EMERGING ROLE

OF COMMERCIAL BANKS AS AGENCIES
OF BUSINESS FINANCE



WHAT DO TWENTIETH CENTURY developments in the relations
between business enterprises and commercial banks, as reviewed in
the preceding chapters, imply for the functioning of commercial
banks as business financing agencies? Do the developments reflect
the operation of underlying forces tending to weaken the demand
for the business financing services of banks? How may the future
economic environment of business and banking shape business credit
demands and the ability of banks to satisfy those demands? As a
first step in answering these questions, the major developments in
the relations between business enterprises and commercial banks
may be summarized as follows:

1. Throughout the twentieth century, small and medium-sized
businesses have been the major users of bank loan credit.

2. Up to 1920 business debt owed to banks increased as a frac-
tion of the total funds used by business, but thereafter it fell in
relative importance until 1935.

3. Between 1920 and 1935, and especially after 1929, the impor-
tance of current assets among total business assets decreased, thus
weakening the demand for short-term loans.

4. The ratio of bank earnings on loans to business and holdings
of corporate securities to total bank earnings remained relatively
stable until 1929, after which it declined.

5. Bank holdings of corporate securities increased during the
twenties and bank loans to business remained about constant, two
changes that combined to produce a moderate lengthening of the
average maturity of bank credit to business; during the thirties the
growth of term lending produced a further lengthening of average
maturity.

6. In the thirties business obtained its medium- and long-term

203



204 BUSINESS FINANCE AND BANKING

credit from banks and other financial institutions increasingly on a
direct negotiation basis, thereby decreasing its use of investment
banking and securities markets facilities and bringing these agen-
cies and commercial banks into closer competition.

7. After 1930 the importance of commercial banks as suppliers of
credit to business declined relative to that of life insurance com-
panies, commercial finance companies, and government business
loan agencies.

8. Commercial banks made certain significant adaptations in their
business lending policies and practices after 1933. The most impor-
tant were the extension of longer-term credits and of specially
secured short- and medium-term loans to small and medium-sized
concerns presenting higher-than-average risks.

9. During the thirties government began to play an increasingly
important role in the business credit market through direct lending
and through cooperative programs designed to accomplish the joint
assumption, with private agencies, of credit risks. These develop-
ments were markedly accelerated during World War II.

10. Throughout the period studied bank credit of different kinds
was highly substitu table j consequently, much credit not advanced
directly to business enterprises flowed into the productive system
in such a way as ultimately to affect the credit demands of business.
Thus, during the twenties loans on securities provided, in part,
funds to finance the operations of business concerns; the unprece-
dented growth of consumer instalment sales credit following World
War I resulted in a partial replacement of accounts receivable by
cash on the books of manufacturing and trading concerns j and vast
sums borrowed by the federal government from commercial banks
during World War II were used to provide plant facilities and
working capital for businesses directly for war production, and in-
directly for civilian production.

POSTWAR CREDIT DEMANDS

The amount of credit demanded by business from commercial banks
and other financing agencies is at all times the resultant of a number
of forces, not easily enumerated and even less easily weighed.
Nevertheless, it is possible to point to the principal factors which
determine aggregate credit demand, particularly if the distinction
is made between those factors to which business credit demands are



EMERGING ROLE OF COMMERCIAL BANKS 205

subject over the short run, and those that act upon business credit
demands over the long run.

Short-Run Factors Affecting Business Credit Demands

No attempt is made here to present a quantitative estimate of the
volume of commercial bank loans to business during the postwar
transition. Any such estimate requires assumptions regarding busi-
ness liquidity, the trend of prices, the amount of operating losses
that businesses may sustain during this period, federal tax policies,
and numerous other factors. Several equally plausible assumptions
can be made about each factor, with enormous differences in the re-
sulting estimate of commercial loan demand. However, it is possible
to identify certain factors that can influence the business credit mar-
ket in the transition period, and to classify these as contractive or
expansive of business demands for credit.

i. Contractive Factors Certain major factors, such as those
indicated below, may operate to contract, or to prevent a material
expansion of, the demands of business enterprises for bank credit
during the postwar transition. 1

(a) Large cash balances and holdings of federal securities.
During the four years 194144 the annual gain in liquid assets of
corporations averaged between $7 billion and $8 billion, and that of
net working capital, between $4 billion and $5 billion.

