Southern Branch of the University of California Los Angeles Form L-1 .7' - V'/>=' THE BUSINESS MAN AND HIS BANK mnmiipiigpiiifflg "yke QrawJiillBook (m Ine. PUBLISHERS OF U O O K. S F O FU/ Coal Age "=" Electric Railway Journal Electrical World "^ Engineering News -Record American Machinist vlngenieria Internacional Engineering S Mining Journal ^ Power Chemical 6 Metallurgical Engineering Electrical Merchandising THE BUSINESS MAN AND HIS BANK BY WILLIAM H. KNIFFIN AUTHOR OP THE PRACTICAL WORK OF A BANK; THE SAVINGS BANK AND ITS PRACTICAL, work; COMMERCIAL PAPER AND ANALYSIS OF CREDIT STATEMENTS; AGRICULTURAL CREDIT BANKS OF THE WORLD; BILLS OF EXCHANGE OF THE WORLD, ETC., ETC. VICE-PRESIDENT, BANK OP ROCKVILLE CENTRE, LONG ISLAND, AND INSTRUCTOR IN BANKING PRACTICE, NEW YORK UNIVERSITY. First Edition Second Impression > ) u I a '' ''■', ,"' '-;' '•,' "> ."■/. McGRAW-HILL BOOK COMPANY, Inc. NEW YORK: 370 SEVENTH AVENUE LONDON: 6 & 8 BOUVERIE ST., E. C. 4 1920 Copyright, 1920, by the McGraw-Hill Book Company, Inc. THE MAPLE PRESS YORK PA PREFACE ^9 The man who stands before the counter screen of a bank looks at a piece of comphcated yet smooth working machinery that is to him a deep mystery. He admires but does not understand it. He knows that the receiving teller takes his deposit and the paying teller cashes his check. When he makes a loan he gets the use of the funds, how he does not know. He does not understand the bank processes any more than the average man under- (0 stands the mechanism of his automobile. He knows its f* functions and that is enough. Only when it ceases to ^ work smoothly does he appreciate how delicate is the machine that serves him. y! Heretofore all writers on banking have treated the sub- -» ject from within, for the information of the bank clerk gS and the student of banking. It is the writer's aim to treat the bank from without; to show how it touches the A interests of the business man and get the point of con- A tact from the customer's viewpoint. In discussing the subject of credit, for instance, I have tried to show what the applicant for credit should bring to the bank, rather than what the bank man should require. It is a composite picture of banking as it has impressed itself upon the writer after many years of experience, first in mutual savings banks, then in national banks and lastly in a state bank under the able supervision of New York State. If credit is due any one it is to the publisher for suggesting that such a work would be ac- ceptable to the business man. W. H. K. RocKviLLE Centre, Long Island, July, 1920. t y*^> CONTENTS Page Preface v CHAPTER I The Bank and the Business Man 1 The Old Conception of Banking 2 CHAPTER II Types of Banking Institutions 5 Banks of Discount 5 Trust Companies 6 National and State Banks 7 Savings Banks 9 Building and Loan Associations 14 Mortgage Companies 15 Title Companies 15 Safe Deposit Companies 16 Other Banking Institutions 17 CHAPTER III Choosing Your Bank 19 Banks have Reputations 20 Progressive Banks 21 Your Bank Balance 23 What Is a Satisfactory Balance? 24 Interest on Daily Balances 25 CHAPTER IV The Point of Contact 27 Opening a New Account 28 Corporation Accounts 30 Partnership Accounts 31 Fiduciary Accounts 31 The Pass Book 32 vii viii CONTENTS CHAPTER V Page The Receiving Teller 34 Checks without Indorsement 36 Keep a Record of Checks You Deposit 37 The Transit Number on Checks 38 How to Detect Counterfeit Money 39 Checks to Officers of Corporations 41 CHAPTER VI How TO Indorse a Check 42 Different Forms of Indorsement 43 CHAPTER VII Bank Checks and Their Collection 46 Checks Transfer Rights 46 Importance of Bank Checks 47 Why Bank Checks Should Be Collected 48 How Checks Should Be Drawn 50 CHAPTER VIII Protection op Bank Checks 52 Kiting Checks 54 Forgery 57 CHAPTER IX The Paying Teller 74 The Bank's Obligation to Pay Checks 75 Important Features of Bank Checks 76 The Business Man and the Paying Teller 77 Certification 78 Checks Paid in the Order of Their Presentation 79 Legal Tender 80 Uncollected Funds 82 Stale Checks 82 Memoranda on Checks 83 Checks for Small Sums 84 Stop Payment 84 Reconcihng Your Bank Account 85 CHAPTER X Collecting out of Town Checks 87 Collecting Large Checks 88 Collecting Checks Direct 89 CONTENTS ix CHAPTER XI Page Exchange 92 Creating Reserve Accounts 93 "Par Points" 95 CHAPTER XII Profitable and Unprofitable Accounts 97 The Journey of a Bank Check 101 Direct Routing 102 CHAPTER XIII Collection of Checks Through the Clearing House 105 The Purpose of the Clearing House 106 The Clearing Principle 107 The Clearing Process 108 CHAPTER XIV Overdrafts ..... 113 CHAPTER XV Protest 116 Time of Notice 117 CHAPTER XVI Credit and Banking 119 The Science of Banking 120 Credit and Business 121 Credit Defined 122 "Rights" 123 Forms of Credit 123 Acceptances 126 CHAPTER XVII The Science op Credit 128 Credit is Sensitive 129 The Business Risk 130 Why Men Pail 131 The Property Risk 134 The Bank Account as an Indicator of Credit 135 The Statement 137 Refusal to make a Statement 137 The Statement Should be Complete 139 X CONTENTS CHAPTER XVIII . Page How TO Prepake a Statement 140 Cash 141 Accounts Receivable 141 Merchandise 142 Bills Receivable 143 Fixed Assets 144 Commercial Paper 146 The Fixed Liabilities 149 CHAPTER XIX Bank Loans 150 Recording the Loans 151 Loans and Discounts Distinguished 152 Helpful Rules Regarding Promissory Notes 153 Collateral Loans 154 Making a Collateral Loan 155 Loan Secured by Real Estate 156 Substitutions 157 The Profitableness of Borrowing on Securities 157 Proper Form of Collateral 158 Warehouse Loans 160 Goods Held in Trust 161 Automobile Loans 162 Loans on Accounts Receivable 164 Borrowing on Receivables 165 CHAPTER XX Collections 167 Various Kinds of Collections 168 "Duns" 170 Grain Drafts 172 Parties to a Collection 173 Recall of Notes 174 Bank Statement 175 CHAPTER XXI How TO Read a Bank Statement 177 Bond Investments 179 Banking House 180 Real Estate Owned 181 Land Contracts 181 Mortgages Owned 181 CONTENTS xi Page Loans and Discounts Secured by Bond and Mortgage, Deed or Other Real Estate Collateral 182 Loans and Discounts Hecurotl l)y Other Collateral 182 Loans, Discounts and Bills Purchased, not Secured by Collateral 183 Overdrafts 183 Due from Reserve Agents (or Legal Depositories) 183 Due from Trust Companies, etc 184 Specie and Currency 184 Exchanges and Checks for Next Days Clearings 185 Furniture and Fixtures 185 Accrued Interest 185 Customers Liability on Account of Acceptances 186 Capital Stock 186 Surplus Fund 187 Undivided Profits 187 Deposits 188 Due Banks and Trust Companies 190 Bank's Liabilitj' on Account of Acceptances 190 Bills Payable 190 Reserves for Taxes, etc 191 Interest Accrued to Depositors 192 Unearned Discount 192 CHAPTER XXII Acceptances and Their Uses 193 The Purpose of Bills of Exchange 193 Practical Use of a Bill of Exchange 194 Present Day Financing Methods 196 The Disadvantages of the Open Account 197 The Object of the Acceptance 199 Forms of Acceptances 200 Classes of Acceptances 202 The Operation of a Bank Acceptance in a Foreign Transaction 202 A Domestic Acceptance 205 Principles of the Acceptance 205 Advantages of the Acceptance to the Seller 207 Advantages to the Buyer 209 Advantages to the Banks 209 Acceptances not an Innovation 210 CHAPTER XXIII Savings Banks 213 The Function of the Savings Bank 214 Mortgage Loans 215 xii CONTENTS Page How a Mortgage Loan is Made 216 Valuation of Real Estate 218 Bond Investments 219 Interest Rules 219 The Management of a Savings Bank 220 The Routine of the Savings Bank 222 CHAPTER XXIV Bank Examinations 225 What the Bank Examiner Does 225 The Bank Examiner at Work 226 CHAPTER XXV The Federal Reserve Bank and Its Relation to Business. . 229 Federal Reserve Banks Create Confidence 230 Panics • .232 Defects in the Old System 233 Scattered Reserves 235 Hoarding 236 Government Money 237 Our Inelastic Currency 237 No Rediscount System 239 Essential Features of the Federal Reserve Bank 240 Administrative Control 241 Consolidated Reserves 242 Federal Reserve Rediscount System and Federal Reserve Notes 244 Federal Reserve Bank Notes 247 Collecting Checks Through the Federal Reserve Bank .... 248 Gold Settlement Fund 250 CHAPTER XXVI Foreign Exchange 253 How Foreign Exchange Arises 256 Instruments of Foreign Exchange 258 The Basis of Exchange 261 The Monopoly of the English Banks 262 Forms of Bills 265 The Rise and Fall of Exchange Rates 266 American Banks in the Foreign Exchange Market 269 Goods on Trust Receipt 273 Index ... 275 THE BUSINESS MAN AND HIS BANK CHAPTER I THE BANK AND THE BUSINESS MAN Banking and business are so closely interwoven that each would be quite impossible without the other; certainly each would be unprofitable without the other. The success of business enterprises depends largely upon the cooperation of the banks, and the profitable- ness of the banks depends largely upon the borrowings of business. The relation is reciprocal. The business man who succeeds in the highest sense is the one who appreciates the functions of the bank and uses them to his own profit; and the bank that succeeds is the bank that assumes a helpful attitude toward business, adopts an aggressive policy, has a broad vision, and extends liberal yet sound credit to its clients. There was a time, not so far distant, when the business man approached the banker as a supplicant for favor. When, by the grace of the banker, he opened an account, it was a matter of courtesy, and he was the beneficiary. If he asked for a loan, it was not as a matter of business — a right to which he was entitled — but as an act of con- descension. The element of credit in its broad and prac- tical aspects had not yet come to be a vital part of the bank's operations, nor the granting of loans the result of scientific study and standardized rules. The credit 1 2 THE BUSINESS MAN AND HIS BANK statement was not a factor in the operation of the bank and the condition of the borrower was known onlj' in a general way. The banker knew the man, was familiar with his account and the general character of his busi- ness, but he did not know in figures how^ the borrower stood from the viewpoint of net worth, sales, volume of business, profits and progress. The banker's knowledge was casual; and because of his limited information he paid dearly in losses w^hich would have been avoided under better and more exact methods. The Old Conception of Banking. Until a comparatively few years ago banks did not ad- vertise. They did not solicit business. If they carried their card in the paper, it merely gave their capital and surplus, and the directorate. Some banks have boasted that they have never advertised. Others change copy only as to names and dates. A certain bank cashier in New York resigned his position because his bank began to advertise for business. To him it w^as unethical, dangerous, and a sign of weakness. His idea was that the bank must take what was offered, rather than at- tempt to attract business to itself. The old conception of banking was that the bank must conduct itself with dignity plus a coldness that would impress itself upon the public, just as the iceberg impresses the traveler. The bank must be respected but not loved. It did not want affection, but honor. If the public felt too friendly toward a bank, how could it operate safely? Even yet there are banks that work on the theory that the more business they have the worse off they are, and that the more the customer owes, the more he has to pay, and the heavier his burden. Under the old regime, when a merchant wanted to borrow, he did so at his own bank. To have gone to THE BANK AND THE BUSINESS MAN 3 another bank and negotiated a loan would have been an evidence of weakness, a sure sign of trouble ahead. And the offering of one's paper broadcast, as is now done by commercial paper brokers, would have been financial suicide. Gradually there has come about a change, both on the part of the banker and on the part of the business man. The bank no longer keeps itself in seclusion. It has a new business department that seeks new" accounts constantly and consistently. It advertises extensively. It invites business by offering real and efficient service that redounds to the benefit of both itself and the cus- tomer. The banker now believes in growing. He wants a large bank to handle large propositions. He works on the theory that large debts (deposits) constitute no danger if he has good assets to meet them. From this point of view the more his debts the better he is satisfied. The business man is importuned to borrow, and, if he does not do so he is not a good business man. On the other hand, the business man now understands better the banker's attitude. He knows banking prac- tice better than did his father and knows better how to use the bank in connection with his business. The work of the bank as he sees it through the screen may be a mystery to him, and the machinery vast, complicated and intricate; but he knows how he and the bank func- tion together. He opens an account with the distinct understanding that he will borrow. He may even know how much he will be allowed to borrow before he signs his name to the bank's signature card. He makes an agreement with the bank in regard to the collection of his checks, the average balance of his account, the interest to be allowed him on the balance, and submits his statement as a basis of the business he expects to do. He takes liis business problems to his banker. He 4 THE BUSINESS MAN AND HIS BANK often chums with him, and the two work together for their mutual good. They both have the point of con- tact, and each understands the mind of the other. This has been a slow but steady development, and our present high state of business efficiency is due to this evolutionary process. Twenty-five years ago, the business man desiring to open a checking account would go to the bank of dis- count. If he had a surplus of funds to place on interest, he would go to the savings bank. If he had valuables, he locked them in his safe or hid them away. If he made a will, he named a friend or relative as his executor. If he bought and sold securities, he did so through the city broker. Now, however, he may open a checking account, bor- row money, place surplus funds on interest, store his valuables, buy and sell securities, and have his will administered, without going outside the doors of a modern, many-sided banking institution. A bank is no longer a bank — it is a department store of finance. CHAPTER II TYPES OF BANKING INSTITUTIONS The banks of this country divide themselves into two groups: banks of discount — often called commercial or "business" banks; and savings institutions. The for- mer are the more common and include the trust com- panies. Banks of Discount. The work of the bank of discount may be divided into five departments: 1. The receipt of money and checks on deposit, against which checks may be drawn. 2. The making of loans. These are loans on the general credit of the borrower, with or without an indorser, and secured or collateral loans, made against securities of various kinds. 3. The discount of negotiable instruments, the most common being promissory notes and drafts or bills of exchange. While this feature is similar to the loaning of money, it has a distinction in that the ad- vance is made by ''discounting" or ''buying" the instruments which are owned by the one to whom the loan is made. The most numerous of these are notes taken in payment for goods or services. In order to have immediate use of the funds represented thereby, they are sold to the bank at a discount. Thereupon the bank becomes the owner of the note, collects the amount when due, and looks to the one for whom the discount was made if payment is not made by the maker as stipulated in the note. 4. The collection of drafts, coupons, promissory notes^ and other such instruments 5 6 THE BUSINESS MAN AND HIS BANK « that are left with it by customers. By reason of their wide connections throughout the country, banks are enabled to collect such instruments promptly and with httle expense. They are sent by the bank to its corre- spondents and by the latter presented to the obligor and the proceeds remitted to the collecting bank. It matters not how far from home the collecting point may be, the machinery works smoothly. 5. The issue of money. In the conduct of business it becomes necessary to have a substitute for metallic money, which is costly and cumbersome to handle, and of which there is not suffi- cient to meet the needs of the business world. In order to avoid the use of metal it is necessary to have a form of money that can be handled easily and conveniently. Daniel Webster observed that the power to issue money distinguishes a bank from all other monied institutions. The process by which such money is created will be treated subsequently, but the power to issue money is now reserved to national banks and the Federal Reserve Banks. It is one of the most useful functions of the Federal Reserve Banks, and one which vitally affects the interest of business great and small. In addition to the foregoing, we have what is called "trust powers" or the power to act as trustee in estates and bankruptcies, as executor of wills, guardians of minors, registrars of stocks and bonds, etc. These powers are necessary to the common welfare and prof- itable to the banks and trust companies enjoying them. Such powers were formerly reserved to the trust com- panies, but have recently been granted to national banks, and state banks in some jurisdictions. Trust Companies. There are also to be mentioned in this connection, the trust companies which are in most instances banks under TYPES OF BANKING INSTITUTIONS 7 another name, doing the same business as banks of dis- count, with the exception of issuing bank notes. The trust companies have the added powers heretofore given to them exclusively and mentioned above, but now fast coming to be part of the operation of banks of dis- count. Many trust companies are simon pure banks, doing little or no trust business; there are others though extremely few that have adhered closely to their original functions. When we speak of a bank, we ordinarily refer to the banking function as carried on by both banks and trust companies. The trust function is exercised in so relatively few instances that it does not affect the banking public as do the functions of deposit, discount and note issue. The trust function is, however, becom- ing more largely used as the advantages and conveniences of corporate trusteeship are becoming better understood on the part of the public. National and State Banks. There is no material difference between national and state banks. The former operate under charters issued by the Comptroller of the Currency to whom they are responsible as the supervising head. The latter are under the control of the various states, secure their charters from the state authorities and are subject to the control of a state official usually designated ''Superintendent of Banks." The national banks are subject to the provisions of the National Bank Act, and are therefore uniform in this respect, while the state banks are subject to the bank- ing laws of the various states which differ. In so far as they affect the business man, their differences are unimportant; and their relative safety depends alto- gether upon the personnel of the bank. There is a prevalent opinion that the national banks are in a sense guaranteed by the Government, because 8 THE BUSINESS MAN AND HIS BANK the Government has supervision over them and the word ''national" appears in their title. All national banks, except a few that were taken into the national system and allowed to use their old names with the initials "N. B. A." (National Banking Association) are required to have the word "national" in their title, and by this they may be distinguished from state banks. Many of the largest banks and trust companies in New York and other large cities are state institutions, and to conclude that because they are not under national charter they are by that token weakened, is to come to a conclusion not warranted by the facts. As a matter of fact the examinations of the state authorities and the general oversight given by many of the state banking departments are of equal if not superior quality to the national administration; and herein the author speaks from experience, having been under both regimes. It is no reflection upon a bank to be a state institution nor to be a depositor therein, nor is it any distinction to do business with a national bank. It is the quality of the bank and not its name that distinguishes it as an institution. National banks are required to join the Federal Re- serve System, while state banks and trust companies may do so upon the same general terms. National banks may issue bank notes, but this is no longer a mark of honor, since the Federal Reserve Banks wiU ultimately take over the note issue power and exercise it exclusively. The reserves required for state banks are sometimes less than for national banks, but this does not affect the business man and is a matter of technique only. The ratio of loans for state banks differs in some states from that allowed national banks, and this may be a factor to consider; but this can only be determined by com- TYPES OF BANKING INSTITUTIONS 9 paring the loaning restrictions of national banks with state banks in the same jurisdiction. Other than these nonessential variations, there is no material difference between the two types of banks; and the same truths obtain as respects trust companies, which are merely state banks with added powers. In fact the work of a trust company is so much akin to the work of a bank, as a bank is commonly understood, that they may well be considered as banks, in every aspect, except their trust powers. Savings Banks. We have next to consider the savings banks, particu- larly the mutual savings banks, which are in the great minority as compared with about thirty thousand banks of discount. There are only about seven hundred such institutions in this country. Savings banks are in the nature of mutual investment institutions helping the man of small means to save, and giving him a fair return upon his savings; in short, they invest his money for him. The distinction between business banks and savings banks may be seen in several ways: First in the nature of the corporation. The business bank is organized by stockholders who combine their capital for the purpose of establishing a bank. When a bank is organized, or promoted, those who are back of the movement sohcit subscriptions to the capital stock, the same as in any other form of corporation. The investor "subscribes" to the capital stock, which means that he agrees to buy a certain number of shares at a fixed price per share. He thus becomes a stockholder, and part owner of the bank. It is the stockholder's capital that forms the first working fund of the bank. The stock is usually sold at a premium, that is, let us say $125 a share. The 10 THE BUSINESS MAN AND HIS BANK par of the stock must be $100, and the $25 would ordi- narily be applied in the proportion of $20 to the surplus or guaranty fund, and $5 to the expense fund, from which the furniture and fixtures, safes, and equipment will be bought. The stockholders are the owners of the bank. They elect the board of directors "and the board of directors elect or appoint the officers. All the profits of the bank belong to the stockholders. If losses occur they are the ones to suffer. It is the general rule of law that the stockholder is liable to an amount double the par value of his stock. Thus if the bank should fail the stockholder owning one share of stock would be subject to an assessment of $100 or a propor- tionate amount to make good the losses, besides having his stock cancelled. In the savings bank, such as we have in New York, New Jersey, Pennsylvania, and the New England States, there are no stockholders. When a bank is planned (there have been less than fifty such banks organized during the past 35 years in the United States) the organizers have no stock to sell. What they must secure is not stock subscriptions for the proposed amount of capital, but a certain number of men who will agree to contribute the necessary expenses during the period the bank is unable to maintain itself. They must pay the salaries and running expense until the bank can earn sufficient to meet its own expenses. In New York they must subscribe to an expense fund of not less than $5000 and a guaranty fund of the same amount," as evi- dence that the bank will be carried until it becomes self supporting. When the bank earns a surplus above its expenses and interest to depositors, these advances may be returned with interest. In some cases in New York it has taken years to bring the bank to a position where it could repay these advances. The men so TYPES OF BANKING INSTITUTIONS 11 selected become the "trustees" as distinguished from the ''directors" of other banks. In case of vacancy in the board of the savings bank, the office is filled by vote of the board, and the trustee serves for life, unless removed by operation of the law. There is no annual election of directors as in the case of banks of discount, and there is no way by which one desiring a seat on the board of a savings bank can obtain the coveted position except as he is selected for the honor. The power of money does not, therefore, count as an asset in such a matter unless it be that as a man of wealth he is desirable for his standing in the community. In the event that the savings bank should fail, as few have done, the trustees cannot be held hable unless they have grossly transgressed the law. Their sole duty is to operate the bank for the benefit of the deposi- tors, to make no investment not sanctioned by the law, and to use due care — the same degree that a prudent, conservative business man would use in his owai affairs. Doing this they cannot be held for any loss that may attend the operation of the bank. The second noticeable difference between the two kinds of banks fies in the manner of investing the funds. In the bank of discount, placing the loans and invest- ments is within the discretion of the board. They may lend to whomsoever they please, restricted only as to the amount which must be proportionate to the capi- tal and surplus. They may buy the bonds of the United States, foreign governments, cities, states, counties, railroad companies, pubfic service companies, and in- dustrial concerns. In fact the only general restriction is that they shall not loan upon or buy their own stock, and in national banks, cannot invest in the stock of corporations. Their field is as broad as the world. National banks, until the enactment of the Federal 12 THE BUSINESS MAN AND HIS BANK Reserve Act, could not loan on real estate, but banks in country districts may now make such loans. State banks, however, usually have the right to make mort- gage loans. This is not to say that mortgage loans are not good, for as a matter of fact, it is doubtful if any form of in- vestment can show as clean a record as loans on real es- tate security. They take front rank for safety; but at the same time are considered better adapted to such institutions as savings banks and insurance companies, whose investments are presumed to be long time. The nature of their business is such that they can safely place their money in long time securities; for the deposits of savings banks and the premiums and reserves of life insurance companies are invested moneys, and placed with them for long periods. On the other hand, the deposits of banks of discount are in the main subject to demand, and fluctuate more than do the deposits of other institutions. Being subject to demand the invest- ments that follow deposits of this character should be of short duration and kept in a liquid form. Moreover to realize upon a mortgage loan is a lengthy process, attended by certain legal rules that must be followed; and if payment is forced it is costly and slow. Savings banks have always been regarded as invest- ment rather than lending institutions. They do not as a rule lend on collateral as freely as banks of discount and in some states they may only loan upon such secur- ities as they are allowed to buy. In some states the law closely restricts the character of bonds legal for savings bank investment, and as a general proposition the law in all states prescribes the general form of investment for such institutions, while leaving the banks of discount free agents in this respect. In all states savings banks may invest in the bonds of TYPES OF BANKING INSTITUTIONS 13 the United States, the various states, cities, towns, coun- ties and school districts, commonly called ''municipal bonds." Railroad bonds are everywhere permitted as an investment, but in some juridsictions the law is more rigid in its requirements in this respect than in others. Bonds of street railway, gas, electric and power compan- ies, ''public utility bonds," are also legal in many states and only a perusal of the various laws will make these points clear. The point of distinction that here obtains is the fact that savings banks are regulated in their investments while banks of discount are not. All that a savings bank man has to do is to follow the law, while the manager of a bank of discount must use his discretion and his judgment. Which process develops the higher type of banker can easily be judged. We have a third distinction in the contract between the bank and the depositor. In the bank of discount the contract is that the bank will pay the checks of the depositor properly signed by him, in the amount, and to the party named, on or after the date of the check. The relation is that of debtor and creditor. In the case of the savings bank the agreement is to return the funds upon the written order of the depositor, or to his attorney, on production of the pass book. This pass book contains the rules under which the deposit is received and is the contract between the parties, while in the bank of discount the pass book is merely a memo- randum of the deposits. It is not a contract. In accept- , ing the book the depositor agrees to be bound by the by-laws; to notify the bank if the book is lost, and to claim no deposit without producing the book. The bank contracts to use due care in making payment, but nothing more. It is not obhged to make absolute identification, as is the bank of discount. If the one presenting the pass book writes a signature that will 14 THE BUSINESS MAN AND HIS BANK pass scrutiny, answers the questions as to age, birthday, where born, father and mother's name, etc., the savings bank is held harmless if it pays to the wrong party. The savings bank also agrees to invest the funds legally, and after paying expenses and setting aside a reserve for the protection of the depositors, to distrib- ute the excess as interest to the various depositors as they shall become entitled to it according to the rules of the bank. It is a trust relationship. Building and Loan Associations. Building and loan associations are found in all parts of the country, and are especially numerous in Penn- sylvania and Ohio. They are in the nature of savings banks, being mutual investment institutions, the in- vestment of the members being in first mortgages on the property of the members. Their scheme of operation is in the nature of a compulsory savings bank. The members subscribe to a certain number of shares of stock and agree to pay for the.m by monthly deposits. Fines are imposed for failure to pay as agreed. The funds so accumulated are loaned to the borrowing members and the profits are distributed to all members. If a member, for instance, wishes to build a home, and has saved enough to purchase the land, the association will loan him the amount necessary to build. He then subscribes to a sufficient number of shares to repay the loan, and pays a stated amount each month until the amount deposited plus the dividend accumula- tions equal the amount loaned, when the loan is auto- matically cancelled. The ratio loaned is often as high as 75 per cent, of the value of the property. The proc- ess would be the same if the incUvidual were to agree with a savings bank to deposit a certain amount monthly until the amount the bank had loaned him on his property TYPES OF BANKING INSTITUTIONS 15 was repaid. It is a form of compulsory saving that has been most beneficial to the members. The divi- dends have been large and the associations as a rule well managed and highly regarded in banking circles. The money deposited by non-borrowing members may be withdrawn by giving proper notice. Mortgage Companies. Mortgage companies are institutions that lend on real estate security and sell their mortgages to investors, with a guaranty of payment. They make mortgage loans in the same manner as savings banks and collect the interest, see that taxes are paid, insurance in force, and remit the interest when due to the owner of the mortgage. For their guaranty of payment and as compensation for their services they deduct one-half of 1 per cent, from the interest. Thus a 6 per cent, mortgage would net the investor 53>^^. Title Companies. Title companies may be operated in connection with mortgage companies, or the two may be closely affiliated, the one handUng the title in its legal aspects and the other the making and selling of the mortgages. The title company will however insure the title to any prop- erty, irrespective of whether it makes a loan on it or not. It certifies to the quahty of the title, and agrees to indemnify the owner if any defect is subsequently found either by curing the defect or by making reim- bursement. In purchasing real estate it is highly essential that the title be in the seller, else the buyer's title will not be good, and he will buy nothing but a lawsuit. Likewise, in making a loan secured by real estate, it is necessary that the mortgagor be in position to make a valid mort- 16 THE BUSINESS MAN AND HIS BANK gage. On the principle that you cannot pledge what you do not own, it becomes necessary to ascertain that the pledgor be in possession of the thing he pledges. Therefore in all real estate transactions, the title is the paramount question. On the day this paragraph w^as written there was rendered a judgment that clouds the title to all the property in a city block, and the defect dates back to 1848. Such defects never become out- law'cd, and it wdll no doubt cost the property owners a goodly sum to free their property of this lien. Whether the lender is a private individual or an insti- tution, the title should be safeguarded with all care, and the best safeguard is a title policy, which certifies to the fact that the title has been examined and the chain is complete, with no liens other than as stated, and the company guarantees to cure any defect that may sub- sequently arise. This work is often performed by lawyers, but as a rule they only state an opinion and do not guarantee to defend any claim that may be set up that affects the validity of the title. The guaranty of titles is a prerogative of title com- panies and they may be found in all large cities. Safe Deposit Companies. Safe deposit companies are operated in conjunction with banks and trust companies, or they may be inde- pendent concerns. Frequently safe deposit vaults are part of a bank's equipment and incidental to its other business. This form of banking is profitable, inasmuch as the operating costs are low^ After the vaults are installed it merely requires the services of a few^ atten- dants, who keep the records and allow box renters to enter their boxes. The one danger is not of safe breakers, for the vaults are usually burglar proof, but unauthor- TYPES OF BANKING INSTITUTIONS 17 ized entry into a box, which is a serious matter. The renters of boxes or their duly appointed representatives are the only ones entitled to open the box; and where boxes contain millions the risk is obvious. Other Banking Institutions. We have also private banking firms, which do a bank- ing business similar to a bank of discount, and private banks which are licensed and operate under the super- vision of the banking departments of the various states. These do a regular banking business and being privately owned are more or less free lances in their operations. There are also the great bond houses which buy and sell securities, and often have a banking department con- nected with their bond operations; and lastly the stock brokerage concerns which are dealers in stocks and bonds, but do not do a banking business. The tendency of the times is first to give all banks equal powers, so that no one class shall have an advan- tage over another. This is manifest by the giving of trust powers to national banks and state banks, thus putting them on a par with the trust companies; and secondly to make banking in the nature of department store operations, so that the customer will be able to deal with one concern in many ways. This tendency is shown by the fact that many banks are now combina- tions of banks of discount, savings banks, trust compa- nies, bond houses and safe deposit companies. In the banking department are handled the usual deposits and checks, loans, and discounts that pertain to business banking. In the savings department are handled the savings accounts, or interest bearing accounts. In the trust department, wills may be drawn, estates managed, and bonds and stocks transferred as fiscal or transfer agent. In the bond department, securities are bought 18 THE BUSINESS MAN AND HIS BANK and sold and mortgages placed; and in the safe de- posit department boxes are rented and valuables stored. Therefore the modern bank can do for an individual all that he needs done, Uke the department store, and it can serve him alive or dead. CHAPTER III CHOOSING YOUR BANK In choosing the bank with which you are to do busi- ness, several things should be considered. First comes the safety of the bank. You want the funds you leave on deposit to be safely kept, wisely invested and returned to you on demand. You want to know, therefore, something of the soundness of the institution and the character of the management. These features can in a large degree, be determined by an analysis of the bank's statement along the hues laid down in chapter 21, and need not be dwelt upon here. Where it is a choice between a large and a small bank, select the larger, for the reason that in lending, banks are restricted to a percentage of their capital and sur- plus, and unless the bank has a large capital and surplus it may not be able to grant a line of credit commensurate with your needs. You also obtain the distinction of dealing with a large and well known institution, rather than a small and it may be a struggling one. There is a certain prestige that follows an account with a large bank. It puts you in a good crowd, and the mere fact that a well known bank has your account helps your credit. In an examination of the bank's position, note par- ticularly the capital, surplus and undivided profits. Inasmuch as the loan limit is usually ten per cent, of the total of the three items, your direct borrowing capacity will be indicated thereby. The surplus and profits reflect the character of the bank as evidenced by earn- ings — the final test of good management. 19 20 THE BUSINESS MAN AND HIS BANK Another point having to do with the choosing of a bank is its personnel. A perusal of the directorate will give you a fair idea of the management. If the men are men of business, standing well in the community, proven successes in their respective callings, it follows that the bank will be conducted along progressive lines. But if the men are of uncertain worth, doubtful character, unprogressive, unpopular and of negative personality, the bank will quite likely take on the same character. The best test in this respect is the character of the administrative officers. If they carry an air of men who know, who can express themselves clearly, talk intelhgently, make decisions, have opinions, draw con- clusions, and "act the part," the bank will surely be a reflection of the men. If they lack the qualities that distinguish men of affairs and education, the bank will no doubt be patterned after them. How true these facts are, will be seen by applying the above suggestions to concrete cases. Banks have Reputations. Banks hke individuals have reputations. If the bank is known as easy going, slip shod in its methods, careless about little things, easy to borrow from, un- kempt in the office, indifferent about the appearance of the stationery, the conduct of the clerks, the service at the window^s, it cannot claim to be a well managed bank, however profitable it may be. Banking involves a mass of detail, each detail of importance, and unless the bank is careful in the little things, it cannot com- mand the respect and confidence that efficiency pro- duces. You can often judge a bank by the appearance of the cashier's desk, and you can often judge the bank by the cashier himself. He is frequently the master mind. CHOOSING \OUR BANK 21 Here is where you may apply your business psychol- ogy. Your judgment of men, your first impressions, the cordiality of your reception when you open your account, will indicate the character of the bank as it reveals itself to the new customer. You want your bank to be progressive, as you aim to be. You want it to be modern, alert, quick to see an opportunity and to use it. You want it to get away from tradition and move with the times. You want modern business sense appUed to your proposition. You want the banker to have a broad vision, to see things in their true hght, and to help you as you expect to help him. His very attitude may retard your busi- ness development; on the other hand it may help you greatly. Progressive Banks. You want a safely-conservative — progressive bank; a real bank, that endeavors to meet the customer half way and that works for the benefit of both. You do not want, as your banker, a business man who tries to run the bank the same as he runs or ran his business, and who judges every banking proposition by the rules he has established in personal affairs. One of this type was approached for an advertisement and replied: "I do not believe in advertising. I never spent a cent for advertising in my life, and look at me!"- — ^A nar- row minded man, running an unprogressive bank! Nor do you want your proposition viewed, as an automobile dealer had his proposition viewed, by another would- be bank president. The dealer handled a well known make of car and sold all the cars he could secure. He was of good repute, successful, of moderate means, but needed bank credit to handle his growing business. He suggested to the president of his bank that the 22 THE BUSINESS MAN AND HIS BANK bank advance 80 per cent, of the factory cost of the car, and he would advance the other 20 per cent, and the freight, leaving a margin of safety of over 40 per cent, of the selUng price. He would give the bank a trust receipt whereby the title of the cars would be in the bank. He would keep them covered by insurance, hold them in storage, and sell only upon the release of the bank. Without the said release he could not give good title and the bank could claim any car wherever it might be, in case he failed to secure proper release, or pay the loan upon completion of the sale. It was a perfectly safe and business-hke proposition. *'We do not run an automobile business," said the banker, ''we run a bank. You can't do business with us on any such basis as that." The dealer went to another bank, got all the credit he could use on the above terms, kept a five thousand dollar balance, and bought and sold hundreds of cars without a single miscarriage. It re- required a banking mind to see the point of contact, and the would-be banker lacked that essential thing. You do not want to deal with a bank that charges a quarter to change a hundred dollar bill, nor one that refuses to answer an inquiry if postage is not enclosed; nor one that charges the customer for every telephone call connected with his account. The mental processes of such bank managers are too small to merit your patronage. You want to deal with a bank that is big and broad minded, whole hearted, quick to grasp a problem and alert to serve its people. Good will is a creature of slow growth, easily created if the service, the quality and the spirit are there. It is invaluable once it is established; but it is easily lost through neg- lect and inefficiency. The banker who does not realize how important an asset good will is has much to learn about the art of running a bank; and no matter how CHOOSING YOUR BANK 23 good his other assets may be they need the support of the good will asset to make the bank a really great institution. You have a right to expect that the bank will take a reasonable risk with you — the banker's risk against your business risk. You cannot fortify every loan by collateral and the bank has no right to expect it. You need your capital in your business, and you want your ability, your integrity, and your net worth to be con- sidered. And the banker who does not understand the rules of credit well enough to apply them to a going business is a good one to leave alone. Your Bank Balance. In dealing with a bank it must be remembered that banking is expensive business. The operating costs are high. Banking brains are costly and you do not want to deal with a bank that is not well managed. Clerk hire is a large item in the year's budget and the labor cost is constantly increasing. The men expect to be properly compensated and the times demand it. A satisfied man is safer than an insured one. Stationery is a heavy item also, for the books of record are expensive and the gratuitous stationery cost is large. A pocket check book now costs about 13 cents, a pass book from seven to fifteen cents, depending upon the binding, and a check book with the customer's name on the end, numbered, costs about $3. All this is furnished free to the customers. Add to this the taxes of various kinds, income tax, real estate tax, tax on bank stock, profits tax, etc., and the interest paid to depositors, and you will readily see that banking is not all profit. The running expenses are considered moderate if they equal one and a half per cent, of the deposits. A bank earning a hundred thousand a year gross, will have 24 THE BUSINESS MAN AND HIS BANK expenses of about $30,000, pay as much in interest and should have an earning power of about 25 per cent, net on a capital of $100,000, out of which to pay dividends, meet losses, and build up surplus. If, therefore, the bank is to make money, it must have a line of desirable balances as a working fund, from which to produce its profits. You can help make your bank a successful institution by maintaining as large a bal- ance as your business will warrant. If the bank pays you interest, it has a distinct reason why the balances should be ample; and if it does not, the cost of opera- tion, the conveniences it affords, and the service it renders, should be duly considered and a balance main- tained accordingly. Nothing will make you a desirable patron so much as a satisfactory balance; and nothing will help you in the field of business more than a large cash reserve. You and the bank both benefit from a reciprocally profitable account. What is a Satisfactory Balance? To state in exact terms what is a satisfactory balance would be akin to describing what is a satisfactory sale of merchandise. AU the banker asks is a balance upon which he can make a profit, however small. And so many elements enter into the determination of the profit, that only by close analysis can the desirability of any account be ascertained. There is the cost of stationery, as above mentioned, the labor cost, the expense of collecting the checks, and the overhead, as the charges against the account, and the earning power of the money on deposit as a credit. If the balance is sufficient to earn the cost of handling the account, plus a small profit, the banker is satisfied. As a general rule, an account against which a limited number of checks are drawn, say one hundred a year, CHOOSING YOUR BANK 25 and which shows an average balance of $500 would, in most banks, be considered satisfactory, provided no interest was paid on the balances. If it were an active account, w ith daily deposits and a large number of checks such as the average store would require in paying its bills, a $1000 balance would be sufficient. But if the account is a "borrowing account" — that is to say, the firm borrows on its own name and discounts its receiv- ables, a balance of one dollar to four of borrowed money would be quite sufficient. If any hard and fast rule were to be laid down, it would be the latter for borrow- ing accounts, leaving the adjustment of the non-borrow- ing account balances to the judgment of the particular bank. It would be easier to state what is not a satis- factory account, and that is the one that has little or no balance and deposits are checked out as fast, if not faster, than funds are deposited. A great many bank depositors look upon the bank as a philanthropic insti- tution, operated for the accommodation of the public, and conclude that if they cover their checks so that overdrafts are avoided, they have done all that the occasion demands, forgetting the fact that there are certain costs attached to every account large or small, that the bank desires to cover from the earning power of the balance. In this respect every bank is a law unto itself, and only by consulting the bank officials and getting their views, can the depositor accede to the wishes of the banker and so treat his account that there shall be no question as to its desirability. Interest on Daily Balances. The custom of paying interest on daily balances is of comparatively recent origin, and has grown as the competition for new business has become more keen. It started in the large city banks and has spread to all 26 THE BUSINESS MAN AND HIS BANK parts of the country. In substance it means that the bank pays interest on the actual money on deposit for every day it remains in the bank. The computation is usually made monthly, so that the interest compounds twelve times a year. In many banks there is a rule that there shall be a certain free balance, or, to put it dif- ferently, the bank will pay interest on all but a certain amount, as $500. The figuring of this interest is simple. The bank takes the balances for each day, includ- ing Sundays and holidays, adds them together, multi- plies by the interest rate and divides the amount by 365; or, simply find the interest on the total amount at the given rate for one day. These computations are generally made during the last two or three days of the month, so as to keep the first of the month free for other pressing matters. Therefore the interest is computed from, say the 27th of the preceding month to the 27th of the current month, and credited on the first. CHAPTER IV THE POINT OF CONTACT Preceding the time when you walk into "your bank" and open account, certain influences have been at work which have, consciously or unconsciously, directed you there. The bank may have been a progressive adver- tiser, and its publicity has associated banking in your mind with that particular bank, so that when you thought of a bank you thought of that bank; if so, it is to be commended. It may have given such service and proven so helpful to another depositor that the element of good will enters the transaction and a mutual friend has brought you and the bank together. If so, it again is to be commended. You have been, it may be, a casual visitor, and have liked the atmosphere of the bank. It may be finely housed and this has im- pressed you. You may have simply been looking for a bank and drifted in. Whatever the influence that has resulted in your appearance at the new account desk, the point of contact is established when you write your name on the signature card and receive your pass book for your first deposit. It is now your bank in fact. The work of opening accounts may seem merely a clerical task and such it is; but behind the simple act of issuing a pass book and check book, there lies the personal element. The banker is taking your measure. He, like yourself, is getting a first impression. He is more concerned that you shall be a desirable customer than he is about the size of your first deposit. 