Davis Rich Dewey.

Banking and credit; a textbook for colleges and schools of business administration online

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Dewey -
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Southern Branch
of the

University of California

Los Angeles

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^N 3 1924

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uul 1 2 1929

JUL 19 1929

MAY 2 11924

JUL 2 5 1929

JUN 3 1924

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NOV 11 1926

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APR 1 1 1941 .

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Professor of Economics and Statistics, Massachusetts
Institute of Technology



Assistant Professor of Economics, Massachusetts
Institute of Technology

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Copyright, 1922, by
The Ronald Press Company

All Rights Reserved



The field of banking and credit is so extensive that it is im-
possible to describe all its features in a volume of moderate
compass. This text is therefore restricted in its content. It is
written primarily to meet the needs of the individual who uses
the bank for credit accommodation; its aim is to explain the
problems confronting the customers of a bank, and the significant
• factors that control the terms and conditions upon which credit
i may be obtained.

<f The different forms of credit instruments are described and
emphasis is placed upon procedure by which loans are obtained
' and the methods of determining credit risks. To make room for
x this, less attention is given to the history of banking, to invest-
A ment forms of banking, and to theoretical questions concerned
with the nature and principles of money and credit. It is as-
sumed that the reader has some familiarity with the chapters
on money and banking which are found in all elementary texts
on economics, and the purpose of this volume is to supplement
these chapters by more detailed description and illustration of
actual practice in the business world.

A few specific references are given at the end of each chapter
to aid those who wish to read further on particular topics; and in
the Appendix will be found carefully chosen problems and exer-
cises with solutions, designed to make clear the customary
process of banking and credit operations.

Davis R. Dewey
Martin J. Shugrue
Cambridge, Mass.
May io, 1922



if /

1 ' .