(b) Government receivables. Under the Contract Settlement Act
of 1944, payments on government receivables have been made
promptly on the termination of war production contracts.

(c) Refunds of excess profits taxes, 2 carry-backs of net operating
losses, 8 and, possibly, tax reductions. Refunds constitute a positive
source of funds } other tax adjustments may release funds that
would otherwise be paid out to government.

(d) The recapture by war contractors of amounts equal to the
unamortized emergency plant facilities not needed for war contract
work, or recomputation of depreciation over a longer time period.

(e) Price deflation. Price reductions associated with declining

1 This analysis draws on the findings of an investigation by Wilson F. Payne,
National Bureau of Economic Research, Financial Research Program.

2 Revenue Act of 1942, Sec. 250. (Net postwar refunds for 1942 amounted to $545
million, and for 1943, to $902 million. See U. S. Treasury Department, Press Releases
4454, December 31, 1944, and V 229, February 25, 1946.) Recoveries under Section
722 of the Act may also figure in claims.

8 Revenue Act of 1939, Sec. 122.



206 BUSINESS FINANCE AND BANKING

business investment substantially reduce business loan demands.
Even if accompanied by high productive activity, lower prices per-
mit a given expansion in fixed and current assets to be financed with
smaller dollar outlays.

2. Expansive Factors Factors such as the following may tend
to expand, or to prevent any contraction of, business demand for
bank credit during the transition period.

(a) Outlays of cash in connection with expenditures for deferred
maintenance, deferred replacement of equipment, the rebuilding of
production and sales organizations, inventory increases, and credit
extensions to customers. Some concerns may find these outlays neg-
ligible while others may find them so substantial as to give rise to
an excess of cash outflow over cash inflow and a consequent reduc-
tion of liquidity. The liquid assets of concerns not affected by this
excess of cash outflow will not generally be available to offset the
cash deficits of other businesses.

(b) Outlays to finance an expansion of the physical volume of
production beyond the prewar level. If a satisfactory level of em-
ployment is achieved during the replenishment process, the physical
volume of production could be from 40 to 50 percent above that
of 1940. Business concerns would then face the need of providing
plant and working capital to sustain such a volume of civilian pro-
duction. Under conditions of business expansion, a considerable
amount of newly constructed plant and equipment would be called
for, especially in such lines as soft goods manufacturing, trade, and
service industries, the enlargement and improvement of whose
facilities were checked during the war.

The growth in the working capital requirements of business may
be crudely gauged by assuming that the current assets of business
would expand proportionately to the increase in the volume of busi-
ness transacted. If the physical volume of production should be 50
percent above that of 1940, the $55 billion of current assets pos-
sessed by all American corporations, excluding banks and insurance
companies, at the end of 1939 would have to be larger by $27.5
billion (in 1940 prices) to provide the additional liquidity, inven-
tories, and receivables that business would demand. The importance
of funds for rebuilding nonwar inventories and customer credits is
very great, but an estimate of the amount of funds needed for these
purposes is difficult to make because of the possibility of changed



EMERGING ROLE OF COMMERCIAL BANKS 207

trade credit terms, new methods of utilizing inventories, and other
factors.

(c) Industrial readjustments caused by the war. The war
hastened technological progress, raised somewhat the rate of obso-
lescence, and in some instances rendered whole productive arrange-
ments out-of-date. In addition, shifts in population and in the
regional distribution of industry may call for substantial new in-
vestment in the utilities, transportation, service, and construction
industries.

(d) Credit to finance a revival of foreign commerce and foreign
investment. Foreign demands may be present for all types of
goods, especially raw materials and industrial equipment. Some part
of these demands may be financed by long-term reconstruction
loans by government agencies, but a margin perhaps substantial
in size may be financed by private lending agencies on short
term and long term.