27 28 THE BUSINESS MAN AND HIS BANK These impressions are most important, for they con- nect you with the bank and the bank with you. If the reception is chilly, indifferent, and to all appearances the account is accepted but not welcomed, the banker has not gotten away from the old time idea of banking, and the quicker you find a more satisfactory connection the better. You have a right to assume that you are doing the bank a favor, for have you not, out of a large number of banks, selected this one as ''your" bank, to entrust it with your business secrets, to ''lay your cards on the table" and show the banker who and what you are? If at this time he asks questions, be honest and tell him all. He is not inquisitive, but simply wants to know, for only as he knows your business condition, your methods, your markets, your profits, can he in- telligently handle yom- business. You will have the right to refer to your bank as to your credit standing. The bank may be asked to report your condition to Duns and Bradstreet without your knowledge. It can only do you justice by knowing certain things about you. If you make a statement as a preliminary to borrowing, make it an honest one. When you interview the bank man, take all the time you need, but no more. Interviewing is part of his job. Make your message brief and to the point. You will easily know when he is through with you, and that is the time to quit. Opening a New Account. As a rule banks require proper introduction as a pre- cautionary measure, before opening new" accounts. At this time the rules of the bank, if any, as to minimum balances, payment of interest, etc. will be explained. In the case of corporations, partnerships and estates, proper THE POINT OF CONTACT 29 authorization for opening the account and drawing checks will be required. Fortify yourself in advance. Usually two or three signature cards are required, so that the signature may be passed upon in various departments, such as the teller's, the bookkeeping and the credit department. When the signature card is signed and authorization, if any, is in proper form, the pass book will be made out and check book furnished. Ordinary check books are furnished free by all banks, and many will print your name on the stub free, but the latter requires about two week's time. When you have made your first deposit, the bank becomes your debtor. It owes you the amount repre- sented by your credit. You have the right to ch-aw as many checks as you like, in sums large or small, and the bank is bound to honor them. But do not expect it to honor overdrafts, for that is neither good banking nor good business, and it hurts your standing in the bank and out. Do not expect the bank to call you on the wire and tell you your account is short. Keep your check book carefully figured so that you will know how your balance stands at all times, and do not blame the bank for the mistakes you yourself make. Inasmuch as the great bulk of bank transactions are by check, new accounts are opened with cash only as the exception to the rule. Where cash is deposited, the account may immediately be drawn upon and the bank assumes no risk in paying. But where a check is offered as the initial deposit, there is an attending danger that all well managed banks guard against. The check may be irregular, payment may have been stopped, it may be a forgery, or the account short; therefore the bank holds back the checking privilege until the check can be collected, unless the depositor is well introduced, so that the personal equation offsets the banking risk. 30 THE BUSINESS MAN AND HIS BANK The banking fraternity has been swindled so many times through check deposits that to cite the reasons why a bank will not allow checks to be drawn against uncollected funds, or by those they do not know, would be to recite the criminal side of banking, and catalogue the losses that have come to the banks through check operations. Corporation Accounts. In dealing with corporations and partnerships ex- treme care must be used to comply with law and good banking custom. In the case of corporations there must be a resolution by the board of directors authoriz- ing the opening of the account and the conditions under which checks may be drawn. It is a principle of law that a corporation can act only through its officers. A resolution that ^vill cover the ground in such a case is as follows : Offered by Mr. X. "Resolved that the treasurer be authorized to open account in the Blank National Bank in the name of this company, and that the said bank be and is hereby authorized to honor checks drawn against funds so deposited signed by the treasurer and countersigned by the president, until this power is rescinded or altered" A copy of the resolution should be lodged with the bank and certified to by the secretary under seal. The officers authorized to sign will, of. course, sign the bank's signature cards. In many cases the finances of the company are regu- lated by the by-laws and when such is the case the bank will require a certified copy of the by-laws and a resolution by the board of directors that is in keeping with them. This is the bank's warrant for dealing with THE POINT OF CONTACT 31 the corporation according to established terms, and they will adhere strictly to the authorization. Partnership Accounts. In the case of partnerships, the bank will require a copy of the partnership agreement, so that it may be protected in dealing with the firm. The general rule of partnership is that any partner has the power to act for the partnership in all matters affecting the firm, and to bind all members. He may buy and sell goods, sign checks, endorse checks, sign promissory notes, enter into contracts for the firm, and in all part- nership dealings bind it by his acts. But these rules may be altered by the partnership agreement. It may be provided that both partners must sign checks, whereas ordinarily either member may sign the firm name and bind the partnership by his signature. The bank will want to know what the agreement between the partners is, and will ask that the checks be signed in accordance with such agreement. Fiduciary Accounts. In opening accounts with executors, administrators, trustees, a court order or copy of the letters of adminis- tration or letters testamentary will be required. In many cases the account with a fiduciary requires the countersignature of the surety company that furnished the bond, and inasmuch as the instructions to the bank are not to pay without its indorsement, this wiU be insisted upon. As a matter of fact the bank runs its largest risk in dealing with corporations, partnerships, estates, guardians, etc., and quite properly seeks to protect itself from attack because of irregularities possible through a misapplication of such funds. 32 THE BUSINESS MAN AND HIS BANK The proper way to sign checks on corporation accounts, is as follows: "The A. B. C. Co., by A. B. X. Treas." For estates etc, In agency account: "The Estate of John Smith Adam Smith, Executor." "John Smith, by PhiUp Smith, Agent." The signing of one's name with the suffix, "agent," ''administrator," ''treasurer," etc. merely indicates that the person is acting in a representative capacity and does not bind the principal, but the one signing. In all such relationships, the principal should be indicated with exactness, so that the act may bind him and not the signer. The Pass Book The pass book of a bank is a receipt for the money and checks deposited. It is not an absolute receipt, but is in the nature of an acknowledgement of having received the amounts called for on the deposit slip, subject to final payment. In crediting the amount the bank says in substance: "We acknow^ledge having received the amount herein stated. The receipt of the cash is absolute and may be drawn upon immediately; like\vise the amount represented by checks drawn on this bank." The reason for the latter statement is that the bank has the opportunity at hand of verifying the' checks, the signature, the date, filling, amount on deposit, and other such details. The acceptance on deposit is equivalent to cashing and the credit cannot be rescinded. But as for checks drawn on other banks the receiving bank has no such opportunity, and says, "we credit conditional upon final payment by the drawee THE POINT OF CONTACT 33 bank." If the check is not paid upon presentation, it re- serves the right to charge the amount back to the cus- tomer, and this it will do. This right to charge back is based upon the warranty of the indorser, by which warranty he agrees that if the instrument is not paid upon presentation, he will make reimbursement to the one to whom he gave the check. This liability is covered in the Negotiable Instruments Law, the uniform law as respects checks, notes and bills of exchange in forty-nine states and terri- tories within the United States. CHAPTER V THE RECEIVING TELLER The individual with whom the banking public comes into most frequent contact is the receiving teller. He is the great hopper into which the banking grist is poured. He is the receiving reservoir for the whole bank. His interests and the depositor's are closely allied and by working in harmony with him and fulfilling his wishes in respect to the details of the deposits both will be helped. He has a uniform way of doing things, devel- oped from time to time, and the nearer you comply with these practices the more expeditiously will your trans- action be handled. You can make the day's work smooth and accurate and quitting time early, or you can throw confusion into the whole banking structure. The following rules are simple and easily followed: 1. Always take your book in making deposits. If you do not, in making the entry subsequently, the de- posit ticket must be obtained to verify the deposit. Banks have many accounts of similar names and credits are often made to the wTong account, and this leads to trouble and sometimes loss. For your own protection, make out a duplicate ticket when the book is not pre- sented and the teller will stamp it. Place it in your book and the entry will be made when the next deposit is presented at the window. 2. Keep your name plainly printed on the cover. Many books are used a long time and the name becomes obliterated. Needless work and annoyance is caused 34 THE RECEIVING TELLER 35 the clerks in handling such books and a little care in this respect will greatly help the force. 3. Always be sure that you have your ticket made out as you want the deposit credited. Particularly is this true if you have two accounts, one individual, the other as "trustee," ''agent," "executor," "special," etc. The suffix is a most important element in such cases, and be sure to make it prominent. The posting will be made from the ticket and not from the entry in your book or your intentions. Therefore get your ticket right. A certain firm had a firm account and the part- ners had individual accounts in the same bank. One of the members gave his wife a check and told her to deposit it in the bank. She did so — to his account. The firm account became overdrawn, checks were returned and, greatly exasperated, the depositor threatened to make trouble for dishonoring his checks. When the deposit ticket was shown him he changed his mind. In another bank there were two accounts, one "Fred S. Smith, " and the other "Franklin S. Smith." The possi- bility of confusion is apparent if either were to use simply his initials. Therefore use care in making your ticket. 4. Arrange the deposit in the same order as the ticket calls for, bills right side up, lying one way, denomina- tions together; checks in the order of their listing, properly indorsed, silver and gold in an envelope. 5. Make the ticket plain. Omit all dollar signs, place the figures underneath one another so that additions may easily be made. The deposit ticket is an important document, inas- much as it is the original entry — the first evidence of what you offered for deposit. In case of dispute this will be offered in evidence. These records are seldom if ever destroyed. The ticket is your safeguard as well as the bank's. Treat it as a valuable document. 36 THE BUSINESS MAN AND HIS BANK 6. Silver if in quantity should be wrapped as follows; Half dollars in rolls of $10 Quarter dollars in rolls of $10 Dimes in rolls of $5 Nickels in rolls of $2 Pennies 25 or 50 cents as the bank may elect. If bills in quantities are deposited, strap as follows: 50 I's $ 50 50 2's $ 100 50 5's $ 250 50 lO's $ 500 50 20's $1000 The bank will furnish the proper wrappers for both coin and bills. 7. Coupons that are presented for collection must be accompanied by the proper blanks that certify as to the income tax features of the coupon, and whether or not the owner claims exemption. All banks are pro- vided with these blanks and will furnish them upon request. This provision does not apply to Liberty Bond Coupons which are, if due, treated as cash. Checks without Indorsement. Banks will receive for deposit checks that are drawn to the order of a depositor and without his indorsement. WTiile the risk is slight, banks do not favor this irregular practice, although it is sometimes a great convenience. For instance, the owner of real estate moves out of town and instructs the tenant to deposit the monthly rents to his account. The tenant may draw the monthly check to the order of the depositor and indorse it "For deposit to the credit of ," and the bank may safely accept the same. But the better way would be to draw the check directly to the bank for the credit of the owner. It may then be credited to the account of the owner in safety and with a full record of the disposition THE RECEIVING TELLER 37 of the check. Under the rule that a deposit made to a certain account must be drawn out through checks pro- perly signed, banks allow deposits to be made with- out the indorsement of the one to whom the check is payable, although technically speaking the indorse- ment is lacking. The bank in substance guarantees the missing indorsement. Banks will also receive deposits for credit of another bank. For instance, a firm has an account in an out of town bank and an office in New York. It may deposit with a New York bank for credit of the out of town bank. The New York bank will credit the account of its correspondent and advise the latter of the credit. Thus a New York clothing firm has an account in a bank on Long Island. The firm will make deposits in a New York bank to the credit of the Long Island bank, and the Long Island Bank will treat the same as if made over the counter, and allow the clothing firm to check against the credit as if made at the window. This is a frequent custom. Keep a Record of Checks you Deposit. A well managed bank is able to trace practically every check that it handles. It does so by taking a memorandum of the bank drawn on in one department, and from whom received in another. Knowing from whom the check was received they assume that the depositor will have some record of the check for his own protection; and knowing on which bank the check was drawn they know what course it took when it left their hands. Your books should therefore be so kept that you can trace any check that passes through your accounts. Checks are frequently lost in the mails and dupli- cates must be obtained before payment can be had and 38 THE BUSINESS MAN AND HIS BANK the bank will ask you in such cases to obtain a dupli- cate. Your cash book should be so arranged as to show your receipts by check. The detail is entirely optional with yourself. But if the bank should inform you that a check for $50 drawn on the First National Bank of Boston has been lost, they have the right to expect that you can identify the check. They cannot, in the volume of checks handled, "photograph" all checks sent out and must depend upon their customers for cooperation in such matters. You should be able to turn to your records and trace any check you deposit. You cannot expect the bank to keep your books for you. You must remember that the bank's chief concern is to pay your checks as you direct; to make proper credits and debits to your account; to render proper statements from time to time covering these trans- actions. It must return your vouchers and show you proof of its figures; but further than this it cannot go. When the accounts are reconciled its duty is done. It has kept your accounts in so far as it is legally or morally obliged to do. It cannot respond to a test such as this: A customer went into a bank and asked them if "they could tell him what the amount of a check was that he drew to Mr. J's order five years ago." Assuredly not. A bank keeps no records of those to whom checks are drawn. It merely chronicles dates and amounts. And once the vouchers leave its hands, it is helpless to give further information. The Transit Number on Checks. At the right of the name of the bank on most checks,, there will be found a small number, thus "1-8." This is the "transit number" of the bank and will identify it in any bank. Years ago bankers discovered that it was necessary to record the names of the banks on which THE RECEIVING TELLER 39 checks were drawn that passed through their hands. They adopted various abbreviations, but even these were lengthy as compared with the present system of numbers Along about 1910 the American Bankers Association adopted the plan of giving a number to every bank in the country, such number to be permanent, standard for all banks and to follow the name of the bank on its checks. The large cities were given the low numbers, and the clearing house number was added. The states were then given a prefix number and all banks outside the large cities were allotted numbers. Thus in the example above, New York is city No. 1, and bank No. 8 is the National City Bank, and No. 8 is its clearing house number. Banks in New York State outside New York City are numbered ''50 — . " The writer's bank is "50-494." The authentic list is published yearly by Rand, McNally & Co., and provision is made for listing all new banks. It is advisable to keep a record of checks received, by maker, amount, datfe received and the transit number. This will trace any check without difficulty. The receiving teller in some banks makes notation of this transit number on the deposit ticket, and the party from whom the check was received is recorded in the outgoing letter that contains the check. The bank therefore has . a record of from whom checks are received and on what banks drawn. How to Detect Counterfeit Money. The race between the counterfeiter and the govern- ment is a close one and in many cases the former leads; for hardly is a new issue of money put out than it is promptly imitated. The counterfeiting is so skillfully done in some instances as to deceive even experienced bank men. At other times it is so bunglingly done as 40 THE BUSINESS MAN AND HIS BANK to be apparant to even the casual handler of money. Some of the plates used are photographs of genuine notes and these are as a rule blurred in appearance. Others are printed from counterfeit plates, done by skilled engravers and are the most dangerous. Some counter- feits are raised from bills of low denomination to larger ones, by pasting figures over the original ones, or by pen work. There are so many counterfeits in circulaton that to attempt to describe each with its defects would be im- possible in a work of this kind. If the reader is inter- ested in this subject, there are counterfeit detecting agencies that furnish the banks with monthly information of new counterfeits, and which contain a description of every counterfeit bill in circulation in this country. There is one general test that may be applied without study, namely, the silk thread test. The paper used by the Government in all paper money has scattered through it fine silk threads of various colors. This paper is made under a secret process and under close super- vision, so that it never can be had by anyone for any purpose, and is absolutely reserved for Governmental uses. Look for these threads, and inasmuch as they are sometimes imitated by ink lines, take a pin and pick them out of the paper. Sometimes two pieces of paper have been used with the threads scattered between the two pieces. Such bills will split at the edges. The general appearance of the bill is the first thing to be considered. If the lines are clear cut, the engraving sharp and distinct, the numbering perfect, and the silk threads in evidence, the bill will doubtless be found to be genuine. But if any point is doubtful, take it to the bank. It is a misdemeanor to knowingly pass counterfeit money and subject to heavy penalty. THE RECEIVING TELLER 41 Checks to Officers of Corporations. It often happens that an officer of a corporation will draw a check to his own order and offer the same for deposit to his own account. Such checks are drawn for salaries, expenses, commissions and dividends. As a rule the bank will not accept such checks for credit to the account of the officer, on account of the risk that attends. The law holds the bank Uable in such cases in the event that the money so drawn is an abstraction, under the rule that the check carried on its face notice that the funds were being diverted and the bank is charged with the responsibihty of such knowledge. The only safe course for the bank to pursue is to require two signatures to such checks, or to get the authoriza- tion of the corporation to such transactions. The same rule holds true in partnerships, and accounts with trustee, executor, administrator or guardian. The law being as it is and lawmakers being unwilling to change the statue law to reheve the banks of this respon- sibility, the only safe course for the bank to follow is to refuse such checks, or to require proper authority to pay them when apparently irregular. Therefore, do not expect the bank to accept them and do not put yourself in the embarassing position of having them refused or their regularity questioned. CHAPTER VI HOW TO INDORSE A CHECK In presenting checks for deposit, the depositor is required to indorse them. Let us briefly review what this means. The holding of a check duly made out in your name or indorsed to you constitutes you the legal owmer of the instrument and of the amount rep- resented thereby, unless the check has been obtained by fraud or for an illegal consideration, such as a gam- bling debt. In order to get this title out of yourself, you must indorse it by writing your name on the back in one of the several ways subsequently discussed. By so doing, you transfer your rights to the one to whom you indorse, and at the same time assume certain ob- ligations. Assuming that the indorsement is without qualification and consists in merely writing your name "William Smith" or "Pat to the order of John Brown William Smith" you warrant to all subsequent holders in due course the following: 1. That the instrument is genuine and in all respects what it purports to be. 2. That you have good title to it. 3. That all prior parties had capacity to contract. 4. That the instrument was at the time of your indorsement valid and subsisting. 42 HOW TO INDORSE A CHECK 43 5. You engage that on due presentment, it shall be accepted or paid, or both, as the case may be, according to its tenor, and 6. That if it is dishonored and the necessary proceed- ings on dishonor are duly taken you will pay the amount thereof to the holder or to any indorser who may be compelled to pay it. The former rule of law was that the indorsement of a check ''for collection" did not import a guaranty of the genuineness of all prior indorsements, but only of the agent's relation to the principal as stated on the check. It was held that in such a case, the collecting bank was not liable after it had paid the proceeds to its principal, though a prior indorsement was a forgery. This rule was exceedingly inconvenient in practice, and hence it was deemed expedient to make every in- dorser a warrantor of genuineness. There is no hard- ship in this rule for each indorser has a right of recourse against all prior parties. The old rule introduced such an element of uncer- tainty in banking circles that the clearing house asso- ciations throughout the country adopted rules to obviate its effects, and by concerted effort the use of indorse- ments "for collection," ''for deposit" etc. has been in a large measure discontinued. Different Forms of Indorsement. The proper form of indorsement, legally and practi- cally correct, is the special indorsement Pay to the Order of Blank National Bank John Jones" This conveys the title of the check to the bank, and without the bank's indorsement it cannot be negotiated. If the check is lost or stolen, it cannot, except through 44 THE BUSINESS MAN AND HIS BANK forgery, be transferred, and you are fully protected. Use this form wherever possible. There are other forms of indorsement used infre- quently. We have the Qualified Indorsement. "Without Recourse John Jones" This form transfers the check, but avoids liability there- on, and should be used where it is necessary to indorse the check, but without any liability attaching to the indorsement, except (a) that the instrument is genuine. (b) that it is in all respects w^hat it purports to be. (c) that the indorser has good title to it. (d) that all prior parties had the capacity to contract; (e) and that the indorser has no knowledge of any fact which would impair the validity of the instrument or render it value- less. This form should be used when you do not wish to guarantee unqualifiedly the instrument. The words "without recourse^ ^ are notice to the party taking, that the indorser declines to be held liable on the contract or promise. The one taking does so at his own risk. The restricted Indorsement is in this form: "Pay John Jones only William Smith.'' This destroys the negotiability. It gives the indorsee the right to receive payment and to bring an action on the instrument, but it cannot be further negotiated. It stops the circulation of the instrument. A conditional indorsement is like this: "Pay John Jones Upon Completion of his contract. William Smith." now TO INDORSE A CHECK 45 This of course is conditioned upon the fulfillment of the contract and is not common, although used to make a conditional transfer and to postpone payment. Another indorsement is restricted in trust as : "Pay First National Bank FOR account of William Jones John Smith." This gives title to the bank for the use of Jones, and is the form used when a deposit is made for the account of one who cannot make the proper indorsement in person. It is called ''third party indorsement" and is frequently used. CHAPTER VII BANK CHECKS AND THEIR COLLECTION Next to money the bank check is the most common financial instrument handled by the business man, and in some Hnes of business the volume of check trans- actions is far greater than the cash transactions. The business man draws large numbers of checks in payment of bills, and receives large numbers in settlement of accounts. His chief concern is to take only good checks, to get them in the bank as soon as possible, and to keep his bank balance sufficient to cover the checks he draws. In a large sense checks are money to him, and he pre- fers the check to cash on account of the ease and safety in handUng. He knows but little of the technique of the bank check and its legal implications, which are for the most part Greek to him. He is satisfied to know that if he keeps his account sufficiently large his checks will be paid, and if he receives only good checks they will be paid. All else is a mystery to him. It is the pur- pose of the next two chapters to give the proper method of drawing and protecting checks. Checks Transfer Rights. The common idea of a bank check is that it is an order on the bank to pay money; and this it is. But strictly speaking, and in a legal sense, it is the transfer of a right. We have seen that when the bank opens an account it gives the customer the right to withdraw his funds on demand. This is true; but the right more often takes the form of a transfer of the right to demand money than 46 BANK CHECKS AND THEIR COLLECTION 47 it does the actual payment of the funds. As a rule the holder of a check wants to own this right rather than to have possession of the cash itself. To illustrate: A has a bank account and draws his check to B. B, not wishing to avail himself of the right to demand cash, passes his right on to C. C, in turn, passes the right .over to his bank, and from bank to bank the right to demand payment is transferred until it is finally cashed in. What the business man wants in connection with his bank account is not a redemption of the checks he draws in cash, but the honoring of his orders to trans- fer his rights to others. This transfer of rights cancels debts just as truly as if done with money, and is a much safer and cheaper way of meeting obligations. Importance of Bank Checks. The importance of the bank check need not be dwelt upon at length. It is such a vital part of our com- mercial life, that to get along without it would be like going back to the stage coach and the tallow candle. The chief virtue of the bank check is its convenience. In the payment of a bill or the transfer of credit, it is the premier instrument of the business world, and no matter how far distant the creditor may be, or how large or small the sum involved, a few words on the appro- priate blank are all that is necessary to start the banking machine moving. This machinery of banking is finely organized, never sleeps, and rarely misses. It consists of men and women, adding machines, typewriters and the mails. The mechanical part rarely breaks down, and only when the human machine slips a cog does friction result and the check collecting system cease to function perfectly. Checks are now so widely used, so well known, and so rarely bad that they have to a great degree become 48 THE BUSINESS MAN AND HIS BANK the circulating medium of the country. They differ from bank notes in that the latter are promises by the bank to pay, while the bank check is an order on the bank to pay. The certified check assumes the same dignity as the bank note, being Ukewise a promise by the bank, but differs from the bank note in that it lacks the fine engraving and the uniformity of denomi- nation. The check is much cheaper to create than the bank note, inasmuch as the paper need not be so costly, nor the printed matter so carefully done, and the me- chanical process is less elaborate. At the same time it is more risky and more easily counterfeited or altered. A very small percentage of the great mass of bank checks in circulation are not paid upon presentation and a bad check is the exception and not the rule. Why Bank Checks should be Collected. The same fundamental reasons that prompt the bank to collect its checks obtain in the case of the business man. No bank holds checks over. They are imme- diately sent forward for payment. When the day's work is done every check received during the day is in procevss of collection. The checks drawn on itself are charged to the drawers. Out of town checks are in the mails, others are ready for the messenger to take out the next morning, and others are ready for the clear- ing house exchanges. Let us see what these reasons are. By law all banks are required to carry a reserve, that is, a certain proportion of their deposits in cash or in reserve depositary banks. A legal depositary is a bank selected by the board of directors and approved by the Comptroller of the Currency or the state super- intendent of banks, as a lawful bank wherein a certain part of its available funds may be kept. Such deposits may be counted the same as cash in figuring the re- BANK CHECKS AND THEIR COLLECTION 49 serve. Therefore, a check to be of any practical value to the bank, must be turned into cash or into a balance at the reserve bank. Until this is done it is immaterial how good the maker is or how large or strong the bank drawn on may be. A check can be of value only in one of two places — the bank's vault in the form of money, or in the depositary bank as a credit payable on demand. Again, the maker's account may not be good, or the maker may stop payment on the check, thus nulUfying its effect, or the maker of the check may die before the check is presented. It is then automati- cally cancelled and the holder must look to the estate for payment. Therefore prompt action is desirable in order to avoid these possibilities. And finally the maker may go into bankruptcy, when the check is automati- cally cancelled and the holder has only a claim against the bankrupt's estate. Therefore if you work on the theory that the maker is going to die or is contemplating bankruptcy, or the bank is going to fail, or the account is barely sufficient to pay your check, and make due haste to deposit your checks promptly, you will do all that the law requires and all that good business can suggest. Add to the foregoing the legal reason that a check should be presented for payment during the next busi- ness day after its receipt, if the bank is in the same place; or if the bank is in a distant place, the check must be started on its way for collection during the next business day, and we have several practical reasons why checks should not be treated as cash, but should be deposited promptly. The business man should follow the bank rule, for he wants to reduce his checks to a working balance in his bank, against which he may draw checks; and inasmuch as most banks will not pay against checks 50 THE BUSINESS MAN AND HIS BANK until they are collected, he should deposit his checks promptly if he is to have quick use of the funds which they represent. Perhaps the most wonderful thing about American banking is the smoothness of the working of the check redemption machine. When it is considered that some banks in New York handle from 25,000 to 50,000 checks every day and in the New York Federal Reserve Bank upwards of 200,000 checks go through daily — coming in in the morning and going out at night with scarcely an error in all the mass of figures, the importance of the bank check becomes apparent. There are about 30,000 banks in this country. Allowing each but 100 checks a day — a low estimate— would make three million checks handled every day by the banks of this country. How Checks Should be Drawn. There are certain practical suggestions relative to bank checks that will help in the day's work, both for the bank and the maker of the check. The first is to date your checks. This might seem to be an unneces- sary statement; but many checks circulate without date and open the question in the minds of those who are unacquainted with their rights as to w^hat to do. If such a check comes into your hands you have the right to insert the date, if known, and if not, the date of its receipt by you. The next suggestion is to start the filling of the check well to the left, write plainly, use plenty of ink, and fill in the unused portion with a wavy line. Make the figures close up to the dollar sign, omit all dollar signs of your own, and make the figures so plain that there can be no question as to the amount, even by a hurried inspection. BANK CHECKS AND THEIR COLLECTION 51 Next, sign your name in a plain hand. Do not flour- ish. Omit underscoring. "Adopt one form of signature and adhere to that form until it becomes second nature. Some men quite properly, have not changed their sig- nature in many years. And finally do not use forms of other banks. It is a frequent practice, when without a proper blank, to cross out the name of one bank and insert the name of the maker's bank. Banks do not favor this practice, and if it must be done, initial the alterations, or have all the work in one handwriting. The better way is to draw a form of draft on the bank. These forms can be had at any stationery store and all banks have blank draft forms. All first class hotels have blank check forms for the use of guests. These can be filled in for any bank. CHAPTER VIII PROTECTION OF BANK CHECKS According to law, a bank is bound to know the signa- tures of its depositors, and is presumed to know the authorized signature of each depositor on its books. If it pays a check on which the signature is forged, the bank cannot charge the amount to the depositor unless the latter has been negligent, or a party to the fraud. It makes no difference how cleverly the for- gery has been done, or whether good faith and due care were exercised in making payment, the rule applies. The forgery may be so nearly genuine as to deceive even the depositor himself, nevertheless, the bank is liable. In other words, the bank that has paid a forged check cannot cast the burden upon the depositor whose check it purported to be. The relation of a bank and its depositor is that of debtor and creditor, and the implied contract of the bank is to the effect that it will disburse the money standing to the credit of the depositor only on his order, and in conformity with his directions. When it makes payment on a forged instrument, it is held to have paid out its own funds, and cannot charge the amount against the depositor, unless it can show a right to do so on the doctrine of estoppel, or because of negligence which is chargeable to the depositor. This risk of forgery is apparent, and is one of the danger spots in banking, the burden being altogether upon the bank. The business man should, therefore, use due effort to minimize this risk, by protecting his 52 PROTECTION OF BANK CHECKS 53 Q Z < z o K z UJ ^ (f//^//W/ [/^'^a^Ja'T^ ACCOUNT "^ ^' (r/ J-~IJUUha^ y//if BURRELL ENGINEERING & CONSTRUCTION Co Fig. 2. — Number changed from 14256 to 1425; amount raised from $18.00 to $48.00. o z < o d z o q: z 111 o r^^/^/^,,ur/^^y ^/^. APR 13 1918 ^^y -^ 1421 _ od \-M..rr/.r. / -■'J^Z.^^^^A^ ^-^<^ jC^^ta^ .' . ' . ; ;»/)/> ^^g:^:::— *r fl NCfT C^>t O TOR AN AMOUNT tkCEtDiNO FIf TV I ' ct u ' OOLLARS. „ , . ,, DURRELU ENGINEERING A CONSTRUCTION CO ^"^ SUPERINTENDENTS (T^ /^r^A^.fA m I ACCOUNT °" ^ ^-^ C// ^£ ^^ '^^^v-^ Fig. 3. — Number changed from 14215 to 1421; payee changed from J. A. Pittuian to Sam Spivy; amount raised from $15.37 to $48.00. 54 THE BUSINESS MAN AND HIS BANK checks, never giving them to strangers, keeping his check book under control, and never signing checks in blank, for it is possible that such acts may deprive him of his right to recover on a forged signature. Q Z < o o z o S z B 9 O. l>. |V U I _, ,_,__,„.„_.. .,„ BURRELL ENGINEERING a, CONSTRI \ SUPERINTENDENTS {^ /^^A^ h S " ACCOUNT -L- LCA^/ J- Yr. .^ Fig. 4. — Number changed from 14201 to 1420; amount raised from $11.60 to $47.90. Kiting Checks. There is a custom, more or less common, but highly dangerous, known in banking circles as ''kiting checks." It simply means exchanging checks between parties, with or without value back of them. Anyone who stoops to this practice is carrying on a suicidal operation, in so far as credit is concerned. In fact, it is fatal in its consequences. It requires a shrewd, far sighted, and careful set of individuals or firms to carry on a scheme of this kind, and it is sure to be detected by the banks in due time, and the time depends upon the cleverness of the plan and the administration of the banks. Let us see the basic principles of kiting by illustration. A, being short of money, and having a bank account in Pennsylvania, says to B, having a bank account in Northern New Jersey, ''Give me your check and I will give you mine. I will have money in the bank before my check gets back and it will be paid." They therefore exchange checks in the same amounts, which is one of the symptoms of kiting. A deposits B's check in PROTECTION OF BANK CHECKS 55 Pennsylvania and B deposits A's check in New Jersey. It will be several days before the checks can get back to the banks drawn on, and in the meantime, each has had the use of the money represented thereby, unless the bank is careful not to pay against uncollected funds. And if it does, and the check comes back short, or worth- less, the bank is out. The longer the distance between banks, the more dangerous is the practice. There is another method of kiting, by using two banks, the same individual having accounts in both. In such a case he will deposit a check on bank A to his account in bank B to meet checks drawn on bank B in the regular course of business. It is easily detected. For instance, the teller has several checks of a certain individual for payment, and finds the account short. He looks up the deposit for the day, he finds that the maker of the checks has deposited, among other checks, a check on his account in another bank. He has thus ''covered" his checks. If the teller calls up the second bank and finds the account there to be short, it is a pure case of kiting — "stalling" for time; — and time is the essence of kiting. All may go well for a time in the latter in- stance, and the kited checks paid in due course, but once tlie banks send such items direct and not by a round-a- bout method, the game is at an end. In fact it cannot long continue in any bank, and is sure to lead to trouble. The following case of check kiting, intricate and care- fully planned, was discovered and ended by the author in March, 1920. The characters were: Jones, a clerk in a bank in New York; Brown, the president of a corporation; Smith, treasurer of the corporation, and several clerks in the corporation used as dummies. Jones had two bank accounts, one in New Jersey and one in a bank on Long Island. Brown had an account in another bank on I;ong 56 THE BUSINESS MAN AND HIS BANK Island. The corporation had an account in a New Jersey bank. Jones was approached by his brother- in-law who was a clerk in the employ of the company, who said the company needed money. They would make it worth while to him, if he would draw his check to Smith for $4000, which he did, on his New Jersey bank. Brown thereupon drew his check on his Long Island bank to the order of Jones, which Jones deposited in his own bank in New York, to the credit of the New Jersey bank, on which he drew the first check, and which had an account with Jones' bank. Being advised that they had been credited in New York, the New Jersey bank paid Jones' first check. Brown's check on Long Island to Jones came back ''short," thus cancelling the credit in New York. Jones then brought his Long Island bank into play and gave his own bank a check on his Long Island bank to cover Brown's checks which had come back. To cover the check in Jones' Long Island bank, Brown gave Jones three checks on Browai's bank, which also came back "short." Having started the game it could not be stopped, and so Jones began to draw checks to the order of the dummies in the corporation office, which were deposited by the corporation in its New Jersey bank. They in turn gave Jones theu" checks on New Jersey which Jones deposited in his Long Island bank. Thus they switched back and forth for about two weeks, Jones getting from the corporation several checks a day (to make them appear regular) which he placed to his credit, while he drew several checks daily to the order of the dummies (to make them appear regular) which were deposited to the credit of the corporation. When the fraud was detected, by inquiry as to whether Jones was drawing on uncollected funds (which simply meant, ascertaining if the checks Jones had deposited were PROTECTION OF BANK CHECKS 57 honored) it was discovered that these checks were passing between the same parties daily, and in practically the same amounts. The balance to the credit of the cor- poration in New Jersey consisted of $8000 of Jones' checks on Long Island which were bad, and Jones had a credit of $10,000 in Long Island consisting of the cor- poration's checks on New Jersey which were also bad. These bad checks were in the mails for collection, and had not had time to get back to the banks in which they were deposited. In consequence, one bank had paid out $2500 and the other $4000, for which they held bogus checks. In this operation extending over a period of two weeks, not a single dollar of real money existed. Forgery. The law nowhere requires the maker of a check to so draw it that it cannot be altered, and there is no device that the law says is absolute protection; but it does require the maker to use due care in filling the check so that alteration or forgery may not be invited. The rules before given, if followed, will be viewed as using due care in the drawing of a check and protect the maker from the charge of negligence. There has been a constant and interesting race be- tween the check raiser and the check protector. The development of protecting devices would be an interest- ing study. Twenty-five years ago there was simply the device that scarred the paper over the figures as shown on pages 61 and 71. The forger beat this. Then came the machme that punched the figures in a series of little holes (see illustration, page 58). These were easily filled with the same perforated cuttings and the altered amount cut over. Then came the machine that cut the figures out (see cut, page 63). It became easy 58 THE BUSINESS MAN AND HIS BANK to take paper of the same tint, cut the same figures with a duplicate machine and paste them in, cutting the new figures over them. Then came the machine that wrote, "Not over hundred Dollars," struck the figures into the paper and filled the ^•;,* Jj • J ••••••• ragged edges with indelible ink. Such *••' •*•*• •*••• • a check was difficult, but not impossi- FiG. 5.— Second ble, to alter. Then came the check method of protecting ., ,i , -j ii , <. , , checks. writers that write the amount of the check in the writing space, cut the words into the paper and inject the indelible ink into the fibre. There is also a similar machine that writes the words and at the same time scars the paper where the payee's name is written so that alteration of amount or name is almost impossible. NOT OVER imRTY DOLLARS S3i'M> Fig. 6. — Work of the " Protectograph. There are several brands of "safety paper" on the market that protect checks to a considerable extent, although not absolutely. These papers have a thin coating of sensitive ink, and any use of acids immediately destroys the surface and makes the alteration "blotchy." Pay to the ORDER OF' Fig. 7.— Work of the "Check Writer." They are to be recommended, but are not to be considered as beyond alteration, as illustration 16 will show. Surety companies and other concerns are now issuing bonds insuring makers of checks against forgery and TKOTKCTION OF BANK CHECKS 59 60 THE BUSINESS MAN AND HIS BANK alteration. They insure against loss but do not prevent tampering with checks. A firm in Chicago has recently put out a form of check which has various amounts printed in the margin. By tearing off the paper to the figures nearest the amount of the check, the highest amount to be paid is indicated in the same manner as used by the Government on money orders (see illustration, page 59). This, in con- nection with safety paper, would seem to be the last word in check protection. In a pamphlet issued by the Geo. W. Todd Company of Rochester, N.Y., makers of check protecting devices, William J. Burns the famous detective says, in speaking of check raising: As between merely forged documents (manufactured "out of whole cloth") and the genuine document on which the amount is "'raised" or altered, the danger to those signing and handling the altered in- strument is infinitely greater. In fact, from some of the remarkable examples of "raised" checks, drafts, stock certificates and promissory notes that I have examined lately, it would indicate that the "raised" amount is more dangerous to the financial peace of organized society than the nitro-glycerine can of the professional dynamiter. " The methods of the forger, too, in obtaining checks signed by responsible men and business houses are most interesting, as showing how difficult it is to guard against the "check raiser." For instance, they have developed a trick lately of sending a small but perfectly good check of their own to some business house. Then, after there has been plenty of time for it to be duly deposited, there follows a polite letter, notifying the intended victim that a mistake was made in sending this check, that it should have been addressed to another house of similar name in another city, and will they kindly return the money? "In complying with this perfectly proper (?) request, the average business concern naturally responds by sending its own check for the amount to the writer of the letter, explaining that this check had been deposited before his letter arrived. And this check by the way, is invariably for a very small amount, as the "check raiser" does not care to invest more actual money than is really necessary. PROTECTION OF BANK CHECKS 61 r' 'SH3>ioaa 3snoH iAinj.sno 'N3lAi3SnOHiaVM C3 C O c'5 ft « S «S O 62 THE BUSINESS MAN AND HIS BANK J a> o ^- ^ '- - o «^ 5 CO C OS- es dJ -O s o o g= '^ -=) 03 +^ C C 5^ «3 _ ■£ .2 o £"2 I (^ 13 QJ 03 » o ^ O '•-I o 8 o 'H i^ a o c -o ^ J o . ^ 3 o £ o S s «. ^'^'^ U - ^ S b« t^ Oi P ^ tn ■» „ S P. ^ S 2 o ft o ,G .5 )S "^ a ^ •-H . -"^ +^ -ii 03 O rH ^< o b o o o t^ tH CJ O • rt 03 M a - (-. o ■i p. O p, ^ ^^^ B .^ i -^ MO ® u , MX) _ ^ . '73 **-• «<_i a; © ;^ g .£ ® 03 r 5 s 9 -=) I-"? PROTECTION OF RANK CHECKS 63 ■n .£ <0 .2 ^V- -^ C *^ 6 O m" ^ (- r" 4^ £3-3 Si: o a P fen to a; m2 ,3 : 2 f^ o MX*" C .-1 ® 5 52 « * o3 u o t- p a C to ft) O u d c -^ a S O o o 00 i-i d^ ft (1 y-N 6-3 = ^ c-i -^ ^ -g 5 '5 a 03 , rf . - ^ >a ■ d '^ .So 64 THE BUSINESS MAN AND HIS BANK in q: d LU. LU i O r— ^1 it 5 ? ►• (i '. ■^*^'-«--s>*4s . - « — o "« S 2 2 .S I 03 -S -^ r^ "S C» > -a o3 o 2 ^ -^ ^ -^ O :^ ^3 m CO « a 3 o CI !*>,^ O a 5 ua « y-j o d '-' ^ ce 5) c3 o P ^ rM "is 'S ® O c3 jj j5 „. - 5? 5 TO cj eS o 3 ,kj o -g ^ 5 s a 2 3 - ^.2 c3 T) if -i2 r- LO c3 -/J ^ 05 '^ "" 2 2 ;>. 2 ) L-5 C3 9^ O 01 O j3 c«5 Bi CO - H a a -^ O ^ o m" M O 2 CT> O Id ^ ,-( o — 2 'O a^-i aw-g ^< 03 m "03 - '^ ft rt - O o ,2 2 ^ -S P « cj 2 -« "t; ^ ^ iJ riS Q -M 13 -a w; PROTECTION OF BANK CHECKS 65 "You will see that a $5 check signed by a good concern is just as good for his purpose as a $5,000 one, because he can twist the "five" into "five thousand" with very little trouble and only a drop or two of acid and another dro):) or two of ink — provided the concern has not taken the thoughtful precaution to protect its check before sending it to the polite stranger. (And, by the way, it is amazing how many otherwise conservative concerns there are in this country that will safeguard everything connected with their business except their own signatures — which represent all the rest of their property put together! On " receiving the little genuine check, the forger then performs his interesting operation by the use of bleaching acids, removing the design of the paper if necessary, and restoring it after the amount has been altered to suit his needs. He fills up perforations, or punchings, if necessary, and the inks of the best manufacturers are scarcely proof against his skill, since he can remove even printing and lithographic ink when necessary. Moreover, in many cases, it is not required to remove anything at all, as many small amounts can be changed by "penning" — simply adding a few pen strokes to the original amount — and there you are! "When the alteration is finally discovered by the concern that is- sued the check, the question is, "How are you going to prove the alteration?" Or, "Which one of the several endorsers on this check was the guilty party?" It is a very difficult situation, and one that can rarely be cleared up to the satisfaction of the bank, its deposi- tor, the correspondent banks, and others concerned. "I might mention that we have recently investigated cases where they managed to alter checks in such a way that they actually left no loop-hole through which to prove the fraud and indict them for forgery — and they accomplish it in somewhat the following manner: "Orders had been given to a bank to stop payment on a certain check for a certain amount, payable to a wholesale house, dated on such a day, number so-and-so. It was believed that the check had been stolen. Twice within two months the bank was reminded to be on the lookout for this check — and then, in the last hour of a busy Saturday morning during the third month, the check slipjied through. But the bank was not to blame. "The forger had first "raised" the amount by several hundred dollars. Then he changed the number of the check, and brought the date right up to that very day, as though the check had been given to him only a few minutes previous to his appearance at the bank — although the check was really nearly four months old. Lastly, he 5 66 THE BUSINESS MAN AND HIS BANK ■3 o -a 3 CI T3 3 ft. 3 '« d a to o -a o O o _g ■ 'S 03 E~. O S) R o (M ^-' O o o (M a o -a "3 PROTECTION OF BANK CHECKS 67 z < CO -J < z h < z u z < 2 31dW31 \N M Aoeaijeqj uosjapuy ; o^ ; O OC' S o o '(0 ID i>) o S ^ . H o o *^ IS a o C ;^ 'E B ' o >- o « . - o ^ o t ^: O CO , o ^ o d CO o «? fO '3 'TJ >- - 5 a- : S o : _C ■<* I ffl d •+J CO >>* ^^ 5 S Q.2 6 rt ^^ a-c to c3 o -^ — o o - a « to X . . . H K «t> 'x>^ N. a., o 73 -« -H o ft^ ^ o i -fj •< T3 2 c3 to o 3 o M > tC a. O o -u En M ^ « 00 *-H ^^ C5 -13 T-l c3 •*o -»J -< CO C5 _3 •s S) >i a. m ^ M C CO S "O tC t^ lO u o QJ ■^ ■ 1— < ^ U ^ o © ftp >. lO -M t>^ <4-t »o o ^ u a bc o fl^ cj -O +J M-^ C o 03 > • r* d o ^ rJ2 02 (I « ^ p. o « o (B A ^ O ^q^pau-a tsj[a4.iinoo J 2' — I fa PROTECTION OF BANK CllECI'Q:) 71 o ^1 N^>^^i 5) a T3 O to '3 > "3 -a o j3 G 5 — M . c3 , - SI t -a - a ft 4J O - -e - -a o d 00 o CO o -3 a> CO i d I— t 6 72 THE BUSINESS MAN AND HIS BANK m-: ■05 : ^ ?^ K^ fct. ^ ""'n;^' lP«fl '^'^ . Jr?- ^^^^Tii fiS^ CS! '•^ V a 3 <0 m u M > c3 c © o -«; e o j3 ^ .2 S .S ^ (^- d o XSIOVWfcdVHcd xoo n 'H CI PROTECTION OF BANK CHECKS 73 work you are doing makes it all the more dangerous to your customers; because these checks are supposed to be safeguarded, and the banks generally so regard them, and when they get in circulation, as in this case, they are calculated to fool not only the banker, but the mer- chant, anywhere, because it is supposed to be impossible for outsiders to get possession of such checks." "These are some of the questions, gentlemen, that the bankers must take up for the protection of the world of banking and business. They must see to it, first of all, that the printer who prints their checks takes greater precautions toward preserving those checks from crooks. Then, in the next place, they must use their good offices with depositors to see that they are careful as to the manner in which they issue their checks. "I do not mean that depositors can avoid giving checks to strangers — because the strangers will find a thousand ways of getting them, anyway — but they can write them in such a manner that they will not be a positive invitation to crookedness, as so many checks are at the present day. "There is one other matter that I do not propose to talk about publicly, because it is too dangerous; but I want to notify bankers who have safety deposit vaults that if they will see me privately I will be glad to give them some valuable hints as a result of a very im- portant investigation I have just finished, involving the theft of over a million dollars. "In the case of this particular safety-deposit fraud we fortunately succeeded in getting the money back; but it is not always you can do that, because let me admit to you the detective does not possess any uncanny or supernatural method for solving his problems. You have only to apply the same common sense and judgment in this work that you do in every day affairs, and thus you get results. "Some of the most effective work we are able to do is in the line of warning the banks and business public against certain forms of fraud and how to guard against them, as I have tried to do in this little talk — and if there is any field of endeavor in which "an ounce of preven- tion" is worth while, I feel it is in this work of protecting the banks against up-to-date forms of fraud." CHAPTER IX THE PAYING TELLER As the recei\dng teller was likened to the hopper into which is poured the receipts of the bank, so the paying teller may be hkened to the other end of the funnel. He gives out what the receiving teller takes in. He is the dispenser of the bank's funds and is charged with the following duties: first, cashing checks, both those drawn on his own bank and those drawn on other banks and offered him for cashing; second, making up pay rolls, which is essentially cashing checks in a certain pre- scribed way; third, certifying checks; fourth, settling the clearing house balances, which also is nothing more than paying checks drawn on his own bank in bulk. It matters not whether the check comes to him through the window, through the mails, or through the clearing house, it is his duty to examine it and decide whether or not to pay it. In over-the-counter transactions this must be done in a few moments, but in paying mail items longer time is allowed, although in clearing house settlements the time allowance is about two hours only. During this time thousands of checks in large banks must be examined, and parts of the work must therefore be delegated to others. In the last analysis all checks are presented to the paying teller, for although he does not actually pay those coming through the mail, he authorizes their payment by drawing the bank's draft on its correspondent for the amount of checks so received. The clearing house checks are actually paid by him, as will be seen under 74 THE PAYING TELLER 75 the caption ''clearing houses," and he is therefore the one charged with passing upon all checks drawn on his bank and determining whether or not they are in due form and a proper charge to the depositor's ac- count according to law and the practice governing such payments. We will now take up the payment of a check, first directly tlirough the paying teller's window, then the collection of a check through the mails and lastly the clearing house exchanges. The Bank's Obligation to Pay Checks. The obligation of a bank is absolute in its agreement to pay the checks of its depositors, properly drawn and presented, but the depositor must have on deposit sufficient funds to meet the obligation. Having funds on deposit does not mean that he shall have credit for a certain amount, for this may be merely a credit for checks which have not* been collected. Thus, if there was deposited in a bank in New York ten checks on various cities in New England aggregating $10,000.00, it would be at least three days before the bank could collect these checks. If a check were presented for payment, and the only funds on deposit were these checks in the course of collection, the bank would be paying out its own funds, in reality loaning the amount until the checks were paid. But, assuming the credit in the bank to represent checks actually paid and cash deposits, the bank is in duty bound to pay them as presented, provided the following features of the check are in proper form: 1. The date. Checks may be dated ahead, but they cannot be paid until their date arrives. If the date has long passed, they be- come what is known as "stale checks," and the bank is not author- ized to honor such without due inquiry. 