XV Loans of Banks to Banks

CHAPTER XV LOANS OF BANKS TO BANKS There are several ways in which one bank may lend to another. The most common is, and has long been, on the note of the borrowing bank secured by accompanying collateral in the form of stocks or bonds or customers' notes. A second method is to lend on the unsecured note of the borrowing bank. Rediscounting customers' paper is a third; and a fourth is through the purchase of bonds or other securities by the "lending" bank with the understanding that the same securities are to be sold back to the "borrowing" institution in due time. Banks also make advances to other banks in exchange for certificates of deposit. The writer knows of one bank that "lends" to other banks on certificate of deposit in order to secure convenient means of concealing profits and assets. Of these methods of lending, as employed outside the Federal Reserve banks, the lending operations of which were fully discussed in chapter VI, the first is the usual and prevailing one.

The following table contains the amount of loans to banks made by national banks in all Reserve and other cities having a population of over 75,000, December 27, 1916.1 'Report of the Comptroller of the Currency, 1917, VoL I, p. 204. 253 254 BANK CREDIT Cities No. of banks Direct and indirect loans to banks Securities, etc., purchased from banks with agreement to New England States.... 59 $ 8,042,115 $ 295,042 Eastern States 181 62,309,711 894,550 Southern States 81 9,528,530 23,500 Middle States 124 65,125,350 4,445,322 Western States 38 17,991,908 Pacific States 39 2,349,054 73,465 Total 522 $165,346,678 $5,731,878 It will be readily observed that "securities, etc., purchased from banks with agreement to resell" constitute only three per cent of the combined loans made in accordance with the other two methods. When a bank buys bonds, stocks, or commercial paper at a given price, for repurchase at the same specified price, the selling bank pays interest on that price.

Where the borrowing bank is not required to bolster up its paper with that of its customers' it is, as a rule, because the lending bank is satisfied that the condition of the borrowing institution is above suspicion and the character of the management above reproach. In the numerous cases where banks send along their customers' notes as collateral those notes bear not the signatures of big and well known borrowers, but the names of those whose credit standing is known only locally. Nevertheless, cautious lending banks do make some effort to ascertain the standing of the makers and endorsers of paper submitted as collateral and when LOANS OF BANKS TO BANKS 255 it is found to be unsatisfactory, substitution may be asked for. The amount of the collateral, whether rated or unrated paper, is maintained, when maturities occur, through substitution. The margin of the collateral over the face of the loan may run all the way from ten to one hundred per cent.

If the lending banker, in New York, let us say, knows the Southern banker who is borrowing against receivables, unrated paper is probably to be regarded as not inferior to rated paper. The makers of the unrated receivables the Southern banker knows, and the Southern banker may be fully as jealous of his bank's interest as is the New York correspondent of his own. Resting on a close knowledge of the character of the maker of the paper and the value of his resources, which may be only a few acres and a gray mule, the judgment of the Southern banker is probably better than that based on an investigation of a commercial agency.1 How nearly free from loss are these loans of banks to banks on the security of unrated paper is shown by the fact that one of the leading New York banks that lends very extensively to Southern bankers on this form of security suffered no losses whatever in 1914. The same institution has lost only a few thousand dollars over a long period of years.

Lending institutions usually require that the borrowing bank maintain an average deposit of twenty per cent of the credit extended. There are many exceptions, however, to this rule. 1 A. J. McGrath, The Northern Banker Passing on Paper Offered by the Southern Banker, Proceedings, Fourteenth Annual Convention, Georgia Bankers' Association, 1905, p. 99.

256 BANK CREDIT Investigating the Borrowing Bank City banks employ a great variety of methods in attempting to ascertain the standing of a bank that has applied or that may apply for a loan. Many New York institutions having bond salesmen and solicitors of new business at work in the territory of their bankborrowing clienteles utilize those agencies in securing information from officers of other banks. Closer information can be got through interviews than is possible by correspondence. It would be erroneous, however, to suppose that banks do not inquire concerning their borrowing correspondents by writing both to bankers who are located in the borrower's own and neighboring towns and to other correspondents of the borrowing institution. Information is given almost invariably on what the bankers call non-liability paper, paper containing a statement to the effect that the bank giving the information does so as a matter of opinion for which no responsibility is to attach "to this bank." The following non-liability statement, which appears on letters sent out by a prominent Chicago bank in response to requests for credit information is typical: All persons are informed that any Statement on the part of this Bank or any of its Officers as to the Responsibility or Standing of any Person, Firm or Corporation, or as to the value of any Property or Securities, is a mere Matter of Opinion, and given as such; and solely as a matter of Courtesy, and for which no Responsibility, in any way, is to attach to this Bank or any of its Officers.