(e) Outlays made by newly-established enterprises. Bank credit
has probably always played a small part in the financing of strictly
new, as distinguished from established, enterprises, but it may play
a significant part during the transition period as a result of the
government loan guarantees available to veterans under the Serv-
icemen's Readjustment Act of 1944. Many new businesses, which
would otherwise be started by demobilized servicemen with the ex-
clusive aid of relatives and friends, may utilize bank credit as a re-
sult of such guarantees.

(f ) Price inflation. Price inflation increases the value of current
assets necessary for a given expansion in physical output, without
improving the quality of those assets. It raises profit expectations,
invites over-investment and speculation in inventory, and encour-
ages short-term borrowing.

The possibility that the business economy might require addi-
tional accommodation from banks during the postwar transition,
suggested by these considerations, has been borne out by the in-
crease in commercial and industrial loans after mid- 1945.

Long-Run Factors Affecting Business Credit Demands

The record of the twentieth century indicates that in the long run
the amount of bank credit demanded by business is strongly affected
by such broad factors as the following:



208 BUSINESS FINANCE AND BANKING

1. The rate of expansion of the total assets of business enter-
prises. A small increase in business assets can be financed largely by
retained earnings; when asset expansion is substantial, business man-
agements look to outside sources for funds, thus raising the poten-
tial demand for bank credit. Within a limited period of time, the
movement of total business assets is closely associated with changes
in gross national product. Over a longer period, a tendency for
government to expand its relative share in national product means
an absolute change in business assets smaller than would otherwise
have occurred.

2. Self-financing among business concerns. The ability and will-
ingness of a concern to finance the expansion of its assets through the
retention of earnings clearly determines, given a rate of asset ex-
pansion, the concern's demand for external funds. While there is a
widespread impression that business management relies increasingly
on self-financing, there is no convincing evidence that this has been
true for manufacturing and trade concerns. As pointed out pre-
viously, 4 the annual rate of total asset expansion varies considerably
more than the rate of retained earnings, with the result that outside
funds are needed mainly in years in which asset expansion rates are
high or increasing rapidly. For years in which rates of asset expan-
sion have been comparable, there has been no observable tendency
for the proportion of funds provided from outside the business to
diminish. 5

3. The propensity of business management to rely on ownership
rather than on credit funds. This propensity is revealed by the pre-
ponderance of equity funds in all samples of corporate balance
sheets over the entire period studied, and is of great importance for
commercial banks, because for reasons of prudence the law does not
permit them to supply equity funds to business.

4. The propensity of business management of large corporations
to use increasing amounts of long-term credit relative to short-term
credit. This tendency was unquestionably strong after 1920, and
especially after 1933; underlying it was a desire to avoid loss of

4 See Chapter 3, pp. 92-96.

5 If a larger fraction of the increments in business assets were to be financed with re-
tained earnings, this would require (i) that the rate of asset expansion diminish, (2)
that profit rates increase, (3) that smaller fractions of profits be disbursed in cash or
property, or (4) that two or more of these factors operate simultaneously. In fact,
between 1920 and 1940 profit rates showed a downward drift and there was little
secular change in the fraction of net earnings distributed.



EMERGING ROLE OF COMMERCIAL BANKS 209

capital and control through default on short-term loans falling due
in periods of sharp business contraction. The increasing prominence
of fixed assets in the productive process, and the instability of
business conditions, also have been factors emphasizing the use
of long-term credit. Whether the use of such credit has been as
characteristic of small and medium-sized concerns as it has been
of large concerns is open to question, but even where it might have
been preferred among businesses of small size its availability has
heretofore been limited.

If, in the long run, the rate of expansion in the dollar value of
business assets is high, and if prewar business financing practices
persist, there will be a strong demand for bank credit, particularly
medium- and long-term credit in the form of term loans and corpo-
rate debt securities. A considerable proportion of this credit will
continue to carry appreciable risks.