76 THE BUSINESS MAN AND HIS BANK 2. The words and figures must agree, and if there is any discrep- ancy, the tvords govern, for it is provided in the Negotiable Instruments Law, "Wherever any discrepancy exists between the two, the amount written out shall control." 3. The signature must be in proper form. 4. The payee must be identified, and the check properly endorsed. 5. No stop payment must have been lodged against the check. 6. If presented at the bank drawn on, the account must be good for the amount. Important features of Bank Checks. In scrutinizing checks for payment the paying teller examines the above points; and in so far as possible the business man should follow the same procedure in accepting checks and examine: 1. The date, to see that it is not dated ahead; nor so old as to come under the designation ''stale." A check dated three months back would come under this rule, although the courts have never decided just how old a check must be to be considered stale. 2. The words and figures should agree. If they do not, the words control. 3. The indorsement of the payee (the one to whose order first drawn) must be thereon; and if it has passed through several hands, the chain of indorsements must be complete. It should be first indorsed exactly as made out. 4. If the maker is not known, the one negotiating the check should be so well known to the one accepting the check that in the event the check is returned, reim- bursement may be had from the indorser. Here is where the risk lies in taking unknown checks. If your indorser is not responsible beyond a doubt, caution is in order. 5. There must be no stop order against the check. This fact cannot be known until it is finally presented at the bank drawn on. , 6. The account must be good for the amoimt. This THE PAYING TELLER 77 also cannot be known until the check is presented at the paying bank. Therefore do not cash checks for those you do not know. The Business Man and the Paying Teller. The paying teller is generally conceded to have a more responsible position than the receiving teller in that he cannot verify his work once it is done. When the funds pass through his window they are beyond his control and only the honesty of the customer can save him from loss in case the error is against the bank. A few rules in connection with the paying teller's work will be helpful both to him and to the customer: 1. In presenting a check for cashing see that it is indorsed properly. 2. Name the denominations desired. 3. In requesting pay rolls, use the bank's blanks for classifying the kinds of money desired. 4. In signing checks adhere closely to the signature furnished when the account was opened. 5. Make your figures plainly. 6. Do not use "freak" checks— that is, a form with much personal advertising matter thereon. Do not cheapen your check bj^ too much ornamentation. The less printing the more dignity to the check. 7. Have the figures where the bank prefers they should be, pre- ferably following the filling so that all the checks will have the figures in the same place. This helps greatly in handling the checks in the various departments. 8. Do not use oversize or undersize checks. They are difficult to handle in connection with others. 9. While it is not a legal requirement, some form of protection should be used to prevent the check being altered after leaving the hands of the maker. There are many devices for tliis purpose, and no one can claim to be the perfect method. There are several machines that write the words into the fibre of the paper and inject in- delible ink into the perforations. These are not expensive and should be used by every business man. 10. If you have more than one account, get a rubber stamp and use it to designate the account other than yovu- regular one. 78 THE BUSINESS MAN AND HIS BANK 11. IJse a rubber stamp for indorsing if you handle many checks. This not only saves time in your office but is much better than a penned indorsement. Certification. The certification of a check is equivalent to paying it ; or, to be technically correct, substituting the promise of the hank for the order on the hank. Certification is accomplished by writing the word "accepted" or ''certified" across the face of the check with the signa- ture of the teller or other officer underneath. As a rule this act is performed by the pajdng teller, inasmuch as it falls within the category of paying checks, and therefore properly belongs to his duties. When a check is presented at the teller's window it is presented for payment only; but the holder may waive payment, and accept in its place the promise of the bank. The legal effect of certification is to discharge the maker of the check absolutely and substitute the promise of the bank instead. The practical effect is to charge the account of the maker at once with the amount and credit ''certified checks." The maker is then out of the transaction altogether, and the bank assumes the obhgation. When the check comes back for final payment, it is charged — not to the maker's account, for this has already been done, but to "certified check account," and the voucher returned to the maker for his records. There is a distinction, however, that arises when the maker of the check presents it for certification. When the holder presents the check, the maker is released; but when the maker obtains the certification, he is still liable in case the bank fails before the check is paid. The reason for this is that the holder had the option of taking cash or the bank's promise; and having chosen the latter, he cannot have redress upon the maker; but THE PAYING TELLER 79 where the maker has the check certified before putting it into circulation, the holder does not have this choice and it follows logically that the maker should still be held in the event that the check is not paid when finally presented. Certified checks are used daily in large numbers in transactions affecting real estate transfers, payment of taxes, licenses, Wall Street dealings and other such transactions, in the settlement of which they are re- garded as equivalent to money. Checks Paid in the Order of Their Presentation. The paying teller will pay checks in the order of their presentation and the rule of ''first come, first served" applies. Checks are presented tlirough the mails, through the other banks by messenger and over the counter, and it often becomes a fine point to determine which checks take precedence. If a batch comes in through the mail, they will be paid so far as the funds warrant and the rest will be returned. If several customers were standing in line before the pajdng teller's window, each holding a check of the same party in different amounts, they would be paid so far as the funds were sufficient. If C's check could be paid be- cause it was smaller than B's, C would take precedence over B. B could not be paid in part even though he might be willing to accept less than the full amount. There is an old trick, which may be stated best by illustration. Suppose A holds a check for $100 drawn by B. Upon presenting it is found to be short $10. A might be willing to accept the $90, but the bank can- not pay in part. It must pay in full or not at all. May A deposit $10 and thus make the account good? The opinions are to the contrary. He could only do so by subterfuge and without the knowledge of the 80 THE BUSINESS MAN AND HIS BANK bank. The legal reason is that B may have inten- tionally kept his account short to prevent the payment of the check, and the order is to pay 1100 and not $90' Legal Tender. We frequently hear the term ''legal tender" used in connection with business transactions. Let us see what legal tender is and what is the practical signi- ficance of the term. The law has stipulated what kind of money shall be legal tender, and the purpose is to afford a medium of payment which the creditor cannot refuse. There have been times in the history of this country when the circulating currency was depreciated below par and its value uncertain and fluctuating. Particularly was this true of the old state bank notes. This condition ob- tains in Russia today, where there are several different issues of currency in use, some put out by one faction of the government and some by another. Most of this is worth less than the face amount, and the cred- itor taking such money would of course suffer loss, if taken below the market value. In order to provide a form of payment that must be acceptable, legal tender has come into being. The use of legal tender and its purpose will be seen in the following instances: A certain lawyer held a mortgage which was not yet due on a piece of property in Brooklyn. He was anxious to get title to the property for the purpose of adding to his corner for improvement purposes. The owner knowing his anxiety named an excessive price, and the two could not get together. The lawyer thereupon bought a mortgage that was already on the property which had five years to run. If he could get the owner in default, he could foreclose, and he used his best wits to accomplish this. The THE PAYING TELLER 81 owner was short of funds and the last day for payment of interest arrived. The owner tendered his check, which the lawyer refused to accept unless certified. The bank was closed, and certification could not be obtained. Thereupon, the owner, on the advice of counsel, procured the amount in greenbacks, silver dollars and small change and made his tender, which the owner was obliged to accept and give him receipt. He had made legal tender. In another case a party entered into contract to sell a house for a given amount and accepted $100 down, the balance to be paid on a stated day. Before the day arrived, the owner was offered a larger sum for the property and naturally regretted his contract. On the appointed day the buyer, having heard of the matter, tendered the amount in legal tender, which, of course, the seller was compelled to accept. Legally, he could have refused any other form of money or check. There are not many cases that require legal tender, although instances do occur with some frequency. It is needful, therefore to know what is and what is not legal tender, for otherwise the legal effect may be en- tirely lacking. By the laws of the United States the following are legal tender: Gold certificates in any amount. Gold coin in any amount. Silver dollars except where stipulated otherwise in the contract. Treasury notes of 1890 unless otherwise stipulated in the contract. Greenbacks in any amount. Silver quarters, halves and dimes up to SIO in one payment. Nickels and cents up to 25 cents. The following are not legal tender: 82 THE BUSINESS MAN AND HIS BANK Silver certificates. National Bank notes. Federal Reserve notes. Federal Reserve bank notes. Checks certified or otherwise. Uncollected Funds. Business men frequently receive checks back from their bank unpaid with the notation ''Drawn against uncollected funds. " Let us see what this phrase means by an example. You are doing business in New York and receive a check on a Denver bank. You deposit it with your bank. It will take at least 8 days for the bank to send the check to Denver and receive in return a draft on New York which they can count as their reserve. Suppose you draw a check against this de- posit the next day and the bank pays it, what hap- pens? The bank has loaned you the amount for seven days without interest, for it will be that long before the check is paid to them. The check may come back and the bank would have to look to you for reimbursement. Other things might happen as noted before to prevent the payment of the check. Therefore banks do not, generally, pay against checks that have not been paid to them, and business men should not expect them to do so. How long it will take the bank to reduce the checks deposited to available funds depends upon the time consumed in making the collection. In some cases it is one day and in others eight days. Stale Checks. The question as to how old a check must be to become stale has never been authoritatively stated. It is well settled that when a check is presented a long time after its date, the bank is justified in withholding pay- ment until it can make inquiry, and such a delay is not THE PAYING TELLER 83 a refusal; but whether or not the Ijixuk is utitler abso- lute duty to make inquiry or notify the drawer, is in doubt. Therefore, checks should not be held over for any reason, but should be promptly presented to the bank drawn on for payment. Memoranda on Checks. As a general rule, a bank on which a check is drawn is not requu-ed to take notice of any notations on the margin or in the body of the check, and when such is the case, the memo or figures is not a notice that the check is to be paid from a particular fund, or for a particular purpose. Likewise, a deposit ticket that is intended to go to a particular fund should be kept separate from other deposits of the same party, and must be so marked that the bank may not be misled in making the credit. Thus, if the depositor runs two accounts, one personal, and one as "agent," or "special," or what not, he cannot complain if he fails to mark his deposit ticket correctly causing the bank to make an improper credit. Checks for Small Sums. We have seen that a depositor in a bank has the right to draw as many checks as he may like and in whatever sums, and the bank is bound to honor them as long as the balance is sufficient. There is a natural hesitancy in drawing checks for sums under one dollar, as such seem to be too small to bother with; but it must be remembered that a check is a check, and the same work that follows a check for ten thousand dollars attends a check for ten cents. The bank is just as willing to handle one as the other. The only point to observe is to draw checks under one dollar so plainly that confusion is avoided. Write the word "cents" after the amount 84 THE BUSINESS MAN AND HIS BANK in the filling and indicate the amount in the space for the figures thus ''.^Hoo only." Stop Payment. The depositor has another right that follows the right of drawing checks and that is the right to stop payment, or to cancel his order to pay. The rules in this regard are simple. First the stop order must be in wTiting and it must reach the bank before the check is presented. An oral stop notice is not binding, neither is a telephone request. A telegraphic stop would be binding. Banks as a rule endeavor to comply with an oral request to stop payment, but this would not be effective if the check were presented before the WTitten notice came to hand, and as a strict matter of law the bank would be bound to pay. In filing a stop payment order give the date of the check, the number, amount and to whose order drawn. These stop notices are the bane of the banking world and are not to be encouraged; therefore do not cancel a check unless it is necessary. The risk to the bank is considerable and in the event that the check gets through loss will attend if the customer stands on his legal rights. An appropos story will illustrate the risk. A certain liquor dealer ordered a barrel of whiskey from his whole- saler and drew his check for the amount. In acknow- ledging the order, the firm listed the order as for two barrels, which disturbed the buyer and he cancelled the order and stopped payment on the check. In the rush of the day's work the check got through and was paid. The maker claimed his rights and the bank had no other course open but to refund, which they did. They thereupon paid the government tax on the whiskey, had it shipped to their order and held it as a "liquid asset" until another dealer came along and took it off their hands. Not all miscarriages of stop payments work out so well. THE PAYING TELLER 85 Reconciling your Bank Account. An account with a bank should be reconciled at fre- quent intervals, as a safeguard both to the bank and to the depositor. If any errors exist they may speedily be corrected, and if fraud and forgery have been perpe- trated through the account, the bank may be on guard against a continuance of the practices. In some states the statute provides that if the depositor does not report any claims for forged or altered checks within a stated time, he loses his redress against the bank.* Moreover the business man wants to know that his books are in balance with those of the bank. This work should not be done by the one who draws the checks or handles the funds, for numerous cases are on record where the one who manipulated the account reconciled the balance, and thus covered up his abstractions. Where this obtains, the courts would no doubt hold the depositor negligent in allowing the one guilty of the fraud to check the bank statements. The reconcilements are made in two ways: First by having the bank book balanced. This means that the deposits and checks are totaled and a balance struck. The bank will be careful to return the vouchers that make the total of checks paid, which amount taken from the total deposits leaves the balance. Formerly it was the custom to have the paid checks entered in the pass book, but since the advent of the adding machine, they are run up on the machine and the balance struck. It is obvious that the depositor will draw checks and deduct them from his balance, while they may still be outstanding and unpaid, not having reached the bank for payment. And if the rule is followed that as soon as a check is di-awn, it is considered paid, overdrafts will not occur. In order to reconcile a balance submitted in this form, follow these rules: * Section 326 of the New York Negotiable Instruments Law Provides: "No bank shall be liable to a depositor for the payment by it of a forged or raised check unless within one j-ear after the return to the depositor of the voucher of such payment, such depositor shall notify the bank that the check so paid was forged or raised." 86 THE BUSINESS MAN AND HIS BANK Enter all deposits in your check book. Enter all checks drawn likewise. (Many checks are drawn when the check book is not at hand, and a substi- tute form is used. Be sure to enter these in your check book. From the total of your deposits from time to time, take the total checks drawn, thus giving you your balance. Number all checks consecutively. Arrange the returned checks (vouchers) in numerical order and check back with the stubs. Use a colored pencil and make a prominent check mark on all paid stubs. Make a total of the checks outstanding and subtract this from the bank balance, and the two balances should agree. Second: Many banks are now rendering monthly statements, having discarded the foregoing method. The reason for this is the greater efficiency of the state- ment method, inasmuch as it obviates the tedious work of writing up books periodically (a slow and labor con- suming process) and keeps the work up to date. Many banks render statements to all customers monthly; others monthly to certain customers only, and on request to others. Where the statement system is in vogue, you will either receive your statement and vouchers through the mail shortly after the first of the month or it will be ready upon call. In this instance. Check the deposits shown on the statement with your book. Check the checks listed as paid with your stubs, also checking them with the list as furnished. Subtract the outstanding checks from the bank bal- ance and it will reconcile. In both cases examine the checks to see that the sig- natures are genuine and report promptly any irregulari- ties or differences to the bank. CHAPTER X COLLECTING OUT OF TOWN CHECKS The checks received by the bank from both the receiv- ing and paying tellers divide themselves into the follow- ing classes: (1) Checks on own bank. These are checks received on deposit by the receiving teller and drawn on his own bank, and checks cashed by the paying teller which are also drawn on his bank. The latter are for pay rolls and to obtain cash by the depositors. (2) Checks on banks in the same town that will be paid through the clearing house. (3) Checks on banks in the same place which must be presented by messenger, inasmuch as the bank does not clear through the clearing house. (4) Checks on out of town banks. These must be collected through the mails, and are commonly called 'Hransit items." It is the custom of large city banks to have con-es- pondent banks in all important cities, to which checks, drafts, notes and bills of exchange are sent for attention. Some of the large banks in New York, Chicago and other cities have such connections in practically every city in the United States. They can therefore send such items to their corresponding banks and get quick action and at the same time build up a line of business that is mutually profitable. The rates of exchange charges, time for remitting, and other such details are arranged for between the two, and the collecting bank knows exactly what it will cost to collect a check, note or bill of exchange. Thus the Irving National Bank in New York has 87 88 THE BUSINESS MAN AND HIS BANK connections in every large city. The terms upon which the correspondent bank will collect checks and other items in a certain territory are agreed upon, and all such items coming into the Irving Bank will be sent to its representative. The latter will pay the Irving on the day the item is received less the exchange charge, if any, by drawing its draft on its New York correspon- dent. The arrangement might be that the collecting bank will remit at par once or twice a week for all collec- tions sent to it, and as compensation have the use of the funds for the time between collection and payment. The out of town bank may have an account in the Irving Bank, and the latter will charge all items sent out to it and credit all deposits or collections received from it to this account, which will be its ''New York account" or reserve account, the balance counting in the out of town bank's reserve the same as cash on hand. These various bank connections are most important inasmuch as they expedite the collection of bank checks and greatly facilitate the business of the country. For instance, it is much to the advantage of the depositor in the Irving Bank to know that a check drawn on a Toledo bank and deposited by him will go direct to Toledo for payment and not to Chicago, Columbus, Cleveland and then to Toledo, for each bank handling the check delays the payment by at least a day, and holds back the credit or the right to draw against the check by that length of time. Collecting Large Checks. It often becomes important to collect a large check with the utmost dispatch and these collecting facilities are of great value. For instance, a check for $50,000 is used in a business transaction in New York. The holder wants the use of the funds as soon as possible, COLLECTING OUT OF TOWN CHECKS 89 and the bank receiving the check wants to reduce the amount to a usable balance with the least delay. In- asmuch as a check is not payment and cannot be con- sidered paid until it is certified or otherwise paid, it is highly necessary to present the check for payment at the bank di-awn on without delay. It may be on a country bank, let us say in Iowa. Here is where the collecting machinery does its best work. The transit man in the bank must determine the shortest and quick- est way to obtain payment of the check. He may have several routes open to him and his knowledge of railroad time, exchange charges, and other such matters, will come into play. He may send it to his Iowa corres- pondent and receive returns in five days at par; or he may send it to his Chicago correspondent and receive payment in three days, less the exchange charges. But the gain in interest for a day or two may offset the exchange cost, and it is for him to determine in such unusual cases the most profitable method of hand- ling this check. Collecting Checks Direct. The study of such collections is so intricate and the possibilities of profit or loss so niany that only actual working experience can make a well rounded transit man. It is obvious that he must know his geography well, have definite working arrangements with his correspondents, and watch the details of his department with minute care. While the volume of business is heavy the individual profits are small and each transaction carries its own opportunity for profit or loss. In many cases it is profitable to send the item direct to the bank drawn on, whether it be a correspondent or not, and pay the costs, on account of the quick returns possible by direct collections. A practical illustration will 90 THE BUSINESS MAN AND HIS BANK show the method of quick and direct collection of checks on a distant point : A theatre manager in New York has large interests in California. He transfers funds from the West to the East by the following arrangement : He draws a check on his CaUfornia bank and deposits it in his New York bank. The latter sends it direct to the bank drawn on. The latter, upon receipt of the check, wires the New York bank that payment has been made and draft follows. As soon as the wire is received the bank will pay against the deposit. The California bank charges a special rate of exchange and the New York bank charges the account interest at six per cent from the time they pay until the draft is received from Cali- fornia. The Federal Reserve collection system would still further expedite the transaction as follows: Upon re- ceipt of the check, the New York bank would deposit with the New York Federal Reserve Bank. The latter would send to the Federal Reserve Bank of San Fran- cisco, and the latter would collect and credit the New York Federal Reserve Bank and wire payment, through the Federal Reserve special wires. The New York Federal Reserve Bank would notify the depositary bank and without waiting for draft, the check would be con- sidered paid, the book credits being substituted for drafts. This interchange of credits is the most help- ful feature of the check collection faciUties of the Federal banks, it is a great time and money saver, the collections being handled at par. The average bank is too small to have all this ma- chinery, inasmuch as it does not handle a volume of checks sufficiently large to justify the expense of such a department. It is much better to have two or three correspondents in the large cities to which all out of town checks are sent. Thus a bank in a city of 20,000 COLLECTING OUT OF TOWN CHECKS 91 population will have a correspondent in New York to which it sends all New York and surrounding checks; one in Boston to which all New England items are sent ; one in Chicago to which all western items go ; and one in the South, that collects all its southern checks. Should quick returns be desired, it may send the item direct to the bank drawn on and charge the customer the costs of collecting, should they be unusual. Therefore as the checks leave the teller's cages they are sorted into three or four batches, listed with what- ever information the bank may elect to take and sent to the several banks for attention. CHAPTER XI EXCHANGE Whenever a check drawn on an out of town bank is deposited in a bank, the depositor is often required to pay ''exchange." What this charge represents and what is the basis for its exaction is a mystery to many. Let us see what the term means in its simplest analysis. The obligation of a bank is, as we have seen, to pay checks drawn on it in currency. This it will be obliged to do if the checks are presented over the counter. But it is impossible for the holder to so present most of the checks received and the work of presenting is dele- gated to banks which make the presentment through the mails. This is particularly true of out of town checks that cannot be collected through the medium of the clearing house. As a matter of fact, the holder of a check merely wants credit for the amount, against which he may draw, and is not concerned about the manner in which the collecting bank receives pajTuent. What the collecting bank wants is not currency, for as a rule banks in the smaller places receive more cash than they can use in their local transactions and find it necessary to ship the surplus to their city correspon- dents. A check on a city bank that will be immediately credited to its account is a much more desirable form of payment than the money itself. In the develop- ment of banking in this country, certain cities have been selected as "par points" — that is, checks drawn on banks in these places are received at par everywhere, and are preferred even to cash itself. Thus a check on 92 EXCHANGE 93 a New York or Chicago bank would be a par check and be as readily received as money. Creating Reserve Accounts. In order to draw checks on their city correspondents, the country banks must maintain balances in such banks. To create these balances money must be shipped by express, with its attendant costs. If, there- fore it costs a certain amount per thousand to create these balances, the country banker argues that if he pays checks drawn on his bank in the form of a draft, let us say on New York, the holder of the check should bear his proportionate share of this expense. Thus, in paying a thousand dollar check the paying bank would deduct, say forty cents, to compensate it for the cost of shipping currency to make the check good when presented. There is a profit in this charge, for as a matter of fact, the balances so created in the city banks are not the result of money shipments, except to a limited degree, the bulk of such balances being in the form of checks on other city banks that will be paid at par and the only cost is the postage and stationery. And inasmuch as the charge is never less than ten cents, the toll collected by the country bank for paying its checks is much greater than the cost of creating the balance drawn against. In fact, this profit is often considerable in the course of the year and in some cases sufficient to pay the dividend. In a country bank in New York with deposits of half a million this profit is over $3,000 a year. By clearing house arrangements and rules, member banks are not allowed to bear this expense for the depositor or to in any way compensate him for these charges. (See New York Clearing House rules page 111,1 12) . Therefore the charge accrues to the last holder 94 THE BUSINESS MAN AND HIS BANK of the check, who is compelled to pay it by the bank through which the check is collected. The latter must pay the toll to the country bank, and only as it can "bunch" its checks on certain banks — that is assemble such checks from various depositors and collect in one letter and as one amount, for which it pays an agreed rate, can it make a profit. It may charge three deposi- tors a dollar to collect their checks on a certain bank, while it will have to pay but 60 cents. Therein lies its profit from exchange. The real sufferer is the depositor who may or may not reimburse himself by adding this charge to the price of goods. Let us illustrate by a typical example: The First National Bank of Spencertown, N. Y. maintains an account in the National City Bank of New York. It ships $20,000 in currency weekly to the City Bank, but sends checks on New York banks to the amount of $25,000 a day. The cost of creating this balance is therefore the expressage of $20,000 — about $8 and about $2 in postage and stationery. The First National Bank of Buffalo receives a $1,000 check on the Spencer- town bank, which it sends to the latter for payment. The Spencertown bank draws a draft on the National City Bank for $999 and remits to the Buffalo bank, which in turn sends it to the Chase National Bank for credit to its account. The Buffalo bank could have sent the check by express or messenger and demanded cash, but the dollar ''exchange" would be cheaper and quicker. The Spencertown bank in substance says to the Buffalo Bank ''We stand ready to pay this check in cash at our counter; but if you want a draft on New York, it will, or has, cost us $1 to ship the currency, and this charge we exact from you. You can get it from the holder of the check or not as you Hke." The rules of the Buffalo Clearing House prevent the EXCHANGE 95 bank from assuming this charge and so it is charged to the depositor. As a matter of fact, it may have cost only 25 cents actually to create this thousand dollar balance in New York and the 75 cents is the Spencer- town bank's profit from "exchange." The country banks have found this a profitable line of business and are giving it up only under pressure from the Federal Reserve Banks which aim to make every bank check worth its face value anywhere, as it should be. Exchange is now, as a rule, charged only by a relatively few country banks. The reason why the city banks make an exchange charge is due to the fact that their country correspon- dents make the charge to them. As a rule the city banks make no charge where the check is paid at par; and inasmuch as approximatey two-thirds of the banks are now paying their checks at par, exchange is gradually being eliminated from banking transactions. In due time the Federal Reserve Banks will force all banks to pay their checks at their face value. ''Par Points." It is a common error to treat the bank check as cur- rency and worth par. This is particularly true in those places where the exchange question does not enter and all checks are credited at par by the banks, and the depositor is allowed to draw against the funds immedi- ately. But there are certain costs that attend the collection of bank checks that must be borne either by the bank or by the customer. Where checks are collected at par the bank assumes this cost and endeav- ors to compensate itself in other ways. Where the ex- change is charged against the customer he of course bears the expense. By virtue of the banking arrangements as they have 96 THE BUSINESS MAN AND HIS BANK developed from time to time and through ruhngs of the clearing houses and Federal Reserve Banks, checks on certain places are received at par. Thus a check on a New York bank will be received by practically any bank in the country at par, for two reasons: first because most banks keep accounts in New York and want New York exchange (checks drawn on New York banks) for the purpose of creating a balance in their New York bank; and second because all New York checks are paid at par and there is no exchange cost attending their collection. Checks on certain other cities, such as Philadelphia, Albany, Boston, Providence, etc. are also par points and no exchange follows their collection. Other cities, such as Syracuse, N. Y., have formed agreements among the banks to pay all their checks at par and such checks should pass anywhere at par because there will be no exchange deducted when the check is finally paid. Checks which are collectable through the Federal Reserve Banks are also free from exchange charges and are therefore par checks. CHAPTER XII PROFITABLE AND UNPROFITABLE ACCOUNTS In a book of this nature, intended for general circula- tion, it is impossible to give more than a general sum- mary of check collection arrangements, leaving it to the reader to take the matter up with his own bank and ascertain its exact methods in this regard. It will generally be found to have special arrangements for its check collections. One bank will have one set of rules and another a somewhat different set, depending upon its location and its city connections. It will also have its own rules regarding exchange charges, uncol- lected funds, balances, interest, and other such items and only an interview with the officers will give a clear understanding of its rules. There are two main customs in this regard that ob- tain generally. The first is that the bank will charge its customer the exchange on checks deposited by him, so that the cost to it of collecting his checks is merely the labor and postage, which in the aggregate may be turned into a profit from exchange charges. The exchange may be deducted daily from the deposits or computed monthly and charged back. If the bal- ance is sufficient, the bank may also allow interest on the daily balances at an agreed rate. The second is that the bank assumes all costs of collection and pays no interest on the balances. Whether or not this proves profitable depends upon the balance and the nature of the checks deposited. There is another custom of requiring a time limit, 7 97 98 THE BUSINESS MAN AND HIS BANK within which a check cannot be drawn against. This is the rule in the Federal Reserve Banks, and is based upon the time necessary to send the check to the place of payment and receive payment in the form of a draft on a city bank. In other words, the bank will not pay against the check until it has reduced it to ''reserve." The time varies from one to twelve or founteen days, depending upon the distance the check has to travel. Thus, a check deposited in New York and drawn on Bridgeport, Conn, will be paid on the third day; checks on Western cities from eight to twelve days. In addi- tion to the time limit, there may also be an exchange charge, due to the fact that the paying bank imposes such a charge. No general rules can be given, except those prescribed by the Federal Reserve Banks, which see under Chapter XXV. It must not be forgotten that when a bank allows a customer to draw checks against uncollected items, it is essentially paying a check before it has been paid — in other words, loaning the customer the amount with- out interest until it receives credit for the check. And unless the actual balance is large enough to ofifset such losses, the account is unprofitable. Let us illustrate this point by examples. Here is a meat house that maintains a balance of $10,000 without interest. It deposits large numbers of checks drawn on country banks within fifty miles of the collecting bank. Such checks aggregate $10,000 a week. The bank must pay the country banks }^{o of 1 per cent, or $10 weekly in exchange in order to reduce these checks to New York funds. This costs the bank $500 a year not including postage, stationery and clerk hire. The bank must keep a reserve of 15% or $1,500 of this deposit with its reserve agent at 2%. The balance, $8,500 may be loaned at 6%, or $510 a year, making PROFITABLE AND UNPROFITABLE ACCOUNTS 99 the total income $540 from this account. On this basis it would be a losing account, while apparently it was a profitable one. Upon making an analysis such as above outlined, the bank would be justified in charging the cost of collection to the customer, and in return pay him interest on the balance. It might then show a profit. But if the checks could all be collected at par — that is, all the banks on which these checks were drawn were to remit in New York funds without charge, the account would be decidedly profitable. But only a detailed analysis can determine whether an account that is active and deposits large numbers of checks daily is desirable or not. Here is another example. Take the account of a large hotel. The deposits average $4,000 a day, part in cash and part in checks that are collectable at par. The hotel draws checks as fast as deposits are made and against the daily deposit there are daily checks that leave practically no balance at the end of the day. Most of the checks are on New York banks and are paid the next day through the clearings; but the bank's drafts that pay the checks drawn on itself are Ukewise paid the next day. The currency deposited by the hotel must be shipped to New York to maintain the balance, and even in such a close working arrangement it is extremely doubtful if the bank breaks even, and the account, while seemingly large, might be a losing one. There are banks that work on the mistaken theory that a large volume of business is necessarily a profitable business, and that if they keep a large force busy they must make money. In the final test such banking proves unprofitable and the banker does not know why. Other banks analyse their business, apply analytical brains to these problems and endeavor to effect a working 100 THE BUSINESS MAN AND HIS BANK arrangement that will be satisfactory to themselves and their customers. The factors that enter into a satisfactory bank balance are as follows : The average balance; the nature of the deposits; the cheek collecting arrangements of the bank; the interest paid on the balance. For instance if your deposits were all cash, the bank could pay interest and allow checks to be drawn immedi- ately upon making the deposit. If the checks deposited were in the main checks that require three days to collect the bank would be justified in holding back credit on deposits for three days; that is, the deposits for the last three days could not be drawn against. If they were checks that required a week to collect, then a week's deposits should be held back. In fairness to yourself and the bank a test should be made of your account to determine its profitableness, and only such a test where all the elements connected with it are considered, will satisfy the banker that your account results in a profit. When the Federal Reserve Banks began to collect checks the charge was made per item, usually 1 cent per check handled. This was subsequently abandoned and beginning June loth, 1918 checks were collected without any charge whatsoever, provided they were drawn on banks which paid at par. It can readily be seen that the check that travels from bank to bank and reaches the place of payment after a long journey is a form of fictitious currency^ — sort of a floating credit that is undesirable. For instance, you deposit a check in your bank and call it a cash balance. It is not. The bank in turn sends it to its correspondent and calls it reserve, which it is not. That bank in turn sends it to its correspondent and PROFITABLE AND UNPROFITABLE ACCOTNTS 101 calls it reserve, and so on until the check is finally paid. Thus there is a huge amount of ''check money" floating through the banks all the time. The Federal Reserve Bank intends to reduce checks to actual balance — to get them paid in the shortest possible time — ^by sending by the most direct route, just as the business man wants his mail to go direct and not by a circuitous route. The Journey of a Bank Check. Heretofore in the attempt to avoid the exchange charges and to favor certain friends with their business, banks have resorted to indirect routing of checks so that they often travel for a week or ten days before reaching the place of payment. That this is utterly wrong will be seen from two illustrations that are typical of many. A check was drawn on a bank in Sag Harbor, L.L, and sent to Hoboken, N.J. The Hoboken bank sent it to New York. From there it should have gone direct to Sag Harbor for payment, but instead it was sent by the New York bank to Boston^ — why is not apparent. From Boston it went to Tono- wanda, N.Y. The Boston bank no doubt had some friendly arrangement with the Tonowanda bank and desired to give it some of its collections. From Tono- wanda it went rightly enough to Albany, from Albany to Port JefTerson; (an Albany banker previously had made a trip on Long Island and made arrangements with several banks on the Island to send them Albany business). From Port Jefferson it went to Far Rock- away; Far Rockaway to New York; New York to Riverhead (a few miles from Sag Harbor) ; Riverhead to Brooklyn and from Brooklyn to the place of payment. The circuitous travels of this check need no comment. Figure up the many times it was handled, indorsed, listed, and the delay in its final redemption with all its 102 THE BUSINESS MAN AND HIS BANK attendant dangers, and no other argument for quick collection facilities is needed. Here is a case that came under the writer's notice a few months ago. A check was drawn on the writer's own bank (Bank of Rockville Center, L.I.) and deposited in a bank three blocks distant. From there it went to Jamaica, L.I; from Jamaica to New York, New York to a bank two blocks from the Bank of Rockville Centre; from the latter to the place of payment, — a journey of fifty miles whereas it could have been paid over the counter in the next morning's exchanges with no cost or loss of time. To obviate such practices the Federal Reserve Banks have endeavored to make direct collections thereby reducing checks to available funds in the shortest time possible. To quote from the circular of the New York Federal Reserve Bank as of June 1, 1918: Check Collection System of the Federal Reserve Bank Direct Routing. "The requirements that the Federal Reserve Banks should collect checks, etc. was incorporated in the Act not only to provide an eco- nomical and direct method of collecting checks but for the more im- portant purpose of reducing the "float" caused by indirect routing of checks as well as the so-called "reserves" created thereby. "We anticipate that the suspension of service charges as planned will remove one of the principal causes of the indirect routing of out- of-town checks. We beg to express the hope that the member banks will co-operate with us in the effort to bring about direct routing. Balances built up in one Federal Reserve district can be made im- mediately available, through the Federal Reserve Bank, without cost, in any other such district and all checks should be routed direct to the Federal Reserve Bank of the district in which the first indorsing bank is situated, thus materially reducing the float and the atten- dant cost and labor of the several banks which handle the checks. PROFITABLE AND UNPROFITABLE ACCOUNTS 103 "Through the many branches of Federal Reserve Banks whicli are now in operation, it has become possible to reduce the time of collect- ing checks drawn on these branches and on banks situated in their district. "A par list showing the banking institutions checks upon which can be collected by the Federal reserve banks at par, is published and distributed by the Federal Reserve Board from time to time. In September, 1916, there were 14, 656 banks on the par list; in Septem- ber, 1919, there were about 21,000 and the number is steadily increas- ing. It is believed that the banks on the par list will include over 95 per cent, of the volume of checks in circulation and a still larger percentage of the volume of checks which member banks in this district are called upon to collect. "Recognizing the value to member banks of having their funds on deposit with us immediately available in any other Federal reserve district, we have' arranged to make telegraphic transfers of funds to banks in other Districts absolutely at par, no charge even being made for the cost of the telegram. In order that there may be no delay in making these telegraphic transfers and in transacting other busi- ness between Federal Reserve Banks, private telegraph lines between all the reserve banks and their branches as well as with the Federal Reserve Board in Washington are now in operation. When Proceeds of Items are Available. "All checks drawn on banks situated in New York City (Borough of Manhattan), received by 9 A. M. will be immediately credited at par and will thereupon become available as reserve or to pay checks drawn. Checks drawn on members of the New York Clearing House Association, however, will not be received from members of the New York Clearing House Association. "For all other checks immediate credit entry at par will be made, but such credit will not be available as reserve or to pay checks drawn, until the appropriate period indicated on the time schedule has elapsed. These periods are based on the mail time required for items to reach the paying bank plus the mail time required for the paying bank to remit to the Federal reserve bank of its district. By aver- aging the mail time it has been possible to include all points in the country in four divisions, namely, 1, 2, 4 and 8 days. The schedule is subject to change, and for convenience it has been arranged by States rather than by Federal reserve districts. "Checks drawn on member banks in this Federal reserve district will be forwarded directly to such banks and charged to their accounts 104 THE BUSINESS MAN AND HIS BANK after sufficient time has elapsed for us to have received advice of payment. " Checks drawn on non-member banks in this district will be sent to member banks wherever satisfactory arrangements are made, or may, in our discretion, be sent direct for remittance. "Checks drawn on member or non-member banks in any other district will be sent to the Federal Reserve Bank of such district for collection and settlement. "Unpaid checks not subject to protest must be returned on the day of receipt. Protested checks must be returned not later than the day after receipt. Unpaid checks must not be held for any purpose whatsoever except for immediate protest. Restrictions as to Indorsements. "To insure direct routing this bank will not accept checks drawn on a bank located outside this district, when such item bears the indorsement of a bank located outside of this district. The other Federal reserve banks will adopt similar rules. Sorting Items. "In order to expedite the forwarding of items, member banks are requested to sort their items into the following classes and list each class on a separate sheet: (o) Items drawn on members of the New York Clearing House, (b) Items drawn on other banks in Borough of Manhattan, (c) Items drawn on one day points, (d) Items drawn on two day points, (e) Items drawn on four day points, (/) Items drawn on eight day points. They are also requested to print on their own checks and the checks used by their depositors the figure "2" (signifying Federal Reserve District No. 2), preferably in a large skeleton figure in the center of the check. Collectible at par through the Federal Reserve Bank of New York. "Member banks are entitled to place the words, "Collectible at par through the Federal Reserve Bank of New York," on their own checks and the checks used by their depositors. CHAPTER XIII COLLECTION OF CHECKS THROUGH THE CLEARING HOUSE The most expeditious method yet devised for col- lecting bank checks is through the clearing house. While the term is a common one in business cu'cles, the methods and the machinery of the clearing house are as Greek to the great majority. And yet it is sim- plicity itself. When we speak of a clearing house, ordinarily the mind pictures a fine building such as the New York Clearing House; but a clearing house may be simply an organization and do its work just as effectively in a 12 X 16 office as if its work were done amidst marble and bronze. The work of the clearing house has an immediate bearing on business since it makes for efficiency in the collection of the checks deposited and expedites payment of checks drawn so that the business man is interested in all that pertains to its practical operations. By reason of the quickness with which a check is paid through this instrumentality, funds are placed at the disposal of the depositor in much quicker time than could be possible otherwise. The working of the exchange machinery is so smooth and its accuracy so dependable that it can be relied upon in the same sense that the railroad and the mails may be relied upon to do their work on time. Thus in depositing a check any- where within the scope of the clearing machinery, the depositor may depend upon the check being cleared by a certain time; and if payment is refused he can depend 105 106 THE BUSINESS MAN AND HIS BANK upon a quick return with the same assurance. There- fore a clear understanding of what the clearing house is and what it does, and how it does it, is appropriate in a work of this kind; although it is more technical than other phases of this work. The New York Clear- ing House being a model for all the country, a review of its working rules and practices will give a clear under- standing of the work of a clearing house. The Purpose of the Clearing House. The purpose of the clearing house is well expressed in the preamble of the New York Clearing House, which reads