Chapter Page

I Money and Credit i

II Stock of Money 8

III Commercial Credit Instruments ...... 34

IV Commercial Credit Documents 58

V Letters of Credit 71

VI Negotiability 80

VII Business of Banking 94

VIII Various Kinds of Banking and Credit Institutions 102

IX The Balance Sheet of a Bank 126

X Funds Belonging to Stockholders 142

XI Deposits 150

XII National Bank Note Circulation ..... 164

XIII Commercial Loans 175

XIV Security for Loans 188

XV The Credit Statement 208

XVI Analysis Ratios 220

XVII Individual Items of a Credit Statement . . . 231

XVIII Analysis of Typical Credit Statements . . . . 255

XIX Security and Other Investments of Commercial

Banks 263

XX Cash Holdings and Reserve of a Commercial Bank 270

XXI The Clearing House 289

XXII Defects of the National Banking System . . . 301

XXIII Organization of Federal Reserve System . . . 309

XXIV Rediscounting by Federal Reserve Banks . . . ^33




Chapter Page

XXV Other Operations of Federal Reserve Banks . 344

XXVI Acceptances 357

XXVII Principles of Foreign Exchange 370

XXVIII The Process of Foreign Exchange 385

XXIX Typical Foreign Exchange Transactions . . • 395

XXX The New York Money Market 409

XXXI Monetary Problems 427

Appendix A — Problems with Solutions 453

B — Problems without Solutions 477

C — Interest Tables 483

D— Value of Foreign Coins 493

E — Bibliography 496


Form Page

i. Bill of Exchange Drawn at 60 Days 35

2. Trade Acceptance 39

3. Bank Acceptance 39

4. Bank Check 41

5. Promissory Note 47

6. Travelers' Check 52

7. Certificate of Deposit 54

8. Railroad Bill of Lading 61

9. Shipper's Invoice 62

10. Shipper's Draft 63

1 1 . Warehouse Receipt 64

12. Trust Receipt 68

13. Import Letter of Credit (Dollars) 7 2

14. Travelers' Sterling Letter of Credit 7 6 . 77

15. Collateral Loan Agreement 189

16. Borrower's Statement 213,214

17. Map of Federal Reserve Districts 3 IQ

18. Chart of Reserve Percentages of Federal Reserve Banks 351

19. Diagram Illustrating the Financing of a Shipment of Goods by

Means of Bankers' Acceptances .' 360


Banking and Credit


i. Close Relationship of Money and Credit. — In the highly
complicated mechanism of economic processes which society has
created for the carrying on of business, no parts have aroused
more interest and inquiry than money and credit. They are
closely allied with each other in their uses and are generally
treated together under the heading of "exchange" by authors of
systematic textbooks on the principles of economics. Notwith-
standing this intimate relationship, they are fundamentally
different in their origins and in many of their characteristics. It
is therefore necessary to note briefly the essential nature of each
before entering upon the explanation of the monetary system of
the United States and the credit agencies and instruments which
are in current use.

2. Meaning of " Money. " — Money, by time-honored de-
scription, is a medium of exchange, a measure of value, a standard
of deferred payments, and a store of value. These functions are
so diverse that it is difficult to give a definition of money which
will cover all its characteristics. Some authorities place the
emphasis on the service which money renders as a standard of
value; others on its use as a medium of exchange. As a result
some limit the use of the term "money" to the instruments of
exchange which have intrinsic or commodity value, thus exclud-


ing all forms of paper money; others include under the term all
instruments which effect exchange.

The exchange of values is effected by a variety of instruments.
Included in the list are gold bullion, coins minted by the govern-
ment, promissory notes issued by the government, bank notes,
checks of individuals and corporations, drafts, bills of exchange,
acceptances, travelers' checks, certificates of deposit, postal
money-orders, bills receivable, and promissory notes of individ-
uals and corporations. For the ordinary transactions of retail
trade and wage payments, small coins and paper money issued
by the government or by banks are in familiar use, and to an
increasing extent individual checks are employed in these settle-
ments of indebtedness. In transactions involving larger sums
checks are commonly used; and for payments at a distance, bills
of exchange and drafts occupy a prominent place.

Not all of these instruments, however, are serviceable as a
standard of value, although they are highly convenient as a
medium of exchange. Gold, because of the worldwide estimation
in which it is held, most completely satisfies the requirements of a
standard of value, and to a certain degree it is a medium of ex-
change. Other instruments, however, may perform much of the
exchange work of the community better than gold. A check is an
excellent medium of exchange, but is worthless as a standard of
deferred payments.

3. Various Definitions of Money. — The conflict of opinion in
regard to the definition of money is well summed up by Conant
in the opening pages of his treatise on "The Principles of Money
and Banking." After limiting the definition of money to that
"commodity of intrinsic value acceptable in exchanges which
has become by law or custom the usual tender for debt," he

Put into more popular language, this means that the term
money, -under existing social conditions, is applicable to gold or


silver coin, and should not be extended to the various forms of
paper which economize the use of money. For most practical
purposes, gold bullion held in bank reserves is properly classed as
money, and falls within the definition given, . . . The use of
the word money is extended by many authorities to different
forms of credit obligations — by some to redeemable government
paper or redeemable bank-notes; by others to irredeemable paper
of either type; and by still others to the checks, deposit entries,
and various written instruments which are employed in carrying
on exchanges. The difficulty about these extensions of the defini-
tion beyond coined metal of intrinsic value is that there is no
logical point at which the things included in the definition of
money terminate. If the definition is extended to instruments of
paper credit, it is not clear why it should stop with legal tender
instruments and fail to include bank-notes which are not legal
tender. If it is extended to the latter, it is not clear why it should
not extend also to foreign bills of exchange, which are kept by
many of the European banks as a part of their coin reserves,
ready to be sold for coin whenever they have need for it. '

Although there is a wide difference between a gold coin and a
check representing an order upon a bank to pay a certain sum, it
is not necessary in a preliminary description of the various in-
struments of exchange which serve the needs of business society,
to make a definitive and final choice of the media which are to be
included under the term "money." Such a definition is impor-
tant in the analysis of certain applications of monetary theory,
as the quantity theory of money and the relation of money to
prices, but further discussion on this point is deferred to a subse-
quent chapter.

