mercantile creditors; (4) reports from banks with whom he has dealt; (5) reports from commercial agencies; (6) reports from other departments of the bank that may have come in contact with him; (7) general "gossip" of the community.

The most important of these sources of information is by all odds the financial statement. It is an itemized exhibit of the resources and liabilities of the customer, usually at date of last inventory. A careful analysis of a statement will show the amount of cash that could be realized from the business if it were suddenly liquidated and its assets thrown on the market. Some of the largest banks now supplement this statement by an investigation of the factory or store conducted by the borrower. Expert appraisers and engineers are sometimes employed for the purpose.

Dun's and Bradstreet's reports furnish a great amount of valuable historical data as well as collateral evidence bearing on the present status of the borrower. They collect information with reference to business houses and give them a "rating" in their reports. They aim to cover the entire field and include every individual business man, but with new enterprises and even new cities springing up daily it is impossible in practice for them to furnish recent information on all mercantile concerns. A serious handicap to reliable information lies in the fact that the agency reporters are not always treated with the greatest freedom and confidence. Moreover, the reporters are poorly paid, and hence many of them are poorly qualified for the work in hand. There is also, in many instances, an evident desire on the part of the firms concerned to strengthen their "rating" by deliberate deception. Nevertheless, the service performed by the agency reports is an invaluable aid.

The remaining information is obtained by correspondence and interviews, and it usually furnishes much collateral evidence on the financial and moral responsibility of the borrower.

It is not a function of the credit department of a bank, however, to analyze the information collected and pass judgment upon the loan. It merely supplies the information to the loan officers of the bank, who render the decision and assume all responsibility for, the loan.

34. A FINANCIAL STATEMENT

The following is a form of financial statement recommended by the American Bankers' Association. The statement proper is

followed by a long list of questions as to the character of the individual items.

35. COMMERCIAL PAPER HOUSES AND NOTE BROKERS

The business of note brokerage arose in response to a very definite economic need. Banks in a given community frequently find that they cannot fully utilize their resources there, and wish in consequence to make loans in a wider market. Similarly, it frequently happens that borrowers in a given community are unable to procure adequate accommodations for the reason that the banks there have already made loans to their full capacity; in consequence borrowers often wish to procure funds in a wider market. The opportunity thus afforded in bringing together the banks and borrowers of different localities has given rise to a distinct type of financial middleman. A remunerative business was early developed by individuals in taking notes of merchants in one town and selling them on a commission basis to banks in another town. This business has become so important today, however, that in place of the individual note broker we now usually find the commercial-paper house, an institution quite as important in the financial world as the banks themselves. Some of these houses purchase and sell commercial paper amounting to hundreds of millions of dollars annually. Their operations are nationwide in extent; they sell the paper of New England dealers to banks in California, and that of merchants in Portland and Seattle to the bankers of Chicago and New York. The commercial-paper broker thus serves the important economic function of adjusting or equilibrating the demand and supply of loanable funds.

The commercial-paper house may either buy the paper outright and then sell it to the bank, or it may merely offer the paper for sale

with the knowledge that it can be obtained on request. The former method is usual nowadays among the larger houses. In either case, however, the brokerage house is a mere middleman, for it is not a part of its business to loan funds; it always buys to sell on a commission basis. It may be added that the house guarantees the genuineness of the signatures to the paper, though it does not indorse the paper and thereby assume a secondary liability.

Where the commercial-paper house buys the paper outright there is much more likelihood that the broker will investigate the financial standing and general character of the borrower than if he merely secures the paper upon request, for he may find himself unable to sell the paper. This is regarded by many as an important consideration, for the banker is at a disadvantage in investigating business firms at long range. With a local customer the bank as a rule deals with persons who have been known to it for many years and whose business standing is a matter of record in the files of the credit department. But in the case of paper bought in the open market, unless the name of the borrower is particularly well known, the bank has to deal in the main with an abstract proposition in the form of the borrower's statement. The commercial-paper house, through its investigation, may therefore serve as an additional check on credit on the principle that two investigations are better than one. There is a possible danger here, however, in that each investigation may be less rigid than would be the case if the responsibility were not divided.