as follows: "The object of the Association shall be the effecting at one place of the daily exchanges between the members thereof and the payment at the same place of the balances resulting from such exchanges, the promotion of the interests of the members and the maintenance of conservative banking through wise and intelligent cooperation." These associations are purely voluntary, there being no compulsion in the membership. There are many advantages, the chief of which is the daily exchange of checks and the harmonious working together of the banks, particularly in times of financial stress. In New York member banks must have a capital of at least a million dollars and the entrance fee is $5,000 for those whose capital does not exceed five million, and $7,500 for those whose capital exceeds five million. Trust companies are admitted on the same basis as banks. Members are required to furnish the manager a weekly report giving the average daily condition and the actual condition at the close of business on Friday. The following items are reported: Loans, discounts, investments, reserves, deposits and circulation. These figures are published for the information of the public. The expenses of the clearing house are borne by the COLLECTION OF CHP]CKS 107 members in proportion to the average amount of ex- changes sent to the clearing house during the preceding year. The annual payment for this purpose shall not be less than $1,000. The clearing house also has its staff of examiners, who work independently of all other bodies, and examine only member banks. These costs are levied pro rata based on gross assets. Member banks are allowed to clear for other banks approved by the clearing house authorities and are charged a fee of $1,500 yearly for this privilege. They must also abide by clearing house rules as laid down for non member banks. Banks clearing for non members are liable as for their own transactions, until proper notice of discontinuance of the clearing function. Two clearings are now made in New York, one at nine and the other at ten o'clock. The balances at the nine o'clock clearing are carried over and included with the ten o'clock figures and one settlement is made. Any errors in the exchanges and returned items are adjusted directly between the members. There is now an after- noon exchange of returned items except those missent, under the same rules and procedure as at the morning clearing. The Clearing Principle. The term "clear" may be expressed in the slang 'Ho swap;" and the bank that "clears" a check simply exchanges it for another drawn on itself, and receives or pays the difference in money. Perhaps the idea can be best explained by a simple illustration. The Chase National Bank of New York holds, at the end of the day, checks to the amount of $1,000,000 against the Irving National Bank. These have come in from various sources, such as out of town depositors and through the paying and receiving tellers. They have 108 THE BUSINESS MAN AND HIS BANK been sorted out from all the other checks and run up on the adding machine. The Irving likewise holds checks received from similar sources to the amount of $500,000 against the Chase. The ordinary way would be for the Irving bank to pay its debt to the Chase in cash or some other acceptable form, and the Chase would pay the Irving what it owed. Put any sixteen year old boy on this proposition and he "^vill soon see that if the Irving pays the Chase $500,000 the two reciprocal debts are cancelled. There is the saving in the handling of one amount instead of two, and the use of half a million in money against a million and a half. The bank messengers of London realized the value of this principle years ago and met at a convenient place and exchanged their checks. In this way the clearing house idea originated and has obtained ever since. And if it would be inconvenient for two banks to settle their checks between each other in cash what shall be said of the problem if a hundred banks were to attempt to pay their mutual debts without the operation of this efficient system? The Clearing Process. The work of the clearing house is simple, yet excep- tionally efficient. The great problem is to get the checks ready for the exchange process or ''the clearing." As the checks come pouring into the bank through the mails and the windows they must be sorted, into four classes. All checks drawn on the receiving bank are sent to the bookkeepers; those on out of town banks are sent to the transit department for collection through the mails; those on banks in town and clearing through the clearing house are sent to the clearing house depart- ment, and those to be presented by messenger are sent to the collection department. COLLECTION OF CHECKS 109 At the close of the day there will be a package of checks for each bank in the clearing house association. The amount is listed bj^ adding machine and the total placed on the envelope. These are held over night as "items for the clearing house" or ''exchanges for the clearing house," whichever term is desired. They are treated as cash, for they will be paid the next day. The checks that come into the bank through the mails during the night are also sorted and added to the day's checks, so that in the morning all clearing banks' checks that have come into the bank are ready for clearing. When the packages are ready the clearing house clerk makes a list of the banks against which he has checks for payment and the amount against each. In other words he knows how^ much each bank owes his bank. These exchanges are so heavy in some banks that it requires two men to carry the package to the clearing house. In the clearing house there is a horseshoe arrangement of desks, behind which sit clerks from the various banks. Their duty is to receive the checks drawn against their banks. Therefore each bank has a man at the clearing house laden down with the checks his bank holds on other banks, and a man to receive the checks drawn against his bank. The clearing is done on the tick of the clock and when the gong strikes the line begins to move. The clerk standing in front of the desk of the National City Bank, for instance, will deliver his package against the City bank and take the initials of the clerk receiving the package on his sheet. He steps to the next desk and repeats the operation, so that when he has gone the rounds, he w^ill be before the desk he started from, with empty wallet. Meanwhile the receiving clerk from the same bank has received all the checks drawn against his bank. Knowing what the bank brought to the 110 THE BUSINESS MAN AND HIS BANK clearing house from the sheet heretofore mentioned, and having all the checks against the bank he can quickly tell whether his bank owes the other banks or they owe him. The figures on the sheets are sent to the manager on tickets as the men enter the clearing house, so that the manager makes his own calculations, which must tally with the work on the floor. In a few minutes, usually less than ten, the whole clearing process is over and the clerks begin to make their proofs. When the work is in proof the day's work is done. Forty-five minutes is allowed for the clearing and the proof. The checks have in the meantime been taken to the bank and are ready for examination and payment. If the bank owes the other banks it pays the amount direct to the clearing house, and the clearing house distributes it to the banks entitled to it; and if the bank is creditor to the other banks, it receives from the clear- ing house the amount due it in one sum. In short, the banks pay the clearing house what they owe and the clearing house pays the banks what they have due them, in one sum, rather than have many payments among themselves. In some places, notably New York, these settlements are now made by debiting or crediting the amounts to the accounts of the various banks in the Federal Reserve Bank, thus avoiding the use of money, or its representa- tive, entirely. The rule is that the banks pay what is against them, irrespective of whether the checks are good or not; these adjustments being made directly between the banks. Missent items must be returned to the bank making the error direct by hand and not through the exchanges. The settlements between member banks are made in COLLECTION OF CHECKS 111 gold, gold notes, greenbacks, clearing house certificates, or by adjustment thi*ough the balance of some other member bank or the Federal Reserve Bank, (the latter now prevailing). (Clearing house certificates are cer- tificates issued against gold and lawful money deposited with the clearing house, and are equivalent to the money itself. This obviates the handling of the money). Member banks are not allowed to send through the exchanges checks, drafts, notes or bills of exchange having a qualified or restrictive indorsement thereon, such as '^for collection" or ''for account of" or ''pay any bank or banker" or similar indorsements, unless all indorsements thereon are guaranteed by the bank sending the same through' the clearing house. The interest rates on deposits are regulated by the clearing house and the intent is to prevent undue and costly competition for business by such inducements. The members and non members clearing through the clearing house are not allowed to pay exchange or other charges or to allow time in connection with the collection of checks collectable through the Federal Reserve Bank, but collected through other channels, in excess of the charges which would have been payable or the time allowed had such item been collected through the Federal Reserve Banks. There is a scale of fines from one to 10 dollars imposed upon member banks for various offences, such as errors in the work brought to the clear- ing house, errors in the work at the clearing house, errors in footings, disorderly conduct, delay, failure to pay the balances within the time limit, missent items, etc. These fines are for the purpose of keeping the work up to a high state of efficiency. The clearing house regulates the charges to be made by the member and non-member clearing banks for the collection of checks and other items. These charges 112 THE BUSINESS MAN AND HIS BANK are from }-i to >^o of one per cent., according to the place drawn on and the nature of the item. Some points are discretionary. The minimum charge is ten cents, but checks on the same point may be treated as one amount and the charge figured on the total. These costs are passed on to the depositor, for by the rules of the clearing house they are collectable at the time of the deposit and not later than the tenth of the follow- ing month. No bank is allowed to make any abate- ment of these charges, or rebate or return of the same, or in any other way to allow them. The penalty is $5,000 for breach of this rule. Since 1917 the New York Clearing House has main- tained a department for the collection of non-clearing house items on certain individuals, firms and corpora- tions in New York City. Such checks are deposited with the clearing house and a receipt is issued in return, which is payable through the exchanges the next day. These collections are made by messengers. CHAPTER XIV OVERDRAFTS One of the most delicate, as well as the most annoying features that affect the })ank and the business man is overdrafts. Every bank has it to contend with, and has to find a solution as best it can. Many an over- draft is created innocently, while others are the result of "sailing too close to the wind." The merchant who is doing a steady business which brings in a daily amount of cash, frequently draws checks in anticipation of his daily receipts. If for any reason these are curtailed or his collections are slow, the theory that his daily deposits will offset his daily checks, does not work out. For instance, a hotel doing an average business of $2,000 per day may find its receipts for a few days less than anticipated, and consequently, the checks will be pre- sented faster than the deposits are made. This condi- tion compels the bank either to refuse the checks, or to allow an overdraft. It must be clearly understood that an overdraft, if allowed, is a courtesy only, and the depositor has no right legally or morally to expect the bank to honor checks unless the account is good for the amount. We have seen what the contract of the bank with the depositor is, namely that it will pay checks in the sum ordered, to the party designated, provided his account is good for the amount at the time the checks are pre- sented, but it is under no obligation to honor a check which is not supported by a bank balance. The busi- ness man cannot expect the bank to call him up and 8 113 114 THE BUSINESS MAN AND HIS BANK notify him that certain checks are presented and are awaiting payment, for such a practice would necessi- tate the employment of a clerk who did nothing else but follow up short accounts. An overdraft is a loan without security, and is not in favor with the courts. Being regarded as a loan and due on demand, it may be sued upon. Where a bank refuses to pay a check because of insufficient funds, no presumption arises that the check remains outstanding for payment. The bank is under no obligation to reserve from future deposits an amount sufficient to pay the sum. It frequently happens that a customer upon finding that the account is short will leave the check with the bank for collection. It thus becomes in the nature of a standing presentment, and the bank would, of course, be obliged to pay the same out of the first deposits that would create a balance large enough to warrant payment. The drawing of a check by a depositor in an amount larger than he has on deposit has been held to imply a promise on his part to repay the amount overdrawn, and the bank may recover thereon. In the absence of an agreement, the bank cannot collect interest on an overdraft until the money has been demanded and the payment refused, but after demand has been made, the interest will run as of that date. During the past two or three years, there has been a concerted movement to eliminate overdrafts, and the comptroller of the currency has forbidden national banks to allow customers to overdraw. This is a step in the right direction, and if enforced, is often because the bank has no other alternative. If therefore, as a business man you would keep in the good graces of your banker, do not ask him, or expect him to allow overdrafts; and if your checks are returned OVERDRAFTS 115 because the balance is insufficient, you, and not he, are to blame. There has recently been enacted in New York a law to the effect that the drawing of a check against an insufficient balance is a misdemeanor and is a penal offence. In other words, if the depositor has not the funds on deposit at the time the check is drawn, and it is returned unpaid, and remains unpaid for ten days after protest or demand, action may be brought for having committed a crime. This law has been availed of in many instances, complaint having been lodged with the District Attorney as for any other crime, and indictment and trial have followed. Altogether it is a much needed, if drastic, law. CHAPTER XV PROTEST The business man will not deal long with his bank before he receives checks returned unpaid and ''pro- tested." This feature of banking is closely associated with checks and their collection, and at the same time applies to notes and drafts that are unpaid at the time they are due. Let us see what protest means, legally and practically. When the protested check, note or draft comes back it will have attached to it a paper and carry a fee of from 75 cents to $1.50. The business man may rebel at this charge and conclude that it is part of the bank's "graft" — an easy way to make money. Whether this is true or not is not the present issue; but it may more properly be called a penalty for failing to keep a contract. When a check or a note is indorsed the indorser warrants among other things that he will pay it, if the instrument is presented according to its terms, at the place, at the time and to the party obligated to pay it and payment is refused, and the necessary steps are taken upon the dishonor. Now what are the "necessary" steps? They are that it shall be presented according to its terms and notice of its dishonor sent to the several parties thereto. The course of such a transaction would be as follows: here is a check drawn on the First National Bank of New York. It is properly dated, signed, etc., and is presented to the bank, having been received through several other banks which have indorsed it. The maker is not good for the amount. 116 PROTEST 117 Payment is refused. The bank presenting is bouud to protest the instrument if it would hold the indorsers through whose hands it passed. Therefore the bank's notary enters in his protest book notation to the effect that the check, describing it, was presented on a certain day, at the place named, and payment was refused. This is called the "notation of protest." He must promptly notify the prior parties, or lose the rights against them. He therefore sends a notice of protest to each one. This notice merely testifies to the fact that presentment was duly made, and payment refused. Not having the addresses of all the indorsers, he sends the notices to the party from whom he received the check, enclosing the notices to the other indorses for his indorser to forward. They in turn have the same time as he to forward the notices. Time of Notice. It is important that the law be followed if protest and notice of nonpayment is to be effective. The time is as follows: If the party giving and the party receiving the notice live in the same place, it must reach the latter during the next business day. If the party giving and the party receiving the notice live in other places, the notice must be mailed during the next business day after dishonor. This mailing may be done at any branch post office or in any letter box under the control of the post office. If this is properly and promptly done, the indorsers are bound to pay the amount to the holder. If not they are released. The practical reason is that the indorser, having prompt notice of the nonpayment of an instrument which has passed through his hands may protect him- self. Here for instance is a note made by a grocer in Ohio, payable to a jobber in New York. It is dis- 118 THE BUSINESS MAN AND HIS BANK counted by the jobber's bank and sent to the maker's bank five days before it is due, for payment. On the day it is due the note is not paid and the bank holds it over for a few days, and sends it back unpaid. Be- fore the note reaches the jobber the maker goes into bankruptcy, and the jobber has no redress, nor could he act promptly, because he had no knowledge of the nonpayment. Had he been notified promptly, he might have withheld a shipment of goods about to go forward. He might have levied on property of the mak- er — in many ways he might have protected himself. Ignorance of the note's fate injured him, and in law and equity he should be released from his obligation as indorser. CHAPTER XVI CREDIT AND BANKING The ultimate end of banking is to make money. For this purpose the bank is organized and to this end it is operated. The stockholders have invested their money in the enterprise with dividends in mind, and they demand as their lawful and financial right reim- bursement for their investment and their risk. However much the bank may play the role of a pub- lic benefactor, a business convenience and a commercial necessity, it must, in the last analysis, prove a profit maker, else it becomes not only a losing venture for its stockholders, but a menace to the well being of the financial world. If it makes money for itself, it natur- ally becomes a strong and safe institution; but if it is not successfully operated it jeopardizes the funds of its creditors as well as its own. Therefore for its own as well as for the sake of its depositors it must operate profitably. In order to operate successfully it must have an income that is certain, steady, and of sufficient volume to pay expenses, meet the inevitable losses, and leave a margin of profit sufficient for divi- dends and for building up a reserve or surplus fund. A bank has one principal source of income — interest. This comes from investments in bonds and other se- curities, mortgages, and from loans and discounts. Some banks are large holders of securities for the rea- son that there is not enough local demand to absorb their funds, and as a result the accumulations of money are invested in securities. These may be called ''bond 119 120 THE BUSINESS MAN AND HIS BANK holding banks." Many country banks are of this class, although there are some large city banks also of this character, having become so from choice. There are others which may be called ''discounting banks," the bulk of their investments being in the form of dis- counts for customers, and in commercial paper bought in the market. Savings banks are large holders of bonds of various kinds, and are large lenders on mort- gage security, in fact, together with the insurance and title companies, they are the leading factors in the mort- gage market. But whether the income is from bonds, mortgages, or promissory notes, it is interest, and such income constitutes the principal earning power of the bank. Therefore to earn money the bank must lend money, and only as it lends or invests (which is essenti- ally the same thing), can it earn. The Science of Banking. The science of banking consists of lending money and getting it back again. Rarely if ever does a bank fail through its bond investments. It is in the loans that it meets its losses or makes its profits, and by the char- acter of the loans and the loaning policy it may faii-ly be judged. Some banks require security for everj^ loan and some require little or no security at all. Some bank men are good credit men, and some never acquire the credit sense. Some select their risks with care and intelligence, and some depend upon luck and a kind providence to bring back the loaned money. It is obvious that the business man should not deal with a bank that is loose in its credits; for while it may be to his advantage to borrow at will, it is likewise to his peril. Neither does he want to deal with a bank that requires a dollar of good security for a dollar's worth of credit. He wants the bank to use the same CREDIT Ax\D BANKING 121 degree of care that he uses or ought to use in his own affairs. He wants a helpful, but safe, bank, one that knows a legitimate business risk and is willing to take it. The bank expects its customers to borrow, for only by so doing can it be helpful to them and profitable to itself. It is willing to risk its money, or to be correct, the money of its depositors and stockholders, with that of the borrower in legitimate business enterprises. It will go partner with those whom it learns to trust. Credit and Business. Credit and business, and credit and banking are so closely associated that unless the business man under- stands the fundamental principles of credit as they apply to banking, he cannot get the banker's viewpoint and thereby loses the banker's support and cooperation in his business affau*s. On the other hand, unless the banker understands business and business methods, he cannot run a safe or a helpful bank. It is only as credit is studied in its broad aspects, and its benefits analyzed to the last minute detail that its importance and beneficial results to the busi- ness world can be appreciated. Any attempt to place a value upon these vast benefits would prove futile, and will not, therefore, be attempted, but it may prove help- ful if w^e picture the business world without the element of credit. In the first place there would be no banks, for these are credit institutions to the last degree. No money would be invested by the stockholders and no deposits would be made by the public if the factor of trust did not exist between the bank and its stockholders and depositors. Therefore there could be no banks. There would be no paper money, for paper money is a form of credit — trust in the Government, or trust in the bank, that the promise expressed thereon will be fulfilled. 122 THE BUSINESS MAN AND HIS BANK Merchants dealing with one another would have to do so on a cash basis, this cash being metallic money. No goods could be sold on time. The manufacturer would not have time to turn the raw material into finished product before paying for his supplies. The jobber could not open account with his customer, allow him to place the goods on sale, and receive his pay in due course from the proceeds of the sales. The retailer could not open account with his customer and allow him to buy goods and pay for them as the consumer earned his money. Great corporations such as railroads, gas and electric companies, manufacturing concerns, etc., could not borrow money for buying land, rails, cars, machinery and other equipment necessary to operate, by selling their bonds. Governments could not borrow money to erect buildings, build battleships, equip armies and wage war. States could not borrow to build roads, bridges; asylums, and other public works. Cities could not pave streets, build sewers, water systems, parks and docks. Individuals could not build homes and pay for them out of their daily earnings. In short, the element of credit touches all we are, all we do, and all we hope to have. Credit is the main- spring of life's activities, the bed rock on which indi- viduals, communities and nations build their business structure. It is the life blood of our material existence. Credit Defined. There have been many definitions of credit, some expressive and some vague, but the most inclusive of all is ''a -present right to a future payment." Get the idea. In the conduct of business we handle many things,— things that exist and things that do not exist. We buy and sell the articles of life freely, but we can buy and sell the rights to these articles just as truly. CREDIT AND BANKING 123 " Rights." Occasionally on the stock exchanges there api)ear what are termed "rights" — that is, some corporation has offered its stock to the stockholders at a certain price, usually below the intrinsic value. The stock- holders of the concern and they only have the right to buy the stock at the figure named; but those who do not wish to avail themselves of the privilege may sell their right to subscribe, and this right is as enforceable as the ownership of the stock itself. These "rights" are offered the public at a certain price and are traded in as freely as the stock itself. If I hold a promissory note of an individual, I hold nothing but a piece of paper — a right. This right is to collect the debt when due. I can sell this right by "discounting" or selling the note to another. I merely sign my name across the back and give it to him for value and he in turn has the right to collect. He may take the note to the bank and discount it. The bank now has the right and can enforce it. The real thing is the payment which is to be made at the time stipu- lated. The evidence of the right to receive the real thing is the note, and if the note is not paid according to its terms I sue the maker to enforce my right to col- lect the real thing. These present rights to future payments are surrounded by the powerful arms of the law. If you do not respect the law as a collector of debt just get in debt. Forms of Credit. Let us briefly review the forms of credit as they exist in business and banking transactions. These forins of credit can best be seen by a simple illustration, which I have used elsewhere and have yet to find a better one. Let us assume that a farmer drives 124 THE BUSINESS MAN AND HIS BANK into town with a load of produce and after due negotia- tion with the produce dealer settles upon the prices. The form of payment must then be determined. The dealer says to the farmer: ''I will give you credit for this"- — ^meaning he will open a book account with the farmer and credit him the amount, thus making the farmer the creditor, and the dealer the debtor. The only evidence is a memorandum of sale and the open account on the dealer's books, commonly called an account payable — a Uability. On the farmer's books it would be the reverse and become an account receiva- ble — an asset. The terms of credit may be as agreed upon, ten days, a month or two, but not as a rule longer than three months. ''No", says the farmer, I do not care to have this transaction an open account. I am willing to trust you, but I want some better evidence than the invoice of the transaction — I want something I can use until you pay for the goods. I will give you a month's time to pay for these potatoes if you will give me your note." Here then we have the promissory note- — a negotiable instrument. This is the absolute promise of the maker to pay. When it is due, the dealer cannot set up a defense that the goods were not as represented, or were short in weight — he should have been satisfied on these points before assuming the obligation. If he does not pay the note when it is due the farmer may at once be- gin an action for the amount. The note will prove itself in court. He now has a better /onw of credit than the open account, and can sell, or discount, the note at his bank and have immediate use of the money. If the maker does not pay the note when due the farmer must of course reimburse the bank, but his position is no worse than when he accepted the note. CREDIT AND BANKING 125 When the period of the credit in the open account has expired, the farmer may or may not receive j^ayment. There is no rigid due date as in a promissory note, and if the dealer pays within a few days of the expiration of the term of credit it makes no material difference to him. If he does not pay, there will be the usual request for settlement, dunning letters, interviews, etc., and when moral suasion has failed to collect the debt, the farmer may sue for the amount. He may have to prove delivery of the goods, their quality, price, and the fact that payment has not been made. The dealer may attempt to show that the goods were not as represented, the weight short, and other warranties that may have to be proved from one source or another. In short the account is open to attack from various directions. The promissory note eliminates all these doubtful points, and the rule is simple: "If you do not expect to pay, do not make the promise." If, however, the farmer says, ''I want my pay now," the dealer may give him another form of credit instru- ment, a check on his bank. This is not a promise but an order. It is as good, not as the bank, but as the maker of the check, and many checks are worthless, even though drawn on large and prosperous banks. The farmer takes the check to the bank and the teller asks him if he will take the cash or a certification. If he chooses the latter, he will surrender his rights against the maker of the check and accept the promise of the bank. Not needing the cash he has the check certified. The bank has now discharged the maker of the check from all obligations, and has itself assumed the burden. The maker's account has been charged with the amount and the bank has accepted the debt. Let us assume that the farmer holds the certified check a week, and being in need of cash to pay off his 126 THE BUSINESS MAN AND HIS BANK farm hands, goes to the bank and asks the bank to redeem its promise by cashing the check. The bank thereupon hands out the amount in its own national bank notes. We now have another form of credit, no different in its obhgation than the certified check but in a better form. Whereas the check might have been on flimsy paper, in poor handwriting, the bank notes will be finely engraved on special paper, in various denominations, large or small as he may desire, but an obligation of the bank, secured in the last analysis by United States bonds, but insofar as the bank is con- cerned quite the same obligation as the certified check. (See chapter twenty-five for further treatment of this subject). Let us assume that the farmer refuses the national bank notes, because of his ignorance of what they are, and that the notes are the obligations of a bank which he distrusts, and asks for another form of currency and receives Federal Reserve Notes. He now has the obligation of the Federal Reserve Bank, and ultimately of the United States. Let us go one step further and assume that the farmer distrusts all banks and demands ''real money" — legal tender. This is the highest form of circulating credit in this country — no different for general purposes from the others named, but with a standing in law quite distinctive. The teller therefore hands him greenbacks, the absolute obligation of the United States to pay in metallic money the amount represented thereby. He now has what is equivalent to gold, for the greenbacks are redeemable in gold and are therefore as good as the coin itself. Acceptances. Under the Federal Reserve System and the recent developments associated with it there has come into CREDIT AND BANKING 127 use a new form of credit called the acceptance, which is merely a bill of exchange or a draft which has been accepted. In the present instance the operation of the acceptance would be as follows: Upon delivery of the goods the farmer would draw a draft on the dealer for the amount of the shipment. The dealer would "ac- cept" or agree to pay the amount to the one to whom the draft was issued by writing his name across the face of the bill. Assume for purpose of illustration that the goods were sent by freight to the dealer and he was advised that the draft with bill of lading would come through the Blank National Bank. The messenger of the bank would present the draft or acceptance to the dealer, and if the draft was accepted by signature on the face, the bank would surrender the bill of lading and the dealer could get his goods. As soon as the draft was accepted, the bank would send it back to the farmer and he could discount it at his bank in the same manner as he would the note above mentioned. When the due date of the acceptance arrived the dealer would need to have on deposit at the bank where the acceptance was payable an amount sufficient to cover it, and the draft would there be pre- sented and paid and the transaction closed. We have thus run through the gamut of credit, from the lowest to the highest form; but to say that one form is better than another for practical purposes, is to express an opinion and not a fact. The form to be chosen de- pends upon the wishes of the contracting parties. CHAPTER XVII THE SCIENCE OF CREDIT The science of credit is the estimate of the proba- bihty of obhgations being paid; and to ''extend credit" is to assure one's self that the credit risk has in it those elements that will make the payment of the obligation a reasonable certainty. There are so many of these elements that to treat each one properly would produce a work in itself. We can, however, obtain a clear idea of the banker's viewpoint through a brief analysis of each of the three great fundamentals of credit, namely the moral risk, the business risk, the property risk, or, as they are more tersely stated, the Three Big C's of credit — character, capacity and capital. The banker wants to know you. He wants to know you as a man, with a reputation, a name that stands for integrity, a personality and as a business head. You cannot expect the banker to take you for granted, and because you know yourself to be honest and capable and worthy, to have the banker take you at your own valuation. There is a vast difference between being a depositor and a borrower; for while one is as welcome as the other, there are certain formal- ities that the borrower must comply with that do not obtain in the case of a mere depositor. Banks have suffered many losses through inadequate knowledge of men, or deception by them, and are naturally cau- tious in dealing with those whom they do not know, particularly in regard to loans. A New York business man went into a small town and bought out an estab- 128 THE SCIENCE OF CREDIT 129 lished business. The bank gave him valuable help in checking up the prospects of the business and the results of the former management. He made extensive alterations, put in new stock, carried a good balance. Then he wanted a loan. He was asked for statement and references. He made a good statement, and among his assets were several savings bank accounts. The bank asked him to put these up as security, and imme- diately he took offence, as a reflection upon his credit. The trouble lay in the fact that the bank did not, and could not in so short a time, know the man. His attitude was wrong and the bank's right; and he had no reason to expect a decision otherwise until he had become established. Credit is Sensitive. Credit is a very sensitive thing. It responds to the smallest influences and is helped or injured by the most trivial happenings. Let every business man mark this: the banker watches you. He knows your methods. He knows if you are honest or tricky. He knows whether you are making money or not. He can tell by your bank account how you stand with your creditors. There is a free masonry among banks and they exchange information readily for the common good. What you do in one bank gets back to the other. The surest sign of business trouble is short checks. Just as soon as a bank begins to send checks back, it restricts credit. The ''go-backs" as they are called are the barometers of business. They tell the story of a business "going back." The banker's yardstick is different from your own. It measures men from the outside and not from within. It measures men by an analysis of what they do and have and not by what they think they are. Until you have 130 THE BUSINESS MAN AND HIS BANK established yourself in the mind of the banker you can- not expect him to lend you money. How many a time banks are confronted with this proposition! "If you will lend me this money I can make — ever so much:" says the would be borrower. ''Very good" says the banker, ''but how much of your own money are you risking? We cannot stake you if you do not stake your- self. And until we believe more fully in you we cannot trust you." In a certain board meeting, a loan was under discus- sion. The applicant was in good favor with the board members and his previous transactions had all been satisfactory. Incidentally one of the members remarked that the borrower was a frequenter of road houses and a good spender. He ''rolled high" to use the slang; and immediately the whole atmosphere was changed from favor to opposition, and the loan was declined. Credit is a very sensitive thing. The Business Risk. The greatest asset that any man can have is business abihty — that plant of slow growth that produces such wonderful flowers. It matters not how keen a sense of business integrity he may have, or that he be as "honest as the day is long," his honesty and integrity may be negative virtues that stand for nothing but cold interrogation marks. The thing that wins in busi- ness is aggressive intelligence and not negative ineffect- ualness, for, given ability, a man will succeed in spite of other drawbacks that may at first seem serious. We do not admire the man who has money simply because he has the money; we admire him because he was able to make it. We applaud the process and not the results. Why is the Pennsylvania the premier railroad of the world? Because the men operating it know how. WTiy THE SCIENCE OF CREDIT 131 did Sears, Roebuck & Co. do a two hundred million dollar business in 1919? Not because they sold better goods or at lesser prices than their competitors, but — they know how to sell goods. Why did the great Penn- sylvania Hotel in New York barely open its doors before it was full? Because the Statlers know how to to run a hotel. The world knows they do. The know how — that's the crucial point in all successful business. Why Men Fail. In reviewing the failures for 1918 Bradstreet's Journal says: "Business success or failure is largely personal — in other words, that the individual himself is largely responsible for failure to succeed in business — there has been no higher percentage of personal liability established than in the year recently closed. In that year 86 per cent, of the failures were classed as due to the individual, and only 14 per cent, were charged to extraneous causes. In 1917 85 per cent, of all failures were charged to the individual and only 15 per cent, to outside causes; in 1916 the proportions were 81.5 per cent, personal and 18.5 per cent, non-personal, and in 1915 the proportions were 74.4 and 25.6 per cent., respectively. Never before 1917 in the quarter century of Bradstreet's experience in this sort of statistical work was the percentage due to the individual himself as high as 85 per cent., the nearest approach to this being 82 per cent, reached in 1910 and 82.3 per cent, reached in 1890. To fully understand the above statements, it will be advisable to examine Bradstreet's groupings of the causes of failure proceeding from or inherent in the individual as compared with those outside of his control. A.^ — Due to faults of those failing: Incompetence (irrespective of other causes). Inexperience (without other incompetence). Lack of capital. Unwise credits. Speculation (outside regular business). Neglect of business (due to doubtful habits). Personal extravagance. Fraudulent disposition of property. 132 THE BUSINESS MAN AND HIS BANK B. — Not due to faults of those failing: Specific conditions (disaster, war, floods, etc). Failures of others (of apparently solvent debtors). Competition. "Bradstreet's definition of a business failure is that it "must involve some loss to creditors of individuals, firms, or corporations engaged in ordinary commercial operations." Under this classification, failures of professional men, such as physicians, lawyers, and actors, as well as stockbrokers and real-estate dealers, also old bankruptcies passing through the United States courts, have no place, since these generally are dissociated from the recognized commercial life of the country. Failures to succeed, without loss to creditors, are, therefore not embraced in the data. Bradstreet's statistics do, however include "all suspensions of banks and other strictly financial institutions, even if these suspensions prove only temporary." From 1890 until 1912 lack of capital was the leading cause of failure. In 1912 incom- petence forged to the front and altho passed in turn by lack of capital in 1913 and 1914, incompetence in 1915 again took and has since held first place, with 36.5 per cent, of all failures credited to it in 1918, as against 33.2 per cent, due to lack of capital. These two causes, with the addition of inexperience, which is another form of incompe- tence in 1918 accounted for 76.4 per cent, of all failures, as against 74.2 per cent, in 1917, 69.5 per cent, in 1916, and 62.8 per cent, in 1915. Speculation as a cause of failure has been at a low ebb for four years, and the same is true of unwise credits, neglect, and ex- travagance. All of these personal causes combined totaled 86 per cent, of the failures. "While 86 per cent, of all failures were chargeable to personal causes, only 76.1 per cent, of liabilities were so credited in 1918, as against 77.8 per cent, in 1917, and 73.6 per cent, in 1916. Lack of capital was the most prolific source of liabilities the proportion in 1918 being 30.8 per cent., as against 32.7 per cent, in 1917 and 31.9 per cent, in 1916. The 1917 proportion, it might be noted, was one of the largest in years. Next in importance to lack of capital was incompe- tence, 26.9 per cent., which compared with 25.3 per cent, in 1917 and 21.8 per cent, in 1916. Fraud, the third most important personal cause, accounted for 9.2 per cent, in 1918, 9.9 per cent, in 1917, and 7.4 per cent, in 1916. Inexperience, another form of incompetence, accounted for 4.7 per cent, in 1918, 5.2 per cent, in 1917, and 4.4 per cent, in 1916. The two causes of incompetence and inexperience combined accounted for 31.6 per cent, of all liabilities in 1918, THE SCIENCE OF CREDIT 133 against 30.5 per cent, in 1917. The other personal causes not above mentioned, unwise credits, speculation, neglect, and extravagance accounted for only 4.5 per cent, of all liabilities in 1918 and 4.7 per cent, in 1917. Of the non-personal causes of liabilities, specific conditions were the most hurtful, producing 19.8 per cent, in 1918, as against only 14.2 per cent, in 1917, but 19.3 per cent, in 1916. Failures of others and competition accounted for only 4.1 per cent, of the" 1918 liabilities, against 8 per cent, in 1917. As regards compe- tition, the proportion of failures and liabilities due thereto were not materially different, being respectively 1.2 and eight-tenths of 1 per cent. " Nineteen-eighteen was apparently the best year in nearly two decades for the man with small capital. Of 10,146 failing in the United States and Canada in that year 9,078, or 89.5 per cent., had not to exceed $5,000, and a large number of these undoubtedly had less than this old-time minimum recjuirement. Not since 1897 was there a smaller percentage so provided, the proportion in 1917 being 94.1 per cent., in 1916, 95 per cent., and in 1915, 93.5 per cent. The 1916 percentage, it might be noted, was the highest thus far recorded. Traders in the next higher classification, over $5,000 and less than $20,000, however, suffered more than in any year back to 1897, the proportion in 1918 being 7.4 per cent., against only 4.3 per cent, in 1917, 3.9 per cent, in 1916, and 4.8 per cent, in 1915. Those with $20,000 but less than $50,000 failing constituted 2.2 per cent, of the 1918 failures, and those in still higher classes combined were less than 1 per cent, of all failing. Of the liabilities of the 10,146 persons or corporations failing in 1918, it may be said that 59.1 per cent, owed less than $5,000, as against a proportion of 79.7 per cent, in 1917, a fact speaking volumes for the credit curtailment said to have been enforced in that year. Those with $5,000 or over, however, were a vastly larger proportion than in 1917, which may be construed as indi- cating that credit curtailment was operative most heavily against the small trader. As to credit ratings of those failing, it might be noted that 96.8 per cent, had very moderate or no credit, which differs little from the proportions ruling in recent previous years. The 1916 proportion, 97.7 per cent., was the highest recorded. The constancy of these precentages as to credit ratings over the past four years, in the face of heavily reduced numbers failing, is not the least interesting feature of this exhibit." It is not difficult to tell whether or not a business man has this "know how." A visit to his store is enough. 134 THE BUSINESS MAN AND HIS BANK The poor farmer may be known merely by looking at his barns, the poor business man by his windows, his stock, his fixtures, his delivery, and his advertising. Of the three fundamentals of credit I would give first place to ability, assuming that it carries with it integrity. Some men were never fitted by nature or training to be the heads of business, because natural ability is lacking; and the natural lack has not, and in many cases cannot, be acquired. The human machine is faulty. Place a fortune in the hands of some men and let them go into business and failure ensues. Give an able man a chance and he will make a fortune. If the careers of great men attest one truth, it is not the threadbare axiom that "honesty is the best policy" — (it is the only policy) — but that ability wins against the world. In formulating a recipe for success, I would begin with "brains — plus." Neither money nor honesty can make up for the lack of this essential thing. The Property Risk. The last element in business success is that of capital. The honest man plus the able man, is bound to develop into the successful man, and his success is measured by the increase in his worldly goods. The result of business is the net profit. Net profit means wealth, and wealth means power. The most foolish thing a business man can do is to refuse to show himself to the banker. If the banker asks, as he undoubtedly will, for a statement of the business, it should be fully and willingly given; first, because it affords a correct basis upon which to work, and second because it is but fair that the banker should know. The man who says: "I never give a statement because I never borrow, may sometime need to borrow and find he has no credit. There is but one royal road to credit and that is to THE SCIENCE OF CREDIT 135 borrow and pay as agreed; to buy on time and pay on time; to promise and fulfill; to shoulder debt and pay it off. This property risk determines the probability of the debt being paid and the statement that leads up to it is the statistical evidence. It is obvious that if a borrower has two dollars of assets for every dollar of debt, the chances of meeting his obligations are in his favor; for the assets must realize less than fifty cents on the dollar before the creditors' interests are jeopardized. And if the debtor should repudiate his debts, they must be collected out of his property. In short, if he 'will not pay, he can be compelled to pay. Of course, much depends upon the character of the property which is back of the debt. If, for instance, the debtor owes a thousand dollars and has Liberty Bonds, or a quantity of meat, or lumber, or anything that is quickly salable, the property risk is good: but if he owns a plot of land ten miles from a railroad, which could hardly be given away, the property risk is poor. It depends, not so much upon the amount of property, although that is important, as upon the character. And the increase in property worth is the best evidence that the other two factors are existent, for property is the result of ability and integrity rightly apphed. The Bank Account as an Indicator of Credit. The business man writes large the story of his business in his bank account. A prosperous business is reflected in the bank balance and a decaying business is mirrored in the lack of it. Here for instance is the account of a hotel. It is doing a large business. The balance is always around $10,000. No check ever goes back for lack of funds. The proprietor takes on another place. The banker knows nothing of the terms or the possi- 136 THE BUSINESS MAN AND HIS BANK bilities. It may be he has a loan running to the parent hotel that he considers safe. Soon he notices that the balances are running down. Checks are returned short. Overdrafts creep in. The season comes and goes and the old balance never comes back. Instinctively he knows that the venture has proven unprofitable. The gamble has lost. There is absolutely nothing that commends itself to the banker's credit sense so quickly and so favorably as an ample balance — working capital. It indicates first of all that the business man has a surplus. He has money in reserve. He can buy goods and pay for them. He can take advantage of cash payments. He need not worry about the coming of Saturday for Saturday will find his balance large enough to meet his pay roU. He is not on the danger line all the time and can spend his energies in constructive work and not destructive worry. Again, it indicates that he has made money, for if he has not he would not have a reserve. And finally it indicates that he has quick assets, and these are the backbone of all business. There was a time not so far distant when the granting of a loan on the part of the banker was done through a crude and unscientific method that resolved itself into a mere knowledge of the man as a neighbor or a local townsman. The use of the credit statement was not common twenty-five years ago, and only as banks began to branch out and lend their money over a wider terri- tory has the use of the statement become necessary as a factor in the extension of credit. The principles of credit are now so firmly established and the practice of banks and bankers so uniform that the banker of New York would be at home in a bank in California or Texas, and would use the same identical processes to satisfy himself as to the worth of the credit seeker. THE SCIENCE OF CREDIT 137 The Statement. The basis of all credit operations, whether a bond issue, a flotation of commercial paper, or a single loan, is the statement of condition. This statement is valu- able for two reasons. First, it gives the lender definite information upon which to work, by setting forth in detail the financial condition of the borrower. The fact that a business is rated at a million is very good, but unless the foundation for this rating is known, we have merely some one's say so that the firm is worth as stated. After the analysis of a credit statement is understood, most of the basic facts of the business may be known, and doubtful points cleared up. The ability to do this analyzing is not difficult to acquire. Second, the making of false statements to obtain credit is now a serious offence in the eyes of the law and one making such a statement is guilty of a felony. And because of the latter fact we may assume the statement to be honest; for if otherwise we are dealing in the dark with a criminal. Refusal to make a Statement. To refuse a statement is to open the door to suspicion. If you are good for your obligations why hesitate to show yourself to be so? If you are worth as you claim — $10,000, why fear to show of what it consists? This point is well illustrated by the following incident: A certain business man desired a loan of $5,000 based upon bankers' contracts, a perfectly good security. The loan was granted and the security about to be handed over when the banker asked the would-be borrower about his company, who constituted it and a statement of its affairs. It then developed that there was no corpo- ration as claimed, but a single ownership, and the men posing as the heads were dummies only. The banker then asked the individual for his statement, and it was 138 THE BUSINESS MAN AND HIS BANK refused on the ground that he had never given one and never would, and ''could get his money elsewhere;" and he did. The lending bank lost. Now what was the mental conclusion of the banker when the borrower refused his statement? That the individual was ''too proud to show his statement, " or had a poor statement? A man of means or a big bluff? — ^A straightforward individual or a tricky fellow ?