4. The Nature of Credit. — The nature of credit can best be
approached by considering some of the operations involved in the
production of wealth. Among the agents which co-operate in

1 Vol. 1, pp. 4-5. For further definitions of money, see W. A. Scott, Money and Bank-
ing, p. 1 ; F. M. Taylor, Some Chapters on Money, pp. 11-12; F. A. Walker, Money, Trade
and Industry, p. 4; D. Kinley, Money, pp. 70-71; E. W. Kemmerer. Money and Prices, pp.
27-28; J. F. Johnson, Money ana Currency, pp. 6-7.


production is capital. It may exist in the form of tools, machin-
ery, workshops, factories, railway equipment, shipping, as well
as of cash or money. For nearly all forms of industry the work of
producing an individual commodity stretches over a considerable
period of time. When the article is finished there is often a
further addition of time before the commodity is purchased, and
even then there may be a delay in the payment. The producer,
therefore, must have the use of wealth not only to provide the
initial equipment, to purchase raw material, to hire laborers who
must be paid long before there are any returns, and to pay insur-
ance and taxes which are imposed though the goods are not yet
sold, but also to bridge over the delays before payment is received
for the goods sold. The producer needs present purchasing
power; he may have saved the capital which he uses, or he may
borrow it. If he borrows it he employs the service of credit and
the essential characteristic of this is the possession of present pur-
chasing power in return for a promise to pay in the future. If the
producer borrows in order to establish the initial enterprise he
will probably borrow for a long period of time, obtaining capital
from those who do not wish to employ it under their own super-
vision. The evidence of such borrowing will appear as long-time
notes, bonds, and similar instruments. But even if borrowing is
not necessary for the establishment of the initial undertaking, it
is likely to occur before a final settlement is made in the sale of

Economic organization is highly complex and there are many
interruptions in the marketing of goods. Moreover, if there be
an increasing demand for the goods in the production of which
this producer is engaged, the use of more capital is required.
Every effort is therefore made to obtain control of capital by the
use of credit. Finished goods, even before they are sold, may be
pledged to secure capital; and if the goods are sold but not paid
for, the accounts may be pledged. If the producer has a previous
record of success which inspires confidence, capital may be


borrowed without the pledge of any specific property. To pro-
vide these credits, a specialized economic mechanism has been
devised, consisting of banking institutions and credit instruments.
Thus by means of credit, capital as one of the agents of production
is placed where it can be made more effective, and undoubtedly
the development of these facilities is one of the most powerful
influences in the creation of wealth on the scale which the world
now enjoys.

5. Credit as an Exchange Factor. — Inasmuch as credit pre-
sumes the payment of money — and payment within a short time
if the credit be of early maturity — credit instruments are often as
convenient for the purposes of exchange as the money commodity
itself. Communities in their economic development have con-
stantly struggled to improve their methods of exchanging wealth;
from primitive barter they passed to the use of monetary media
which became standards of value. But with the growth of com-
merce and trade they have utilized a great variety of credit in-
struments which have become serviceable for exchange purposes.
The credit tools devised to make capital more productive have
also been found available for carrying on the work of exchange.

Some forms of credit, as the promissory notes of the govern-
ment and of banks, may prove so acceptable that they readily
circulate and become a part of the money stock. Their credit
significance, however, must always be kept in mind, for they do
not, simply through their creation, add to the wealth of the
nation. The addition of $100,000,000 in gold increases the
national wealth; the addition of an equal sum of promissory notes
does not at the moment increase the total wealth. It may set in
motion forces which will ultimately create wealth, for, as Mill
states it, "although the production funds of the country are not
increased by credit, they are called into a more complete state of
productive activity.


