This section is from the book "Elementary Banking", by John Franklin Ebersole. Also available from Amazon: Elementary Banking.
In the large banks it would be impractical, if not impossible, for the cashier, in addition to his other duties, to keep track of every local borrower and the bank may employ a "credit man," who specializes in credits. The next step is the organization of a credit department, usually in charge of one of the officers of the bank. The credit department collects and files every available bit of information concerning people or firms that borrow money. This material consists of financial reports, press clippings, personal interviews, statements of condition and, in fact, every item that has even a remote bearing upon the standing of borrowers. It requires technical training of a high order properly to classify and analyze this data, but the fundamental idea is to acquire the same knowledge of the true facts that a country bank cashier has with respect to his neighbor. A simple but practical definition of credit is "the ability to buy with a promise to pay," in other words, to obtain present value for a promise to pay in the future. He who has "good credit" can command either goods or money because of the faith or belief that others have in his promise. The word "credit" is derived from the Latin "credo." It is not only essential that the borrower have the ability to pay his note when it is due - he must also have the desire or inclination to pay. Credit is primarily based upon confidence which has as its basis three things. First and foremost is character, the "moral risk" which is indispensable in every case. Then comes capacity, the borrower's ability and business methods. Thirdly, we have capital which, while essential, is distinctly secondary to character and capacity, a combination which is very apt to attract capital. The banker, naturally, in selecting his customers knows that he may be asked to extend credit. He first satisfies himself that the factors of character and capacity are such as to justify confidence. This information is obtained from personal knowledge of the borrower, and by information obtained through other banks, through "the trade" and by agency reports. Trade inquiries are directed to people selling goods to and competitors of the borrower. If all this information is satisfactory, the capital factor is studied in the borrower's financial statement of condition, which balance sheet should be taken off at regular intervals. It must show a sufficiently "liquid" position to satisfy the banker that his loan can and will be repaid when due. To show this, there must be an ample margin of quick assets (those readily convertible into cash) over current liabilities to enable the borrower, despite any natural shrinkage of values in liquidation, readily to meet his obligations. This ratio is often called the 2 to 1 ratio, but differs in proportion according to the character of the business in question. The ability to loan money wisely and to those who are entitled to it - in short, the ability to distinguish between a safe risk and an unsafe one - is the quality that marks the good banker.