FACTORS LIMITING COMMERCIAL BANK
ADAPTATIONS

Certain features of American commercial banking and of the en-
vironment in which it operates have definitely impeded adapta-
tions to long-run changes in the demands for funds by business con-
cerns, and have restrained banks from taking risks in business
financing. Unless these impediments can be removed or sur-
mounted, further development of bank relationships with busi-
nesses may be handicapped. If banks are to perform a significant
business financing function, their operations must be geared to the
credit demands of the market, which the evidence of this study
indicates have been increasingly for loans of medium and long term
and for loans to small and medium-sized businesses often entailing
high costs of loan administration and higher-than-average risk
exposure.

Some of the limiting factors which will now be considered are
related to the nature of the commercial banking system, and others
to the scheme of public regulation that has grown up around it.

Business Fluctuations

Because of its long exposure to the hazards of general economic in-
stability, bank lending is conducted on the assumption that a degree



210 BUSINESS FINANCE AND BANKING

of instability will continue to characterize the economy. The dispo-
sition to assume ordinary risks of shifts in industrial demand and
cost conditions would be greater if the risks of sharp cyclical fluc-
tuations in the economy as a whole were reduced. The importance
of this factor is clearly heightened by a tendency for the credit needs
of business to involve loans of medium and long term to maturity.

Low Ratio of Capital to Total Liabilities

The fact that the commercial bank operates with a far smaller
cushion of equity than do other types of business financing institu-
tions accounts in part for the greater selectivity of risks by banks,
and tends to limit banking operations to the more conventional lines.
The ratio of capital to total liabilities for national banks fell from
34 percent in 1 865, to 20 percent in 1900, 9 percent in 1940, and 6
percent in 1944. The six principal commercial finance companies, in
contrast, at the end of 1941 had ratios varying from 15 percent to
22 percent, and these ratios tended to rise during the war years.

Short-Term Nature and Instability of
Deposit Liabilities

The deposit liabilities of banks are short term and of unstable char-
acter, and they are to a considerable degree beyond the control of
bank management. Banks, owing large sums to the public payable
on demand or short notice, seek to acquire a set of assets that will
enable them to meet their liabilities under all foreseeable condi-
tions. The asset structure of commercial and industrial enterprises,
in contrast, is broadly determined by their production technology;
the major financial problem of these concerns is that of choosing an
appropriate structure of liabilities.

At mid- 1 945 commercial banks had by far the largest volume of
deposits in history. Barring a rapid reduction in outstanding federal
debt, the total amount of deposits held by the banking system will
probably not diminish. It might even increase as a result of a return
to the banks of currency in circulation and bank purchases of federal
securities from the public. Yet the amount and composition of de-
posits of many individual banks are likely to be highly unstable,
because of population movements, basic regional shifts in the loca-
tion of industry, and transfers of deposits between consumers and



EMERGING ROLE OF COMMERCIAL BANKS 211

business enterprises. Under these conditions banks will continue to
give attention to the maturities of their assets. Concern over the ex-
tended maturity of term loans certainly has been a factor limiting
the willingness of commercial banks to undertake this type of lend-
ing.

It may be argued that commercial banks, in acquiring loans or
investments, need not be concerned about the composition and
stability of their deposit liabilities, because they can always have re-
course to the Federal Reserve banks for funds in the event that
deposits are withdrawn in unexpectedly large amounts. Term loans
to business enterprises may, for example, be used by commercial
banks as a basis for borrowing from a Federal Reserve bank. But
American commercial banks are generally averse to borrowing at a
central bank, because of cost, concern over their credit position, and
tradition. For these reasons the accumulation of earning assets by
banks has been, and will continue to be, influenced by the maturity
and other features of their deposit liabilities.

