We have already noted the technical difference between loans and discounts, namely, that banks discount paper for their Reserve excess in Boston. 3,117,143. Increase, 1,611,286. Excess with Reserve Agents, 7,884,143. Decrease, 575,714.

Statement Of The Associated Banks Of Boston

As returned to the Clearing House, for the week ending Saturday, July 25, 1914.

Balances.

15,898,325

5,751.381

11,340,799

Collections Foreign Department

8,429,379 9,190,971 10,052,397 regular customers and purchase the paper of other business houses not regular customers, usually through a third party known as a note broker. The note broker is a middleman between the lending bank and the business house in need of funds.

Weekly Bank Statement.

The business of note brokerage has undergone great changes in the last few years. Formerly the note broker simply acted as an agent for borrowing firms, placing their notes at the lowest possible rate of discount, and charging a commission for handling the paper. Now the note broker or dealer in commercial paper buys and sells outright the promissory notes of his clients; he has large capital, a complete credit department, agents in many cities, and a good line of credit himself at the banks. The business is largely controlled at present by a few large concerns whose operations extend over most of the United States. One authority states that to carry on the business to best advantage a capital of $1,000,000 is required, and that on this amount of capital a dealer in commercial paper can do an annual business of $100,000,000 at an expense of about one-tenth of one per cent.1

In many sections of the country interest rates fluctuate widely at different seasons of the year in accordance with the demand for and the supply of loanable funds. For instance, in the fall of the year when the grain crops of the West must be moved, the demand for funds exceeds the supply at the local banks. After a few months the money expended for moving the crops flows back to these banks and they have a surplus of loanable funds. High money rates, therefore, are likely to prevail in the West and South during the fall months and low rates in the spring and summer. The dealer in commercial paper can take advantage of these fluctuations, buying paper bearing a high interest rate and selling it where the interest rate is lower.

But, it may be asked, why does a business firm sell its paper to a note broker rather than to its bank? Several inducements may be offered by the dealer in commercial paper. By selling commercial paper to the dealer, a firm may keep its borrowing credit at the bank in reserve in case of emergency. Then again the firm may want to borrow a larger amount than its bank would care to handle. The note broker has facilities for distributing the loan among many banks. Generally, banks require a borrower to maintain a balance of at least 20 per cent of his loans. He has actual use then of only $80 out of every $100 borrowed from the bank, which means that a 5 per cent loan actually costs the borrower over 6 per cent. By selling to the dealer he gets the full face value of the loan less the dealer's commission.

1Howard and Johnson: Money and Banking, p. 342.

The purchase of commercial paper is advantageous to the banks as well as to business borrowers. It affords an outlet for the profitable investment of funds not needed to meet the demands of regular customers. The country banks especially are large buyers of commercial paper. These banks, as already noted, keep part of their required reserve with banks in the reserve cities, and often accumulate large balances at those seasons when the local demand for loans is light. Now the big city banks pay only about 2 per cent on these balances, whereas the rate for commercial paper may be 5 or 6 per cent. When the country bank accumulates a good balance it may instruct its New York correspondent to buy, say, $20,000 or $100,000 worth of commercial paper with the money the country bank has on deposit. Instead of keeping large balances with their city correspondents the country banks have tended in recent years to deal directly with the note brokers, though they seek the advice of the big city banks as to the credit and standing of the firms whose paper is offered to them.

Another advantage to the banker of buying commercial paper is that on such loans there will be no request for renewal. Many of the bank's regular customers expect to renew their notes again and again and they become chronic borrowers. But in the case of commercial paper there is usually no thought of renewal; borrowers make it a point to protect their commercial paper at maturity, even if someone else has to go unpaid, for one default would probably injure the borrower's credit with the dealer.

The dealer in commercial paper does not indorse the notes he sells or become responsible for their payment at maturity. Hesimply guarantees their genuineness. However, the banks in buying paper place much dependence upon the dealer, whose success depends largely upon his reputation for handling only good paper. Dealers in commercial paper must, therefore, maintain highly efficient credit departments which investigate thoroughly the financial condition of every client. Few banks outside the large cities can afford such departments and they have to rely largely upon the information furnished by the note broker. Country banks in purchasing paper generally seek additional information from their city correspondents as to the credit and reliability of the issuer of the paper, and banks in different cities supply each other with similar information. The reputable note broker will not agree to handle the commercial paper of a client until after making a careful investigation of his financial condition. A financial statement is always required and this must frequently be revised. Usually the dealer will not buy paper unless the statement of the maker shows "quick assets" which include cash, merchandise, accounts and bills receivable, equal to at least twice the amount of liabilities.