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Home -> Neil H. Jacoby -> Business Finance And Banking -> Summary

Business Finance And Banking - Summary

1. Preface

2. Summary

3. Part 1 Chapter 1

4. Chapter 2

5. Part 2 Chapter 1

6. Chapter 1 - continue

7. Chapter 2

8. Chapter 3

9. Chapter 3 continue

10. Chapter 4

11. Part 3 Chapter 1

12. Part 4 Chapter 1

Twentieth Century Developments In Bank Financing Of Business

ABOUT ONE-HALF OF THE earning assets held by American banks
at the beginning of the twentieth century may be classified as "busi-
ness" loansj the remainder were principally loans made for agri-
cultural purposes, loans secured by stocks and bonds and real estate,
and securities. The bulk of the business loans were short-term cred-
its extended to nonfinancial business and mainly to manufactur-
ing and trade concerns of small and medium size for financing
working capital needs. The network of banks was appropriately
described as a "commercial" banking system, because short-term
loans to nonfinancial business were the largest single class of bank
earning assets, and banks were the principal agency engaged in
making such loans.

Forty years later this relatively simple pattern of banking had
altered in five important respects: "commercial" lending or
what in this study is called "business" lending by banks had
become subordinated to other bank financing activities, notably to
the financing of the federal government} the types of loans made
to nonfinancial business, and bank practices in extending such loans,
had been greatly modified} banks were in more active competition
with other types of financing institutions in lending to nonfinancial
business} loans to financial enterprises, such as consumer and com-
mercial finance companies, constituted a major element in bank
loan portfolios} and the direct financing of consumers had become
an important factor in banking.

Various interpretations have been placed on these broad changes
in banking, not the least uncommon of which is that they indicate a
long-run, and persisting, tendency for the business lending func-
tion of banks to decline. The present summary attempts to describe
briefly the character of the changes in bank lending activities after
1900, and to show why these changes took place. Specifically,
answers to the following questions are sought:



What basic underlying forces affected the business credit market
after 1900 and, in particular, influenced the demands of non-
financial business for bank credit?

What changes occurred after 1900 in the character of the busi-
ness economy, and of business demands for funds, which influenced
the demand for credit facilities?

How did the business financing needs met by the banks change
after 1900?

What changes took place up to 1 940 in the way commercial banks
functioned as business lending agencies, and in the competitive
framework within which these functions were performed?

What adaptations did banks make in lending policies and proce-
dures to meet the changing demands of business for financing?

How did World War II affect business financing by banks?

And finally, against the background of this near half-century of
development, what are the problems that banks face in adapting
their lending practices to the changing credit needs of business?


Developments in the business credit market between 1900 and
1940 reflected the action of numerous economic forces, some of
them so deep-seated and so significant in their effect on business
financing as to warrant special attention. These forces and their
principal effects may be summarized briefly:

First, the general growth of the economy until 1929 and the in-
terruption of growth in the thirties produced qualitative changes
in the organization and practices of business, which affected the
aggregate demand for business financing and which compelled
financing agencies to make important adjustments in their business
lending practices.

Second, after the beginning of the century, most sectors of the
economy particularly the extractive and manufacturing indus-
tries tended to use higher proportions of fixed capital to direct
labor. This development encouraged long-term, compared with
short-term, financing and increased the risks of business lending,
because of the greater potential and actual variability in the level of
business activity.

Third, the tendency, especially marked during the twenties, for


consumers to spend a greater proportion of their income on durable
goods of high unit value caused an increase in the degree of in-
stability inherent in the economic process and raised the proportion
of consumer to producer credit in use in the business system. Among
the results of this shift were the rise of the finance company, the
partial substitution of credit extended to financial enterprises for
credit extended to nonfinancial business, and significant changes in
the institutional structure of the credit market.

Fourth, the persistent and, to a certain extent, increasing in-
stability of business activity after 1 900 was responsible for levels of
risk higher than would otherwise have been the case. This fact af-
fected both the magnitude and the character of business needs for

Fifth, after 1930 the increased importance of government in the
process of capital formation, and the financing of a sizable part of
government expenditures by borrowing, resulted in an accumula-
tion of government debt in the banking system and substantially
altered the structure of assets held by banks. Furthermore, to the
extent that the financing of government deficits increased the
liquidity of business concerns, as during World War II, business
demands for bank credit were weakened.