Risk Quality of Bank Assets Other Than Business Loans

Ordinarily a bank is able to accept more risk and longer maturities
on its business loans, the higher the quality and the shorter the ma-
turities of its other loans. It is clear that for many years following
World War II loans to government will be the principal earning
asset of American banks. The preponderance of federal securities in
bank portfolios raises the question of the extent to which banks are
exposed to risk in carrying these assets. The Board of Governors of
the Federal Reserve System implied that government securities
may be regarded as "riskless" assets by bank managements, when it
pointed out that the large growth in bank liabilities since 1941 was
accompanied by a growth in assets involving "no risk of loss." 8 If
commercial bank holdings of government securities continue to be
free from risk, they must be immediately salable in unlimited
quantities without loss. If the official policy of the federal fiscal and
monetary agencies should be to give long-term unqualified sup-
port to the price of government securities, important implications
for business lending operations would follow. Bankers would then
consider themselves able to extend loans of longer maturities and to

6 Thirtieth Annual Report of the Board of Governors of the Federal Reserve System,
i943> P- 30-



212 BUSINESS FINANCE AND BANKING

take greater business loan risks than would be true if they should
face the possibility of market depreciation of their large holdings of
government securities. Conversely, a definite withdrawal of support
would, among other consequences, lead to a more cautious attitude
toward business lending.

Regulation of Bank Investments

Both law and administrative regulation have restricted bank financ-
ing of business through the purchase of debt securities. The National
Bank Act of 1 863 was silent on the subject of bank investment, with
two exceptions: it required that a national bank purchase govern-
ment bonds as collateral for its circulating notes j and it limited the
liabilities of a single obligor for money borrowed to a stated percent
of the paid-in capital of the bank. Later, under an interpretation of
the National Bank Act by the Comptroller of the Currency, national
banks were permitted to purchase corporate and other bonds, and
in 1927 they were given specific statutory authorization to make
such investments. As a result of the Banking Acts of 1933 and 1935
banks were required to abstain from underwriting security issues
through affiliated companies, from wholesaling securities, and from
holding the obligations of any one obligor in amounts exceeding 10
percent of their capital and surplus account.

Equally effective in limiting bank participation in business financ-
ing through the purchase of debt securities were the regulations of
the Comptroller of the Currency in regard to the valuation of in-
vestments by bank examiners. Up to 1936 for national banks, and to
1938 for state banks, security holdings were valued by examiners
at market prices, and deficiencies of market price under cost were
viewed as "estimated losses," which were required to be Written off
the books of the bank. In 1938 a joint agreement of federal and
state bank supervisory agencies modified this practice by providing
that "investment grade" securities be valued at cost, and other secu-
rities not in default be valued at average market prices during the
preceding eighteen months. "Investment grade" securities are de-
fined by three classifications: those placed in the four highest groups
by recognized rating services} bonds rated below these four groups
but viewed by the examiner as of investment quality j and unrated
securities of equivalent grade. Unrated bonds on which inadequate
bank credit information prevents determination of quality are not,



EMERGING ROLE OF COMMERCIAL BANKS 213

in general, adjudged of investment grade a procedure that
places a premium on bank investment in better-known and well-
rated securities of large concerns. While banks are not prohibited
from buying the unrated securities of small or less well-known
businesses, they are required to maintain credit files containing
adequate information for the appraisal of such bonds as to invest-
ment quality. The maintenance of such files necessarily involves
considerable cost and inconvenience.

Examination of Bank Loan Portfolios

Public supervisory authorities and bank officers agree that examina-
tion of bank loan portfolios has affected the readiness of commer-
cial banks to make innovations in their business lending policies,
particularly as regards term lending, or to engage in special types of
business lending involving higher-than-average risks.

Traditionally, the practice of bank examiners was to place, or
"classify," loans subject to criticism in "slow," "doubtful," or
"estimated loss" classes. Up to 1934 it was not unusual for a bank
examiner to classify all loans maturing in more than one year as
"slow." At a joint examiners' conference called by the Secretary of
the Treasury in that year it was agreed that the term "slow" would
not be. applied to loans which were reasonably certain of ultimate
repayment "by reason of the sound net worth of the maker and/or
endorser, even though their assets or a large part thereof may not
be of a liquid nature under present conditions . . . " 7 It was further
agreed that collateral loans would not be classified as "slow" as
long as the collateral had "sound intrinsic value" even though it
was not salable at the time. In 1938 a further step was taken to re-
move any unfavorable stigma from intermediate- and long-term
loans. The bank supervisory agencies agreed to place all uncriticized
loans in Class I, and to classify all criticized loans in classes desig-
nated II, III, and IV, dropping altogether the categories "slow,"
"doubtful," and "loss," the first category being dropped because of
its "improper emphasis on maturity." 8 The new procedure placed
major emphasis on the earning capacity of the borrower and en-
dorser, and less emphasis upon the immediate value of the borrow-
er's liquid assets or collateral. Despite these changes, it was stated as

T Annual Report of tit* Federal Deposit Insurance Corporation, 1938, p. 62.
1 Ibid., p. 63.



