The underlying principles followed by the banker in extending credit have been touched upon in the two preceding sections. It is important to bear in mind particularly, first, that the commercial banker must confine himself to making short-term loans; second, that he should satisfy himself that the money he loans is to be invested in such a way that it can readily be reconverted into cash; third, that credit granted on the general standing of a business enterprise entitles the banker to full and detailed knowledge of the inside workings of the enterprise; fourth, that collateral, to be acceptable, should consist either of securities and merchandise which are readily salable, or of drafts and accounts receivable which are quickly convertible into cash.

Supplementing these four basic principles, there are some observations to be made at this point as to factors which are taken into consideration by banks in making loans. First of all, attention should be directed to the growing custom of requiring detailed financial statements of customers to be filed from time to time. There was a time in this country not many years ago when a bank's request for such a statement was looked upon by the customer as in the nature of an affront or an impertinence. This is even yet the case in some sections of the United States, and is notably true in South America. However, this feeling is rapidly giving way to the saner idea that a bank is certainly entitled to reasonably accurate and full information as to any concern to which it is lending money, and that it is to the interest of conservative borrowers to comply with the bank's request for statements and thus put itself in a different class from non-conservative borrowers who are inclined to be secretive. The banks themselves are more and more inclined to insist not only on complete statements, but also on statements certified by public accountants. Such a suggestion is not intended as a reflection on the honesty or capability of the corporation's own accounting force; it simply brings to bear in addition the judgment of an unbiased person of wide experience who is in a far better position to value assets than any officer or employee of the corporation.

That banks are in favor of certified statements is plain from the answers received to a circular letter sent out in March, 1914, by the American Association of Public Accountants, asking for bankers' opinions on this point. The 844 replies were distributed as follows:

Strongly in favor...

121

Favorable.........

501

Opposed.......

15

Strongly opposed......

5

Non-committal..........

202

Among the factors considered by banks in making loans, must necessarily be the legal restrictions in force or likely soon to be in force. The banking law which went into effect in 1914 provides that, "any Federal Reserve Bank may discount notes, drafts, and bills of exchange arising out of actual commercial transactions." The effect of this law is to increase the value of two-name paper, accepted drafts, and other evidences of debt, which are the direct results of commercial transactions, and correspondingly to decrease somewhat the value of paper which is not available for rediscounting at Federal Reserve Banks. Under this law, the paper issued by one subsidiary'company to a holding company as an accommodation note - such as the 30 to 40 million dollars of Claflin notes previously referred to - would not be available for re-discounting. One result of the collapse of the Claflin firm was to strengthen greatly the movement in favor of putting a premium upon paper which arises out of commercial transactions.

The Federal Reserve system also favors the policy of getting more written information than has heretofore been required from customers in making applications for loans. Not only will paper based upon certified financial statements be favored in the rediscounting operations of the Federal Reserve Bank, but also there will probably be a strong tendency to insist that some evidence be given that bank loans are "self-liquidating" and that some assurance be extended that the loans are not to be used for permanent improvements to plants and the like.

Among the unwritten rules that have long been customary among bankers in making loans, these two are of chief importance: First, at least 20% of the bank loans should be retained as a deposit in the bank, the other 80% only being available for meeting obligations. This is a long standing custom, but is not universal. It is more strictly applied by some banks and in some lines of business than in others. Second, all bank loans should be "cleaned up" at least once a year so that the bank may make sure that the money it lends is not going into permanent investments. This is especially necessary in those lines of business which have well marked seasons of activity. It would be clearly inadvisable for a bank to allow a customer in such a line credit for the coming season until after he has paid up his loans for the previous season. With manufacturing corporations the rule is not so strictly applied; yet, even here it is properly thought to be desirable that the company's balance sheet should once in a while be wiped clear of bank loans. If this cannot be done, it is clear enough evidence that the company is using bank funds as a part of its permanent capital, and that it should be reinforced by the sale of more stock or long-term securities.

All these rules of successful and conservative banking are also the rules of successful and conservative financing of all business corporations which borrow from banks. There is no conflict whatever between the two points of view. A banker wishes in normal times to lend as much as he can safely place; the treasurer of a borrowing corporation wishes to borrow as much as is consistent with safety. In theory there should never be a disagreement or a hitch between them. However, the frailties of human nature are not so easily set aside. A treasurer's prejudices and fancied interests frequently lead him to oppose reasonable requests and criticisms; on the other hand, a banker is at least equally liable to suffer from obstinate prejudices. Recently an eastern manufacturer asked his banker for a loan of $25,000. "I see," said the banker looking over the manufacturer's statement, "that your advertising expense for last year just about equals $25,000. If you would cut off your advertising you would have all the money you need." The manufacturer tried to explain that it was necessary for him to advertise in order to sell his goods, and that the money borrowed from his bank was required in order to purchase raw materials which would be quickly manufactured into salable articles. But the banker had a prejudice against advertising which nothing could shake.* The banker's work has a tendency to make him a slave to routine and to fixed ideas, which are obstacles to the prosperity both of his customers and of himself.