ELIGIBILITY FOR REDISCOUNT 163 based on the sale of agricultural implements are barely within the requirements.3 The merchant's or the manufacturer's loan must fit these requirements: (a) It must be a note, draft, or bill of exchange, the proceeds of which have been used, in producing, purchasing, carrying, or marketing goods in one or more of the steps of the process of production, manufacture or distribution, or for the purpose of carrying or trading in bonds or notes of the United States; (b) no bill is eligible the proceeds of which have been used, or are to be used (1) for permanent or fixed investments of any kind such as land, buildings, machinery (including therein additions, alterations, or other permanent improvements, except such as are properly to be regarded as costs of operation), (2) for investments of a purely speculative character, whether made in goods or otherwise, or to make loans to other borrowers; (c) it must have a maturity at the time of discount of not more than ninety days.2 The bank which holds paper and offers it for rediscount must certify to the Federal reserve bank that the paper is eligible. If the paper is a bill of exchange drawn by a seller on a purchaser against an actual sale of goods, there is prima facie evidence of its eligibility. A note in a like case would reveal its purpose. When the borrower with only his name as security gets a loan to take discounts on goods already bought for future sale, there is no such evidence. For such paper the character of the business and the credit of the borrower must be carefully examined. The Federal reserve act excludes mere investments and expressly provides that a loan must not be used for carrying, or trading in stocks, bonds, or other investment securities, except bonds and notes of the United States. The farmer's statement of condition will not only 2 Federal Reserve Board. Regulation A. Series of 1922. 3 Federal Reserve Bulletin, Feb. 1916, p. 67. 4 Section 13. show whether the short-term loans are safe, but if they bear such a relation to the entire property and investments as to indicate that he is borrowing for seasonal activities rather than for investment in land, securities, or other speculations. For other borrowers the statement also indicates the security and self-liquidating character of the loans in that they are used for commercial and industrial purposes rather than for investment, the test being whether there is a reasonable excess of quick assets (excluding bonds, stocks, or speculative purchases) over current liabilities on open accounts, short-term notes, or otherwise." Statements of the borrower's financial condition may be waived where paper offered for rediscount has been discounted by member banks for any depositor other than a bank in the following cases: (1) If the draft bears the signature of the purchaser and the seller of the goods and presents prima facie evidence that it was issued for goods actually purchased, or sold; (2) if the aggregate amount of obligations of such depositor actually discounted and offered for rediscount does not exceed $5000, but in no event a sum in excess of ten per cent of the paid-in capital of the member bank; or (3) if the note be specifically secured by approved warehouse receipts covering readily marketable staples, by live stock, or by bonds or notes of the United States. 6 The Federal Reserve Board in addition to requiring that (1) the loan is not for permanent improvements, (2) the loan must be self-liquidating, and (3) a reasonable excess of quick assets over current liabilities must be shown, have approved the basic principles that (1) borrowers should furnish banks with credit statements signed under oath 5 C. A. Peple, "Statements of Borrowers," Journal of Accountancy, June 1916, p. 416. 6 Federal Reserve Board, Regulation A, Series of 1922. ELIGIBILITY FOR REDISCOUNT 165 covering "full and complete information as to the financial responsibility of the borrower, including a short general description of the character of the business, balance sheet, and profit and loss account"; (2) these should be certified by an outside audit; and (3) "the statement should furthermore show the aggregate amount up to which the concern supplying this paper expects to borrow on short credit or sale of its paper, and the concern giving the statement should obligate itself to obtain the member bank's consent before exceeding the agreed limit." These principles may or may not later become requirements. (See also 242.) The Federal intermediate credit banks are also banks of rediscount. They have authority to rediscount paper for any national bank, state bank, trust company, agricultural credit corporation, incorporated live stock loan. company, savings institution, cooperative bank, cooperative credit or marketing organization of agricultural producers, or other intermediate credit bank. The note, draft, bill of exchange, or debenture which is offered for rediscount must be one the proceeds of which have been used for agricultural purposes, or for the raising, breeding, fattening, or marketing of live stock. Such paper when discounted or purchased by a credit bank must have a maturity of not less than six months nor more than three years. Such notes or drafts which are secured by warehouse receipts, to be eligible, must be secured by receipts which have been issued by a warehouse bonded as provided for by the Federal statute, or which have been issued by a satisfactorily bonded warehouse operating under state law. The Secretary of Agriculture of the United States has the authority to give a Government license to properly managed warehouses for the storage of any product which 7 Federal Reserve Board, Circular of Nov. 10, 1914. he considers to be sound collateral. In 1923 there had been licensed 360 cotton, 227 grain, 62 tobacco, and 20 wool warehouses. 126. Distribution of the loans of a bank. - In so far as a bank's deposits are payable on demand, its loans or investments must be quickly convertible into cash. A Federal reserve bank has about one-third of its loans due each month. But if a bank calls its loans in times of stress, it will wreck what is already sailing hard, and deny a customer assistance when he most needs it. To enable it to meet seasonal demands for loans and to carry those of its customers who cooperate with it, a bank builds up a secondary reserve. It buys investments which it can quickly sell. Many banks prefer to purchase the commercial paper of non-depositors, which it is under no obligations to renew and which does not shrink in value. Such a bank may invest in bankers' acceptances, trade acceptances, and loans through note brokers, which have an early maturity and are easy to resell. It goes into the open market and lends on call. On the floor of the New York Stock Exchange single money brokers have loaned $5,000,000 to $25,000,000 in behalf of large banks. The Federal reserve banking system makes a secondary reserve out of all paper that is rediscountable at a reserve bank. A rule which enables a bank to scatter its risks and distribute its loans fairly among its customers, is the "value of account" rule, or the requirement that no loan shall be made in excess of a certain number of times the balance carried (see 123). The loans of a bank just about equal its deposits. If the above rule is enforced each borrower, if he is a safe risk, and his responsibility 8 The reports of the Comptroller of the Currency prior to 1921 gave statistics of the loans of national banks which were made direct to non-depositors. The lending operations of some banks are world-wide, while those of others are almost entirely local. LIMIT OF BANK'S LENDING POWER 167 warrants, can enjoy loans in proportion as he patronizes his bank. The best customers are cared for first, and many a concern borrows money to prevent its bank account from becoming unprofitable. When a concern divides its business among several banks, this rule serves as an automatic check to the amount it can hope to borrow from any one lender. If the security is the same, a bank seeks the higher interest rate, consequently if interest rates are higher at certain seasons than at others, it seeks to distribute its maturities so that it may have strong lending power during the profitable period. The lending power of a bank is one of its strongest bids for business. Many a customer who finds a bank unable to accommodate him, changes to another which is both able and willing. 127. The limit of a bank's lending power. - National and state laws make general restrictions as to the character of bank loans. Federal reserve banks cannot foster speculation; Federal land banks can lend only on farm land for certain purposes; reserve city and country national banks can lend on real estate; and different states restrict in different ways the activities of state, savings, trust, and private banks. There are also limits to the loans which are allowable: (1) A national bank in a central reserve city must keep as a reserve 13% of its demand and 3% of its time deposits; a national bank in a reserve city, 10% of its demand and 3% of its time deposits; and a country national bank, 7% of its demand, and 3% of its time deposits. The Federal Reserve Board has the authority to reduce the reserve required of a national bank located in an outlying district of a reserve or central reserve city (see 231). State banks must also maintain reserves. A savings bank in Ohio is required to keep 15% of its de |