214 BUSINESS FINANCE AND BANKING

late as April 1941 that confusion still existed as to the new examina-
tion procedure and that some examiners "still criticize capital loans
and, to a lesser degree, real estate and other long-term loans." 9

Usury Laws

Last of the significant factors that have limited the functional flexi-
bility of commercial banks is the fact that maximum interest rates
exist with respect to lending activity. These limitations are imposed
by the usury laws, and they also grow out of the reluctance of banks
to lend money even where law would permit at rates in excess
of "standard" or "conventional" bank rates. While some banks
charge service fees or employ other measures to raise the gross in-
come return, especially on small loans and on those which, due to
higher-than-average risk exposure, involve special costs of adminis-
tration, other banks, uncertain of their legal position, have held
back from accepting loans in which the circumstances called for
higher gross charges than were consistent with legal maximum rate
regulation.

A maximum charge, whether fixed by law or convention, clearly
acts as a restraint on lending under conditions of relatively high
risk or high cost of loan administration. Such maxima unquestion-
ably have retarded the readiness of banks to undertake certain of the
newer forms of collateralized business lending or to make small
term loans.

ADJUSTMENTS IN BANK LENDING
POLICIES AND PRACTICES

Commercial banks have made several adjustments to the changing
structure of the business credit market and to the changing needs of
businesses for credit. One adjustment has been "constructive lend-
ing" that is, extending the application of credit survey techniques
to small and medium-sized business concerns, actively seeking out
promising managements, and taking a positive attitude toward the
formulation of financing programs designed to meet specialized
needs. Other adjustments involve the more extensive use of corre-

9 The Answers of the American Bankers Association, in Reply to a Questionnaire
of the United States Senate Committee on Banking and Currency (New York, April
1941) p. 42.



EMERGING ROLE OF COMMERCIAL BANKS 215

spondent relationships in assuming business credit risks, and cooper-
ative action with public lending and loan-guaranteeing agencies.

Constructive Lending

The increasing complexity of business operations poses serious prob-
lems for the small and medium-sized concerns that comprise the
bulk of the market for bank business credit. In such businesses the
principals are often specialists in but one field of management, such
as engineering, marketing, or production, and they may not be well
qualified to formulate policies and supervise practices in other fields.
The small size of such concerns makes it difficult for them to possess
all types of managerial talent, and therefore the services they re-
quire of financial institutions include business counsel as well as
credit.

The association of management counsel with credit advances was
particularly noteworthy in the operations of commercial finance
companies during the thirties. Some finance companies had separate
counseling organizations, and for the services of these organizations
they charged fees in addition to loan charges. The ability to render
counseling service, especially to small concerns with inadequate
managerial staffs and relatively weak financial standing, made it
possible to make loans that were not otherwise feasible and to pro-
tect the interest of the financial agency in such loans. Among com-
mercial banks it has long been customary to give informal counsel to
business customers, and recently some banks have organized depart-
ments for this purpose.

Part of the task of meeting more adequately the financial needs
of small and medium-sized concerns is the formulation and intro-
duction of lending programs specially designed to meet these busi-
ness needs without sacrifice of reasonable margins of safety, and the
administration of such programs within manageable ranges of oper-
ating costs. Surveys of business credit demand are often undertaken
in connection with these programs, since their success may hinge on
the acquisition of a volume of lending of a given type sufficient to
support the administrative outlays associated with specialized fi-
nancing procedures. Such analyses of the market for bank credit, to
determine the amount and character of the financing services de-
manded by business, and constant alertness to the needs of individ-



216 BUSINESS FINANCE AND BANKING

ual customers will continue to be essentials of constructive lending
operations.

