States Bonds Bonds and Securities Total Quick LIABILITIES : 7. 8. 9. 10 . 11. 12 . 13 . 14 . Circulation Due to Banks Individual Deposits, Demand Individual Deposits, Time Rediscounts Bills Payable Bonds Borrowed Margin in Quick s 23. 24 . 25 . 26 . 27 . In In In In In 28 . 29 . 30 . 3 1. Direct Indirect Statutory Bad Debts Other overdue Paper FIXED ASSETS: T 5 . Banking H ouse 16 . Furniture and Fixtures 1 7 . Other Real Estate 18 . Other Assets 19 . . T 20 . Capital 2 1 . Surplus and Profits 22 . Total Capital and Surplus S INVESTED: Banking House Furniture and Fixtures Other Real Estate Bonds and Securities Loans and Disc. T d ir e c t o r s ' l ia b il it y : CREDIT D E P A R T M E N T IM P R O V E M E N T S 287 The first five items under quick assets are listed on the ma chine and the sub-total key pushed down, which prints the total quick assets on the sheet. Then the subtracting key is set and items 7 to 1 3 , inclusive, are printed. This makes the machine deduct the liabilities from quick assets. Then the sub-total key is pushed again, and this gives item 14 , “ Margin in Quick.” Then, under fixed assets, items 15 to 18 , inclusive, are printed and the key fo r totals pushed and the amount printed, thus clearing the machine. This gives the margin in quick plus fixed assets. Then items 20 and 2 1 are printed, giving item 22 , “ Total Capital and Surplus,” which should be the same as the sum o f the margin in quick plus fixed assets as given above. This afifords a machine p ro o f o f the analysis. W hen item 22 , “ Total Capital and Surplus,” is printed, the sub total key is pushed down, the substracting key is set, and then items 23 to 26 , inclusive, are printed. Then the total key is pushed down, and the result gives that proportion o f the capital which is invested in loans and discounts. This last figure is the amount o f paper that the bank has, which even if bad, leaves the bank solvent fo r its debts. This operation also clears the machine. Then items 28 to 3 1 are printed on the machine, no total being taken. On the back o f these statement blanks are lines on which to insert the names o f the officers and directors o f the bank, also columns to showT for four years the comparison o f the follow ing item s: Earnings, after deducting losses and expenses; Dividends paid during year; Net earnings, or surplus after payment dividends. This gives an accurate analysis o f the bank’s condition so stand ardized that it is easy to compare the figures from year to year. The method also saves a great deal o f time, since, as the statements com e in, the head o f the credit department can mark them, fo r in stance, item 1 on the form above mentioned includes 10 to 20 on the report o f condition made out in the com ptroller’s form . This insures that the report to the comptroller is carefully gone over by someone who thoroughly understands credits, and after these re ports are so gone over and marked, they can be turned over to any clerk who can run an adding machine, and the form that w e have adopted be filled out. These, what we may call standardized form s, are kept in a looseleaf binder and from them, at a glance, the con dition o f any member bank can be obtained any instant. I have mentioned this method in detail, because we have used it fo r quite a little time now and have found it thoroughly effective and a great saver o f time. W e believe that by applying the same principles, a similar machine analysis and standardization can be made o f statements o f condition o f all borrowers o f money. A s yet, however, we have not found that statements o f the same b or rowers are com ing before us with sufficient regularity to make it advisable to use this method on them. The National Association o f Credit Men has done most ex cellent work in the way o f getting credit information. Several years ago it issued an argument fo r the requirement o f statements o f 288 CREDIT MEN’S BULLETIN condition from all those who do business on credit and the influence o f the association has had great effect in developing proper credit standards. The Federal Reserve System has already demonstrated that it is effective, and I believe that one o f the greatest results o f its establishment, though perhaps an indirect one, will be seen in the improvement in business methods o f business concerns, manu facturers, farmers, etc., in the community. Its leadership in ask ing for statements o f condition will help all those, who extend credit, to require such statements, and the farmer, firm or corpora tion, that gets in the habit o f at least once a year expressing an actual financial condition in cold figures, will immediately improve business methods. An accurate statement may bring about a change o f policy, which will turn the business from a losing business to a successful one. I f the individual business man or farmer sees in black and white his condition and does not continue guessing at it, as is too often done now, he will commence to stop the small leaks and will make money by saving it. In fact, proper credit departments in member banks and Federal Reserve Banks mean the proper keeping o f accurate records by business interests in general, and this, in turn, means safe business and profitable busi ness, and a great gain for the whole community. Standards The fact that they are honored more in the breach than in the observance does not diminish the value o f standards,— they are there just the same, and men gradually learn to recognize them. Take the standards o f credit practices. Many may smile at the statement o f standards set out as expressing the requirements o f good order in business and credits, yet it is necessary to have these standards to guide when the break comes, and violations, conscious or unconscious, o f the laws o f business and credits, have brought in full force their demoralizing effects. This is why the Association undertook to frame canons o f commercial ethics; not with the expectation that they are going to be conform ed with, or their value and necessity fully recognized, but because a clear statement o f standards is good to have. Year in and year out the successful credit grantor can measure his suc cess in the proportion that he has observed consciously good standards. The Special Committee on Credit Ethics offers the Eighth Canon o f Commercial Ethics. It is thoroughly sound and its ob servance will insure health, clean conscience and good order to those who observe it, “ The stability o f commerce and credits rests upon honora ble methods and practices o f business men in their relations with one another, and it is improper for one creditor to obtain or seek to obtain a preference over other creditors o f equal standing from the estate o f an insolvent debtor, fo r in so doing he takes, or endeavors to take, more than his just proportion o f the estate, and therefore what properly belongs to others.” The seven preceding, articles o f the Canons o f Commercial Ethics can be found on page 34 o f the January, 19 15 , “ Bulletin.”