Finally, the persistent decline in interest rates after 1930 was
a fundamental cause of many changes in the business credit market.
One important result was that the widening margin between returns
on loans and returns on investments encouraged banks to intensify
their business lending activities. Bank lending policies and practices
were changed, and new lending techniques were adopted. The dif-
ferent term structure of interest rates with short-term rates be-
low long-term rates encouraged an extension of bank activities
into the medium-term credit field.




Relative Decline of Industries Most Heavily
Dependent on Bank Credit

In general, the changes in the industrial composition of the
economy that took place between 1900 and 1940 were such as to


weaken rather than to strengthen the demand for short-term bank
credit. Industries most heavily dependent on bank credit such
as manufacturing and agriculture tended to fall in relative im-
portance, while industries less dependent on bank loan funds either
held their own or gained, e.g., service trades and transportation
and other public utilities. Furthermore, within the manufacturing
group itself the industrial subgroups that showed the greatest in-
creases in their relative contribution to total output were those
typically placing least reliance on bank borrowings, while the in-
dustries that fell behind were those most dependent on banks. The
enormous growth after 1930 in government's role in the economy
of course involved no direct use of business credit.

Increase in Average Size of Business Enterprises

The increasing average size of business enterprises, evident in every
major industry except wholesaling after 1900, was an adverse
factor in the use of bank credit, since the relative dependence on
such credit was, in general, least among concerns of largest size,
except in wholesaling. In the fields of manufacturing and retail
trade, particularly, the very largest enterprises relied to only a
minor extent on short-term financing. In wholesaling, the average
size of concern probably did not change much between 1900 and
1920, but thereafter it declined. Since the dependence on bank
credit by wholesale enterprises increases with size of concern, the
tendency for their average size to fall after 1920 was a contractive
factor in bank credit demand.

Shifting Relative Importance of Asset Items

Changes in the asset structure of business concerns, and in the
amounts of various kinds of assets used to conduct a given vol-
ume of sales activity, influenced the amount and character of busi-
ness demands for bank funds. Not much is known about changes
in asset structure during the years from 1900 to 1914, except for
a combined sample of large manufacturing and trade concerns
whose current assets in percent of total assets rose rather gradually.
However, if this broad change in asset structure is representative
of changes in other industrial areas, it reflects conditions favorable
to the gradual increase in outstanding short-term bank credit dur-
ing those years.


For manufacturing and trade concerns, World War I produced
a sharp rise in the relative importance of current assets a change
that was reflected in the expansion of short-term debt relative to
long-term debt from 1916 to 1920. The opposite condition pre-
vailed in 1921-22, as the economy suffered a sharp postwar de-
flation, and as short-term debt was repaid or in some instances
funded into long-term debt or equity.

Most of the changes in the asset structure of manufacturing and
trade concerns from 1923 to 1928 weakened the demand for short-
term funds and strengthened the demand for long-term financing.
These changes were generally characteristic of large companies,
which were accounting for a growing proportion of sales in this
period, and not of small and medium-sized concerns. Fixed assets
grew in relative importance; cash increased in proportion to total
assets; and receivables and inventory became relatively less im-
portant elements among business assets. All these factors, while not
characteristic of every line of manufacturing and trade, were suffi-
ciently general among large concerns during this period to counter-
act in part the expansive influence of economic growth and business
asset expansion on short-term bank credit demands, and to encour-
age long-term as against short-term financing.

After 1929, the general decline of prices and the contraction of
business assets notably current assets were accompanied by a
sharp deflation of short-term business debt. While this tendency
was reversed after 1933, no appreciable recovery in the amount of
bank credit used by business occurred until 1936. However, the
bank credit that began to be used then in increasing amount was
credit of medium term, extended primarily to large concerns; it
differed from conventional short-term bank credit not only in re-
spect to term but also in repayment provisions, which were com-
monly arranged on a regular amortization basis.

Increases in Business Cash Balances

Not until the thirties did holdings of cash or its equivalent by large
manufacturing and trade corporations assume amounts that could
be considered excessive in relation to business needs for funds.
Concurrently, the notes payable element among the liabilities of
large concerns tended to decline in importance.