^ — ^An honest man or one who would bear watching? What would you have done under the circumstances? The refusal to make a statement does not redound to the credit of the one so refusing. It may be true that no credit is asked; but banks are repeatedly asked for information concerning business houses, and even though cash is paid for all purchases, the credit standing of the concern is often required even though it be a cash transaction. The banker can act much more intelligently if he knows the facts. Even though all his casual information is favorable, to fortify it with facts and figures lends much to the dignity of the reply. The fact that the great reporting agencies do not list the name is no credit to the one so omitted; it rather opens the question box. If a bank were to take the position that it asked no one to trust it; that it did not borrow; that it was an inde- pendent concern caring httle or nothing about the opinion of the public, it would soon feel the blight of criticism and decay. But reversely, it shows its hand; it lays its cards on the table, and is willing to have the public know where it stands. The same is true with regard to the business man who is wilhng to open his books and have his condition known; for only as it is known can he be assured of the support and confidence of the banker; which support and confidence he will sooner or later need. THE SCIENCE OF CREDIT 139 The Statement Should be Complete. The statement should be complete and should rep- resent the signer's whole estate, even though the accom- modation asked for be so small that it would be amply fortified by only a portion of the borrower's entire net worth. The reason for this is that such a statement is apt to mislead the bank officials as to the true status of the borrower, and at some future time operate to his disadvantage. This point can be more clearly seen by an actual example: A certain business man de- sired a loan of $500. He made a statement showing a net worth of $10,000 all in real estate. The loan was granted and paid off in due course. Two years later he desired a loan of $1,500, and in the course of the nego- tiations it developed that he had previously set down only his local property, whereas he had a substantial holding in a manufacturing concern, owned a business property in a neighboring city, and over a thousand dollars worth of Liberty Bonds. His net worth was more than double the original showing, and the bank men had been giving him a rating orf less than half the amount he was really entitled to. His argument was that he set down enough to secure a small loan and thought that sufficient; but the result was that he hurt himself in the minds of at least five bank officials. He was unfair to himself and the bank was unfair to him, but solely through his own fault. CHAPTER XVIII HOW TO PREPARE A STATEMENT It has come to be a common custom among large and small concerns to have a periodical audit made by a competent accountant. The reasons are two: first the safeguard that attends an independent checking of the books, and second, the weight that such an audit carries in banking and business circles. It is apparent that if the audit is made by the bookkeeper himself, it must of necessity be a biased audit; and if the owner appraises his own property it must likewise be a biased appraisal. Therefore at stated times firms of chartered accountants audit the books of all well managed con- cerns and submit their findings to the owners and they to the banks. It would be called in accounting circles an audit and an examination with the results submitted in the form of a balance sheet and a report. In reviewing this balance sheet the banker is chiefly concerned about the following matters, not necessarily however in the order herein set forth. First, the ratio of quick assets to quick liabilities. The quick assets consist of cash, accounts receivable, notes receivable, merchandise and investments. The quick liabilities are notes payable; accounts payable. All other assets are fixed or slow, and likewise are all other liabiUties. Out of the quick assets the current liabilities must be met, and the solvency of the concern depends upon the liquidity and the ratio of these items. There are com- ing due daily the invoices for the stock and promissory notes outstanding having short maturity. Out of the 140 HOW TO PREPARE A STATEMENT 141 inflow of money that follows the payment of accounts and bills receivable, these charges must be met. If the ledger accounts are slow and represent ill advised credit, and the sales of merchandise are slow by reason of poorly chosen stocks or unseasonable weather, the maturing invoices cannot be met, for these do not depend upon the weather but are as sure as death and taxes. The banker looks upon the business in its liquidating possibilities and attempts to measure the success of liquidation from the quality of the statement. If the borrower has two dollars of quick assets that are not only quick, but good, he feels assured of the payment of the current liabilities, even though the quick assets shrink one-half in liquidation. Much depends, of course, upon the character of the business as well as the charac- ter of the credits. Staple lines such as groceries and meats will liquidate much nearer par than seasonable and specialty goods. Whereas a margin of one and one-half to one might be ample in meats, in fancy dresses and millinery three to one would be much safer. Cash. Cash should of course be what it purports to be — cash on hand and in banks, and nothing else, — no ''I. O. U's" or debit tickets from members of the firm or office force. This is the easiest of all the assets to actually verify. A count of the cash on hand and verification of the bank balances is sufficient. Accounts Receivable. Accounts receivable represent goods gone out of stock, merchandise taken from the shelves and put on the books; and since it was good merchandise, paid for in good money, the accounts must also be good, else the seller has given away his money. These accounts should not be of long standing, and their quality can 142 THE BUSINESS MAN AND HIS BANK easily be determined by a perusal of the books. They will divide themselves into: accounts not yet due; accounts due and unpaid; accounts past due; slow ac- counts, and doubtful accounts. In setting up the statement the total accounts are usually listed and provision made for the slow and doubtful ones, thus showing as an asset only those considered by the auditor as good. Merchandise. The merchandise item is the most difficult of all to appraise, either by the owner or the accountant. It means the handling of every article and a listing of its price and quantity; the measuring of every piece of goods and all the mental and physical labor that attends the handhng of goods out of bulk. Take for instance the inventory of a large department store. It must be done in a reasonably short time. Sales must go on daily and the goods handled many times between the count and the proof. Measuring is usually done by the clerks as time affords and the quantity marked on a ticket. As goods are sold, the mark is reduced until the final clean up, when all hands work overtime record- ing the quantity and the inventory price. Again, the listing of the many thousands of articles in a large hardware store, drug house, grocery, etc., can readily be seen to be a vast labor consumer and endlessly tire- some work. And yet, there is no other way to get a true account of stock. There are concerns that keep a running inventory. This is done by getting a correct starting point and adding to and taking from the mer- chandise item the purchases and sales; but this will not verify losses from theft, nor errors in the bookkeeping work, and must be supplemented by the periodic test of actual inventory. HOW TO PREPARE A STATEMENT 143 Inasmuch as inventory is the most difficult asset to check, it should be given the most care. The banker will pay more attention to inventory than to any other feature of the statement. Under the income tax pro- visions inventory plays an important part in the esti- mate of the tax, and inasmuch as it is one of the most vital elements in the statement it should have proper attention. The true basis for inventory is a matter of opinion. There are many ideas on the subject. The fairest would seem to be: cost if the market value is higher than the cost, and market if the cost is above the market. A well known firm of accountants has laid down the rule that inventory should be taken at a figure that will give the usual margin of profit irrespective of other factors. For instance the mark up of the firm is one- half. Therefore an article must bring one-half more than its cost to realize the margin of profit, and a dollar article (cost) must sell at $1.50 to realize a profit of one-half the cost. Here for instance is an article that will bring $1 and cost 80 cents. What shall be the in- ventory price? If we get our margin of profit above the inventory it must be listed at 66 cents, allowing a mark up of one-half. This would seem to be practical and fair. Bills Receivable. While bills receivable are regarded as a quick asset, they are found in but few of the credit statements, busi- ness now being carried on through the accounts receiv- able. They may still be found in a few lines, and it is well to state for what reason they have been taken and whether or not they are collectable. They often repre- sent slow accounts, settled by notes. Sometimes they are for money loaned to the members of the firm or em- 144 THE BUSINESS MAN AND HIS BANK ployees. If so they are not a desirable addition to the statement. Where the custom of settling by note ob- tains, it should be so stated, so that the reason for this item will be apparent. As the acceptance method of selling grows in favor, acceptances will form a chief asset, and will materially strengthen any statement, inasmuch as this method is now looked upon with great favor by banks and business houses, chambers of commerce and credit associations. Fixed Assets. The foregoing assets may be said to be primary, and all others are secondary, however good they may be. Out of the quick assets the quick liabilities must be met, leaving it to the slow or fixed assets to add backbone to the business. The fixed assets usually consist of the following items: 1. Land and buildings. These are regarded as the last to be realized upon in case of failure. The build- ings usually have a special utility, ofttimes a limited usefulness and in an ordinary real estate market would move slowly. Manufacturing concerns of course must have such investments, but the less the holding price the better the banker is pleased. The favored custom is to show the buildings at cost less depreciation, some- times attended by an independent appraisal. 2. Machinery. This is often a large item, and a neces- sary one; but inasmuch as it is specially adapted to the business, it would be worth only its scrap value in any other line. Like real estate it should be stated at its cost less depreciation, making the latter figure hberal. The upkeep of the machines should be charged to ex- pense and not added to their cost. 3. Stocks and bonds (often in subsidiary companies). These should be stated in detail and not grouped; for HOW TO PREPARE A STATEMENT 145 some may be worthless and only an inspection of each item will determine its value in the statement. 4. Delivery equipment. This consists of horses and wagons, automobiles and trucks. Like machinery they wear out and should beUberally treated as to depreciation. 5. Patents, trade marks, etc. These are often costly and valuable, and their worth to the concern can only be known by a valuation of the business in the Hght of these facts. A basic patent on an article may be the keystone of a huge business, and a trade mark may be the greatest asset of a concern, for upon it the sales depend, and upon the sales depends the business. 6. Good will. This is often an illusive term, and often a most valuable asset. It is best defined as ''the tendency of trade to follow an estabhshed course." Trade follows trademarks. The public cares little who makes Uneeda Biscuits as long as they are good bis- cuits and come in the famiUar package. Nor would the sales of Ford cars dimmish whoever might be the head of the firm or the sales manager. It is the Ford name and quahty that sells the cars. Here trademarks and patents are priceless, and the good will that follows the name is likewise invaluable; but a million may have been spent upon a patent that never proved a financial success and in such a case it would add nothing to the worth of the statement. Good will is often the amount the concern can safely pay dividends on. To say that the bread trade worked up by a large bakery in New York is worth five millions is to guess in the dark; but to say that the firm has made profits enough in the past five years to pay six per cent on five millions of good will is to state a fact that is capitalized every day in business reorganizations and adjustments. As for the banker, he usually disregards quite largely the item of good will in a statement. 10 146 THE BUSINESS MAN AND HIS BANK Quick Liabilities. The quick liabilities are as a rule of two kinds — notes payable, and accounts payable. The accounts payable are the book accounts for goods purchased. They represent merchandise in stock and not yet paid for. They should not be in a larger amount than is war- ranted by the volume of business. The proper amount of- accounts receivable and accounts payable can be estimated from the volume of sales. If, for instance, the sales are $10,000 a month, and the credit terms are 60 days, the firm should not have on its books more than three months' sales. On the other hand, if it buys at the rate of $10,000 a month (cost price of merchandise) it should not have unpaid bills of more than a current month; for it should take the cash discounts, even though the credit term be longer. And if the unpaid accounts are equal to three months' purchases, it indicates that it is not taking the cash discounts. Inasmuch as well managed concerns take advantage of the cash discounts there should be in this item only those accounts that are in process of audit. If they are past due, it indicates poor management and poorer business; for there is no better way to make quick money in business than by paying cash. This leads us to a brief statement of commercial paper. Commercial Paper. Bills payable represent two classes of loans: loans from the home bank and loans by outside banks that have bought the promissory notes of the firm through brokers. The process of issuing commercial paper and its purpose may be seen from a practical illustration. The True Fit Shoe Company has orders on hand for 200,000 pairs of shoes for the spring trade. It needs leather, and can buy advantageously for cash. It needs HOW TO PREPARE A STATEMENT 147 money to pay its hands. To finance the season's out- put will require $100,000 in addition to the firm's re- sources. It will have an audit made by a recognized firm of accountants, giving its condition as of a stated date. It will submit this statement to a ''Commercial Paper Broker" (there are probably less than fifty such firms in the country and not over a dozen in New York) . The broker will assure himself that the firm is in good standing, its methods and management clean and its history honorable. He will become personally ac- quainted with the members and if satisfied that the risk is sound will ''take on the name" — meaning, will agree to sell the paper of the firm as long as he is satisfied with its condition. Twenty notes for $5,000 each are made out, payable six months from date, usually in New York, Boston or other large cities. These are signed by the officers authorized to sign such instruments. He then makes a transcript of the statement and sells the notes to banks through the mail and by salesmen. The broker will either sell the notes and remit the pro- ceeds, or in many cases he is strong enough and has such bank connections that he can pay for them on dehvery. The commission is usually $12.50 on $5,000, and the interest rate on the loans depends upon the state of the money market, running from 3 to six per cent. The broker does not guarantee the paper or even in- dorse it; but he does warrant that the paper is genuine, and the signatures proper to bind the firm. As a rule the buying banks are allowed ten days within which to "check" the paper, which means, satisfy themselves that it is a safe risk. This is done by writing the banks given as references on the statement, asking their experience with this firm's paper. The banks used as references are usually large city banks where the firm keeps account, and which loan the 148 THE BUSINESS MAN AND HIS BANK firm on its direct obligations, and are acquainted with the personnel of the business; also the home banks which are of course most familiar with the condition of the firm. Such paper is bought by banks in huge volume, some firms handling more than two milUon dollars a week. Frequently the individual members of the firm or company indorse the paper thus lending their individual worth to that of the concern as a corporate entity. From the proceeds of the paper the shoe concern will pay for its leather, taking advantage of the cash discounts, and meet its pay rolls. As the shoes are sold and paid for by the retailers or jobbers, the funds will be in hand to meet the maturing notes. The record of commercial paper is especially clean. It is regarded as the bank's most liquid asset, payment rarely faihng. Most banks are buyers of such instruments, and many prefer it to any other form of investment. In making such an investment the banks require: a recent statement, preferably audited ; quick assets of at least two to one, as a rule; favorable checking; a statement that analyzes well. The statement usually gives the volume of sales, and net profits, so that by following the course of the firm's business from year to year the banker has a very good idea of its progress. Knowing the sales, he can judge with a fair degree of accuracy several features of the business. Take the turnover, for instance. If the sales are $1,000,000, let us say in dry goods, with a mark up of one-half, the goods that have gone out of stock have cost $666,000. If the inventory shows $300,000 of goods on hand, the turnover has been twice. In other words the goods on hand have been completely sold out twice during the year. With gross sales of $1,000,000 the monthly average is $80,000. If, therefore, the accounts receivable are $400,000, it indicates either too long credit (five HOW TO PREPARE A STATEMENT 149 months) or poor collections; for if the firm is extending credit wisely, it should not have more than sixty days sales on its books. Again if it sells at the rate of $80,000 a month it should buy at the rate of about $50,000 to keep the stock adequate; and it should not have unpaid accounts (accounts payable) of more than ten days, as- suming it takes its cash discounts, as it should if it bor- rows on its commercial paper. The Fixed Liabilities. The fixed liabilities consist of mortgages upon the property, if any, and bond and stock issues for capitali- zation purposes. The maturities of the mortgages should be given, also the due dates of the bonds. The capital stock is usually stated as "preferred" and "common." In addition, many firms give the volume of sales, profits, dividends, and reserves for taxes, especially the income tax which is now an important charge against income. The profit and loss account is merely a bookkeeping term, to balance the statement. Whether it represents real profits or not depends upon the goodness of the assets and the possibility of their realizing the listed values. If for instance, we were to increase the value of the merchandise by a forced inflation, we would in- crease this item. It moves up or down with the mark up or mark down of any asset, and personally, I have never regarded this as a controlling factor in judging statements. The fairness of the appraisal of the assets is of far greater importance. The net return on the capital, net profits, dividends, additions to surplus, etc., may all be determined from the statement, if properly set up, and the banker who knows how, can discover any dangerous element of weakness that may exist in the management, provided, of course, the statement is honest as it must be, if the borrower is to exist long. '^ CHAPTER XIX BANK LOANS All that has been said in tiie foregoing chapters on credit applies to the credit setting of a loan, and is independent of the practical aspects, which are purely mechanical. While no two men would use the same mental processes in arriving at a conclusion regarding a loan, the bookkeeping is more or less the same in all institutions. While in one bank the request would be passed upon directly by the attending officials, in others it would have to wait the meeting of a committee; but as soon as the note is accepted and passed to the proper clerks for treatment, the methods are quite standardized as to the records kept. The usual process of a loan is as follows. The request for the loan is made to the proper officer, usually the cashier. The statement of the borrower if not on file is furnished and the purpose of the loan is inquired into. In fact it is quite the common custom for borrowers to state the reason for the loan as a matter of business. The cashier makes his memorandum, either in the offer- ing book or on a slip. It is then taken up in committee, at which time the statement will be reviewed, together with the average balance of the borrower, his present line of discounts and whatever other information may be desired in passing upon the request. If the loan is granted the note is executed and put through the books. If the loan is in the form of a ' ' receivable ' ' discounted — meaning the promissory note of a customer of the bor- rower, information may be desired as to the worth of 150 BANK LOANS 151 the maker of the note. This is the case where the one discounting may not be in good credit and the strength of the paper Hes in the maker. It is customary to give a stated hne of credit to the borrower, either on his own name or on his receivables or both. In the former case he can put in his note at any time within the hmits and have immediate credit. In the case of receivables, he is privileged to put in paper for discount within the Umits; but as a matter of protection both to him and the bank, the makers of the paper are investigated before making the discount. For instance, a lumber dealer will be given a line of $10,000 on his receivables. He may send in his paper as he needs funds and receive immediate credit; but before making the advances the bank will check up the firms making the paper and becoming satisfied as to their credit will accept such names thereafter without the credit checking. Recording the Loans. The bank keeps the following records relating to loans : 1. Offering book, in which all notes offered for discount are recorded. The committee usually signs this book. 2. Loan register, in which all loans actually made are recorded as they are put through the books. Each note is given a number to identify it. Some banks take a full description of the paper in this book. 3. The maturity book, in which each note is listed as to its maturity. The bank therefore has before it each day the notes that mature as of that day, and payments or renewals are obtained as the case may be. It is the common custom to send out notices to the makers of notes a week or ten days in advance; but this is not obligatory. It is however valuable in that it keeps the files free from past due paper. 4. The hability book in which the total amount loaned to each borrower is 152 THE BUSINESS MAN AND HIS BANK recorded. Both the direct and indirect obhgations are here recorded and the bank can at any time know how much the borrower is indebted to it. 5. The average balance. This records the average balance of the borrower. It is the rule to require the borrower to maintain a balance proportionate to his line of credit, usually four to one; that is, for every hundred dollars of loans he is expected to maintain a balance of $25. The reasons for this are twofold: first to prevent the borrower working on too small a bank balance. It keeps him in funds, whether he is so inclined or not. It gives him a working fund. And second it gives the bank additional profit, for while it charges interest on the full amount it advances but a part. If the line of credit is large and the balance proportionate, the bank may agree to pay interest at a nominal rate on the bal- ance, thus equalizing the matter. With the above information, classified, the bank has definite and complete information respecting every note that passes through. It is often of great value to be able to trace such transactions. The most valu- able from a practical standpoint is the maturity book, for upon it depends the proper presentation of the notes for payment — a very important part of the loaning process. Loans and Discounts Distinguished. In all bank statements there appears the item ''Loans and Discounts." There is a technical, but not material, difference. The term ''loan" is applied to advances of money on promissory notes, usually payable on demand and "collateral notes" which are used in those loans which are secured by pledge of stocks and bonds. The interest is collected when the loan is paid or at stated times, monthly or quarterly. The term "discounts" BANK LOANS 153 is applied to promissory notes made by the borrower, or promissory notes held by the borrower and '^ dis- counted" or sold to the bank, which are, as a rule, for a definite time, the interest being deducted when the loan is made. Promissory notes are made in four forms: payable at a stated time after date; payable a certain number of days after date; payable a certain number of months after date; payable on demand. It is important that the due date be accurately computed, because the note must be presented for payment when it is due — not before, nor after. Helpful Rules Regarding Promissory Notes. The following rules regarding notes will be found useful. They are embodied in the Negotiable Instru- ments Law, the basic law of all the states of the Union and are therefore universal in their application. 1. A note due on a certain date is due on that date without grace, and carries interest if so mentioned, from its date to the date named. 2. A note payable a certain number of days after date is due on the last day of the time mentioned in days. 3. A note due a certain number of months after date is due on the same day of the month indicated. 4. Unless interest is mentioned in the note, it carries no interest until after its due date, and then draws interest at the legal rate for the state wherein the con- tract was made. 5. Days of grace no longer obtain. 6. The words '' value received " are no longer necessary. 7. Notes due on Sunday fall due on Monday, 8. Notes due on a holiday fall due the next business day, 9. Notes due on Saturday, where Saturday is a half holiday, are due on Monday, 154 THE BUSINESS MAN AND HIS BANK 10. If the note reads "with interest" the interest is added to the face amount and the total becomes the face of the note. In discounting such notes banks add the interest to the face amount and discount the full amount. 11. If a note carries interest, and is discounted after the date, the interest is computed for the full time and the discount is figured from the date the note is discounted. 12. The making of a note payable at a bank is equiva- lent to an order on the bank to pay it on its due date. Banks prefer that notes should be payable at a bank, for it gives them the opportunity to check the paper through the bank where payable. Inasmuch as the maker generally has an account in the bank where the note is made payable, it is easy to get an opinion as to the credit risk, and banks exchange this information freely. It also makes presentation easy. If notes are payable at an office or store, there may be no one present authorized to make payment; the place may be closed, and numerous other reasons will readily suggest them- selves, as to why a note should not be made payable at any place other than a bank. If in such cases as just mentioned, the messenger finds no one to whom to present the paper, he is justified in returning it unpaid, it not being the custom to make more than one attempt to present a note, and the law requires but one proper presentation to hold the parties liable. 13. In figuring the time, exclude the date and in- clude the day of payment. Secured or Collateral Loans. Generally speaking it is easier and quicker to secure a loan properly supported by collateral than it is to obtain an advance on open credit or on a bill receivable dis- counted. The reason is that in most banks the attend- BANK LOANS 155 ing officers have the authority to make collateral loans without consulting the loan committee, while in dis- counting notes on open credit the committee must either be consulted or its meeting day awaited. There- fore the business man can pursue no more helpful poUcy than to invest his profits in such form of collateral as is generally acceptable to banks. This form is stocks and bonds listed on the various stock exchanges and having a readily ascertained market value. Having such a line of investments he can be assured of obtaining money quickly from his bank under practically all circumstances. One of the great mistakes made by successful men is to invest profits in real estate, whether for investment or for speculation. The chief trouble with real estate is its slow liquidation and the ceremony which attends its transfer either on sale or as security. Whereas to borrow on a listed stock or bond simply requires the ascertainment of the market value in the daily paper, and the signature on the back of the certificate, or the execution of a power of attorney, the pledging of real estate requires legal formalities such as search, the formal deed or mortgage, or assignment, appraisal, recording, tax search, etc., all of which are expensive and slow. Making a Collateral Loan. Let us review the steps necessary to secure a loan on collateral listed on the New York Stock Exchange. You approach the banker and ask for a loan of $4,000 and offer as security the following stocks and bonds: 10 shares Anaconda Copper 10 shares U. S. steel 10 shares Baltimore and Ohio, pfd. 1 Bethlehem Steel First 5s. 1 Michigan Central 5s. 1931 $500 Liberty Bonds. 156 THE BUSINESS MAN AND HIS BANK The banker simply turns to the stock exchange sheet of the day before and finds the quotations to be as follows: Anaconda Copper, 68^ $685 U. S. Steel, 105H 1055 B and 0. pfd., 503^ 505 Bethlehem Steel 883^ 885 Michigan Central 940 Liberty Bonds 3rd Issue, 95 475 $4545 Finding the value of these securities to be $4545 the banker offers to loan you 80 per cent, of the market value or $3,600. He then makes out a collateral note, payable on demand, lists the security, asks you to sign at the bottom, and also on the backs of the stock certificates. The bonds being coupon form need no indorsement. He makes out the tickets and hands to the bookkeeper and you are immediately credited, or given a cashier's check. That is all there is to it. Loans Secured by Real Estate. Now let us assume you are the holder of certain mort- gages on real estate and make the same request. There must first be an inspection of the property covered by the mortgage and an appraisal by the bank's committee. This usually costs a fee. Then the attorney will satisfy himself that the title is good. This may be done by a simple "short search," or he may accept your title policy. The assignments must be drawn and recorded. The insurance must be changed to run to the bank as mortgagee so that in case of fire it will be protected. All this is costly, for the attorney will exact his fee for services. The real estate transaction will require, it may be a week or two, and the stock transaction a few minutes. When you pay off the loan, the banker on the one hand simply hands you back your securities and BANK LOANS 157 on the other he must reassign or satisfy the mortgage, which again adds to the cost. The borrower whose wealth is represented by equities in real estate may in his own mind be a good risk, but real estate is not favorably regarded in banking circles, unless it be free and clear, for otherwise it is expensive to carry. ''Real estate poor" describes many a would- be wealthy individual. Then again, it is often unmar- ketable and slow in turning into money. It should be bought judiciously by the man who expects to borrow. Substitutions. In collateral loans, banks will allow the borrower to take out one kind of security and substitute another. The only requirement is that the security offered must be of equal or greater value than that withdrawn. Brok- erage houses carrying large quantities of stocks and bonds on call loans, and buying and selling constantly for themselves and clients, are obliged to obtain securities in order to make deliveries and receive payment for the same. They are permitted to take out securities on proper order and substitute others and thus "clear" their trades. Banks, in dealing with private clients and located outside the large cities, will deliver stocks and bonds by mail to the brokers and receive payment for their clients; and the brokers, on the other hand, will send stocks and bonds to banks by mail for clients and receive payment through the bank; but in Wall Street transactions these deliveries and substitutions are made by messengers employed by the brokerage houses. The Profitableness of Borrowing on Securities. It is, as a rule, profitable to borrow on securities. Only when the bank rate is greater than the income from the securities will this be a losing proposition. For instance: Here is a $1,000 bond paying 6 per cent. 158 THE BUSINESS MAN AND HIS BANK or $60 a year. You need eight hundred dollars. The bank will loan you the amount at not over 6 per cent, or $48 a year and you draw $60 a year on the bond, a net gain of $12. You have your cake and eat it too. On the other hand, an individual with a small amount of cash, or standard stocks and bonds may find it profit- able to buy other stocks and bonds by putting up the securities already owned, or the cash in hand, as a mar- gin on the purchase of the other securities. This can better be seen by a practical example, which the aver- age bank will consider. Let us suppose an indi- vidual owns $500 of Liberty Bonds. He is in position to buy $2,500 w^orth of other bonds, by lodging the Liberty Bonds as part of the collateral, the purchased bonds or stocks forming the other part. The details of the transaction would be as follows: Presuming he were to buy $2,500 of bonds netting 7 per cent, the income would be $175 a year. Add $500 Liberty Bonds at 434% 21.25. Total income $196.25. Collateral loan $2,500 at 6 per cent. $150.00 Net income $46.25, or .0945 per cent, on the $500. The only precautions to be observed are first, to obtain the loan at a bank and not ''on margin" through a brokerage house, which may, in a panicy market, sell out the customer and thus bring a loss; and second do not buy speculative securities. All banks favor collateral loans that are well secured and it is not diffi- cult to obtain such accommodation as above suggested. Proper Form of Collateral. One of the essentials in borrowing on collateral is that the stocks and bonds shall be in proper form for good delivery and by this is meant in such form as will be accepted for delivery on the stock exchanges. Be- fore a share of stock can be transferred on the books of the issuing company the transfer from seller to buyer, or BANK LOANS 159 from the borrower to the lender, must comply with certain formaUties. It ,must be signed in blank and witnessed. If it is not signed, (and many borrowers prefer not to sign the security itself,) there must be a power of attorney properly executed. The bank as lender must be placed in position to sell the stock if the loan is not paid as agreed, and it must be in posi- tion to do so without reference to the borrower. In the fine print that is found on all collateral notes, it is provided that if the borrower defaults in interest, or fails to pay the loan when it is due, or if a demand loan, when payment is called for, then the bank may sell the security at public or private sale without notice to the borrower. Any balance remaining after the claim of the bank is satisfied will, of course, revert to the borrower. When a collateral loan is made the intention of the borrower is to pay it off when due. He does not sell the collateral to the lender, but pledges it as se- curity. He says in substance: ''I expect to pay this loan, with the interest as agreed; but if I do not, you may sell the security in a regular way and legal manner, and satisfy your debt. I find no fault if you do this, and I consent to these conditions. My failure will be my loss." The usual rule is to require a margin of 20 per cent for safety — that is the bank loans 80 per cent of the market value. In some cases a margin of 20 points is required — that is, on a stock selhng at $60 they would only loan $40. If the market goes down to the point where the margin of safety is exhausted, the bank may call for a reduction of the loan, or more security; and failing to receive either, it may call in the loan. Fail- ing to pay upon such a call the security would be sold and the debt would be satisfied from the proceeds. 160 THE BUSINESS MAN AND HIS BANK Warehouse Loans. There is a class of loans known as ''warehouse loans" that is very common in banking circles. Such loans are secured by goods in storage and are highly regarded on account of their safety. The more staple the commodity, the higher the grade of the loan, and banks are everywhere ready to make advances against such articles. There are three requirements: First, that the goods be stored in standard warehouses and proper receipt issued for the goods, the return of the receipt being necessary in order to obtain the goods. This is called the non-negotiable receipt, meaning, it cannot be passed from hand to hand like money. Second, that the goods be of the quality and quantity specified. The receipt of the warehouseman usually gives the case numbers, or quantity of articles, barrels, etc. and the character of the goods may be ascertained from an appraisal or from the original invoices. And third, that the goods shall be insured in favor of the lender. Let us take an example. You desire to buy fifty cases of canned goods, to be stored by the X. Y. Z. Storage Company until needed. You instruct the seller to deliver the goods to the warehouse and obtain ware- house receipt for them specifying the case numbers. The invoices are attached to the receipt, insurance is effected, and these instruments are taken to the bank. The bank will loan 60 per cent, of the invoice price; or in other words, you put up 40 per cent, of the cost and the bank advances the rest. The greater part of goods of all kinds in storage, is carried by bank loans; and the one precaution to bear in mind is that the bank wants the goods to be as represented. It will then watch their market value. Any goods that deteriorate, or spoil, such as butter and eggs, fruits, etc., will not be as readily accepted as BANK LOANS 101 canned goods, dry goods, rubber, leather, hides, and other articles that are not subject to the elements. Banks will lend freely upon grain in transit and in storage. While in transit it is represented by the bill of lading, and while in storage by the elevator receipt. For instance you wish to buy ten cars of wheat or corn or oats, or fifty bales of cotton. As soon as you can present the bill of lading for the shipment, the bank will make a loan on the security of the papers, which give it control of the goods. The character of such commodities as wheat and cotton is certified to by grad- ers who inspect the grain or cotton at certain points and once the grading is made it will be accepted in all markets. If for instance a cargo of wheat is graded as No. 1 winter wheat at Duluth, this grading will hold until the wheat is finally delivered to the mill. The weight is of course certified to by the railroad or other carrier. Banks have different customs in regard to such loans, but the loans themselves are easily secured, once the proper documents are in hand. Goods Held in Trust. Once the credit of the business man is established with his bank he may have the bank buy goods for him and allow him to hold them in trust by giving what is known as a trust receipt. The process can best be described by a simple example. Let us suppose the A. B. Knitting Mill, of Paterson, is in such credit with its bank that the bank will buy for its account a cargo of raw silk from Japan, through processes elsewhere described. The silk is delivered to a warehouse in New York. The mill wants ten bales, and may take this amount out of storage by giving the bank a trust receipt whereby it acknowledges having received the goods u 162 THE BUSINESS MAN AND HIS BANK as the property of the bank, for the purpose of manufac- turing into finished silk, and agrees to hold the ten bales and the product thereof as the property of the bank, and to reimburse the bank for the advances so made as sales are made. In other words the mill is the bank's agent to turn raw silk into finished silk, and after paying the bank for the raw material, plus the carrying charges, it may treat the balance as its own. Automobile Loans. The retailing of automobiles has reached such pro- portions that the average dealer is not strong enough financially to procure the cars necessary to meet his demands. In order to secure the agency for any well- known car a certain number must be contracted for and taken, not as the dealer makes his sales, but as the dis- tributing house elects to send the cars, which must be paid for in cash on delivery. It is readily apparent that the dealer must be financi- ally strong, or have good banking connections that wiU give him sufficient funds to take up these deliveries as made, otherwise he will be unable to get cars and his selling efforts will be considerably hampered. The problem, therefore, has resolved itself into finding a method of operation that is safe on the part of the lender and not too costly on the part of the borrower. With the wide demand for cars of certain makes, they have become good collateral in the same sense that any stable commodity is good security for banking accommodations. We must view the automobile in the same light as articles of necessity in our daily affairs. While we cannot class automobiles in the same category as meats or canned goods, yet they take rank toward the front as liquid collateral. BANK LOANS 163 The most workable method yet devised for the hand- ling of automobiles by banks is on the trust receipt, the operation of which can be seen by the following practical illustration. A dealer contracts to sell fifty cars during 1920 and must pay cash as they are delivered, this delivery being optional with the jobber. The jobber is quite hkely to send a carload of cars to the retailer, whether the latter is actually in need of them or not; but if he does not take them up he may not be able to obtain cars at all. The dealer therefore arranges through his local bank that as the cars are dehvered, the bank will ad- vance 80 per cent, of the cost price of the car at the factory, making the dealer's investment, the freight, and 20 per cent, of the factory cost. A demand note is taken for the amount and a trust receipt given, describ- ing the car by name, car number and type. This trust receipt stipulates that the loan is made for the purpose of purchasing the car mentioned, that the car is the property of the bank, and is held for its account by the dealer as warehouseman. He agrees to keep the same properly insured against fire and theft, not to use it for demonstration, and to sell only upon the release of the bank. Whenever a car is sold, the loan is paid off and the release issued. If a car should be sold without this release or payment of the loan, the bank could follow the car wherever it might be found and reclaim it. In other words, the dealer would be guilty of conversion. The risk is two-fold; first, that the dealer may not be a man of honor and therefore sell without the release, which would be risky: and second, the character of the car. It would not be a safe proposition on a new and untried car, nor would it be advisable on cars of an expensive type, but it is perfectly workable on standard cars running under $2,000. 164 THE BUSINESS MAN AND HIS BANK The writer has been instrumental in bringing in for dealers during the last three years hundreds of cars on this plan without a single miscarriage. If a car is sold on time payments or notes are taken for the unpaid balance, it is for the bank to determine whether it will issue a release and take what the dealer gets in payment, or insist upon all cash. The above plan is elastic, safe and helpful, and can be operated in any territory by any bank that will grasp the significance of the idea and the practicability of its operation. Loans on Accounts Receivable. During the past few years a practice has arisen of borrowing on assigned accounts receivable, a practice which has grown to large proportions, and has its favor- able and unfavorable sides. While banks in general do not follow this practice, many make such loans to well known customers, but the bulk of these loans is made by "commercial bankers" who specialize in this form of banking and find it exceedingly profitable. The loan usually takes the form of a note secured by an assignment of accounts receivable. The original invoices together with the shipping receipts are produced as evidence of the sale and delivery of the goods, and a margin of from 20 to 40 per cent, is required. The pro- fit to the banker arises from the fact that while standard interest rates are charged, the charge is based upon the whole amount of the collateral, and besides there is a fee, called a service charge, of about So per thousand dollars, which adds to the cost of the loan, and at the same time to the profits of the lender. Banks as a rtUe do not favor this form of borrowing since it pledges the most liquid asset of the firm, and credit statements often require information as to the prevalence of this practice on the part of the borrower. BANK LOANS 165 It is likewise an evidence of financial weakness, inasmuch as the borrower could, if in good standing, obtain ample credit with the banks and need not resort to this expensive form of credit. That there is need for such loans and satisfaction on both sides is evidenced by the growth of these companies and the ever increasing number of merchants and manufacturers resorting to this method of financing. There is undoubtedly a favorable side as respects the borrower, for it gives him immediate use of the money represented by the accounts receivable, and the costliness of the loans is offset by the quick payment. Borrowing on Receivables. The operation of this form of borrowing and the advantage even in a ten day credit will be seen by an illustration. The A. B. C. Furniture company has sold a bill of goods to a New York department store that pays cash in ten days. As soon as the goods are shipped, the firm will take a copy of the original invoices and shipping receipts to the commercial banker, make out proper note, and immediately receive 80 per cent, of the amount of the sale. The agreement is that the original check received from the department store will be sent to the banker as soon as received, and even though the bill is paid as soon as the goods arrive and audit can be made, the manufacturer will have had his money a week or more before the check comes to hand. There are two methods in vogue, the notification and non-notification. In the former the buyer is advised that the account has been assigned, and in the latter no knowledge reaches him that the account has been pledged. In the first case the remittance will go direct to the banker, and in the other to the seller and by him turned over to the banker for credit on the loan. 166 THE BUSINESS MAN AND HIS BANK There is but one safe course to follow where this practice is pursued, and that is to so indicate on the statement, or to do so by advice and consent of the banker where the regular account is carried. There are cases where the bank may not be large enough to extend sufficient credit to the customer and such borrowing may be advisable; but this can be over- come by selecting another and larger and perhaps more liberal bank. Or, it may be, the borrower has exhausted his bank credit and must needs resort to other fields of borrowing, and if so it is a danger signal which is well to heed. However, the writer has seen many cases where firms have been entitled to considerably more credit than their local bank would allow and were justified in going to other banks with the accounts; the reason for the restricted credit being inadequate knowledge of business and unfamiliarity with credit operations on the part of the bank officials. It is no unusual thing to find a firm entitled to a fine of, say $10,000 credit on their own paper, hmited to half this amount and that only on collateral, by banks that are dominated by men whose ideas regarding loans and credit were obtained in the narrow sphere of their own business and who are in no position to pass upon the require- ments of other men. In short, they endeavor to run a bank as they have run their own business, and apply the same crude and illogical ideas, to the detriment of the bank and its customers. Whether the custom of loaning against accounts receivable be good or bad, it is here to stay, and the problem is to make it sound in its operation and satis- factory to both borrower and lender, leaving the question of cost and profit to be settled between them. CHAPTER XX COLLECTIONS Banks carry a great many accounts that are un- profitable and some that are a distinct loss. The only justification that can exist for such practices is service to the public and the philanthropic spirit that must attend bank administration. It can readily be seen that the account that shows practically no balance, cannot result in a profit on account of the labor cost of handling it, together with the actual cost of stationery used in its operation. While some accounts are small, they are accepted because of their peculiar setting and their relationship to other accounts. These are looked upon in the same Ught as the grocer regards the sale of sugar or kerosene oil, namely- — as an un- welcome necessity. In handling such accounts the bank renders a real service that cannot be obtained elsewhere, no matter how much the customer may value the con- nection as viewed from his own end. There are many other features that attend banking that are unprofitable and constitute the unrequited part of banking service that makes for the common good. Among these may be mentioned collections. The man who steps up to the teller's window and asks to have a check cashed forgets too often that he confers no favor upon the bank, but rather is asking one. And what shall be said of the business man who collects liis notes, coupons and drafts, through his bank without effort or risk or cost? 167 168 THE BUSINESS MAN AND HIS BANK Various Kinds of Collections. Collections may be divided into classes: (1) The collec- tion of notes held by the customer. For instance A in New York holds the note of B in Texas for $1,000, due at the Dallas National Bank on a certain date three months hence. It must be presented at the bank, on the day it is due if it is to be properly and lawfully presented. He simply hands it to the collection clerk and the banking machinery will see that the note is presented properly at the appointed time, and the proceeds returned, or prompt notice given him of non- payment. The charge, if any, will be made at the other end, and so far as the collecting bank is concerned, it is a labor of love — part of the service that goes with a cus- tomer's account. 2. Collection of Coupons. Banks handle large num- bers of coupons, and increasingly so since the Liberty Loans. If the coupons are of standard concerns, gov- ernments, municipalities, railroads, industrial organi- zations of recognized standing, they are received as cash. If their payment is doubtful they are received "for collection." They must be accompanied by proper blanks for income tax purposes, and are sent by regis- tered mail, insured, all of which requires additional labor and care and entails considerable expense. 3. The collection of checks which are doubtful or irregu- lar. Such items are not received as cash, but are sent forward for payment by the receiving bank as a special safeguard or as a special favor. 