Essential Features Of A Broad Discount Market

The factors necessary to the maintenance of a broad discount market may be analyzed as follows:

1. Those creating the acceptances, or the accepting banks in the case of bankers acceptances, and the seller and buyer of goods in the case of trade acceptances.

2. Those purchasing and selling acceptances, generally the banks.

3. The central bank of rediscount; in the United States, the Federal Reserve banks; in England, the Bank of England; in France, the Bank of France, etc.

4. Discount corporations, brokers and others of a similar nature, which though considered as middlemen, are highly essential to the maintenance of a broad discount market.

In England, where the acceptance is most highly developed, the discount market acts according to supply and demand. Should the supply of bills thrown out in the market be greater than the demand for the same by the investing classes, the tendency would be to increase the rate of discount, thus putting an automatic stop to the use of acceptances and commercial paper, and thereby checking credit over-extension.

The liabilities arising on account of acceptances by the accepting banks abroad average generally from fifty to seventy-five per cent. of their capital and surplus. The acceptance banks, though not extending money but their credit, are limited in their operations.

In this country, it is believed that with the development of the acceptance, the bankers here will be enabled to operate in the same manner as the accepting banks of Europe. The liability that an accepting bank assumes is very much the same as that arising out of a "deposit," and though banks do not, by accepting, obligate themselves to give a present right to demand money, still the acceptance implies a future payment, and it is well to consider to what extent the banks could use or extend their credit if they should operate as extensively as the acceptance houses and banks abroad. To this may be said that so long as the proportion of a bank's capital and surplus to its total liabilities is of a fair ratio, it could safely pledge its credit to advantage. But the requirements of its customers for that form of accommodation must also be considered, and thirdly, the credit standing of the bank, and lastly, the attitude of the market for acceptances at the time.

The second class having a direct bearing on the discount market are the banks and other purchasers and sellers of acceptances, which constitute the active discount market. It is by the sale and purchase of drafts that the discount market is really maintained, and this is in accordance with the individual cash and investment position of the banks and investing classes. For this reason a discount market should afford wide facilities for acquiring ready cash in exchange for paper in the form of investments and vice versa.

Banks would do well in purchasing acceptances to spread their maturities so that they could continually have such acceptances maturing in quantity, thus affording both a cash and an investment advantage. In order that a properly balanced and liquid condition of its assets may be maintained, a bank must have on hand at all times a certain amount of cash. This includes the legal reserve such bank carries with the Federal Reserve Bank and its cash in vault, which constitute the bank's primary reserve.