The effect of these twin tendencies on the demand for bank credit


by large concerns was to increase the flexibility of their financing
with bank funds } that is to say, where the ratio of bank debt to
total assets was low, a relatively minor transformation of receiv-
ables and inventory into cash might have been sufficient to supply
funds promptly to eliminate that debt from the balance sheet.
When bank debt was eliminated, or nearly so, further inflows of
cash were used to retire longer-term funds, to pay dividends in
excess of earnings, or to build up "free" balances. Since there are
limits during a period of business contraction to which it is possible
and appropriate to follow the first two of these policies, the last
took place on a considerable scale. Consequently, when sales growth
set in again it was financed in large part by a transformation of
cash back into receivables and inventory, even into plant, without
recourse to external funds. Only when sales, and expectations of
sales, were very high was an expansion of total assets needed, and
consequently only then did a demand for outside funds arise.
Since the amount of sales expansion that could be achieved with-
out the use of outside funds increased with the amount of "free"
cash holdings relative to total assets, the credit needs of large
concerns, whose cash accumulations were most marked, were gen-
erally slow to increase.

Small and medium-sized companies up to 1940 were less suc-
cessful than large concerns in accumulating cash j moreover, their
ratios of payables to total assets showed no tendency to decline.
Therefore, in years of reduced sales volume their cash holdings
were decreased through operating losses, payment of unearned
dividends, and retirement of current debt j and in years of expansion
their use of short-term borrowed funds increased rather promptly.
In other words, small and medium-sized enterprises had less flexi-
bility than large concerns in financing asset accumulations with
short-term credit.

Changing Relative Importance of Debt Items

In the period 1900-1920, when bank loans to business were grow-
ing continuously, the proportion of debt to total business assets
showed a corresponding tendency to rise. All types of borrowed
funds increased, with notes payable expanding particularly during
World War I and into 1920.


Beginning in 1920, however, all debt items declined as a per-
centage of total business assets. Among large manufacturing con-
cerns the decrease was particularly marked for long-term debt and
notes payable} the decline of trade credit was much less drastic.
The liquidation of debt accelerated in the early thirties but ex-
hausted itself by 19355 there was then some tendency for both
short- and long-term debt funds in percent of total business assets
to increase among all sizes of manufacturing and trade concerns.

Asset Expansion and External Financing by Business

In general it appears that business concerns did not retain sufficient
earnings to finance rapid expansion of their assets, but that when as-
set expansion was at a low or moderate rate, retained earnings came
near to satisfying the demands for funds. Sample data for manu-
facturing and trade concerns reveal that the annual financing needs
of these enterprises increased sharply during World War I, rose
persistently and at a relatively high rate during the twenties, and
then contracted sharply in the early thirties. A rapid increase in
1934-37 was followed by a decline in 1938 and an enormous in-
crease throughout the war period. This record of variability con-
siderably exceeded that of the earnings retained by manufacturing
and trade concerns, and suggests that the demand for external
funds was more actively determined by the rate of growth of busi-
ness assets than by the retention of earnings.

During 1934-37 the rapid growth of business assets created as
great a demand for external funds, relatively speaking, as in any
period of business expansion after 1914, indicating that the de-
mand for outside funds continued to be substantial provided the
expansion of business assets was at a high, and particularly at
an accelerating, rate. However, the mere maintenance over a pe-
riod of years of a given rate of expansion of business assets, even
at a relatively high rate, seems to have been an insufficient basis
for a vigorous demand for external funds. During such a period
dependence on outside funds apparently was reduced because of the
persistence of a high level of earnings, leading to a more rapid
accumulation of retained earnings than to increased dividend dis-
bursements, and because of a tendency for financing needs to be
anticipated and provided for in the early stages of expansion.



Shifts in Relative Importance of Industries
Borrowing from Banks

Information on the relative importance of different industrial
groups as commercial bank borrowers is not available prior to 1920.
In that year loans to manufacturing and trade enterprises comprised
the largest percentage of total bank loans to business. Bank borrow-
ings by public utilities and finance companies, in contrast, were of
negligible importance in 1920. By 1940, however, the proportion
of total loans extended to these businesses had risen sharply, while
the percentage of loans to manufacturing and trade concerns had
dropped considerably. Changes in borrowings of wholesale and re-
tail trade cannot be measured separately, but indirect evidence
clearly points to a substantial decline between 1920 and 1940 in the
relative importance of loans to wholesalers.