4. The transmission of -papers which are to be delivered upon certain conditions. Thus, A in New York holds a mortgage on property in Pennsylvania, which it is to be paid off. He does not want to deliver the papers until payment has been made to his agent, and so takes the papers to his bank with instructions to forward COLLECTIONS 169 them to its correspondent, to be delivered upon the payment of a specified sum. The bank will then send the documents to its correspondent and when the amount is paid the delivery will be made. 5. Drafts for Collection. We can best illustrate the latter class by a simple and practical illustration. The A. B. Truck Co. in Detroit has sold an automobile truck to a farmer on Long Island. The condition is that he shall pay $500 upon delivery and execute twenty promissory notes and a conditional bill of sale for the truck before he can obtain delivery. The truck is shipped by rail. The Company draws a draft on the farmer for $500, makes out the notes and conditional bill of sale on its regular forms, obtains the bill of lading from the carrier and hands them to its bank with in- structions to deliver the bill of lading only upon payment of the draft and the signing of the notes and bill of sale. Upon the arrival of the truck the carrier will notify the farmer that the shipment has arrived. The firm will also have advised him that the draft, bill and notes have been forwarded to the local bank for collection. When the bank receives the papers it too will send notice and when he pays the bank the $500, signs the notes and bill of sale, he will get his bill of lading and with it the truck. There is some risk in such a transaction, for should the farmer be allowed to take the bill of lading without signing the other documents, the bank will be liable. It cost a large bank in New York nearly $2,000 a short time ago through failure to get the signature to such a bill of sale. The purchaser having apparent title to the car, mortgaged it before the error was discovered and the bank was held liable to the seller. If the farmer refuses to sign the papers he cannot get the truck. As a rule such shipments are made in the 170 THE BUSINESS MAN AND HIS BANK name of the shipper, and title never passes out of him until the bill of lading is properly indorsed and delivered. The foregoing would be called a ''draft with bill of lading attached." It is a common form of collection, used in large numbers by business houses and is a safe and practical way of shipping goods to those whose credit standing may not warrant an open credit. "Duns." There is another class of collections — "duns, " that are often regarded as a nuisance. They consist of small drafts used by merchants to collect small debts where other methods have failed. The process can best be seen by illustration. The American Law Book Company has sold a set of books to a lawyer in a distant town, on agreed terms of credit. The bill remains unpaid for a long time after due, and letters of request for pay- ment are of no avail. The firm then sends notice that if not settled within five days, it will draw on the debtor. This it does by delivering its sight draft to the bank ''for collection." The receiving bank sends postal card to the lawyer notifying him that it holds draft on him for a certain sum, drawn by the book company. He pays no attention to the matter and after a few days the draft is returned. So frequent have these drafts become that many banks refuse to recognize them unless accompanied by a small fee, usually about fifteen cents, to cover postage, labor and handhng. Many of these drafts are presented by messenger, thus adding to the cost of collection. If paid by the drawee, the collecting bank will remit to the bank sending the item, or credit the amount to the bank from which it was received. Many banks send all such items to regular correspondents, thus adding to the number COLLECTIONS 171 of handlings with the attendant costs. For these ser- vices the bank actually collecting the items deducts a small fee, but as a rule the home bank does not, credit- ing the amount to the customer as a collection, at cost. Such collections are of course given attention, but the drawee is never pressed for payment, notification being sufficient, unless it is requested in the collection advice to place the matter in the hands of attorney if collection is dishonored. Many times these "duns" produce good results, but when their harmless charac- ter becomes known to the debtors they are often ignored. When the collection is returned the reason for its re- fusal is usually given on an attached slip, among which are: "No Attention to Notice" "Will Remit by Check" "Does not Owe this Bill" "Amount Incorrect" "Refuses to Pay Exchange" "No Such Party," etc. Collections are given more detailed care than checks, being recorded in the collection register by number, (for identification) maker, drawee, date, time, to whom sent, amount, when due, and fate. This must be done at both ends, and the labor cost of handling collections is much greater than in handling checks. Collections are not as a rule credited until actually paid. The bank may enter them in the pass book, ''short extended " or in the back of the book as a memor- andum for tracing purposes; but they are usually treated as "time items" and credited only when paid. If the dunning drafts must be used as a collecting process — and in many instances they are honored- — the surest way to get good service is to enclose a self ad- 172 THE BUSINESS MAN AND HIS BANK dressed envelope and a small fee, fifteen or twenty cents, and the receiving bank will gladly give the col- lection attention; but where no fee accompanies they are often merely filed and returned when postage is sent. Grain Drafts. Drafts are employed in large numbers in grain ship- ments, and here we find their proper use. A simple illustration will show the process. The Western Milling Company in Minnesota has sold a car of oats to a dealer in New York State, cash on delivery of the goods. As soon as the car is loaded the invoice is made out, bill of lading secured from the railroad company and draft drawn to cover the amount. The three documents are given the Minnesota bank for collection. The latter will forward to the local bank (it is sometimes agreed upon at the time of sale what bank shall receive the draft for collection, the buyer designating his own bank) for collection. Inasmuch as the arrival cf the car is uncertain, these drafts are drawn payable "upon arrival of the car" and are called ''arrival drafts." As soon as the car arrives, the dealer will be notified and will take up the draft and thus obtain the bill of lading which insures delivery of the goods. Frequently the instructions will allow inspection of the goods before the draft is paid. Shipments of produce from farmer to commission merchant in the large cities, butter, eggs, etc. are also sent upon draft with bill of lading, the pur- pose being to make it a cash transaction upon arrival of the goods and this method accomplishes the purpose admirably. In many instances the bank will advance money on the bill of exchange or draft accompanied by a bill of lading. Thus in the oats case, the Minnesota bank might give credit to the customer for the face of the COLLECTIONS 173 draft on the strength of having the goods under its control, of standard quahty and of readily ascertained market value. Cotton is shipped on this plan to a very large degree, the essence of the transaction being the bill of lading which controls the ownership of the goods. The cotton dealer is therefore assured of payment for his cotton as soon as it is loaded and bill of lading issued by the carrier. In recent years the carriers have become more strict in regard to the bills of lading. Whereas before it was an easy matter to obtain possession of goods by merely calling for them and paying the freight, it is now im- possible to obtain goods without the shipping documents. Gross frauds crept into the former practice and large losses followed the loose methods of former days; but a bill of lading is now quite conclusive evidence of the existence of the goods and of control over their dis- position. Parties to a Collection. The parties to a collection are: Drawer — the one who signes the draft; drawee- — the one directed to pay the draft; payee — the party (usually a bank) to whom payment is to be made; indorser- — who is in the first instance, the payee; acceptor- — the drawee after signing the draft across the face, or writing the words "Accepted" with the date and his name underneath. Drafts are drawn payable at sight, a certain number of days after sight (presentation) or at a certain time designated. In order to be properly presented they must be presented at the time, at the place and to the party drawn upon; and any deviation from this rule will waive the legal rights against the interested parties. The acceptor of a draft cannot change the time or 174 THE BUSINESS MAN AND HIS BANK the amount; but he may make it payable at his bank and it then becomes an order on his bank to pay the amount and charge his account. Recall of Notes. Inasmuch as it is the custom to send notes to the place of payment so that they will be at the paying bank on the day due, anything that changes the original tenor of the instrument will interrupt the smooth working of the bank machinery. Notes that are ready for presentment are often recalled at the last moment. A renewal may have been arranged for or the maker of the note may send his check to the discounting bank to take up the note, forgetting that it is far better to meet the note at the place where it is to be paid. A recall must go through the same channels as the original note. It can take no cross cuts. For instance: A Chicago bank holds a note due in Poughkeepsie, N. Y. It will send the note to Albany and the Albany bank will send it to the place of payment. If for any reason the maker concludes to renew it, or sends his check to the Chicago bank after the note has left its hands, the recall must go from the discounter of the note to the Chicago bank, from Chicago to Albany and from Albany to Poughkeepsie. Banks will only honor recalls when sent by the bank from which they received the item. Such transactions involve needless labor and expense and should be avoided as much as possible. Some banks make a charge for recalling notes as a penalty for inter- fering with the regular course of collections and to cover the expense attending. Where the telephone is used, especially for long distance recalls, the expense is considerable. Banks are under no obligation to recall items and to do so is a courtesy on their part. Use it, but do not abuse it. CHAPTER XXI HOW TO READ A BANK STATEMENT Banking is a public function, performed for private gain. While the profits of a bank accrue to the owners, these profits arise from the employment of funds received from the public at large. Were it not for the deposit function of the bank, it could not exist, and because of the fact that it holds itself out as quahfied and able to employ safely these funds it becomes a profit making institution for the stockholders. It occupies a position of honor and trust that is pecuhar to itself and sacred in its obligations. It has long been recognized as a proper function of the state to regulate and supervise banking institutions, to the end that the interests of the public may be safe- guarded. It is part of the police power of the state. AU states have banking acts. Some of these are crude and poorly drawn, and can hardly be dignified by the term ''banking laws," while others have well nigh perfect banking acts that have been developed from time to time as changes have been found necessary. As a matter of fact the latter predominate, the degree of excellence reaching its highest point in such states as New York and Massachusetts. In fact, it is difficult to imagine a more excellent set of banking laws than obtains in New York at the present time. The National Banking Act which dates from the Civil War is the controlling power as concerns national banks, and embraces more institutions than any other banking legislation, the number of these banks being upwards of 8,000. 175 176 THE BUSINESS MAN AND HIS BANK Having a set of rules and principles for the guidance of banks, it becomes necessary to see that they are enforced. We have therefore the office of Comptroller of the Currency as supervising head of the national banks, and a banking department in each state to over- see the banks and trust companies working under state charters. This work is so highly technical and of such volume and character that it is generally made a sepa- rate department, although in some states it is combined with the State, or Insurance Department. The work of this department is to supervise banking institutions by calling for frequent reports and to in- quire more closely into their affairs by frequent examina- tions. These examinations are made by paid examiners sometimes appointed by the Comptroller or Superinten- dent of Banks at will, or from civil service tests. The examiners report for duty without previous warning and make a detailed audit of the bank. Examinations are also required to be made by the directors, both as a rule at six months' intervals. Whether a bank is a half-billion dollar bank in New York, or a hundred thousand dollar bank in the moun- tains, it must keep the same books of record, make the same reports and is subject to the same examinations. It is a difference in degree but not in kind. The one handles millions and the other thousands, but the books of the latter would answer the general purposes of the former. Barring the impressiveness of large figures received from many sources, the general bookkeeper of the country bank could keep the books of the city bank and be perfectly at home. Therefore, if the statements originate from the same general sources, the ability to understand the statement of a small bank qualifies the reader to understand the statement of a large one. We shall take the statement HOW TO READ A BANK STATEMENT 177 Report of the Condition of the Bank of Blankville at the Close of Business on the First Day of January, 1920. Resources : Bond investments, viz.: Public Securities $1,489,752 . 57 Private Securities 1,363,054 . 04 Banking House 75,000.00 Real Estate Owned 59,607 . 54 Land Contracts 18,065 85 Mortgages owned 300,000.00 Loans and discounts secured by bond and mortgage deed or other real estate collateral 121,326.77 Loans and discounts secured by other collateral 1,288,887.22 Loans, discounts and bills purchased not secured by collateral 1,528,689 . 83 Overdrafts 1,551 .70 Due from approved reserve deposit- aries, less amount of offsets 165,147. 18 Due from Trust Companies, banks and bankers not included in pre- ceding item 43,500.63 208,647.81 Specie 16,349.22 Other currency authorized by the Laws of the United States 197,600.01 Cash items, viz.: Exchanges and checks for next day's clearings 194,297 . 76 Other cash items • 1,259 . 83 195,557 . 59 Other assets, viz. : War Savings Stamps 245 . 00 Furniture & Fixtures 806.05 Accrued interest not entered on books at close of business on above date 51,656.40 Customers liability on account of acceptances 150,000.00 7,066,797.60 12 ' 178 THE BUSINESS MAN AND HIS BANK Liabilities : Capital stock 200,000.00 Surplus fund 170,000.00 Undivided Profits 35,906 . 36 205,906 . 36 Deposits : Deposits by the State of New York 32,000.00 Postal Savings deposits 4,449.33 Deposits subject to check 2,031,729.58 Demand certificates of deposit . . 28,036 . 00 Deposits withdrawable only on pre- sentation of pass books 4,282,556.53 Cashier's checks outstanding, in- cluding similar checks of other officers 2,165.99 Certified checks 8,656 . 38 Due trust companies, banks and bankers 5,597.43 Total Deposits 6,395,191.24 Bills payable, including indebted- ness for money borrowed, repre- sented by notes, certificates of deposit or otherwise 50,000.00 Other liabilities, viz.: Reserves for taxes, expenses, etc.. . 15,000.00 Interest accured to depositors 35,200.00 Estimated unearned discounts 15,500 . 00 65,700 . 00 Liability on account of acceptances executed for customers 150,000.00 $7,066,797.60 HOW TO READ A BANK STATEMENT 179 of a typical bank and trace each item, showing its derivation and its place in the balance sheet. While the order of the items and the arrangement in the statement may differ, they represent precisely the same thing whatever the character of the bank. Much can be learned about a bank from its published statements, particularly if the reports are kept for future reference so that comparison is possible. The growth in deposits, additions to profits, and variations in the other items may be followed if this is done. For in- stance in a recent report of a bank, it was found that it had undivided profits of $25,000. In the report a year previous it showed $50,000, while its capital and surplus remained the same. At first sight, it was presumed the management had ''marked down" the bonds, but these were practically the same as a year previous. Therefore nothing else could have affected this state- ment thus except the ''cutting of a melon" and this w^ould have been known to the stockholders. They might have increased salaries of the favored few, but hardly in such proportion. Only one conclusion could be drawn — they had charged off losses. They had not only run behind $25,000 in their undivided profits but had also sacrificed a year's earnings. Bond Investments. This item represents the amount invested in bonds of various kinds. They may sometimes be found classified into "pubhc" and "private" securities, as in this case, "government obhgations," etc. The figures given are the value at which they are held by the bank, commonly called the "book value." This value is presumed to be the market value, or seUing price. It is the poHcy of the best managed banks to mark their bonds at the market price, which is conservative to say the least. 180 THE BUSINESS MAN AND HIS BANK It depends largely upon the attitude of the examining authorities. Some are strict and compel adjustments as bonds shrink or advance in value; and no set rule can be given. During the war period prices deemed "con- servative" in a normal market were accepted. It must be borne in mind that a bank is a going con- cern. It does not go out of business. It sells securities to take care of its customers' needs but rarely. As a rule it holds securities until maturity, or sells if at all at a profit. And a bank should no more be compelled to show the selling out price of its securities than a merchant should be compelled to list his stock at auc- tion prices. We must never forget that business keeps moving, and under normal conditions previous expectations are realized. Banks expect to hold their bonds until paid in full at maturity. The fairest price at which to make this inventory is the cost price adjusted to the present time; that is to say, if a bond cost 110 five years ago and will be paid five years hence, one half of the premium should have been absorbed at this time, and 105 would be a fair appraisal value; but if it cost 90, it would be a proper figure to hold it at 95. Bond investments differ from merchandise in that the former has a certainty of payment that merchandise does not possess as to sale. Of course, if the bond buying is without knowledge of securities, and with ill advice, the quality of the holdings may negative all that has been said above, but we assume that the bank man knows quality in bonds as the merchant knows quaUty in merchandise. Banking House. This item in the balance sheet is the book value of the banking house. No bank is ever allowed to purchase real estate as an investment. They are, however, in HOW TO READ A BANK STATEMENT 181 all jurisdictions allowed to build or buy a banking house, renting the unused portion. Permission to do this must be obtained from the authorities and the amount in- vested therein is usually passed upon by the supervis- ing officials. This is often "charged off" or charged down to a nominal value, inasmuch as banking struc- tures as such have a limited utility. Real Estate Owned. While a bank may not invest in real estate, other than its banking house, it may take over real estate for debts previously contracted. In fact a bank may do anything to save itself from loss from preexisting debts, even though the act would in itself otherwise be unlawful. Such real estate as is taken over is held as an asset, rented until sold and the profit or loss (usually the latter) adjusted. Such holdings can be held for a stated period, usually five years, when an extension of time to sell must be obtained. Land Contracts. This represents the amount of real estate sold under contract for which deed has not been given. Title has not passed out of the bank as yet and payments are constantly being made on these accounts. This form of accounting is pursued in order to separate the prop- erty sold from that still unliquidated. Mortgages Owned. This is a state bank and is allowed to make loans on real estate secured by first mortgage. National banks were not allowed to make mortgage loans until the passage of the Federal Reserve Act. They are now, except in the large cities, permitted to make such loans under certain conditions. These conditions are that the land shall be farm land, within one hundred miles of 182 THE BUSINESS MAN AND HIS BANK the bank, and the amount loaned not over fifty per cent of the value, for a term of not over five years, and for not over one year on city property. This figure is the amount loaned on real estate security. Loans and Discounts Secured by Bond and Mortgage, Deed or other Real Estate Collateral. It is the intention in New York to keep the banks free from real estate collateral loans as much as pos- sible, such loans as are made on real estate to be in the form of first mortgages. It frequently happens that the owner of a mortgage will want to borrow for a short time on the security of his mortgage, and such loans are regarded as equivalent to a real estate mortgage; and if the mortgage is a first lien upon good property, it is favorably regarded in banking circles. In real estate booms, banks have been over optimistic in this respect, and have taken second mortgages as security, to their sorrow. The New York State Banking Department holds that the place for realty loans is the savings banks, and does not favor mortgage loans for commercial banks. This item is for the pur- pose of checking the banks in this respect. Frequently deeds are offered as security; but the only proper way is to make the loan upon mortgage security, with the papers properly recorded. If a deed were taken as security, it would be regarded as a mortgage and not an absolute transfer of the premises. Well managed banks will not accept deeds under any condition. Loans and Discounts Secured by other Collateral. This includes the collateral loans of all kinds, other than on real estate security, such as Liberty Bonds, stocks and bonds listed on the stock exchanges, and unlisted securities. They are often called ''demand" or ''secured" loans. HOW TO READ A BANK STATEMENT 183 Loans, Discounts and Bills Purchased, not Secured by Collateral. These are loans represented by promissory notes. The '' discounts" are notes held by customers and dis- counted for their account. The ''bills purchased" are commercial paper purchased in the open market as treated under the head of Commercial Paper page 146. Overdrafts. An overdraft being "a loan without security" must be set up in the statement to show, first, that such items exist and to what extent, and secondly, to get them in the assets, which they properly are. Being a debt due to the bank, they must be listed among the assets just as any other obligation would be. Overdrafts are frowned upon in all banks. They in- dicate one of two things: first, carelessness on the part of the depositor. In many instances the depositor gets confused as to his bank balance and overdraws un- consciously. Second, the result of working on too small a margin, and drawing checks faster than deposits war- rant. In the national banks the allowing of overdrafts is forbidden, and in all cases the practice is discouraged. Due from Reserve Agents (or legal depositories). By law all banks are required to carry a certain portion of their deposits in cash, or with other banks (called reserve agents). These sums they may con- sider in the same class as cash on hand. The ratio varies in different communities. In New York City banks must keep 13 per cent of theii" demand deposits and 3 per cent of their time deposits in reserve. The reserve must be kept in the Federal Reserve Banks, if the bank is a member. In cities such as Albany, Buf- falo, etc., the ratio is 10 and 3, respectively, elsewhere, 7 and 3. The cash on hand is now optional in national 184 THE BUSINESS MAN AND HIS BANK banks, the legal reserve being held by the Federal Re- serve Banks. In state institutions the reserve must be kept in lawfully appointed reserve banks and on hand and the ratio is slightly different. Before a bank can qualify as a depository it must be voted upon by the board of directors and approved by the Superintendent of Banks. Under the former regime, in national banks the consent of the Comptroller of the Currency had to be secured. Funds so held are listed separately and reported as "due from reserve agents." Due from Trust Companies, etc. These are balances due from banks other than reserve agents. They are created by sending items to such banks for collection. Since these balances cannot be counted in the reserve they are separated; otherwise they are of the same nature as reserve balances. Specie and Currency. This is the silver and bills in the bank's vault. In this bank, with deposits running over five million dollars a month, it is found that $200,000 is enough cash to keep on hand, the inflow being more or less steady. In fact the cash accumulates faster than it can be used for local purposes and the surplus is shipped to the New York correspondent for credit. In the event that the bank should need cash in unusual quantities, it would draw on its New York bank for cash shipments. This failing, it would either secure a loan on its bonds, or rediscount its paper. Under the Federal Reserve Act, the latter would undoubtedly be the course pur- sued. As a matter of fact this bank finds that with deposits of over six million it can safely operate with $400,000, part on hand and part in New York banks, sustaining the theory that one dollar in money will support four or more dollars of credit. HOW TO READ A BANK STATEMENT 185 Exchanges and Checks for Next Days Clearings. These are the checks received during the day and drawn on banks that clear through the Clearing House and will be paid the next day. They are regarded as equivalent to cash. In this case they are checks on neighboring banks received after the bank has made its daily exchange of items, and will be paid the next day. In the New York banks this is a very heavy item, running into the milUons in most of these large insti- tutions. War Savings Stamps are those carried by the bank for sale to customers. Furniture and Fixtures. This is the investment in desks, adding machines, typewriters, safes, etc. The proper way is to charge this account off from time to time, so that as the equipment wears out it will show a lesser valuation on the bank records. Accrued Interest. This is interest not yet due but "accrued." That is to say, interest that cannot be collected because not yet due. Take a simple illustration. The bank holds $10,000 of certain bonds, interest due February 1st and August 1st. This report is made as of January 1st, There is up to this time $240 of interest due on this investment but not collectable until February 1st. Likewise the interest on demand notes, which is collected at stated times during the year. The amount so due is computed on each item and forms part of this accrued interest. In short, this represents all the interest that the bank has due to it up to the time and not col- lected because not yet due, together with interest past 186 THE BUSINESS MAN AND HIS BANK due but which is considered good. It is often an im- portant item inasmuch as it represents hidden yet real assets that properly belong in the statement, and j-et are not shown by the books, which do not show such accruals from day to day. Customers Liability on Account of Acceptances. This is a new item not found in all statements, but generally obtains in the case of large city banks that are making acceptances. When a bank makes an acceptance for a customer it takes some form of security, or obligation, to assure the payment of the debt. It may be the promissory note of the customer, an agreement, or collateral in one form or another; but the obligation which the bank has assumed is safeguarded to itself and appears in this item. Liabilities Capital Stock. This is the working capital of the bank, contributed by the stockholders. In addition, they are liable to an assessment equal to the face value of their stock in case the bank fails. WTiile the profit in banking comes from a small capital and a large line of deposits, so that the earnings of several dollars of deposits will accrue to the benefit of one dollar of capital, there is added protection to the depositors in a large capital. Moreover it gives the bank additional lending power. Inasmuch as the law hmits the loans a bank may make to a proportion of its capital and surplus, the bank with a small capital finds itself handicapped in handhng the affairs of large concerns. There is no rule in this respect, except the legal rule, which stipulates the capital required, which is graded according to population. HOW TO READ A BANK STATEMENT 187 Surplus Fund. This is the fixed surplus. When a bank is organized the stockholders contribute to the surplus fund, so that it starts off with a certain amount of surplus as an added protection to the depositors. If the stock is sold at $120 per share, $100 would be placed in the capital stock fund and $20 in the surplus fund. This fund is increased from time to time from profits, so that in some cases it far exceeds the capital, and makes the stock the more valuable. For instance, a bank on Long Island has a capital of but $30,000; but the surplus fund is $250,000, created largely from profits, thus making the stock very valuable and closely held. This item marks the management, for it can only increase as profits are made, and profits arise from sound policies. Follow this item in bank statements carefully from time to time, as well as the next. Undivided Profits. This is the undistributed profits. As the books are closed from time to time, usually every six months, the profits are carried to undivided profits, and out of this fund dividends are declared. As the undivided profits grow, additions are made to the fixed surplus which is rarely changed except by additions. Undivided profits accounts is the profit and loss account of the bank, and shows the current earnings. This item and the surplus should be considered together. If losses are taken they are charged to this fund and a decrease in the undivided profits usually indicates that the bank has charged off bad debts, or "marked down" its bonds. Banks usually exhaust all legal means before charging off a note. Often they are then carried in "suspense account" as one dollar and many are afterward paid, which of course is in substance a clear profit. 188 THE BUSINESS MAN AND HIS BANK Deposits. These are generally classified to show the various kinds of deposits. In this case we have: 1. Deposits by the State of New York. These are public moneys deposited by the state authorities, and are usually secured by a pledge of state bonds as col- lateral. In other words, before the state will deposit with a bank, the latter must buy state bonds, lodge them with the State Comptroller or Treasurer, who in turn will deposit with the bank. The same is true of United States deposits. 2. Postal Savings Deposits. This is of the same nature as state deposits. The local post office is authoriz- ed to deposit the postal savings deposits with local banks that qualify as depositories. To do so the bank must buy certain bonds (government, state, and munici- pal bonds) and when these have been deposited with the Postal Savings Commissioners in Washington, postal funds may be deposited up to certain limits. The securities are of course the property of the bank and interest is collected by the bank; but in case of failure, the Government would be reimbursed from the proceeds of the bonds and the balance returned to the bank for liquidation purposes. 3. Deposits subject to check. These are the demand deposits, subject to the checks of the depositors. They are always shown separately. Interest may be paid on these deposits on daily balances, but they are payable as the name indicates, on demand. 4. Demand certificates of deposit. Instead of issuing a pass book for interest bearing accounts many banks issue a ''certificate of deposit" which is, as its name implies, a certificate that the one mentioned has deposi- ted a certain amount, payable on demand or at a certain time, with or without interest. "Time certificates of HOW TO READ A BANK STATEMENT 189 deposit" are of the same nature, but are payable only at a stipulated time. 5. Deposits payable only on presentation of pass books. These are savings deposits, precisely the same as savings bank deposits. They are represented by pass books, and such deposits are subject to notice of with- drawal as a matter of protection to the bank. The law usually requires a less reserve against such deposits on account of their nature, the time notice being a safeguard, and the character of the deposits such that the bank would not as a matter of practice be required to pay on demand. The law recognizes the fact that such depositors would not all withdraw their funds at the same time, and so permits their closer investment than the demand deposits. In some states these deposits are ''segregated" — that is, invested separately in recogniz- ed savings bank investments and considered apart from the general assets of the bank. 6. Cashier's checks. These are the checks of the cashier or other officers, given for various purposes. In paying the expenses of the bank, or in issuing the bank's own checks, this form is used. A draft on the bank's city correspondent would answer the same purpose, but inasmuch as the cashier's check is the bank's order on itself, it is considered an obligation until paid. If a New York draft w^ere drawn, for instance, to pay for a block of bonds, it would be charged against the New York account; but if a cashier's check were issued it would still be an obligation of the bank until cancelled by payment in another form. In short, the bank pays its debt and owes it too. 7. Certified checks. When a check is certified it is immediately charged to the maker, and ''certified check account" is credited to keep the books in balance. When it is paid, the certified check account is charged 190 THE BUSINESS MAN AND HIS BANK and the record is closed. This item shows how much the bank has outstanding in certified checks; and these being its own obHgation must be shown to indicate the habihty in this direction. To repeat, a certified check is not the obHgation of the maker, but of the bank, and must be so shown in the statement. Due Banks and Trust Companies. Many banks have '^collection accounts" — that is to say, accounts with one another. Checks are sent to one another for collection and are credited the bank sending them and paid for as agreed upon, once a week or semi-monthh', and the amount is carried as ''amount due banks and trust companies." Banks Liability on Account of Acceptances. This is the offsetting item to '' Customers liability on ac- count of acceptances." The two items are usually in the same amount, the one balancing the other. When a bank makes an acceptance, it incurs an obligation. It must stand ready to meet the obligation, even though its customer does not make good to it ; therefore it sets up a liability in the amount assumed to show how much of such instruments it has accepted, or agreed to pay when due. Bills Payable. At times banks find they have over invested in bonds "or over loaned," — meaning they have made loans to such an extent that they find themselves short of money on account of unexpected withdrawals, and must therefore, replenish their reserve accounts. They might sell bonds, or call in loans, but the former might entail loss to the bank and the latter might work hardship to the borrow- ers. To overcome these objections, they may redis- HOW TO READ A BANK STATP^MENT 191 count some of their promissory- notes with other banks, or borrow on their bond holdings. Both processes may be profitable, for in rediscounting, it is often possible to do so at a lesser rate than the loans carry, and loans may be obtained on good securities at a less rate than the bank receives from it customers. For instance, a bank needs $100,000 to make good its reserve. It holds $100,000 of choice commercial paper drawing 5)-2 per cent. It may rediscount this at the Federal Reserve Bank at 4}^ per cent, leaving a profit of 1 per cent, to itself. Or, it may borrow on Liberty Bonds at the same rate, thus leaving its assets intact but partly pledged, and creating an obligation as indicated in this title. As loans are paid, securities mature, or deposits increase, funds will be in hand to pay off this obligation, leaving the assets undisturbed. This practice has become quite common during the past few years, especially since the advent of the Federal Reserve banks, and this item may now be found in a great many statements. Reserves for Taxes, etc. It is the custom among banks and business houses to set aside from time to time an amount sufficient to cover fixed charges that have accrued but are not yet due. Taxes which accumulate constantly, including real es- tate, income, profits tax, etc. should be provided for by holding out a sum sufficient to cover them to the date of the statement. Otherwise the earnings will be in- flated, and the true condition will not be shown. This item is of the same nature as accrued interest to deposi- tors. The bank estimates that $15,000 will cover these charges and has properly set up a reserve to cover them. If this were not done the profits would be that much greater, and the statement would not reflect the real condition of the bank at this time. 192 THE BUSINESS MAN AND HIS BANK Interest Accrued to Depositors. All banks pay interest to depositors and the charge is running all the time. Credit is made at stated times during the year, but until the interest is calculated it cannot be credited. Let us assume that the bank under review has a million of deposits on which it will pay interest at 4 per cent, on February 1st. At the time this statement was made there was five month's interest '' accrued." but not yet due, and we deceive ourselves if we do not figure accordingly. While it does not become due until a month hence, it is never- theless running against the bank every day, and so we compute five months interest on a million dollars at 4 per cent, yearly, and enter this as a liabihty. Unearned Discount. When a bank discounts a note it takes out the interest in advance and immediately credits the amount to income account. It is obvious that it has taken profits or earn- ings in advance. It has anticipated time and ''drawn its pay" in advance. For instance, here is a note, for $1,000 dated October 1st for six months at 6 per cent. The bank discounted the note on the same date and deducted $30 as the discount and carried the same to income as an immediate earning. This statement was taken as of January 1st, 1920. It is obvious that only half of the $30 had been earned up to that time. There- fore we must take out of our profit and loss account the $15 to get a correct statement of condition as of that date. We do this by setting up as a hability the total of these various amounts and call it ''unearned discount," or "interest received but not earned." It has its counterpart on the other side of the statement in the item "accrued interest." CHAPTER XXII ACCEPTANCES AND THEIR USES Before discussing acceptances, their uses and what the introduction of these instruments is intended to accom- pUsh in American banking and business circles, let us get clearly in mind what an acceptance is. An accept- ance is nothing more than an '' accepted" bill of exchange. If the latter instrument is understood as to its underlying principles, the acceptance, which grows out of a bill of exchange, will hkewise easily be compre- hended. A bill of exchange is an unconditional order in writing, addressed by one party to another, signed by the one drawing the bill, requiring the party to whom it is addressed to pay on demand or at a fixed or determinable future time a sum certain in money, to or to the order of a specified party, or to bearer. The Purpose of Bills of Exchange. The purpose of the bill of exchange is now, and always has been, since its introduction centuries ago, to transfer funds by giving an order on the debtor to pay the sum stated to another, the bill being his warrant for doing so. Thus, A holds funds belonging to B, or is otherwise in debt to B. B draws an order on A to pay the amount to C. This order is a bill of exchange, and would prop- erly be called a "finance bill," since it simply transfers money and does not arise out of a sale of goods. If, however, B were to sell a bill of goods to A, and ship 13 193 194 THE BUSINESS MAN AND HIS BANK them under a bill of exchange or draft drawn upon A, requu-ing him to pay the bill before obtaining possession of the goods, we would have a commercial bill of ex- change, or commercial draft. The bank check responds to the definition of a bill of exchange inasmuch as it is an order on a bank to pay a sum certain in money to a designated party or to bearer on demand, and these instruments have always been regarded, and truly enough as bills of exchange by the text writers. There has, however, developed a branch of the law and numerous cases that are peculiar to bank checks, and in this respect they may be con- sidered as a special type of bill that has had a develop- ment coexistent with the development of banking, particularly in those countries where the bank check has had its largest growth, namely the United States, Canada and England. The most common use of the bill of exchange is to accompany a shipment of goods, requiring the buyer either to pay for them, or to execute a promise to pay by "accepting" the bill before possession of the goods may be obtained. In such cases the bill of exchange is usually accompanied by a bill of lading, which, being necessary in order to obtain the goods from the carrier, can only be had by paying or accepting the bill. There- fore an '^ acceptance" is merely a bill of exchange accepted; but on being accepted, it loses its character as an order and becomes a promise. It is then equivalent to a promissory note. Practical Use of a Bill of Exchange. Let us take a simple, yet common, example of the practical use of the bill of exchange in a domestic trans- action, showing also the use of the bill of lading in a sale for cash on delivery. (As a matter of fact, such ACCEPTANCES AND THEIR USES 195 transactions are merely " C. O. D." transactions with a little dignity added) . The A. B. C. Wagon company in New York has sold a wagon to a farmer in New Jersey. He is not known to the firm and upon checking him up they find him to be slow pay, and decide upon a cash transaction. The wagon is shipped to his railroad station. The bill of lading issued by the railroad is an ''order bill," drawn to the order of the wagon company and requires its indorsement before the goods can be delivered. In other words the title to the wagon never leaves the com- pany. The company draws a sight, or demand, draft on the buyer, attaches the bill of lading and sends the two documents to the farmer's bank for collection. The instructions to the bank are to deUver the bill of lading (which has been duly indorsed) to the farmer upon payment of the amount of the draft. On the arrival of the w^agon at the railroad station, the agent notifies the farmer that the wagon has arrived. The bank, upon receiving the draft will also notify him that the draft is at hand, with bill of lading attached. (In referring to bills of lading, the initials ''B. L. " are gener- ally used). When the farmer pays the amount to the bank he can get the bill of lading and with it, the wagon. If he does not take up the draft he cannot obtain the wagon and the company may take it back without ceremony, it still being their property. This is the most common use of the bill of exchange in this country and is used daily in thousands of trans- actions involving the sale of goods; but inasmuch as funds belonging to others are as a rule held by banks, bills for the transfer of money usually take the form of bank checks, and when drawn by banks upon their correspondents are called ''bankers bills" or "bankers drafts." 196 THE BUSINESS MAN AND HIS BANK Present Day Financing Methods. If the foregoing is clearly understood, we are prepared to discuss the acceptance as it is an outgrowth of the wagon illustration, and see how it is intended to im- prove business and banking transactions and customs in this country. Prior to the Civil War it was the custom of merchants to make periodical visits to trading centres and to purchase goods for several months in advance, giving in payment, their promissory notes, which the seller discounted at his bank, or held until maturity if his means permitted. Owing to the disordered condition of the finances of the country, and the fluctuating value of the currency, the amount which the seller actually received when the notes were paid often proved less than was contemplated, thus reducing the profits. This un- certainty of course had to be duly considered and the prices arranged accordingly. In order to overcome this condition, a custom arose of offering the buyer a cer- tain discount from the face of the invoice if payment was made in cash within a stipulated time. This arrangement rapidly grew in favor and the custom of cash discounts has become a fixed element in American merchandising methods. But in order to avail him- self of these concessions, the buyer had to have cash funds, and there arose another custom, namely, the seUing of promissory notes through commercial paper brokers, as fully treated under the subject ''Commercial Paper," page 146. Out of this process there has developed what is now the common and most widely used form of credit in this country, the open account, or book credit. This sim- ply means that the seller opens account with the buyer and ''charges" the amount. The goods are sold on agreed terms of payment running from a few days to ACCEPTANCES AND THEIR USES 197 six months, with cash discounts if payment is made within certain prescribed times, as 2 per cent, for pay- ment within ten days, one per cent, for payment within thirty days, or the face amount of the invoice if not paid until the end of the credit period, say, sixty days. These terms would be expressed as "3^io, ^io, net 60." This form of credit requires that the seller be finan- cially strong enough to carry the buyer on his books until payment is made, and the accounts so opened are called "accounts receivable" or simply ''receivables." The giving of promissory notes by the buyer now obtains in but few of the lines of merchandising, and is relatively rare, the open account predominating to a very large degree. The Disadvantages of the Open Account. The disadvantages of the open account form of credit are many and are easily recognized. First, credit in the form of open accounts is cash, tied up and prac- tically unavailable as long as the credit is unliquidated; that is to say, the seller cannot easily use this form of credit for borrowing purposes. (See hypothecating accounts receivable, page 165). In making up financial or credit statements, these open accounts are always listed as " accounts receivable " and constitute one of the four quick assets of the business, inasmuch as they are constantly turning into cash. If the credit methods of the concern are sound, they are regarded as next to cash as a quick asset, but to dispose of them in any way, as by hypothecating these receivables, is regarded as a sign of weakness and impau'ing the stand- ing of the concern. Realizing the intrinsic goodness of these receivables there have been organized during the past few years 198 THE BUSINESS MAN AND HIS BANK several large and prosperous concerns that make a business of lending against these accounts, or in other words, buying the accounts, thus anticipating their pay- ment. Some banks will lend upon the assignment of receivables, but this form of borrowing is not favored by the banking fraternity, inasmuch as it weakens the borrower's condition because it takes away one of his most liquid assets. The second disadvantage of the open account is that it has no fixed time of payment. Even though the credit terms be distinctly stated, and agreed upon, a lapse of a few days in remitting is no serious matter, because the credit is open. In an investigation covering the hardware line, the following results were shown. Among manufacturers the terms are usually 60 days, less 2 per cent, ten days. Those paying within the ten day period average 15 days before settlement was finally effected, and those taking the full credit term settled in from 75 to 80 days. Ten per cent of the customers took 90 days — an obvious extension of the credit term over the agreed time. From 40 to 50 per cent, of the jobbers took 15 days for settlement, while of those who took the 60 day option only 30 per cent, settled promptly. Of the remaining 20 per cent, only about one-half pay in the period be- tween 3 and 4 months after purchase, while the other half pay in from four to six months, or never, notwith- standing the terms of sale, were 60 days. (Pamphlet on Acceptances issued by the New York Federal Re- serve Bank). The third disadvantage of the open account is that its collection is retarded by the fact that payment may be delayed as above ■ indicated without seriously im- pairing the credit of the debtor, and suit must be brought to recover for goods sold and delivered, which is sub- ACCEPTANCES AND THEIR USES . 