Correspondent Relationships

Correspondent relationships, which have always facilitated coopera-
tive action among banks, have recently been adapted to serve more
effectively the business financing activities of commercial banks.
The adaptations have taken several forms, one of which is the
wider use of participatory arrangements to provide financing facili-
ties for large enterprises in industry and trade. Arrangements of
this type may be carried on within a given network of correspond-
ent relationships, or they may involve the joint participation of
several correspondent systems. It is customary in such participations
for the lead to be taken by the larger institutions.

Of special interest to this study are participations in which the
loan originates in a small institution and, because of its size, com-
plexity, or other factors, is turned over in part to a neighboring in-
stitution or to one in a larger money market. In certain cases the
cooperating bank may, by virtue of its experience and specialized
personnel, play an important part in formulating the loan agree-
ment. Participatory arrangements of this type make it possible for
a unit banking system to operate, where such operation is essential,
with the conveniences and capacities of a regional or national
financing system.

A second important adaptation of correspondent banking rela-
tionships relates to the provision of financing facilities for small and
medium-sized concerns requiring specialized types of credit because
of the relatively high risks involved. In such instances correspond-
ent relationships are useful in making available to associated banks,
especially those of small size, the skills and techniques developed
in the specialized departments of other banks, and in sharing with
correspondent institutions the experience of specialized lending
operations. While these participations often consist primarily of
sharing information on procedures, practices, and experience, they
are sometimes extended to the cooperative assumption of risks on
loans which, for various reasons, an individual bank wishes to share
with other lenders.

A third general line along which correspondent banking rela-



EMERGING ROLE OF COMMERCIAL BANKS 217

tionships are being developed is that in which a given bank makes
arrangements with a manufacturer of consumer durable goods, or of
commercial and industrial equipment, for the financing of sales,
usually on instalment terms, within a given region through a system
of specially selected associated banks. This is again a means of giv-
ing to a system of independent banks the advantages of a regional
or national organization.

Finally, special mention should be made of the regional credit
pools organized under the sponsorship of the Small Business Credit
Commission of the American Bankers Association. The plan in-
volves the establishment of a pool of credit to which banks in a
region can subscribe. The pool will take all or part of any loan which
a local bank considers itself unable to make, either because of the
size of the loan or because some feature, such as the term to matu-
rity, involves risks that the individual institution prefers not to
assume alone. By early 1946 forty-eight regional bank credit
groups had been formed with about $670 million pledged to aid in
financing medium and small businesses.

Government Business Lending and Loan
Guaranteeing Agencies

The development described above as "constructive lending" in-
volves independent action by individual banks in adapting their
lending policies and practices to changing credit demand conditions.
In contrast, the development of new ways in which correspondent
bank relations can be made to serve more effectively in the conduct
of business and consumer financing requires the joint or collective
action, within the framework of independent banking, of a group
of banks. Adjustments have also taken place at a third level, in-
volving the cooperative action of public and private agencies.

It has been pointed out previously 10 that, where existing banking
facilities are unable to meet particular credit demands, a public
agency may function as a direct lender, carrying the full amount of
the loan involved. Public agencies also participate in loans of com-
mercial banks, or make commitments to take up all or part of a
loan made by an individual institution, if the latter institution de-
cides at some point that it wishes to dispose of the loan. Public agen-

10 Chapter 4, pp. i a i ff., and Chapter 7, pp. 187 ff.



218 BUSINESS FINANCE AND BANKING

cies guarantee loans made by banks. Finally, public agencies help to
introduce new lending methods and facilitate the wider application
of techniques of lending specially designed for small and medium-
sized enterprises presenting relatively high risks.