2 J. S. Mill. Principles of Political Economy, Book III, Ch. XI.


The great increase in the production of wealth witnessed
during the past century is due not only to the discovery of new
mechanical processes and applications of natural and physical
science, but in large measure also to the extension of credit facili-
ties. So remarkable has been this extension of credit and so ser-
viceable has been its uses in effecting the transfer of values, that
some have been led into the error that commodity money could
be abandoned and that all exchange operations might be satis-
factorily performed through credit substitutes.

Authors of textbooks on economics usually treat the subject
under four main headings: production of wealth, exchange of
wealth, distribution of wealth, and consumption of wealth. As
credit has become so large a factor in the operations of exchange,
it is generally discussed under the second of the above headings.
Exchange, therefore, includes not only the characteristics and
functions of money, but also the use, development, and influence
of credit instruments, the character of banking institutions which
enlarge the use of credit, and the relation of the quantity of
money, including credit substitutes, to prices and the money
market. It must, however, be ever kept in mind that credit
primarily has to do with the transfer of wealth in the form of
capital as a productive agent. Because of its serviceability as a
tool of exchange, however, it is allied to money, and the discussion
of the one involves the discussion of the other.

6. Credit in Relation to Prices.— One further point should be
raised before entering upon the following descriptive chapters.
The use of credit makes available a mass of values as a medium
of exchange. Does the addition of these credit media affect the
value of the commodity money medium, and thus affect prices?
Do credit tools, which undoubtedly aid money, under its narrow-
est definition, in the work of exchange, modify the value of
money? If so, the development of credit assumes a new impor-
tance and its use becomes a price-making factor. This is a ques-


tion which has aroused much dispute, but its discussion is for the
present deferred. It is raised at this point in order that the reader
may recognize that credit may be more than an agency in render-
ing capital productive, or simply a part of the machinery whereby
values are exchanged.


Practically all treatises and textbooks on general economics
devote paragraphs to the nature and functions of money and
credit. Specific references are not needed, as these texts are


Conant, C. A. Principles oi Money and Banking. Vol. I, pp. 17-31.
Holdsworth, J. T. Money and Banking, pp. 12-16.
Jevons, W. H. Money and the Mechanism of Exchange.

On the functions of money, pp. 14-18.
Johnson, J. F. Money and Currency, pp. 11-17.
Kinley, D. Money, pp. 59-70.
Laughlin, J. L. Principles of Money.

On the functions of money, pp. 1-22.
Scott, W. A. Money and Banking, pp. 2-13.
Taylor, F. M. Some Chapters on Money, pp. 11-33.
Walker, F. A. Money.

On the primitive functions of money and contains generous quota-
tions from other writers, pp. 1-123.


Johnson, J. F. Money and Currency, pp. 34-41.

Laughlin, J. L. Principles of Money, pp. 71-114.

Moulton, H. G. Financial Organization of Society, pp. 121-131.

Principles of Money and Banking, pp. 5-12.

Phillips, C. A. Readings in Money and Banking, pp. 1-9.
Westerfield, R. B. Banking Principles and Practice. Vol. I, pp. 35-47.



i. Legal Tender and Lawful Money. — Preliminary to the
description of the different kinds of money, one special attribute
of money — its use as legal tender or as lawful money — requires
explanation. As will be presently noted, the United States has
a composite body of monetary instruments. When our coinage
system was established in 1792, silver as a monetary standard
held an important position throughout the world. Congress
authorized the use of both gold and silver as standard money.
There were at the time few banks and their note issues were not
large in comparison with metallic money. Within a few years
banks began to multiply and their issues were large. These notes
however had no special legal attributes; they were simply the
promissory notes of the institutions creating them and their
acceptance depended only on public confidence.

Again, as the result of urgent financial need of the government,
Congress at various times authorized the issue of promissory
notes by the government, and during the Civil War, in order to
strengthen this financial prop, made the notes legal tender.
State bank notes were driven out of circulation by taxation and
national bank notes took their place. The inconvenience of
using gold and silver as media led to the use of substitutes in the
form of certificate money. And more recently, in the attempt to
reform our banking system, the Federal Reserve Act provided
for a new form of note designed ultimately to eliminate the
national bank note.