LOANS OF BANKS TO BANKS 257 Non-liability paper is also used in making replies to inquiries concerning non-bank borrowers. The practice of city banks sending representatives, frequently vicepresidents, over the country to attend bankers' conventions has two purposes: (a) to secure new business and (b) to secure credit information in a personal and very expeditious way. The most capable representatives of the metropolitan banks in attending a convention, endeavor in addition to the direct solicitation of new business, to obtain credit information along three distinct lines: 1. Effort is made promptly to meet the representatives of correspondent banks present, to discuss freely mutual inter-bank relations and to obtain as much information as possible concerning the nature of the business carried on by the interior institutions, and whether other connections or affiliations are maintained. Meeting the country banker face to face enables the officer or other representative of the city bank to form a definite opinion as to the moral risk.

2. As far as possible an effort is made to get an interchange of views with other correspondents of the interior banks, as well as an expression of opinion from representative local concerns respecting the credit standing of bank correspondents in the section visited. 3. Business methods prevailing in the locality of the country bank are made the object of inquiry, as are the development of the resources of that section and the basis of local loans, whether cereals, cotton, live stock or other commodities. The information secured by the visiting representative is later copied in the credit files of the institution 258 BANK CREDIT to which it pertains and serves as an important help in passing intelligently and fairly upon applications for credit coming from the interior bank.1 The way in which a bank handles its accounts with the city correspondent is also an indication of character. Balances and loans over long periods are watched; overdrafts, if any, are noted. Any evidence of businesslike methods coming to the attention of the lending bank does not fail to make an impression favorable to the borrowing institution. Even such an apparently trivial matter as the promptness with which reconciliation slips are handled is closely watched as an indication of carefulness and promptness or of lax and slip-shod methods.

Lending institutions welcome a suggestion from the borrowing institutions that a representative be sent to make an examination of its affairs before business relations are entered into. The findings of such a special representative are almost certain to be diverse. In one case the conditions and methods found might prove a model for many a large institution; in another the reverse.2 A Particular Case Let us now examine briefly the factors underlying the making of a loan by a bank to a bank. The First National Bank of Weston, Ohio, makes an application for a loan of $25,000. In anticipation of the aforementioned application the New York correspondent has 1 Proceedings, Georgia Bankers' Association, 1905, pp. 84-86. 2Cf. A. J. McGrath, The Northern Banker Passing on Paper Offered by the Southern Banker, Proceedings, Fourteenth Annual Convention, The Georgia Bankers' Association, 1905, p. 100.

LOANS OF BANKS TO BANKS 259 found out about the standing of the Weston bank by writing to banking friends in Toledo, lima and perhaps elsewhere. The lending officer of the New York bank also has at his fingers' ends figures showing how profitable the account has been, and facts as to the promptness with which reconcilements have been made, etc. A statement of the Weston bank will also have been secured by the metropolitan institution. The statement follows:1 Liabilities Loans and Discounts . .$142,704 Capital $ 25,000 U.S. Bonds 20,000 Surplus 10,000 Banking house, Fumi-Undivided Profits 757 ture and Fixtures. .. 10,000 Notes 20,000 Other Assets 7,159 Demand Deposits 28,330 Due from Banks 16,094 Time Deposits 108,966 Cash 8,909 Due to Banks 11,813 $204,866 $204,866 The ratio of reserves to deposits is satisfactory, as is the ratio of capital, suplus and undivided profits to deposits. The bank could lose almost twenty five per cent of the amount of its loans and still be able to pay depositors one hundred cents on the dollar. The statement is excellent; the standing of the personnel of the bank officers and directors is high; the bank is popular in the community, assuring the improbability of heavy deposit withdrawals; business and crop conditions in and round about Weston are promising; the extension of the loan is justified.

1 Report of the Comptroller of the Currency, 1915, VoL II, pp 744-745.