199 ject to proof of delivery, terms, etc., and is open to dispute as to the quality and quantity, all of which is time consuming and costly. When the buyer fails to pay for his goods as agreed, he forces the seller to carry the account with his own or borrowed capital with no compensation for the addi- tional term of credit, and each day the credit is un- liquidated adds that much to the seller's loss on the transaction. It is apparent, therefore, that the open account ties up the funds on the books of the seller unless he can use them in such a way as above indicated, or borrow on his general credit standing. The larger firms carry their customers by selling their commercial paper in the open market, or borrow from their local banks on their own promissory notes. But whether the merchant hypothecates his receivables or borrows to carry his customers, funds represented by receivables are non liquid and are not a quick banking asset in the sense that we shall subsequently discuss in treating the acceptance. The Object of the Acceptance. The introduction of the acceptance has for its object the elimination of all the disadvantages of the open ac- count and is the logical method of handling transactions based upon credit. Let us illustrate the relative merits of the two methods by a simple case, and at the same time show how an acceptance works out in practice. The firm of A and B have a contract for furnishing a restaurant with its equipment, consisting of ranges, cooking utensils, dishes, furniture, linen and silver. Payment is due when the outfit is ready for business. In the open account method, the buyer is charged the amount on the books of A and B when the goods are 200 THE BUSINESS MAN AND HIS BANK delivered to the restaurant premises and the amount represented thereby becomes a "receivable" to the seller. If they must go out into the market and buy the articles, they in turn must create receivables to the seller, or borrow in order to meet their payments. The funds are tied up until payment is made by the restau- rant firm, even though part payment is made from time to time. If, on the other hand, the terms of the sale are that A and B will draw a sixty day draft for each lot of goods delivered, which the restaurant firm must accept upon delivery, A and B have an instrument that they can immediately discount at their bank. If A and B also accept drafts on themselves as goods are delivered to them, the sellers may also have immediate use of their funds. All parties are benefited, for as soon as the accepted draft is in their hands they have an obligation that has a definite maturity, and which is practical banking paper. It carries the obligation of the acceptor and the indorsement of the maker or drawer. While the obligation to pay on the open account would be no less an obligation, its form is such as to make it difficult and costly to handle; while the accep- tance is prima facie evidence of the obligation and its form is such as to make it a usable instrument in banking circles. Its simplicity is its chief virtue. Forms of Acceptances. There are two forms of acceptances: trade acceptances; and bank acceptances. The trade acceptance is simply a bill of exchange arising out of a sale of goods, which has been accepted by the buyer by writing the word ''accepted" across the face of the bill, with his name and the date underneath. By so doing he assents to the terms of the bill and agrees to pay it according to its ACCEPTANCES AND THEIR USES 201 »1»JS po» 'aij^J. JO Xno ,93^0,. pJ >M JO 9S3Jppv )»3Jlt '^OVq •9^61 3n;a ^ I^JO}da33V aoNvxdaoov 3av>ix 202 THE BUSINESS MAN AND HIS BANK tenor. He assents that the goods have been received, and that the amount is due and will be paid. If there is any dispute it does not affect the instrument, such matters being adjusted independently. In the bank acceptance, the acceptor is a bank instead of a private party. While trade acceptances are used most frequently in domestic transactions, the bank ac- ceptance is used extensively in foreign transactions, or those involving the importation or exportation" of goods. We may make another classification into documen- tary bills — bills accompanied by shipping papers, bill of lading, insurance, invoice, etc., and clean bills — that is, bills without documents. There are also bills pro- viding for the release of the documents upon payment of the sum, and bills that release the papers upon acceptance. The Operation of a Bank Acceptance in a Foreign Transaction. The operation of a bank acceptance in a foreign transaction is as follows. Let us assume that a coffee merchant in New York has contracted with a coffee exporter in Brazil for a cargo of coffee. The merchant in New York may not be known to the exporter, or even if so, the latter desires his money as soon as the cargo is ready to ship. He cannot wait until the goods are de- livered and paid for by bank check. He cannot take the merchant's note and have it discounted at his bank, for the Brazil bank may know nothing of the New York merchant's affairs, and moreover, custom has decreed that such transactions shall be for cash as between buyer and seller. Therefore the New York merchant arranges with his bank for a bank acceptance. The beginning of this transaction is a letter of credit, issued by the ACCEPTANCES Ax\D THEIR USES 203 204 THE BUSINESS MAN AND HIS BANK New York bank, which states that the bank in New York will accept drafts on the New York merchant up to a certain amount, if accompanied by certain documents, such as bill of lading, insurance papers, invoice, etc. The New York merchant is furnished with a copy of the letter of credit, which he sends to the exporter in Brazil, which authorizes the latter to draw on the bank as soon as the coffee is on board ship. As soon as the conditions of the letter of credit are complied with, the exporter takes the papers to his bank, and the latter, having assurance that the goods will be paid for on arrival, by virtue of the letter of credit, buys the bill from the exporter, and forwards the same to its New York correspondent for collection. The latter presents the bill to the bank that issued the credit, which accepts the bill, thereby obtaining the docu- ments accompanying, which gives the bank technical possession of the coffee. The bill now bears the promise of the bank to pay at maturity, and can readily be ne- gotiated in the money market, being a favored form of bank investment- — prime paper, as it is called. The coffee, however, must be turned into money in order to meet the acceptance when due, and must there- fore be turned over to the merchant for sale. The bank takes a 'Hrust receipt' from him, which in effect gives him possession of the coffee, but retains the legal title in the bank until paid for. He can now sell the coffee and from the proceeds will have funds in the bank to meet the acceptance at maturity. The coffee might be stored in storage warehouse, and warehouse receipts delivered to the bank as security for the goods, which would be released to the merchant as needed for current sales. It will readily be seen that the bank has parted with no money in such a transaction. It has simply loaned ACCEPTANCES AND THEIR USES 205 its credit, first by guaranteeing to accept the bill and afterward by accepting. It has secured itself by taking legal title to the goods, and at the same time permitted the merchant to sell them as if they were his own prop- erty, the only restriction being that the proceeds shall be turned into the bank to meet the acceptance when the due date arrives. The danger lies in the fact that the goods may not realize the price paid for them or, they might spoil, if perishable, before sold, in which case the merchant's general credit would come into play. For thus expedit- ing, or better, making possible, the importation and sale of the coffee, the bank makes a small charge for the risk it has assumed. This is termed a foreign bank acceptance, since it involves inter-country dealings. A Domestic Acceptance. In a domestic acceptance, that is, one involving, let us say the shipment of a cargo of flour from Minneapolis to New York, the operation would be precisely the same, except that the acceptance might be returned to the miller who would discount the same at his bank, or the transaction could be put through his local bank which would give him credit for the proceeds of the bill as soon as the flour was loaded and the bill with complete docu- ments presented to it. The advantage in the latter case would be due to the fact that the New York bank issu- ing the letter of credit would be better known to the Minneapolis banks than it would to the South American banks, and therefore the more readily accepted. Principles of the Acceptance. The fundamental princii)les of the acceptance are: first, that the seller shall have absolute assurance that the goods will be paid for on production of the documents representing the shipment. This is covered by the let- 206 THE BUSINESS MAN AND HIS BANK ter of credit. Second, that the bank issuing the letter and making the acceptance shall have security for the goods while in the process of manufacture or resale. This is covered by the trust receipt or the warehouse receipt. The former retains title in the bank until the goods are finally paid for, and the latter keeps the bank in actual possession of the goods until released. In recent bank statements there will be found two items that have a bearing on the acceptance business of the bank. On the asset side will be found ''Obli- gations of customers on account of acceptances." This means notes or other obligations, or other forms of security held by the bank as guaranty for the payment to it of moneys advanced or obligations incurred for account of customers. On the liability side will be found "Liability for accep- tances executed for customers." This means the liability of the bank incurred by reason of letters of credit issued or acceptances made for its customers. Both items are always in the same amount, which indicates that for every dollar of obligation the bank incurs against itself, it takes a dollar of obligation or security running to itself. These bank acceptances are now offered in the open market by firms that make a specialty of this line of finance, and circulars are sent out weekly or oftener offering the acceptances of certain banks, giving the time, the amount and the rate of discount. In New York there is an open and active daily market for such paper and the transactions now run into large amounts. It is equivalent to buying the promissory note of the bank making the acceptance. The bank's obligation in an acceptance is the same as on its bank notes, except that one is payable on demand and the other at a stated time. ACCEPTANCES AND THEIR USES 207 Advantages of the Acceptance to the Seller. The acceptance form of credit has certain distinct advantages over the open book account or the promissory- note given in payment of goods. First, it gives the seller immediate payment for his goods in a form that can readily be discounted at his bank, and by the bank in turn, can be rediscounted at the Federal Reserve Bank. Being paper that is eligible for rediscount at the Fed- eral Reserve Bank, members of the Federal Reserve Bank may freely discount such paper in the assurance that it may be quickly turned into money by the dis- count facilities of the Federal Reserve Banks. Second, the seller has in his possession indisputable evi- dence that the sale has been consummated and that payment will be made according to the terms. Third, being a favored form of banking instrument, it will be discounted at a rate of interest which is often lower than on single name paper, thus adding to the profits or reducing the cost of money to the seller. In the fourth place the elimination of the open account and the substitution of the acceptance will reduce the amoimt of capital required in a business, and the burden of carrying the credit will rest upon the banks, which are especially created for such a purpose, and are pe- culiarly fitted to assume such burdens. Fifth, it has been estimated that from two to three times the volume of business can be done on the same capital by the use of acceptances instead of on open book accounts. This would in turn lower the operating costs and increase the profits to the invested capital. Sixth, there will not be the necessity of selling book accounts to obtain working capital, thus avoiding the high cost of money to those, who by force of circum- stances, have been obliged to adopt this expensive method. Our national business vices have been said to 208 THE BUSINESS MAN AND HIS BANK be trying to do business on too small capital, and the ex- tension of too long credit. The acceptance will correct both of these evils. If the retailer were to give the wholesaler accep- tances, the latter would in turn dispose of them to the banks, and the banks to the Federal Reserve Banks, to be by them used as the basis of the circulating currency of the country as discussed under the chapter on Federal Reserve Banks, thus converting the four thousand millions represented by book accounts from a 'Hied up asset" to a circulating credit, to be used by the business inter- ests of the country to a distinct profit. The acceptance method will curtail if not end the bad practice of taking unearned or unauthorized dis- counts and reduce the returned merchandise evil. Inasmuch as the Federal Reserve Banks generally quote an interest rate of about >^ per cent, lower for acceptances than for promissory notes, the cost of money is reduced accordingly. Even though the seller does not need to discount the acceptances received from his customers, the fact that he holds paper that is readily accepted by his bank gives him the assurance of quick money when he needs it. He has the best security the bank can ask for, namely two name paper, of short maturity, and widely scattered as to the business risks. It also gives the seller his maturing payments week by week with reasonable certainty. It is found in practice that a merchant regards the obligation that has a fixed maturity in a different light from one having an indefinite and elastic date. All firms are jealous of their credit and anything that tends to weaken that credit should be discouraged, and anything that strengthens it should be encouraged. ACCEPTANCES AND THEIR USES 209 Advantages To the Buyer. First, he will have the advantage of lower prices. Since the cost of money enters into the price of goods, the lower the cost of money the lower the cost of goods. Second, having assumed a liability with a definite maturity, he will buy cautiously, extend credit conserva- tively and collect promptly. He will be a better credit risk and will accept better credit risks. The open ac- count invites slow and loose credit methods. Third, those who buy on the acceptance method will put themselves in the class of preferred buyers, or essen- tially cash customers, while those who adhere to the open account method will be at a disadvantage in comparison. The reduction of costs, economies in management, and business efficiency being for the public good, the retailer, by giving acceptances relieves the jobber, and he by the same process relieves the wholesaler, from the bur- den of acting as banker, a service which the buyer has forced the seller to assume at considerable expense. The acceptance will create in the mind of the buyer a sense of responsibility towards his obligations, if he agrees distinctly to stated credit terms that cannot be ignored except to his hurt. It will create a higher class of merchants than we have heretofore had. It will simplify the bookkeeping methods of business concerns, acceptance bookkeeping having many advan- tages over the open account in its bookkeeping processes. Advantages To the Banks. Anything that redounds to the safety and profit of business redounds to the safety and profit of the banks. They are affected by the same influences. Banking experience has demonstrated that the loan that is based upon an agreement and sale of goods is the most satis- factory of all loans, on account of the self liquidation of 14 210 THE BUSINESS MAN AND HIS BANK the debt. And the trade acceptance, arising out of such a transaction, is therefore the most desirable bank- ing security. It is fundamentally sound and doubly protected by the two name liability. Most banks are limited in their direct lending to a proportion of their capital and surplus, usually ten per cent; but acceptances do not come under this rule and broadly speaking there is no fixed limit for such paper. Business men can therefore secure a larger line of dis- count, and banks can legally and safely extend such discounts beyond the rigid rule laid down in the law for such advances. Acceptances furnish the banker the highest credit information, namely, accurate information as to the origin and purpose of the instrument; and whatever helps to dignify an instrument will help in its acceptance by the bank. And inasmuch as the business man must borrow, the better the form of instrument offered, the quicker and the easier is the loan obtainable. Acceptances not an Innovation. The acceptance, while comparatively new to American banking and business interests, is by no means a new idea, such instruments having been in use in European countries for many years. It is the common method of financing business transactions in England, France and Germany. Prior to the advent of the Federal Reserve Banks, national banks were not permitted to make acceptances, although a few of the large trust companies were making them on a small scale; but with the legalizing of this form of credit, for both state and national banks, such institutions have encouraged acceptances by making them freely. Chambers of commerce, credit men's associations and large business interests have instituted ACCEPTANCES AND THEIR USES 211 propaganda seeking to popularize the acceptance, and the growth of this Hne of finance during the past five years has been quite remarkable. Heretofore importers in the United States have been obliged to arrange their credits through the London banks. These banks are known throughout the world and have branches in all important centres of trade, and a letter of credit issued by any of these banks is good anywhere. American importers have arranged with their local bank to obtain such letters on London, the American bank guaranteeing the credit to the London bank. They have, therefore, on account of the indirect connection, been obliged to pay two commissions, one to London and one to the local bank. Thus, in the coffee transaction, under the old system, the credit would have been arranged through London by the American bank, and two commissions would have been charged. Under present methods the credit could be arranged direct with an American bank. On account of the important role the United States has played in the financial affairs of the world during the war, American banks have taken a front rank among the great banks of the world, and ''dollar exchange," or ''dollar drafts," meaning drafts drawn in dollars on American banks, are now recognized in all parts of the world. American credits will shortly be if they are not already on a par with London credits. It has been estimated that American importers and exporters have been paying London banks upwards of ten million dollars yearly for such acceptance credits. This will now come to American banking interests. The purpose of the acceptance being to bring about a more scientific method of financing the business of the country, the Federal Reserve Act does not permit acceptances to be made for the purpose of borrowing 212 THE BUSINESS MAN AND HIS BANK money or for carrying stocks and bonds. They must arise out of a business transaction, — a sale of goods. They must be of short maturity, in most instances Hm- ited to 90 days. And any acceptance that so arises is eHgible for rediscount in the Federal Reserve Bank. Of course, the customer's bank may lend on any form of acceptance that would constitute a lawful loan of money, but the acceptance must conform to the rules of the Federal Reserve Bank to be accepted by them for rediscount. According to rulings of the Federal Reserve Board, members of the Federal Reserve Bank may accept for themselves bills of exchange arising: 1. Out of the shipment of goods between the United States and any foreign country, or between the United States and any of its dependencies, or between foreign countries. 2. The shipment of goods within the United States if the bill, when accepted, is accompanied by shipping documents. 3. The storage within the United States of readily marketable goods, provided the acceptor of the bill is secured by warehouse, terminal or similar receipt. 4. The storage within the United States of goods which have actually been sold, provided the acceptor of the bill is secured by the pledge of such goods. 5. If the bill is drawn by a bank or banker in a for- eign country or a dependency of the United States for the purpose of furnishing dollar exchange. All bills drawn in accordance with the above condi- tions and having a maturity at the time of discount of not more than 90 days exclusive of days of grace, and endorsed by a member bank, are eligible for rediscount in the Federal Reserve Bank. CHAPTER XXIII SAVINGS BANKS The value of the savings bank to the business interests of the country and the place of this type of bank in the financial scheme can best be seen by contrasting it with the bank of discount, whose operations we have already treated at length. Let us, however, review briefly these functions. In the first place the bank of discount promotes the business interests of the community by affording a safe place for the deposit of the money funds that form the working capital of business, these funds being subject to the checking process, by which their ownership is transferred from one to another and from place to place. The bank of discount comes into existence because men have accumulated capital and have invested it in a bank- ing enterprise. The bank not only exists because of accumulated capital, but it continues to do business) because men have acquired capital for use in their own business and employ it largely through the medium of business bank. In the second place, through the loaning or discount function, the bank of discount carries the debts of the business w^orld, affords working capital to those whose credit is good, and purchases the instruments of debt that arise in business transactions, thus relieving the business world of the burden of operating on private capital. On the principle that borrowed money is equivalent to capital if used for productive purposes, and the business man may treat his bank loans as he 213 214 THE BUSINESS MAN AND HIS BANK does his own savings in carrying on his business, the bank of discount is the medium through which the business world acquires and uses a large part of its working capital. Finally through the note issue function, the business world is furnished with its circulating currency, without which it could not operate. Inasmuch as the needs of business require the use of money for the smaller ex- changes, bank notes are necessary, and the banks by furnishing such instruments vitally assist in carrying on the business transactions with cheapness and dispatch. The Function of the Savings Bank. In contrast with the above we have the savings bank which provides none of the foregoing services and yet performs an equally acceptable and necessary function. The term savings bank is applied to those institutions without capital stock that are organized for the purpose of assisting people of small means to save money, and to reward the saving of Inoney by the payinent of in- terest on the deposits according to certain standard rules. While there are less than seven hundred strictly mutual savings banks in the United States — that is, banks with- out capital and operated solely for the benefit of the depositors, there are many other institutions that accomplish the same purpose. Among these may be mentioned the banks of discount which operate ''savings departments," building and loan associations, stock savings banks (practically the same as banks of dis- count) and mutual investment companies; in fact, any institution that accepts small deposits, pays interest on them, and whose aim is to encourage the saving habit, is essentially a savings bank. The savings bank starts without capital of its own and its stock in trade consists of the deposits of the public. SAVINGS BANKS 215 It is therefore an assembler of capital — the reservoir into which the small streams of capital flow, accumulating force as the deposit fund increases. In the sense that it affords a safe depositary, it resembles the bank of dis- count, but it differs in that it does not allow the checking function to operate, the payments being over the counter. It never issues bank notes and lends only on security. It makes no "open credit " loans. We can see the differ- ence more clearly by contrasting the contract of the sav- ings bank with that of the bank of discount. When an account is accepted by the bank of discount, the bank becomes the debtor of the depositor and agrees to repay the money on demand, this demand taking the form of a check. This agreement is general and not specific and exists only in the law. The savings bank, however, enters into a distinct and printed contract with the depositor, the pass book which contains the by-laws being the contract of deposit. In this contract the savings bank agrees to invest the money according to law, to pay such interest as may be warranted, and to make repayment only upon production of the book, with an order in writing signed by the depositor or his attorney or lawful representative. The pass book is therefore required with every transaction and an order on a savings bank is not a negotiable instrument because of this fact. The manner in which a savings bank may invest its funds is closely covered by the laws of the various states, the law being explicit and most conservative in this respect. These investments are of two kinds: (a) mortgage loans and (b) bonds. Mortgage Loans. All states permit savings banks to invest in mortgage loans, or in other words to lend on real estate security. In fact this form is encouraged on account of the safety 216 THE BUSINESS MAN AND HIS BANK and benefits. Of all forms of investment, mortgage loans no doubt have the cleanest record, losses from this line of investment being practically nil. It not only helps toward home ownership and the acquiring of property, but it has a broad economic aspect that redounds to the common good. Let us see this by a practical example. The Bank of Savings has accumulated $100,000 from a thousand depositors. This fund must be made to earn an income, from which to pay the expenses of the bank and to give the depositors return on their deposits. The bank therefore agrees to make ten $10,000 loans on various new buildings. Immediately the wheels of industry begin to move. The builder begins to buy lumber and building materials of various kinds, and to employ laborers and mechanics. Wherever lumber and cement, brick, iron, paint and all that enters into building construction is produced, the impetus is felt, and the accumulated savings of the thousand people find their way back into the channels of trade and com- merce and benefit ten thousand other people. And after paying the costs of living, the balance finds its way back into the banks for another like purpose, and the savings bank becomes an institution of perpetual motion and a continual round of beneficial activity. It will here be opportune to discuss How a Mortgage Loan is Made. The making of a mortgage loan affects so many people and is such a common experience that the method of procedure should be known to all. Let us follow the practice of a large and well managed savings bank as typical. First, we have the application for the loan. This gives the location of the property, size, character of building, improvements, value of the land, buildings, and other details as the bank may elect. An appraisal SAVINGS BANKS 217 fee is often required to cover the cost of examination of the property. In this stage the application is turned over to an appraiser or appraisal committee who examine the property and" report then- valuation and recommenda- tion. The amount loaned does not often exceed sixty per cent of the appraised value and is limited by law in most states. The amount of the loan having been agreed upon, the matter is reported to the board of trustees and the loan accepted and authorized closed. In the third stage the attorney of the bank will institute a ''search" of the property to ascertain if the title is clear and in the borrower. When the ownership of the property has been traced back a number of years, sometimes as far back as fifty years or more, and no liens, judgments, unpaid taxes, assessments, or other claims are found that will affect the title, a "certificate of title" is issued. If a title company makes the search, there is issued a "title policy" which not only certifies to the title, but guarantees that the title is as stated. The papers are then drawn. These are : (1) the bond, which is the obligation to pay. (2) the mortgage, which is the security. These papers always come in pairs, and are spoken of as the ''bond and mortgage" and the loan as "a loan on bond and mortgage." The mortgage is a "conditional deed, " by which the borrower transfers the property to the lender conditional upon the payment of principal and interest, and if payment of interest and principal is not made as provided for in the bond, the lender may sell the property under the mortgage. The selling process is called "foreclosing," or shutting out the right of the borrower to repay the amount borrowed and be discharged of the debt and have the property released from the lien created by the mortgage. In other words, as long as the borrower pays the interest and principal as agreed, the mortgage 218 THE BUSINESS MAN AND HIS BANK is inoperative; but when defaulted, the mortgage may- be enforced and the debt collected out of the proceeds of the property when sold at public sale. After being signed, the papers must be recorded. Only the mortgage is entered for record, in the County- Clerk's office, thus making the loan a lien of record upon the property. In addition to the bond and mortgage there is required the certificate of title or title policy, as before noted, the insurance policy, endorsed to the lender (called the mortgagee), tax receipts or tax search, showing all taxes to have been paid, and the appraisal of the property. The latter is usually a certificate of value on the original application. The same procedure obtains in the case of a private loan and the process is quite the same everywhere. In some states there is a mortgage note in place of the bond and a series of interest notes for the collection of the interest as it falls due. It is necessary in all mortgage loans to keep the taxes paid, the insurance in force, and running to the lender. The payment of interest is of course necessary to pre- vent foreclosure, but this devolves upon the borrower. Tax payments are evidenced by tax receipts and insur- ance by the policy properly indorsed. Valuation of Real Estate. The valuation of real estate is surrounded by so many elements that extensive treatment of the subject cannot be undertaken here. There are three methods of arriv- ing at a valuation: (1) The replacement value, or the cost to reproduce the property under current conditions; (2) the market value of the premises; and (3) the capitalized rental value. The market value is, of course, the price it will bring if sold, but the best test of all is the ''capitalized rent." SAVINGS BANKS 219 This simply means the vakie of the property as an in- vestment. It is axiomatic that property must show a net income if it is to be of any financial benefit to the owner in the present. However much value it may appear to have in the future, it must show an earning power in the present if it is to be regarded as an invest- ment and not a speculation. The charges against property are: interest on the mortgage, if any, taxes, insurance, water rents, repairs, depreciation. These items deducted from the gross rental gives the net income. Therefore property must earn as a rule at least ten per cent, to show any adequate return, and its value should be on the basis of ten per cent, income. If it does not earn this amount, the value must be de- termined from other sources.^ Bond Investments. The second line of investment of savings banks is bonds of various kinds. To enumerate these would be to give a digest of the various state laws. In some states the banks are free lances and are allowed a wide latitude in regard to the bonds they may buy, while in others the law is strict and the investments limited. Municipal bonds, that is, bonds of governments, states, cities, counties, villages and school districts, are every- where legal. Bonds of railroads, street railway com- panies, hght and power companies and "industrials" are also legal in some states, but as a rule stocks, except bank stock, are not authorized. Interest Rules. The interest rules are more or less uniform. Interest is paid on deposits, quarterly or half yearly, on such sums ' (See chapter on Mortgage Loans and Real Estate Values in The Savings Bank and its Practical Work by the same author.) 220 THE BUSINESS MAN AND HIS BANK as have been on deposit for a certain length of time, either from the first of the various months or from quar- terly periods. Withdrawals of money before the close of the period usually forfeit interest. Thus, a deposit made on July 1st and remaining in the bank until January 1st will be entitled to six months interest; but if withdrawn on December 1st, no interest will be al- lowed. Deposits made in August will draw from Sep- tember 1st, or October 1st, depending upon the rules of the bank. Interest not withdrawn acts as principal and becomes such as soon as credited. Accounts on which no transactions have taken place for a term of years, running from five to twenty-two years, become ''dormant" and are entitled to no further interest. The writing up of the pass book keeps the account from becoming dormant and should be done at frequent periods. In some states these accounts are taken over by the state and in others remain on the books of the bank as unclaimed deposits, subject in both cases to payment upon proper proof of ownership. The Management of a Savings Bank. The management of a savings bank differs from that of a bank of discount in that the managers of the savings bank are called "trustees" and are as a rule elected for life, while in the bank of discount they are elected yearly and are called "directors." The trustee has no financial interest in the bank and in some jurisdictions is not even allowed to be a depositor, while the directors must be stockholders. In order to become a trustee of a savings bank, one must be selected and elected by the other trustees, while to become a director, one need only acquire stock votes enough to elect him. There are few and infrequent changes in the personnel of a savings bank, while in banks of discount there are fre- SAVINGS BANKS 221 quent and sometimes drastic changes in the management. Directors as a rule receive a fee for attending the meet- ings, while trustees do not, and where this is permitted the remuneration is nominal and is restricted by law. In short the management of a savings bank is of the same character as that of a church, hospital or other public institution. The trustee has no other interest in the bank than to obey the law and conserve the interests of the depositors for whom he acts, while the director, being a stockholder, shares the profits of the bank with other stockholders whom he represents. To say that one method of management is better than the other is to express mere opinion, for it is certain that in many banks of discount the management is as of high order as in savings banks and vice versa. It is largely a question of men ; but there can be no manipulation of a savings bank for private gain, and the losses in savings banks are exceptionally small and failures almost an unknown thing. The profits of a bank of discount belong to the stock- holders, and the surplus is built up for their benefit, as well as to protect the depositors; but in the savings bank the surplus never reverts to the trustees, they having no interest in building it up, except to add to the safeguards for the depositor. In case of liquidation the entire sur- plus would be distributed among the depositors. The risks taken by savings banks are of two kinds. First, advances on property that depreciates and so jeopardizes the mortgage loans; and loans that must be foreclosed and the property taken over and sold when opportunity offers. Such losses are insignificant. Sec- ond, bond investments that prove unwise and result in defaulted bonds with the attending losses. These too are rare and of no consequence in the great mass of 222 THE BUSINESS MAN AND HIS BANK investments made by savings banks. Business banks, lending on open and unsecured credit, assume infinitely larger risks than savings banks. As a matter of fact banks of discount take greater risks by far than savings banks can possibly assume, and therefore require a greater degree of banking skill and a much higher degree of care and attention than savings banks, since the ele- ment of human judgment predominates in the business bank in a much larger measure than it does in the savings bank. The savings bank produces but few great bankers, while the business bank must needs have them as a practical necessity. The Routine of the Savings Bank. The bulk of the work in a savings bank consists in making the daily credits and charges to the various ac- counts, which process is attended by more detail than similar work in the bank of discount. While savings banks do not handle as many individual items as banks of discount, the work is done with more ceremony. We can best see the contrast by following a deposit through its course in both institutions. Banks of dis- count use names as the key to transactions, while sav- ings banks use account numbers. When an account is opened in a savings bank, a serial number is given the depositor, represented by the pass book, and the ledger account corresponds. In making a deposit, a ticket is made out with the account number, name and amount. The name is used to verify the correctness of the account number. The teller enters the amount on his cash sheet for proving purposes, and the ticket goes to the distri- bution clerk. Inasmuch as accounts are grouped, so that any one group can be proven by itself, the amount of debits and credits on each group must be accurately kept. The distribution clerk has a sheet for each group SAVINGS BANKS 223 of accounts, and enters the amount on the proper sheet by number, name and amount, with a blank column left between the name and amount. The posting clerk then posts the amount to the ledger account, which may be a card ledger, loose leaf, or bound book. The balance is extended at each transaction. When postings are all made the checking clerk takes the distribution sheets, turns to the ledger number and enters whatever he finds posted as of that date. The amount column has been detached from the main sheet and he has no guide but the number and name. When the sheet has been checked, he makes a total, which must agree with the amount on the detached stub, thus showing that all postings have been made, and to the right accounts. Withdrawals are put through the same process. In the bank of discount, the deposit is simply listed as it leaves the tellers cage, as to amount, given to the bookkeeper to post, and then to the journal clerk who lists it under its proper alphabetical letter by amount only, when the ticket is ready for filing. In many banks the postings are now made by machines that print the date and amount in the proper columns, and add or subtract the amount from the previous balance and extend the new balance, automatically. The individual items are not checked back, unless there is an error. The work is proven by comparing the balances on the ledgers with the balances on the statement sheets, and the same work having been done on each, the results must be alike. In many commercial banks, a trial balance of all accounts is taken daily, which must tally with the general ledger. Such a process would be physically impossible in a savings bank ; for while a bank of discount with two million deposits would have about two thousand accounts, a savings bank of the same size would have three or four times as many. The savings 224 THE BUSINESS MAN AND HIS BANK bank could operate with three men; the bank of discount would require ten. The savings bank trial balance consists of making a total of all accounts, group by group, which must agree with the controlling figures on the general ledger. All well managed savings banks keep their accounts in per- fect proof, and these tests are usually made half-yearly. The computation of the interest on each account is a lengthy process and is one of the bookkeeping events of the year. Each account must be examined and the interest computed according to the rules of the bank. It is then posted, the balance extended, and entered on the pass books as presented. CHAPTER XXIV BANK EXAMINATIONS The reports which a bank makes to the supervising officials are similar to the statements which business men make for the purpose of obtaining credit. They are the bank's estimate of itself. They are unaudited statements, and therefore as reliable as the bank officials making them. The principal safeguard of banking is not the periodical statements, but the frequent examinations by the bank examiners. These are more nearly in the nature of an audit, and are on the whole reliable. What the Bank Examiner Does. Bank examinations are for two purposes: to protect the public by keeping the bank in a state of healthy solvency, and to protect the managing officials from themselves, thereby safeguarding the interests of both stockholders and depositors. If it were not for the watchful care exercised over banks, the failures which are now so rare would be common, for even though some men would be careful and conservative, examinations or no examinations, the great mass of bank managers could not be trusted to operate on the principle that they should be as good children while the teacher is out of the room, as when teacher is at her desk. The enviable record that banking has made in this country during the trying period of the war, and before, and the imnumity from failures, have been due largely to the watchful oversight given to these institutions by the state and national authorities. 15 225 226 THE BUSINESS MAN AND HIS BANK The scope of a bank examination depends largely upon the examiner and the jurisdiction under which he works In some states the examination is lax and in others rigid. In national banks it depends largely upon the examiner himself. But as a rule the country over, these tests may be said to be reasonably rigid. The writer is familiar with the New York examina- tions and also those in the national banking system. The former is more exhaustive and may well be taken as a model for all the rest. Let us see how far the examiner goes in making his periodical test, which as a rule is made twice a year without previous notice. The Bank Examiner at Work. He (or they) usually makes appearance at the close of the day or before the opening of the doors, so that the cash may be counted before it has been disturbed or before it is put away for the night. The cash held in the reserve chests is sealed until proven, and likewise all compartments, drawers and files containing assets of the bank, such as bonds, notes, mortgages, collateral loans, etc. After cash has been proven he verifies the bond hold- ings, by actual count, and any such assets held outside the bank for any purpose must be accounted for by proper receipts. The market value of these is com- puted in making up the final report, to show the bank's actual condition on a selling out basis. The notes secured by collateral are then examined: (a) To see that the note is in proper form; (b) that the security is ample and good ; (c) that it is in proper shape to sell if the borrower defaults in payment. All notes discounted are examined and totaled. The name of each borrower is taken on a card with details. This card is filed with the Banking Department, and BANK EXAMINATION 227 at the next examination, the fate of the note is recorded. If reductions are made, these are noted. If it is renewed from time to time without payment, it is ultimately classed as slow and finally as doubtful. Thus every loan is watched from its birth to its extinction and due action taken. Mortgages if any are examined to see that the papers are complete, the mortgage properly recorded, appraisal made by the bank, insurance in force and taxes paid. Real estate held by the bank must be evidenced by the deeds running to the bank and likewise recorded. The ledger balances are run up on the adding machine and must agree with the general ledger. Outstanding certificates of deposit must be shown to exist by the uncancelled stubs. The accounts with other banks are reconciled. The minutes are examined to see that the meetings are held properly and attended by the board members. The outstanding stock is proven from the stock book. After all these details are properly verified the report is made up and submitted to the Department with recommendations. Frequently and in many cases always, the board members are brought together and the notes gone over, so that the joint opinion of the paper may be obtained. It can readily be seen that unless there is gross fraud in the bank and irregularities carefully concealed, the results shown by the examiner must be accepted as a true audit. By this process the banks are kept in a condition of good health, slow^ loans brought into a condition of activity, and all doubtful assets, in time, eliminated through charging off. There are of course jurisdictions where more laxness obtains than in New York, but this is examination par excellent and none better can be found anywhere. Many banks are now employing public auditors to ex- -228 THE BUSINESS MAN AND HIS BANK amine the bank at stated times. These auditors make a very thorough test, inasmuch as the element of time does not enter. They take all the time they need to do a good job. Besides verifying the assets that can be checked from within the bank, they also verify the loans by communicating with the borrower. He is asked to verify the amount of the loan and the collateral, if any. They also pay particular attention to the liabili- ties. A bank can be swindled in many ways. It is sometimes done by taking the assets and as often by falsifying the liabilities. These auditors therefore check the amounts due the various depositors by statements to them, the verifications being returned to the auditors direct. These examinations sometimes take the place of the directors' examinations, and in some cases are supplemental thereto. CHAPTER XXV THE FEDERAL RESERVE BANK AND ITS RELA- TION TO BUSINESS One of England's leading bankers has characterized the Federal Reserve Bank as the ''world's foremost banking system." It is an impartial judgment from long range observation. We who are close to it, are perhaps too near to get the right perspective, and too near to appreciate its mighty force for good. The war had hardly broken out when the Federal Reserve Banks opened their doors. It was an experi- ment in banking, an untried thing, a combination of ideas and principles taken from the banking systems of the world after close study by experts as to their adaptibility to American business methods. How well the system has worked cannot be told in a brief space and can only be fully realized by a close study into its operations. When it is considered that we have gone through the most trying time in the world's history without a financial panic; that the machinery of finance has moved smoothly month in and month out, with the burden of financing the world on our hands, then and then only must we admit that some new and powerful force has been at work in our midst. Putting the five Liberty Loans "over the top" would in itself be a great achievement. To round out an organi- zation that could reach into every hamlet and home and store and office and factory, and enlist the financial support of millions of people heretofore unacquainted with the buying of bonds would at any time be a great feat of generalship; but the war financing has merely 229 230 THE BUSINESS MAN AND HIS BANK been an incident in the day's work — the greater task has been to mobihze the financial strength of the country and keep the situation under control. The Federal Reserve Banks have been the great balance wheel of the war, the automatic throttle, to increase or decrease the speed of the financial engine as the needs required. Federal Reserve Banks Create Confidence. The greatest service of these banks to the public at large has been in the role of a creator of confidence. We somehow felt that a master hand was at the helm and that all would be well. Under the old regime every bank was solicitous of its own condition, hoarded money to be in position to meet an unexpected demand on the part of its clients, and instead of helping a bad situation made it worse by their very fears. Take the panic of 1907 for example. Conditions were fundamentally sound, but suddenly banks began to get frightened. They felt that the supply of money would not be ade- quate, and so tightened up on loans and locked money in their vaults in unheard of quantities until the supply was so curtailed that business was crippled for want of ready money to move it. There was not enough money to go round, and no w^ay by which it could be quickly created. Individuals like the banks began to get fright- ened and they too hoarded. It was no uncommon thing for a bank to hand out money to its customers, only to have it taken and placed in the bank's own safe deposit vaults; and every dollar so locked up injured the cause of business, as hoarding always does. In the World War we have had no such distrust; for while certain individuals have hoarded, it has in no sense been an epidemic. And when money has been needed the Federal Reserve Banks have been able to THE FEDER.\L RESERVE BANK 231 furnish it. There has at no time been a dearth of cir- culating media. Shortly after the war broke out the Federal Reserve Banks began to accumulate and conserve the gold supply of the country. The coin was held back from circulation and the ''yellowbacks" — representative of gold, were withheld from circulation by the banks and sent to the Federal Reserve Banks, so that in the course of time we as a nation had assembled the largest stock of gold the world ever saw under one flag. Having the gold, we had the foundation for sound currency, the Federal Reserve Banks holding at times from 60 to 80 per cent, of their outstanding obligations in the yellow metal. The meaning of this was that they could pay off all obligations assumed by them to the extent of almost dollar for dollar in gold. The masterly handling of the finances of the nation, and the confidence created by a continuation of the nor- mal functioning of the banks, has been the underlying reason for our freedom from financial and business panics during the past five years. Just as long as business moves in its accustomed channels, loans and discounts are secured from the banks as in normal times, currency in plenty is available for commercial purposes, and faith prevails in the banking system under which we live, just so long will we be free from periods of unrest and doubt as to the future; and being free to spend our efforts in constructive work and not destructive worry, business will continue to perform its necessary functions for the public good. But without confidence, the machine breaks down, and panic follows; for panics are merely lack of confidence come to a head. In all the doubt that a great war creates as to the final outcome, and all the hardship and waste that follows in its train, unless the people trust the banks to handle the financial end satis- 232 THE BUSINESS MAN AND HIS BANK factorily, financial and industrial panic follows, which adds to the worries incident to war a load which business is unable to bear and chaos follows. It is doubtful if we as a nation would have survived the shock of the war had not the Federal reserve banks been in operation to steady the ship of state while it was crossing the dangerous seas of 1914-19. Certain it is that we would not have come through with honor and credit, and reached a point in the world's financial scheme that makes us the creditor nation of the world and its most mighty financial factor. Just how this has been ac- complished, history has yet to tell. Panics. Prior to the advent of the Federal Reserve System we had a panic about every ten years, when business was disrupted, labor unsettled, the people frightened, the banks weakened and chaos brought about in the com- mercial w^orld. We have had no such experience under the Federal Reserve System, and any instrumentality that can prevent a panic, at the slightest sense of danger, is w^orthy of being classed a public benefactor. The chief aim of the Federal Reserve System is to co- ordinate the banking interests of the country and get them working together for the good of all. Instead of pulling apart they now pull together. They act as a unit. They move in one direction rather than in thirty thousand directions, and with thirty thousand interests to consider. The proposition would be the same if each citizen were to have his own coal supply and feel that when this was gone no more could be had at any price, in contrast with the condition where each one knows for a certainty that he can get all the coal he needs from a central supply depot. Imagine the feeling of security THE FEDERAL RESERVE BANK 233 that bankers now have in contrast with the old feehng of uncertainty. Formerly the banks held certain bonds in their vaults as their ''anchor to the windward." In case their depositors made unusual demands, they would sell these bonds in Wall Street to meet the call for money. This meant a loss, and sometimes could not be done except at ruinous pri ces. Under the new system, the banker knows that as long as he has sound paper in his portfolio, he can turn it into money within a time incredibly short. If, for instance, your bank were to need half a million tomorrow, all it would have to do would be to take half a million of its notes discounted (that conform to the requirements of the Federal Re- serve Board) and as quickly as it could get to the nearest Federal Reserve Bank and back, it would have money — • real money, to meet any demand made upon it. At the same time, it knows that as long as it makes safe loans it may keep on loaning, knowing it can turn its loans over to the Federal Reserve Bank by the rediscount privilege accorded it. Therefore the business man knows for certain just where he stands, and as long as he does sound business and takes sound paper he can con- tinue to borrow. Defects in the Old System. The banking system that breaks down at a critical time is a menace to the well being of the business world, just as a bridge that collapses at an unusual strain is a menace to the public. Only that system is safe which continues to perform its functions in season and out, in time of panic as well as in times of peace. It has long been an accepted fact in this country that our banking system was weak; that it collapsed at the most critical times; that it worked smoothly only as long as business conditions were normal and no unusual 234 THE BUSINESS MAN AND HIS BANK happenings occurred to disturb the finances of the country. But just as soon as a great fire occurred, or war broke out, or the crops were short, or an era of speculation came about, our banking machinery ceased to function, and the whole country was thrown into a condition of financial chaos. As a result of either preparing for possible happenings or recovering from panicy conditions, we were in an unsettled condition most of the time. Prior to the advent of the Federal Ueserve System there were several danger spots in American financial methods that caused most of the trouble. First, there were approximately thirty thousand banks, each a dis- tinct entity, operated for its own profit, concerned mostly with its own welfare, jealous of its own condition and looking to its own safety, whatever the cost may have been to the country at large or to the business interests. The business of these banks was mostly local. Their interests were home interests. In a few instances the banks of a city were organized into clearing houses, in the hope of obtaining united effort and concerted action ; but otherwise it was ''each bank for itself." At the slightest sign of danger, as the banker saw it, these banks would curtail loans, hoard cash, and in other ways seek to safeguard themselves. In the nature of things they could not work together, because there was no common interest and no common leadership. The country banks threw the burden upon their city corres- pondents and these worked together as best they could under the existing laws and with the crude machinery then at hand. The case would be precisely the same if each householder sought to protect his own property from fire and theft, and cared little what became of his neighbor's, forgetting that his interests and his neigh- bor's are closely allied. mE FEDERAL RESERVE BANK 235 Scattered Reserves. In the second place these banks were each required to maintain reserves, and each did so as a matter of necessity and business prudence. Part of these reserves was in their own vaults and part in depositary banks. The latter amount consisted of balances actually created in the depositary banks, and in checks sent to the latter for collection but which were considered as a cash de- posit as soon as put in the mails. To illustrate: A bank in Syracuse, New York, would be required to carry a reserve of 15 per cent, or a million dollars. One third of this would be in cash, and the balance could be in banks in Albany. Part of the Albany balances con- sisted of checks on banks in New England, deposited with the Albany bank for collection, but considered as a cash deposit by the SjTacuse bank. The Albany bank must in turn keep a reserve of 25 per cent, of its deposits, but one half could be in New York banks. As soon as the checks were forwarded to New York, the Albany bank would consider the amount as its reserve. The New York bank must keep all its reserve in its own vault, the proportion being 25 per cent, of its deposits. Until these checks were collected and reduced to cash, the only real reserve behind the deposits of the bank in Syracuse was the cash on hand, the proportion of the cash in Al- bany bank and the proportion of the cash in the New York bank. This reduced the real reserve to a fraction of the supposed 15 per cent. These checks in process of collection amount to hundreds of millions, and are called the "float" in bank- ing circles — meaning the checks that are in the mails for collection. It can readily be seen that a check is not money. Until it is paid, it is merely an order on a bank, which may or may not be honored. 