Thus from time to time new forms of money have been added.
But as the government is slow in every department of political
activity to discard old forms, so in the money system it has re-



tained varieties of money which have no immediate significance
and which would probably find no place if a new monetary system
should be established in accordance with present economic needs.
Silver, for example, has been discarded as a standard by nearly all
nations; but although the United States no longer provides for
free coinage of silver dollars, it retains a certain portion inherited
from the period when silver was recognized as a standard money.
So, too, the federal government issued a large amount of promis-
sory notes during the Civil War. It redeemed a portion of these
obligations but left the liquidation incomplete. There is there-
fore still in circulation a considerable volume of United States
notes, although the government is abundantly able to meet this
indebtedness. The plan to abolish the national bank note circu-
lation by the substitution of federal reserve notes has been in-
terrupted by the recent war. As a result of this past experience
we possess a heterogeneous mass of monetary instruments.

Not all of them are legal tender or lawful money; that is,
creditors cannot be forced by law to accept them in payment of
indebtedness. The statutes define which kinds of money are
legal tender and, in the absence of special contracts, these forms
must be accepted, if tendered, whenever the amount of the pay-
ment is expressed in dollars.

2. Various Forms of American Paper Money. — This point
may be illustrated by reference to the statements made on the
various forms of paper money in circulation at the present time:

United States note, popularly known as " greenback " :

This note is a legal tender at its face value for all debts public
and private, except duties on imports and interest on the public

Gold certificate:

This certifies that there have been deposited in the Treasury
of the United States of America dollars in gold coin pay-


able to the bearer on demand. [More specifically the federal
statutes declare that] Such certificates shall be receivable for
customs, taxes, and all public dues, and when so received may be
reissued, and when held by any banking association may be
counted as a part of its lawful reserve. (Act of March 14, 1900.
sec. 6.)

By later legislation (December 24, 1919) these notes have
been given full legal tender power.

Silver certificate :

This certifies that there have been deposited in the Treasury

of the United States , silver dollars payable to the bearer

on demand. This certificate is receivable for customs, taxes, and
all public dues, and when so received may be reissued.

National bank note:

This note is receivable at par in all parts of the United States
in payment of all taxes and excises and all other dues to the
United States except duties on imports and also for all salaries
and other debts and demands owing by the United States to
individuals, corporations and associations within the United
States except interest on the public debt.

Federal reserve note:

This note is receivable by all national and member banks and
federal reserve banks and for all taxes, customs and other public
dues. It is redeemable in gold on demand at the Treasury De-
partment of the United States in the City of Washington, District
of Columbia, or in gold or lawful money at any federal reserve

Federal reserve bank note:

This note is receivable at par in all parts of the United States
in payment of all taxes and excises and all other dues to the
United States except duties on imports and also for all salaries
and other debts and demands owing by the United States to in-
dividuals, corporations and associations within the United States
except interest on public debt.


Some kinds of money are full legal tender in the satisfaction
of all kinds of debt, both public and private; some are receivable
for one purpose and not for another. Others have no legal tender
attribute but because of their general acceptability perform most
of the functions characteristic of money instruments. Gold coins
and gold certificates of whatever denomination are legal tender;
so are silver dollars. Subsidiary silver coins and minor coins are
legal tender for limited amounts. United States notes are legal
tender, though they may be excluded from certain governmental
payments; and silver certificates are acceptable for some public
debts but not for private debts. National bank notes and federal
reserve bank notes are not legal tender but are receivable for all
public dues except duties on imports, while federal reserve notes,
though not legal tender, are receivable for all public dues without

Online LibraryDavis Rich DeweyBanking and credit; a textbook for colleges and schools of business administration → online text (page 1 of 40)