Prior to World War II these several devices were used by the
Reconstruction Finance Corporation, the Federal Reserve banks,
and the Export-Import Bank of Washington; during the war they
were extended to the Smaller War Plants Corporation and, in the
case of the loan guarantee, to all the government procurement
agencies. Under the Servicemen's Readjustment Act of 1944 gov-
ernment loan guarantees of potentially vast funds are available,
while the International Bank for Reconstruction and Development
extends the principle of government guarantee to foreign invest-
ment. On August 24, 1944 Chairman Eccles of the Board of Gov-
ernors of the Federal Reserve System proposed legislation to ex-
tend the V loan principle to postwar business loans of all kinds; this
would be accomplished by authorizing a member bank to apply to
the Federal Reserve bank of its district for a guarantee up to 90
percent of the amount of any loan made to a business concern for
any purpose.

The development of government lending and loan-guaranteeing
operations is readily explained by the economic instability and un-
certainty that characterized the period of the thirties, and by the
special credit problems involved in business financing during World
War II. While these techniques undoubtedly aided banks to adjust
themselves to new conditions in the business credit market, they
raise questions concerning the future position of banking. This is
particularly true of the use of loan guarantees. Clearly, if loan
guarantees are developed to the point where government carries
the risk of virtually all business credit, then the commercial bank is
left only with the clerical task of loan administration. Business
would depend for the conduct of its operations upon the availability
of what would, to all intents and purposes, be public credit. Unlike
the other adaptations considered above, public loan guarantees in
the long run entail a constriction of the independent business financ-
ing function of the banks. 11

11 The problems inherent in this development have been stated in the Annual Report
of the Federal Deposit Insurance Corporation^ 1943, p. 1 3 : "Assumption by the Govern-
ment of the risks inherent in credit extension by privately owned financial institutions



EMERGING ROLE OF COMMERCIAL BANKS 219

FUTURE RELATIONSHIPS BETWEEN BUSINESS
ENTERPRISES AND COMMERCIAL BANKS

The primary purpose of this study has been to trace and explain
the development since 1900 of the relationships that exist between
commercial banks and business enterprises. The study was origi-
nally suggested by a basic question confronting the commercial bank-
ing system: Are the business financing functions of commercial
banks undergoing gradual decline?

The evidence clearly shows that while the manner in which com-
mercial banks perform business financing functions has changed
considerably in the last 25 years, and while the bank credit used by
business during the thirties was far less, absolutely and relatively,
than the credit used during the twenties and earlier, there is no
reason to believe that in the calculable future the business financ-
ing functions of banks will be of less importance than at present. On
the contrary, the evidence shows that the adaptations made by banks
in their business financing practices enabled them, during the revival
years of the thirties, to play a more important role in the business
credit market than they did during the early thirties. Whatever may
have happened in the second half of the thirties in the proportion of
business loan assets to other assets of banks, it is clear that there was
a revival in the absolute amount of bank credit used by business.

That revival can be attributed in part to changed conditions in
the total demand for funds by business enterprise, traceable ulti-
mately to a higher rate of business asset expansion. But it was
brought about also by adaptations which commercial banks began
to make in their business lending policies and practices. A willing-
ness to risk funds on long term reestablished their position in the fi-
nancing of large concerns. The development of lending techniques
more appropriate to the needs of the small and medium-sized busi-
ness concerns, which have traditionally constituted the bulk of the
banks' market for business credit, brought banks into broader con-
tact with this part of the business community. The revival of busi-

to private business enterprise would reduce the chances of continuation of banking and
business under private ownership and control. In order to avoid excessive loss the
guarantor, an agency of the Federal Government, would have to set standards and
review each individual loan transaction. In effect, the guarantor would determine who
could and who could not have credit, as well as the channels through which such
credit would be obtained."



220 BUSINESS FINANCE AND BANKING

ness lending by commercial banks was facilitated by certain changes
in public laws and regulations affecting these institutions} among
these were the liberalization of rediscount facilities, the revision of
bank examination procedures, and the action of public agencies en-
gaged in direct business lending and in loan insurance.

The business financing function of commercial banks might well
decline if banks should confine their operating practices and policies
to those characteristic of the first three decades of the century. Re-
cent developments strongly suggest, however, that if the business
economy continues to experience growth, if banks make the adapta-
tions which are within their power, and if the environment of public
law and regulation within which banks operate is conducive to risk
taking, there will be no decline in the demand for their business
financing services.