Evening star. [volume] (Washington, D.C.) 1854-1972, 1912-12-29
BUSINESS CREDIT IS BEST
BASIS FOR SOUND BANKING

Director Of the School of Commerce In the
University of Wisconsin.

l AASAAA4Aa&
Director of the School of Commerce in the
University of Wisconsin.
The confus on Of commercial with in
vestment banking is one of the most Sc
| r.ous defects of financial practice in the
United States. 1t leaves the doors wide
| open at all times to credit and currency
Imitation, and is a potent cause of hard
times and commercial crises.
The distinction between these two kinds
| of banking is easy to draw IN theory. but
difficult in practice under present condi-
| lions in this country. Commercial bank
| ing is concerned with the current COM
! merce of the country. IT supplies the
greater part of our medium of exchange
and manipulates nearly all of it. Its
chief function is. through debit and credit
accounts, to balance on its books the
mutual Indebtedness of individuals. COM
| munities and nations. Its chief instru-
| mentalities are checking accounts, note
| issues against commercial assets, dis
counts of commercial paper and clearing
houses.
Investment banking. on the other hand,
! is concerned with the investment of the
new savings of the community and with
| transfers from one form of fixed invest
ment to another. 1t deals with fixed
| rather than circulating capital; should
have nothing to do with the supply of
a medium of exchange, and operates
chiefly by means of savings accounts,
and purchases and sales of bonds, stocks,
real estate mortgages and other longtime
securities. The stock market is one of
the most highly developed and sensitive
parts of it's machinery, and speculation
one of its by-products.
Two Kinds of Banking Confused.
Under present conditions in this coun-
try 1t is difficult to separate these two
kinds of banking. because both are car
ried on by the same institutions. and be-
cause the larger part of our commercial
paper is not differentiated in form from
investment paper. National banks are
business. since they must invest a per-
centage at least of Their capital in gov
eminent bonds and must ISSUE their
notes against investment instead of COM
mercial securities. State banks are under
no such compulSion, but they are expected
to and do deal heavily in real estate
MORTGAGES. and both state and national
banks conduct savings accounts. Trust
companies, while organized especially for
investment purposes, to the extent that
they do banking business, usually do
commercial banking also. unless they are
expressly prohibited by law.
The promissory note is the most widely
used form OF banking security i'm this
country, whether the purpose of the loan
be the conduct of current commerce or a
more or less permanent form of invest
ment. On account of the almost uni
versal practice of carrying" business
men by an indefinite number of renewals
or their notes. the length of the period Of
maturity or such notes is no criterion for
distinguishing investment from CONNER
cial paper
Under these conditions. the avoidance
OF the confusion of commercial and in
Vestment banking is only possible when
bankers are keenly conscious of the evils
which result from such confusion and
carefully conduct their business with this
object in view. The only practicable plan
is the conduct of an efficient credit de-
partment. which will inquire into and find
out the use to which the proceeds of
plans are put, and which will keep the
officers who make loans supplied with in
formation which will enable them to know
how prospective borrower will use funds
put at his disposal
Danger of Imitation,
Unfortunately banks conducted accord
ing to this pan are rare. Most bankers
are not aware of the Importance of the
distinction between these two kinds of
banking Their inquiries regarding loans
are usually limited to the security back
OF them. If they are satisfied that the
man or men whose names are on the pa
per they buy are good for the amount
borrowed they consider the loan good,
and take 1t without hesitation, blissfully
unconscious Of the fact that a good loan
Tor an investment banker may be a very
bad one for the commercial banker bad
not necessarily in the sense that it will
not ultimately be paid. OF even in the
sense that it may cause trouble immedi-
ately to the banker who makes ii, but in
the sense that such iOans. If they exceed
in the aggregate the banks capital. sur
plus and genuine savings deposits, are
certain to result in imitation and to con-
tribute to the evil consequences of such
condition.
Initiation is much used but imperfectly
comprehended term. 1t is a word to con-
1ure with rather than one which brings
before the mind of the person who uses
1t perfectly definite financial condition
1t is. therefore. badly in need of ex-
PLANTATION in this connection.
1t describes the state Of the commercial
banks of a country when they have Gre
ated against themselves as a group obli-
cations which they are unable to meet in
the normal course of their business. The
characteristic business of a commercial
bank is the exchange of it's obligation to
pay on demand for the obligations of
others to pay in the future. Its ability
safely to conduct this kind Of business
depends upon the strict limitation of its
operations to the processes of bookkeep-
ing mentioned above. If the debts and
credits 1t registers on it's books balance
or so nearly balance that the difference
between them can easily be met by the
cash that normally circulates in it's COM
munity. or which 1t can attract from
other communities by normal methods
no difficulty can arise. but, if the differ
ences are greater than this, extraordinary
and painful methods of adjusting them
are necessary, methods which always re-
suit In financial loss to large numbers Of
peop.e and frequently in commercial and
financial crises.
Tying Up Liquid Capital.
Now precisely this condition of things
Is produced when commercial banks pur-
chase investment securities In excess of