Where the paper is of an unknown name, it is the usual custom for the bank to buy the paper on an option of seven or ten days, during which time it may make an adequate investigation of the firm or corporation offering the paper. Such an investigation must be conducted chiefly by means of letters of inquiry to the banks and business men in the town where the borrower is located, to those in the trade who have sold goods to the party in question, and to bankers in great commercial and industrial centers where the paper is likely to be placed on the market. If the paper is not acceptable after investigation, it is returned to the commercial-paper broker, the bank of course keeping the interest earned while the paper was in its possession.

The term "commercial paper" as used in the financial world often refers, not to all paper arising out of commercial transactions, but only to paper that is handled by the commercial-paper houses. Such paper has its own special quoted rate, which often varies materially from the rate on direct loans of banks to their customers.

(3) COLLATERAL

36. LOANS ON COLLATERAL

Loans that are contracted for the purpose of investing in fixed capital, or in any way that does not give rise to funds for the payment of the loan at an early maturity, must be classed as investment rather than commercial loans. Such short-time loans may be perfectly safe if the bank is not required to pay on demand, but it is clear that a bank cannot meet demand liabilities with assets whose maturities depend upon the more or less remote incomes to be derived from investments in fixed capital. In a similar way loans granted to individuals for personal consumption or non-commerce, or to be used in speculative enterprises, are unsafe for a commercial bank whose liabilities are demand liabilities. Unless borrowed funds are used in the manufacture or marketing of goods, there is not a reasonable assurance that the loans will be paid at maturity. Accordingly, noncommercial loans are usually made on collateral; that is, the borrower pledges with the bank as security some valuable claim to wealth, such as bonds, stocks, or warehouse receipts. In case, then, that the loan is not paid at maturity, the bank can sell the security thus pledged and thereby keep itself in funds. In the event that the loan is paid, the collateral is returned to the borrower. This sort of loan, when properly safeguarded, is in normal times quite as liquid as commercial-paper loans. The nature and types of collateral may be indicated by reference to a few typical cases.

A bond or brokerage house is a concern which deals in investments or securities, and has nothing to do with the marketing of goods. It would be dangerous for a bank to loan to such a concern without collateral security. But such a house owns blocks of securities, stocks and bonds, which have a definite market value and which can be hypothecated with the bank as security for a loan.

A distiller has his capital invested in the manufacture of products which will be consumed only after an interval of several years, often from four to eight years after they are manufactured. These goods are stored in government bonded warehouses and negotiable receipts are issued by the warehouses to the owners of the goods. These receipts can be used as security for a loan at a bank in the same manner as stocks and bonds.

Spring eggs are placed in cold storage and negotiable receipts are issued by the warehouse. The eggs are covered by fire insurance

and are safeguarded by such means as the cold storage affords. The possibility of wide fluctuations in value render them undesirable security for commercial loans, but the warehouse receipts, with a proper margin, can be safely used as collateral for a loan.

Grain is stored in grain elevators under the supervision of the government. In Illinois, for instance, there is a State Warehouse Commission under whose supervision warehouse receipts are issued certifying that the wheat, corn, or oats is all of a certain grade. These receipts are insured against theft or loss by fire, and they pass current almost as money does. They are, therefore, well adapted to serve as security for loans at a bank, and are among the most common forms of collateral security.

It is not safe for banks to make loans to the full present market value of such securities. They may fluctuate widely in value during the life of the loan and prove inadequate in case of forced sale to cover the amount of the loan. It is necessary, therefore, to require a margin, an excess of valuable securities over the amount of the loan. This excess is, of course, returned to the borrower after the loan has been paid.

The amount of margin required will vary in proportion to the chance of sudden shrinkage in the salable value of the collateral. In the case of the best bonds ten per cent is usually regarded as a safe margin. Twenty per cent is usually required in the case of the best active listed stocks. On less active or more speculative stocks, and in common stock, a much larger margin is necessary for safety. Mixed collateral is obviously better than that of a single class of bonds or stocks. In the case of collateral, marketability is even more important than steadiness of value or ultimate safety. Collateral is not regarded as an investment. It is merely a protection for the investments in the form of loans, hence ready salability is of first importance. It is for this reason that collateral that is regularly quoted and dealt in on the exchanges is much more acceptable than non-listed securities. "The fact that a security is listed on a stock exchange, however, even the New York Stock Exchange, is not in itself evidence to warrant its being accepted as the best of collateral, any more than the fact that a security is not listed should preclude it from acceptance as collateral." Investigation of the conditions surrounding the given security is necessary in either

case.