23G THE BUSINESS MAN AND HIS BANK Hoarding. In the third place whenever a cloud appeared on the financial horizon banks would begin to accumulate cash in their own vaults. They were fearful that they might not be able to obtain it when needed and so built up their own supply. This feature may be illustrated by a town wherein each householder has a pail of water for fire purposes, or a number of pails, which he guards jealously, rather than a reservoir of water connected by pipes that touch every part of the community. And instead of building up the community supply of water in one place, each individual endeavors to create a small reservoir for himself, to the detriment of all. Thus the banks, instead of having a reservoir of money, each had a little supply, which worked out exactly as would the water pail in case of a conflagration. The banks also had, as above noted, what they thought was a secondary reserve, composed of bonds of various kinds, and loans on call in the money markets. The city banks, when in funds, would place their deposits out as loans on call, secured by stock exchange collateral. In the event that. money should be needed, these loans were called, or securities sold, thus increasing the danger. The Syracuse bank, needing funds for its local require- ments, would draw on Albany, and Albany, to replenish its reserves, would draw upon New York. New York would in turn call loans, and if they could not be paid, panic ensued. Witness the panic of 1907. The supply of gold and currency was plentiful, but money went to a premium, and in some places was almost impossible to obtain, because each bank was hoarding for itself, and locking money up rather than putting it into the channels of trade. For the same reason that a water system has been found superior to the old fire cisterns scattered through- THE FEDERAL KP]SERVE BANK 237 out the town, a central reservoir of bank balances — cash, has been found necessary to protect the business and banking interests against panics. Money to be of service must, like water, be concentrated — mobilized if you please, like an army. It must also be moved about where needed. It must go to the danger spots quickly and at little cost. If a bank knows it can get money at any time, under all conditions, it will not hoard, no more than will a householder hoard water if he knows he can turn a tap and get it. And if the financial in- terests know they can send money at any time to any place where it is required, they will be in the position of a well equipped fire department^ — efficient in putting out fires. Government Money. The fourth danger spot was due to the fact that the Treasury of the United States received large deposits of money for taxes and government payments and locked them up in the various sub-treasuries. When money became scarce, these deposits were released to the banks, the proportion depending upon politics and the whim of the administration. The deposits went, not necessarily where they were most needed, but where the head of the department thought they ought to go; and he was often influenced by personal and political reasons. Our Inelastic Currency. Fifth: We have in this country seasonal demands for money — actual cash. This comes mainly from the crops in the west and southwest. When the crops are being marketed, the returns are sent to New York and other large cities, there to be employed in stock exchange loans, for which there is always a market at some rate. 238 THE BUSINESS MAN AND HIS BANK Banks find it necessary to get into this market if they are to obtain any return on short time deposits. When the crops are being planted and harvested in the spring, summer and early fall, these deposits are withdrawn in cash. The banks should therefore be in position to obtain cash as needed for such purposes, and our money supply should expand and contract as the needs of business require, just as the supply of any other com- modity expands and contracts with the call for it. At times we had too much money and at times not enough, due to the fact that our money supply depended upon the profit that ensued from the issue of bank notes. Under the National Banking Act all national banks were required to invest a portion of their capital in Gov- ernment bonds, at two and three per cent. These bonds were generally at a premium. In return, the banks could lodge these bonds with the Treasury at Washington and obtain the par amount in National Bank Notes. The amount so received could be loaned out at the current rate of interest and the bank would therefore draw in- terest from two places, the bonds and the loans. If the premium on the bonds was high, the net return would of course be less than when the premium was low. The average return on the two per cent, bonds used as the basis of note issue was around l}i per cent. A bank lending this money out at 6 per cent, would therefore receive 73^^ per cent, on the amount invested in bonds. Some banks took the required amount only, while others took out circulation in large amounts. The amount of paper money was not based upon the country's needs, but upon the policy of the banks and the price of bonds, illogical and dangerous as events proved. The process of issuing notes was so cumbersome, that only under severe necessity did the banks increase their circulation, and the delay often increased the THE FEDERAL RESERVE BANK 239 unrest; while the process of retiring excess money was so slow that it often became a source of danger because of the excess supply. When the banking machinery broke down, as it often did, all sorts of expedients were resorted to to overcome the trouble, such as clearing house certificates, checks used as currency, practical suspension of cash payments, etc., all of which went to prove that we had no real banking system, no concerted action, no governor to the financial engine. In such times the Treasury came to the rescue as best it could under the existing laws, but the relief was unscientific and a makeshift only. No Rediscount System. Sixth: There was another chief defect, namely, the lack of a rediscount system, or to put it differently, a place where banks could rediscount their loans and turn them into money or its equivalent. This was done by the city banks for their country correspondents, but there was no place where the city bank could, in turn, do the same thing. There was a time when to rediscount any of the note holdings of a bank was a sign of danger; and yet it might simply indicate that the bank had more call for money than it could take care of, or had over- loaned and needed to ''cash in" some of its loans. Banks, like business men often need to borrow, and dur- ing the war, they did so freely at the Federal Reserve Banks, as their statements would show. And some of these are the largest and strongest banks of the country. Rediscounting may now be said to be a common cus- tom among the banks, large and small, and part of their regular operations. The evil of indu'ect routing of checks to avoid the exchange charges imposed by certain banks and clearing houses was also a danger and resulted in a large amount 240 THE BUSINESS MAN AND HIS BANK of "float," estimated at over three hundred milHons constantly in the mails. Checks were not sent home for payment in the quickest possible time, but by any route that would be cheapest. Local checks were promptly collected, but foreign items were traveling around — "joy riding" as it were, to escape a tax. These checks constituted a large part of the reserves of the banks. Lastly, we were paying the London banks enormous sums for financing the foreign trade of the United States. Inasmuch as American banks were not well known to the other banks of the world, while London had become the financial centre of the world and a credit on any of her banks acceptable the world over, we were badly handicapped in all matters having to do with foreign trade. Our banks could not operate foreign branches, and could only play a part in the world's game of trade through their London correspondents. The Federal Reserve System came into being because of and to remedy all these defects of our old banking regime. Having seen the defects of the old system, we are prepared to review the Federal Reserve System to see how these evils are cured. Essential Features of the Federal Reserve Bank. A technical discussion of the Federal Reserve Bank would be out of place here. It will suffice to get a practical summary of its organization, purpose and plan of operation. It is a bank of banks. Individuals have nothing to do with the Federal Reserve Banks. They may not become stockholders and they cannot open accounts with it. All the stock is owned by banks. Every national bank must, and state banks and trust companies may, subscribe an amount equal to 6 per cent, of their capital and surplus to the capital of the Federal Reserve Bank, one half of which has been paid in and THE FEDERAL RESERVE BANK 241 the balance is subject to call. (This will probably never be done) . Therefore the banks own the Federal Reserve Banks. The identity of each bank is unimpaired and it still remains a law unto itself, continuing its practice of building up its community and itself^ — ^the keynote of American banking success. The Federal Reserve Sys- tem unites these banks in purpose and plan of opera- tion. It welds them into a united, composite body. It "federates" them, to use Dr. Kemmerer's expression. The Federal Reserve Banks operate through the indi- vidual members. It is the tree; they are the branches. The United States has been divided into 12 Federal Reserve Districts, each with its own bank, a part of the national system. A list of these banks will be found below\* Several of them have branches. The adminis- trative control is lodged with the Federal Reserve Board consisting of seven members and having its headquarters in Washington. These are appointed by the president of the United States for a term of ten years, except the secretary of the treasury and comptroller of the currency exofficio. This board has general supervision of all the banks and is the central power. Administrative Control. The administrative control of a Federal Reserve Bank is in the member banks, each bank, irrespective of its size, having one vote for directors. The banks of each district are classified as to capital and surplus into three groups, by the Federal Reserve Board. The intent is to * Federal Reserve Banks are now located in: New York, Boston, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minne- apolis, Kansas City, Dallas, San Francisco. The New York bank has a branch at Buffalo, the Richmond bank at Baltimore, the Cleveland bank at Cincinnati and Pittsburgh, the Kansas City bank at Omaha and Denver and the San Francisco bank at Portland, Spokane, Seattle and Salt Lake City. The United States is divided into 12 districts, each with its Federal Reserve Bank, thus covering the entire country. 16 242 THE BUSINESS MAN AND HIS BANK place banks of similar capitalization in the same group. Each bank has one vote for two directors, one of whom, called "Class A director," is a banker and represents the banking interests of the group, while ''Class B director" is a business man and represents the business element. To these six directors are added three known as "Class C directors" appointed by the Federal Reserve Board. One of the Class C directors must be a banker and is known as "Chairman of the Board" and ''Federal Reserve Agent." The Board therefore consists of nine directors holding office for three years, the term of one director in each class terminating each year. The Federal Reserve Board has, as an advisory council, a board of twelve men appointed by the boards of the various Federal Reserve Banks. This advisory board meets with the Federal Reserve Board at least four times a year. This interlocking of interests and intellects, the appointment from above of directors to the various boards, and the appointment by them of a representative from below, makes for a common interest and unity of action and purpose. Consolidated Reserves. Since June 21, 1917, the entire legal reserves of member banks have been kept with the Federal Reserve Bank of the district. Thus the old practice of having compulsory ''reserve agents" for country banks has been abandoned and balances with the reserve banks substituted.* The cash on hand no longer counts as reserve and is optional with the bank. This has brought into one central reser- voir the legal reserves of the member banks, making it a powerful fund for the common good. Member banks * In some states, state banks and trust companies joining the system are allowed to carry, only part of their legal reserves in the Federal Reserve bank of the district; but National banks must now carry all their reserves in the Federal bank, the Cash in vault being optional. THE FEDERAL RESERVE BANK 243 may still maintain accounts with tlieir correspondents, but these balances cannot count in the reserve. The amounts now required as reserve in the various banks follow : Percentage of Percentage of demand deposits time deposits' Country Banks 7 3 Reserve City Banks 10 3 Central Reserve Banks 13 3 Reserve Cities are: Albany, Baltimore, Boston, Cin- cinnati, Chicago, Cleveland, Detroit, Louisville, Milwau- kee, New Orleans, New York, Philadelphia, Pittsburgh, St. Louis, San Francisco, Washington. Central Reserve Cities: New York, Chicago, and St. Louis. The Federal Reserve Banks must maintain a reserve of 35 per cent, of their deposits in gold, the balance being invest] ble funds. The policy of all the Federal banks has been to maintain much larger than the legal reserves. These reservoirs of money to be effective must not only exist but they must be mobile — ^that is quickly available at various points, just as the water in a reser- voir to be of any benefit must be connected by pipes to the various buildings and hydrants. The Federal Reserve System admirably performs this function. Money may quickly be moved from one district to another as needed, both physically and by means of credit. If for instance, the Federal Reserve Bank of Kansas City is in need of funds, it may rediscount some of its paper in Chicago. If Chicago is loaned up, it may rediscount in New York, and so on, the money coming from the place where it is in abundance to the place where it is scarce. *A time deposit is one wliich by the rules of the bank must or may have notice of withdrawal, not less than 30 days, and postal savings deposits. 244 THE BUSINESS MAN AND HIS BANK If again, the Government, in a large operation like that of building the Hog Island Ship Yard, must make heavy payments through Philadelphia, it will deposit with the Philadelphia Reserve Bank, or draw on it against deposits already made from the sale of Liberty Bonds or Treasury Certificates. If Philadelphia should be unable to respond to the call, funds would be trans- ferred from other banks not needing the money. Federal Reserve Rediscount System and Federal Reserve Notes. Perhaps no feature of the operation of the Federal Reserve Bank is more interesting and affects the business interests of the country more vitally than the rediscount function, for out of it grows the circulating medium of the country. Federal Reserve Notes. Through this device the member banks are protected, knowing that at any tiime they can turn their assets into cash. It is a source of immeasurable safety and relief to the banker to know that as long as he makes sound loans, and conforms to the Federal Reserve requirements as to their character, he can turn these loans into money to meet any demand on the part of his people. Let us illustrate this principle by an illustration that is true to life. The Federal Reserve Act permits the Federal Reserve Banks to issue Federal Reserve Notes as long as they hold a reserve of 40 per cent, in gold against them, together with 100 per cent, of accepted commercial paper. Let us suppose that bank A finds itself in need of $100,000. It may be short in its reserve, on account of heavy withdrawals, or it may have made loans in anticipation of certain deposits remaining in the bank that have been suddenly checked out. All it needs to do is to take certain promissory notes from its files to the Federal Reserve Bank of the district and THE FEDERAL RESERVE BANK 245 it will immediately receive credit for the proceeds at the current rate of interest. Or, it may receive the amount in cash, if it needs cash. And as long as the Federal Reserve Bank holds $40 in gold to $100 in accepted paper it may continue this process. The result of this privilege to the business man is this: As long as he accepts sound paper he may rest assured of being able to continue to receive discounts, for the bank can pass the loan on to the Federal Reserve Bank. The bank is safe in extending credit knowing that it can itself rediscount. This logically makes for protection to both business and banking interests. The trade acceptances discussed in Chapter 22 are a favored form of paper in the Federal Reserve Banks, and are freely accepted for discount. One of the chief reasons why merchants should favor this form of set- tlement is the fact that they are eligible for discount in the Federal Reserve Bank and as a rule carry preferential rates. Bank acceptances are of course in the same class and highly favored because of the quality of their acceptance. At times the Federal Reserve Banks go into the market and buy both bank and trade acceptances, thus placing money at the disposal of business and at the same time distributing funds from places where they are abundant to those where scarcity exists. By this method the discount rates are equalized and the volume of money regulated. Paper to be eligible for rediscount must conform to the following general requirements. (1) It must be of short duration, not over 90 days at the time of redis- count, except that a limited amount of bills drawn for agricultural purposes or based on live stock may have six months' maturity. (2) Paper endorsed by a member bank arising out of actual commercial transactions. 246 THE BUSINESS MAN AND HIS BANK (3) Paper bearing the indorsement of a member bank issued for the purpose of trading in or carrying United States obHgations. (4) Paper based upon goods in storage or in transit represented by the proper documents. (These would be bills of lading or warehouse receipts.) In short, any promissory note, or acceptance that represents a commercial transaction, whether large or small, may be rediscounted at the Federal reserve banks. But obligations representing mere loans, or issued for the purpose of trading in stock or bonds (Wall Street transactions) or for fixed investments, such as land, machinery, etc., are not eligible for rediscount. The purpose of the loan is usually certified to by the discount- ing bank, and the paper need not bear more than one name if it conforms otherwise to the requirements. The security back of Federal Reserve Notes consists of: (1) Paper endorsed by member banks and issued for strictly commercial or agricultural purposes or for the purpose of carrying or trading Government obligations. Any paper eligible for rediscount may be used for note issue purposes. (2) Bills of exchange endorsed by a member bank and bankers' acceptances bought in the market (3) Gold and gold certificates. In order to reduce the amount of notes when surplus money is in circulation, which is as important as to increase the amount when needed, the machinery works smoothly. Money sooner or later finds its way into banks, and these banks naturally send their surplus funds to the Federal Reserve Bank for reserve purposes. The Federal Reserve Bank will withdraw such notes as are not needed as comes to its hand, from circulation, sending the notes of other Federal Reserve Banks to the banks issuing them, the law requiring these banks to send to the place of issue all such notes received. In THE FEDERAL RESERVE BANK 247 other words, one Federal Reserve Bank may not pay out the notes of another but must send them home for redemption. Federal Reserve Bank Notes. The Federal Reserve Banks are authorized to issue ''Federal Reserve Bank Notes, which are precisely the same as national bank notes and are secured by United States Bonds. As has heretofore been said, national banks are permitted (and before the Federal Reserve Act was passed were compelled) to buy a certain amount of United States Bonds. These were lodged with the Treasury of the United States and in return the banks received national bank notes for the full face value of the bonds. A national bank note is therefore nothing but a Government bond reduced to small denominations without interest. It is the intention of the Federal Reserve Act to eventually retire the national bank notes and issue in their stead Federal Reserve Bank notes under the same general procedure. The process of retiring the national bank notes and substituting the Federal Reserve Bank notes is technical only and is not pertinent to the present work. The profits of the Federal Reserve Banks are appor- tioned as follows: To the member banks, 6 per cent, on their invested capital. The balance is placed in the surplus fund of the Federal Reserve Banks until it equals the capital stock of the banks. After the sur- plus equals the capital, 10 per cent, of the net earnings above the 6 per cent, dividends is to be added to sur- plus; the balance goes to the Government as a franchise tax. The net earnings of the Federal Reserve Banks for 1920 are estimated at over $100,000,000, making them extraordinarily profitable. This is due to the fact that they pay no interest to any one on deposits. 248 THE BUSINESS MAN AND HIS BANK Collecting Checks through the Federal Reserve Bank. In the chapter on checks we saw how banks collect their out of town and clearing house items. Briefly summarized the process consists in sending local checks to the clearing house and out of town checks to the bank's correspondents. These collection facilities were part of the service rendered the country banks in return for the deposit maintained at a low rate of interest. However well developed the collection arrangements might have been under the old regime, they failed to put the bank check at par the country over, and the question of exchange was still an unsettled one. The country banker charged it and the city bank paid it, and passed the charge on to the last holder of the check. When the Federal Reserve Board made it compulsory for the banks to carry all their legal reserve in the Federal Reserve Banks, it made the balance in the depositary banks of no account as reserve and a courtesy only on the part of the country banks. As part of the program of placing the bank check on a par basis, and to help the country banks reduce their checks to legal reserves in the shortest time possible, the Federal Reserve Banks inaugurated extensive collection facilities. The problem of installing a system that could handle the vast number of checks that would naturally be poured into the Federal Reserve Banks, once the collec- tion of checks was undertaken, was a serious one and the development has been gradual. The various Federal Reserve Banks now operate on a uniform plan. Each bank exercises the function of a clearing agent for the banks of its district, and for non -member banks that wish to avail themselves of the privilege. The Federal Reserve Bank holds itself out as willing to receive at par checks drawn on all member, clearing member and other non-member banks that agree to remit at par through THE FEDERAL RESERVE BANK 249 the Federal Reserve Bank of the district. Checks are also received for collection on banks outside the dis- trict that agree to remit at par. All banks clearing through the Federal Reserve Banks must pay checks drawn on them at par when presented at their counters. Checks may now be collected at par in over 21,000 banks in the Unites States. Under the old regime, a check was considered reserve as soon as it was put in the mails. Under the new, checks become reserve only when actually collected. Therefore rules have been laid down as to the length of time necessary to collect checks on various points, running from one to eight days. Thus a check deposited in the New York Federal Reserve Bank and drawn on a New York bank is immediately credited. If it is on Chicago, three days; Texas, eight days, etc. Banks are permitted to ship currency to the Federal Reserve Banks at the expense of the latter and the cost of collecting checks is borne by them also. The banks are, however, allowed to charge exchange to their deposi- tors not to exceed one-tenth of one per cent. Time items, such as drafts, coupons, and bills of exchange may also be collected through the Federal Reserve Banks, with no charge except that made by the paying bank. On unpaid items there is a charge of 15 cents to prevent the misuse of the collecting machinery for dunning drafts as described under the head of Collections. By virtue of the fact that the various Federal Reserve Banks have direct wire connections with each other, checks may be paid by w^ire with the utmost dispatch. Thus a check deposited in New York and drawn on San Francisco would ordinarily take from ten to twelve days to collect. But as soon as the check arrives in San Francisco and is paid, the San Francisco Federal Reserve Bank will wire the New York bank that the check is 250 THE BUSINESS MAN AND HIS BANK paid and charge its account, a saving of nearly a week, a very decided advantage. These telegraphic advices are without cost to the depositing bank. Otherwise their collecting machinery is no different than that of other banks. It is of utmost importance to the business man that the checks he receives in the course of business shall be paid in the shortest possible time, thus giving him the use of the funds represented thereby. It is not custom- ary for banks to pay against uncollected funds (checks that have not been paid) and the quicker a check can be presented to the paying bank the quicker the funds be- come available. Under the old system a check would often go by a roundabout route to the place of payment, and if not paid, come back the same way, and it would be several days and often a week or more before the fate of the check was known. Under the Federal reserve system, checks are sent by the most direct route possible, and are considered paid as soon as they reach their des- tination, rather than wait for the remittance of the draft that eventually pays the check in New York or Chicago funds. Therefore the business man knows that if his checks are collected through the Federal reserve banks, he will get the quickest returns possible, by using the fast mails and the telegraph. This is perhaps one of the greatest benefits of the Federal reserve system to the business interests, and is closely followed by the elimination of exchange charges. The bank check now circulates at par in fully three quarters of the banks of this country. Gold Settlement Fund. One of the fundamental principles of banking is that the banks shall be the custodians of the money funds of the country, giving their depositors the right to issue THE FEDERAL RESERVE BANK 251 orders against these funds, commonly called checks, which transfer the ownership of the funds from one to another. Out of this principle has arisen the checking function of banking, now developed to a high degree of usefulness. One of the weaknesses of the old system was the neces- sity of frequent shipments of currency between banks, with the attendant risks and costs. The Federal Reserve Banks, being large holders of money, were no exception to the rule, and soon found a better medium of settlement necessary. Therefore each Federal Re- serve Bank was required to deposit at least a million dollars in gold or gold certificates with the nearest Treasury or Sub-Treasury, and in addition an amount equal to its indebtedness to other Federal Reserve Banks. (This fund now amounts to over $600,000,000.) Each bank is required to maintain a balance of at least a million dollars in the fund. This contribution is counted as part of its legal reserves. The Federal Reserve Agents also have large sums of gold deposited with them as security for Federal Reserve notes, they being the custodian of the gold so held. By reason of this fund, the various Federal Reserve Banks are enabled to make telegraphic transfers one to the other. The combined funds exceed a billion dollars and the weekly clearings through these funds often exceed a billion a week. It is through this fund that settlements for checks sent out by the various Federal Reserve Banks are made, by a transfer of the ownership of this fund. If, for instance, the Federal Reserve Bank of Chicago owes the Federal Reserve Bank of Atlanta a million dollars, all it has to do is to transfer by tele- graph a million from its part of the gold fund to the credit of the Atlanta bank, just as one merchant will 252 THE BUSINESS MAN AND HIS BANK draw a check on his bank balance to settle his debt with another. The Federal Reserve Banks have established close connections with the great banks in foreign countries for the purpose of furthering our foreign trade, and the large banks are now opening branches throughout the world, a privilege conferred upon them by the Federal Reserve Act. CHAPTER XXVI FOREIGN EXCHANGE The basis of the world's trade is not money, but goods. In the intercourse of nations as well as the dealings of individuals, the one desire is to obtain the things the others possess, for these alone can satisfy the wants of men. Money is merely the measure of the worth of the things — the yardstick by which the relative values are judged. At the close of the World War, Europe was in a state of poverty. The people were hungry. They were ill clothed and poorly housed. To have sent a cargo of gold from the United States to any of the hungry nations would have been mockery, for they could not eat it, it would not warm them, and it would not turn the wheels of their factories. Only as the gold could be exchanged for goods did it have value to them; and to have sent over a cargo of coal, or wheat or meat would have ap- plied economic principles to actual conditions. The nation that is rich in land and therefore produces grain or dairy products needs the manufactured articles she cannot produce. The nation that has water power, ores, raw materials of various kinds, may need the butter and cheese of the dairy country, and must exchange the articles she produces for the things she lacks. In fact it is necessarj^ to thus exchange goods if the well being of the world is to be maintained, for it is said in the Good Book that ''man shall not live by bread alone." The most useless thing in the world is money, unless it can be exchanged for goods; and unless the goods are available for the exchange, of what use is the money? 253 254 THE BUSINESS MAN AND HIS BANK We therefore have built up through the centuries a world-wide trade in goods, each country producing that for which it is best adapted and exchanging the goods it has and cannot use for those it needs and cannot produce. The farmer in Iowa who produces corn wants to exchange his corn, turned it may be into pork, with a manufacturer of linen in Belfast. Since the Belfast manu- facturer wants pork, they trade together. The process may be intricate and round-a-bout, but it exists just as truly as if the farmer were to take a bushel of corn to the village store and exchange it for a yard of table linen. If the merchants of one country bought of the merchants in another country exactly the same amount of goods valued at the same amount in pure gold, there would simply be an offsetting of debts. One transac- tion would cancel the other. But such a state does not exist. A nation may be creditor to one nation and debtor to another. It may buy in one market and sell in another. For instance, at the present time, France and England owe the United States for food and war material, while the United States owes Brazil and the Argentine for coffee and hides. England could pay the Argentine for our account, or England could pay us and we pay the Argentine. The result would be the same, whatever the process. The principles of the clearing house apply here, and instead of settling debts by each paying the other what is owing, only the balance is settled; and all that has been said about the efficiency of the clearing house for bank settlements, applies to foreign exchange for in- ter-country settlements. If a silk merchant in France sells a consignment of silk to a New York dealer, the latter could ship him gold bars for the amount. If an iron manufacturer in New York sells a cargo of iron in France, the French- man could pay for it by sending gold bars to America. FOREIGN EXCHANGE 255 But why this double shipment of gold across the Atlantic with the cost of shipping, the risk of loss, insurance and freight? Why not let the silk merchant get his pay from the iron merchant in France, and the iron merchant in the United States get his pay from the silk importer here, thus eliminating the cost of the double shipment? When the silk merchant ships his goods he draws a draft on the buyer. This draft is sold to a banker, who sends it to New York, and the New York bank collects from the importer and pays the iron merchant, thus "clearing" the transaction without the shipment of money. While the illustration is simple, its working details are complex and out of such dealings arise foreign exchange transactions. The subject of foreign exchange can be made as in- tricate as mathematics or as simple as a trade in goods. To the banker it is a matter surrounded by a thousand different influences. The volume of trade, one country with another, the internal conditions of nations, interest rates, the supply and demand for goods, wars and rumors of wars, speculation, politics, and all the various inter- ests that go to make up human life have their direct and indirect influence upon exchange rates. The ad- justment of relative values depends upon all these factors, so that the foregin exchange banker must be of wide vision, shrewd insight, and have a world wide knowledge of men and events. I would place him at the top of his profession. On the other hand, the mer-' chant in New York, buying olive oil in Italy may simply know that if he pays the banker so many dollars he will get so many gallons of oil, little caring what intricate influences have been at work to establish the basis of the transaction. The merchant in New York wants to know how many 256 THE BUSINESS MAN AND HIS BANK dollars he must pay for a cargo of olive oil in Italy, and the oil merchant in Italy wants to know how many lire he wiU receive for his oil, else he cannot long continue in business. And if the importer must sell his oil for dollars, he must know how many dollars the oil repre- sents to him else he too will be working in the dark. They therefore adjust their differences when the trans- action is made, the Italian merchant knowing just how many lire he will receive and the New York merchant just how many dollars he will have to pay. They trade in goods, but measure in gold. The trade, one nation with another is termed ''foreign trade" and the financial operations that arise out of it are termed ''foreign exchange." The latter simply means the adjustment of prices for goods by adjusting the money of one country to that of another. If every nation used the same standard of value, there would be no foreign exchange. A dollar would be a dollar the world over, since it would represent a definite amount of pure gold, which is the basis of all inter-country dealings. But inasmuch as different countries use dif- ferent monetary systems, it is necessary that these values be adjusted through the medium of banks and bankers. How Foreign Exchange Arises. The basis of foreign exchange being debts, let us see how these debts arise. First is the buying and selling of merchandise, raw materials and manufactured goods. Second, insurance and freights paid by one country to the ship owners and insurance companies in another. Thus England is the great carrier nation of the world. Her ships sail every sea. Her great insurance com- panies insure cargoes the world over. The premiums must be paid to the home office in London, and so FOREIGN EXCHANGE 257 money must be sent to London for these freights and insurance premiums. Third, securities held abroad. Thus at the present time, the United States holds bonds of England, France, Italy, Russia, representing loans to these countries. The interest on these loans must be paid on this side the Atlantic and when the bonds are due they must be paid in this country. Japan has a loan outstanding that is payable in London in 1925 in sterling. Japan will therefore be obliged to have funds in London to meet these bonds when due and interest from time to time as it falls due. Fourth, travelers expenses. Europe, being the great play-ground for Americans, receives annually vast sums from the United States from this source. As a rule these travelers do not carry much money, but letters of credit, which entitle them to re- ceive money abroad as needed. This money must of course be provided for. Fifth, money loaned by banks in one country for investment in the markets of other countries. Thus, if the interest rate in England is 6 per cent, while the rate here is 5 per cent., the bankers here will send money to London for lending in the English market. Sixth, the war. This is a new element in foreign ex- change matters and has changed the whole course of foreign exchange. Before the war we were a debtor nation. The balances were always against us. We owed Europe more than Europe owed us. We borrowed heavily in European markets. We used English ships and English insurance companies and our travelers spent their money freely. The war has changed all this and we are now the creditor nation. The European nations bought heavily of our war supplies to carry on the war. We furnished food for millions of fighting men and stay-at-homes. 17 258 THE BUSINESS MAN AND HIS BANK We bought back our securities held abroad. We loaned vast sums to the fighting nations. We sold them goods and took their bonds in payment. We sold more than we bought and the balance of trade was for the first time in our favor. Lastly, the remittances to those Americans (?) who have moved abroad, or have married into titled families and draw their income from estates and investments on this side. They earned or inherited their money here and spend it abroad and it must needs be sent to them. This is not a controlling element but an important one nevertheless. While European travel was suspended by the war, travelers expenditures were not a leading factor. The sightseer who contemplates a trip to Europe arranges with his banker for a letter of credit, good any- where. As he needs funds he presents the letter to the foreign banker and has the funds advanced to him, and indorsed on the letter. The foreign banker charges the amount to the bank issuing the draft and in due time draws a draft on the American bank in settlement. Instruments of Foreign Exchange. The chief instrument of foreign exchange is the bill of exchange, which is ''an order in writing signed by the maker, directing a third party to pay to a designated second party or to bearer, a sum certain in money, on demand or at a fixed or determinable future time." These bills come into existence through several causes and the supply depends upon the intensity of the cause. The supply of bills in this country arises from: (a) Merchandise sold abroad, the seller drawing on the buyer, or on a bank designated by him. (6) Securities sold abroad. The seller draws on the buyer, or broker in the transaction. (c) Foreign loans placed in this market, the repre- FOREIGN EXCHANGE 259 sentative here drawing upon the lender abroad for the amount to be loaned. (d) Finance bills, which are bills drawn by a banker here on a banker abroad, the banker on this side selling them and using the proceeds until they become due. The demand for bills in this country arises from: (a) The buying of merchandise abroad (imports), payment being made by purchase of bills payable abroad to be sent to the seller in settlement. Thus if an im- porter buys a consignment of goods, he may have the seller draw on him or his bank; but if he can purchase a bill payable in the same country and send to his credi- tor to collect, it will accomplish the same purpose. (b) The need for bills with which to pay for securities purchased abroad. (c) The payment of interest and dividends on foreign capital invested here. (d) The remittances of foreigners residing here to be sent home. (e) The payment of freight and insurance earned here, belonging to foreign companies. (/) Tourists expenses and remittances to Americans living abroad. (g) Bills for the payment of maturing loans. The medium through which foreign exchange trans- actions are carried on is the bill of exchange, or draft, as already stated. When a bill of goods is sold to a buyer in another country and the goods are ready to move, a draft for the amount is drawn on the buyer. This draft is sold to a banker at the place of shipment and the seller has immediate payment for his goods. If an English insurance company has due it from its agency in this country, premiums for insurance WTitten and col- lected it would draw a draft on its New York agent for the amount and this could be sold in London. If a 260 THE BUSINESS MAN AND HIS BANK a o a tCl ■a o a a 2 FOREIGN EXCHANGE 261 London bank were loaning a certain amount of money, in the New York market, it would authorize its New York correspondent to draw on it. We therefore have drafts arising from these transactions constantly. Perhaps the procedure will be more clearly seen by an illustration, which shows the use of the letter of credit. A linen merchant in London sells a quantity of linen to a New York importing house. The importer being in good credit with his bank, obtains a letter of credit from a New York bank, which letter guarantees to pay against the shipment of linen up to a certain amount, on drafts accompanied by bills of lading and insurance certificate. The importer forwards the letter to the seller. When the consignment is ready to go forward, the draft is drawn, insurance effected and bill of lading secured from the carrier and attached to the draft. Having the assurance from a New York bank that the bill will be paid upon presentation, the London bank will immediately credit the seller with the amount, less interest for the time the bill has to run. These letters of credit are the basis of foreign dealing as they are the warrant that the bills drawn in accord- ance with the terms will be paid. In short, it is the bank's guaranty of payment. The Basis of Exchange. Quotations for English or ''sterling" exchange fluctu- ate around $4.8665, which is the equivalent in United States money of the English unit, the pound sterling. In the pound (or sovereign) there are 113.00157 grains of pure gold and in our dollar there are 23.22 grains. Dividing the former by the latter, we have 4.8665 as the quotient. It is around this amount, $4.8665, as a center that quotations for drafts on Great Britain fluctuate. 262 THE BUSINESS MAN AND HIS BANK The German mark contains 5.53113 grains of gold which is the equivalent of 23.8 cents of American money. Quotations for exchange on Germany have usually been given in terms of four marks which are worth in American money 95.2 cents. Recently, however, quota- tions are being given in terms of one mark. The French franc contains 4.48025 grains of gold and is the equivalent of 19.3 cents in American money. Quotations for French exchange, however, are not expressed in the same way as those on England and Germany. The American dollar is worth 5.18 francs and quotations for French exchange fluctuate about this figure as a center. The same method of quotation is used for Belgium, Switzerland, Italy, and Greece as for France. The Monopoly of the English Banks. Heretofore, in financing exports or imports, the Eng- lish banks were the medium through which the credits were arranged. The exporter in South America selling to a New York merchant would require a letter of credit issued by an English bank, the American banks not being known to him. When the goods were shipped he would draw a draft on the English bank and send the same to England for acceptance, while the goods went to New York. As soon as the draft was accepted, the shipping documents were sent to New York and the goods were delivered. When the acceptance was about to mature the American importer was obliged to go into the ex- change market and buy a draft on London to cover the amount due, which he sent to London. Since American banks have been accepting drafts, ''dollar exchange" — drafts drawn in dollars on American banks, have been used in financing imports and exports. Some of the great New York banks and trust companies FOREIGN EXCHANGE 263 have established branches in various parts of the workl, and new corporations have been formed to handle this business. The practical operation of an import and an export transaction will be seen from the following illustrations, taken from a pamphlet issued by the National City Bank of New York. Acceptances Covering Exports Bill of Exchange for $3,749.60. New York, January 25, 1917 Ninety days after sight of this First of Exchange (Second unpaid) pay to the order of International Banking Corporation, Three Thousand Seven Hundred Forty-nine 60/100 Dollars United States Currency Value received and charge to account of Letter of Credit I. B. C. 16/8721. Two automobiles S/S Kandahar to India. (Signed) John Jones & Co., Inc., John Jones, President. To The National City Bank of New York, New York City. Across the face of the draft is stamped Accepted January 25, 1917 The National City Bank of New York New York and signed by one of the Vice-Presidents or the Cashier of the Bank. The draft is indorsed on the back by the International Banking Corporation. In this case some one in India wanted to purchase two automo- biles from Jones, who was unwilling to ship them without first receiving his money. The Indian went to his local bank, in this case prob- ably the International Banking Corporation, and arranged with it to open a credit with The National City Bank against which Jones could draw at 90 days' sight. This being arranged. The National City Bank advised Jones that the credit had been established and he shipped his automobiles. Since the draft is made payable to the International Banking Corporation, Jones drew his draft as above and to it attached the bill of lading and other shipping documents and -264 THE BUSINESS MAN AND HIS BANK sent them all to the International Banking Corporation. The I. B. C- in turn presented all documents to The National City Bank where, everj^thing being in order, the draft was accepted and returned to the I. B. C, the documents being detached and forwarded to the Indian bank arranging the credit. The I. B. C. discounted the draft for Jones, who thereby received the cash for his automobiles. The I. B. C. sold the bill to The National City Company, thus getting their money back, and The National City Company sold it to an institution looking for a high grade short term investment. In the meantime, the automobiles are presumably on their way to India, where they will probably arrive before the 90 days have elapsed. Shortly before the 90 days are up the Indian merchant places his bank in funds with which to meet the bill and they in turn transfer it to The National City Bank. At maturity the holder of the draft presents it to The National City Bank and receives payment for the full face amount. It will be noticed that The National City Bank was not using any of its funds during this whole transaction; in fact, it received a com- mission for extending its credit. Jones received payment for his automobiles as soon as they were shipped. The International Banking Corporation got its money back when it sold the bill to The National City Company, which in turn was reimbursed when the bill was sold to the investor. Also the Indian will probably have his automobiles before being called upon to pay his local bank, which in turn will transfer the funds received from him to The National City Bank. Acceptance Covering Imports Bahia, the 5th January, 1917, For $18,267.68. At ninety days' sight pay this First of Exchange (second and third unpaid) to the order of The British Bank of South America, Limited, Eighteen Thousand two hundred and sixty-seven dollars and sixty-eight cents. Value of same Drawn under Letter of Credit dated 28/11/16 against shipment of 1,500 bags cocoa per S. S. Raphael to New York, account of H. H. Harris. (Signed) A. B. Smith To The National City Bank of New York, New York. The bill is accepted just as in the first example. The following indorsements are on the back of the draft: FOREIGN EXCHANGE 265 The British Bank of South America, Ltd. The Bank of New York, N. B. A. Attorney F. A. Klingsmith, Assistant Cashier. Indorsement guaranteed The Bank of New York, N. B. A., F. A. Klingsmith, Assistant Cashier. In this case, Harris arranged with The National City Bank to permit Smith to draw on it. The credit being arranged, the Bank notified Smith of that fact, either by letter or cable, depending upon the urgency of the matter. Smith, upon shipping his cocoa, sold his draft to the British Bank of South America, Ltd., at the prevailing rate for dollar exchange in Bahia. The British Bank forwarded the draft and documents to its New York correspondent, the Bank of New York, with instructions to discount it in the open market after it was accepted. When accepted, the documents were detached by The National City Bank and the acceptances returned to the Bank of New York, who sold it to the City Company. Harris' credit standing being of the highest, the shipping documents covering the cocoa were probably turned over to him, thus giving him 90 days in which to sell the cocoa and place himself in funds with which to pay the bill at maturity. If his credit is not good enough, the Bank may retain the documents until the maturity of the draft or release them only upon deposit of approved collateral. Forms of Bills. There are several forms of bills offered in the exchange market, namely: (1) Commercial bills. These are bills drawn by merchants for shipments of goods, and due in thirty, sixty or ninety days. They are usually accompa- nied by documents, such as bill of lading, invoice, insurance, inspection certificate, etc., and are called "documentary bills." (2) Bills drawn for the purpose of transferring funds from place to place, usually called "finance bills." (3) Bankers drafts, which are drafts drawn by bankers in one country on their correspondents abroad, and are 266 THE BUSINESS MAN AND HIS BANK similar to bank drafts in this country drawn by one bank on another, usually a country bank on a city bank. They are used for the same purposes in foreign trans- actions as cashiers checks or "drafts on New York" are used in domestic. Foreign exchange iiistruments are usually drawn in sets of two or three. The reason is the perils of the sea. They usually read ''At days sight, pay this first of exchange (second unpaid) " etc., — meaning that two drafts have been issued in duplicate but only one is to be paid. One copy is sent by one steamer and the other by another, so that in case of shipwreck the evidence of the transaction will survive. The Rise and Fall of Exchange Rates. Inasmuch as the rise and fall of exchange rates is regulated by the supply of and demand for bills, rates in this country will go up when: 1. Imports are large, necessitating the purchase of bills with which to make payment. 2. The purchase of securities abroad, or the repurchase of our own securities held abroad. This also requires bills to effect payment. 3. American bonds falling due, and held in Europe. 4. Low money rates here, and consequently a demand for bills to send money abroad for investment. 5. High money rates in some money centre, leading to a desire on the part of banking interests here to invest abroad. Reversely, rates will fall through causes quite the opposite, which are: 1. Heavy exports of merchandise, resulting in a large supply of bills. This condition obtained during the period following the war. 2. Loans made in Europe for the account of concerns FOREIGN EXCHANGE 267 in this country; or the purchase by foreigners of our securities. Each transaction carrying with it a bill of IRVING NATIONAL BANK WOOLWORTH BUILDING, NEW YORK Rruocablt Export Credit No. Dated New Vork, January Ist. 1920 Mr. John Doe. Expiring New York Po^rnary 15,1920 Hew York City. Dear Sir: - We are informed by Barclaya Tank:, Ltd, London . - . - that you will draw upon us at----- ------ f- -flight ------- for account of Plchard Koe , London "^/^'i,,-:^. r . - - - to the extent of TEN THOUSAHD AITD OO/lOO DOLIAES f|l6,00(iioO^'/*- - - - - - covering shipment of cutlory Documents (corripljff^gw unlesj/<5thcrwise stated and of a character which will meet with our approval Steamer Bills of Lading i: suecl^ order, enddrsed In hlank Invoice Insurance policies coTering marine and WMrriak All documents are to be surrendered to us upon payment Bills of Lading issued by Forwarding Agents will not be accepted unless specifically authorized herein, and payment will be effected only provided shipment is actually on board or loading on the vessel named in the Bills of Lading. Insurance must cover from warehouse at point of departure to consignee's warehouse at destination. Drafts must clearly specify the number of this Credit, and be presented at this Bank on or before February 15, 1920 This letter is for your guidance in preparing documents and conveys no en- gagement on the part of the Bank as we have no instructions to confirm the Credit. Any amendment of the terms of the Credit must be in writing over an authorized signature of this Bank. Yours very truly, PBO-*OnKA No payment will be nude unleu (he lemu mdicated htrein »re ttrictlr obtcrrcd. U impotsible to comply whb cune, pleue romiouiucate with as uid/or the coasignee bffore m&kiog ihipineiitf with a virw to obtaining mMlihcstioo of the Credit to coafonn to the tenn* of sale. m» O* O'lt Fig. 21. — Export letter of credit. exchange, these transactions bring into being many such bills in ordinary times. 268 THE BUSINESS MAN AND HIS BANK 3. Withdrawal of deposits made by financial interests in this country with banks abroad. IRVING NATIONAL BANK • WOOLWORTH BDILDING, NEW YORK Irrevocable Export Credit No. JJr. John Doe , Hew York City. Deer Sir:- Dated New York,' January lat, 1980 Expiring New York^Fetruary 15. 1920 -sight At the request of Barclays Banlc Ita. tonflon- we hereby authorize you to draw upon u& at ------- for account of Richard Koe, london- -------- to the extent of TEH THOUSAHK AMD OO/lOO DOJJAjiS (§10.000..00) covering shipment of cutlery Documents (complete sej^i)filg^ther\)(i1i process of manufacture or rt-manufactureio that the product can no longer be identified, the iindersigp^Ithercupon agree to keep and to hold in trust for above bank and as their trust property manufactured^oods of' equal value with the prbpert'y origitially;dcUvr .cred to the iimlcrsigned and undersigned will on>J