Importance of Loans to Small and Medium-Sized Businesses

Shifts after 1900 in the industrial character of the companies bor-
rowing from banks make it difficult to reach conclusions as to changes
in the average size of borrowing enterprises. For example, the ris-
ing importance of service concerns, which were typically small,
tended to counteract the increasing importance among bank bor-
rowers of public utility concerns (including railroads), where aver-
age asset size was high, and of a few very large finance companies.
But whatever the size pattern of the business borrowing clientele
in 1900, the "typical" short-term borrower around 1940 could be
described as a small or medium-sized manufacturing or trading
concern, of somewhat less than average profitability. Of the total
amount of bank loan credit used by business around 1940, some
70-80 percent is estimated to have been used by companies with as-
sets of less than $5 million.

Growing Importance of Medium-Term and
"Direct" Lending

Bank lending in the field of medium-term credit under a specialized
instrument the term loan agreement increased markedly be-
tween 1933 and 1940. As a result, loans of short maturity declined


in importance among the business loan assets of banks: thus, bank
loans with maturities of less than 90 days accounted for 57 percent
of all loans and discounts in 1913 and about 30 percent in 1940. In
medium-term lending, banks served size groups of borrowers rang-
ing from very small to very large} but the bulk of credit of this
type which they extended was to businesses that lay between the
very large concerns financed by life insurance companies and the
medium-sized and small concerns served by public lending agen-
cies. Because medium-term loans had been made by banks for only
a short period prior to World War II, generalizations regarding
change are precarious, but at the outbreak of the war bank term
loans apparently were being used to an increasing extent by com-
panies of smaller size and by a wider range of industries than in the
middle thirties.

Changes in the role played by banks in the long-term credit
market, through their purchases of corporate debt securities, may be
indicated, roughly, by broad shifts in the character of the bond
market. Between 1900 and 1939 the pre-eminence of the railroad
in the market for long-term credit (represented by bonds with origi-
nal maturity of over 1 5 years) was successfully challenged by public
utilities; and in the medium-term credit market (represented by
bonds of maturity of 15 years and less), by manufacturing com-
panies. Average size of long-term credits, like credits in the
medium-term market, increased, and original maturities of out-
standing bonds had a somewhat lower average term in 1939 than in

Another important change in the medium- and long-term busi-
ness credit market was in the relative importance of "direct" as
against "indirect" borrowing, that is, in the advance of funds on the
basis of direct negotiation between borrower and lender as against
the acquisition of funds through the public sale of evidences of
debt. In so far as the functioning of commercial banks is concerned,
there was little if any change in the relative importance of the two
means of raising funds up to 1922; during the remainder of the
twenties, however, indirect financing, through bank purchases of
publicly offered corporate securities, gained considerably in rela-
tive importance. This tendency was reversed in the thirties as the
private placement of corporate securities and the acquisition of
medium-term funds through term loans tended to grow in im-




Billion Dollars

portance. Of the gross proceeds of bond issues in 1942-43, 42 per-
cent was provided by private placements, in contrast to 29 percent
in I934~3S5 and bank term loans in 1940 amounted to one-half of
bank holdings of corporate securities, whereas in the middle thir-
ties the proportion was negligible.


Although a basic continuity is apparent in the development of re-
lations between banks and business enterprises between 1900 and

1940, it is strikingly evident
BUSINESS LOANS OF NATIONAL BANKS, that the banking changes which

1900-1940 took place can be described

most effectively if the entire
interval is divided into a series
of relatively brief periods.
Thus, functional shifts and
adaptations can be discussed
by periods in which substan-
tially different forces and con-
ditions were influencing the business credit market. The dividing
years may be determined, roughly, by changes in the business loan
outstandings of national banks, as indicated in the accompanying
chart} they are not necessarily the same as those years which divide
periods of change in other aspects of the economy.

1900-19 75; A Period of Sustained Banking Growth

Since the present study is limited to banking changes in the twen-
tieth century, the first period of banking development is dated
arbitrarily from 1900. In this period which extends through 1915,
business loans of national banks grew fairly regularly at an average
annual rate of about $150 million. Gently rising prices and a grow-
ing volume of business assets were associated with the gradual ex-
pansion in business financing by banks, whether measured by the
increase of bank portfolios of business loans and discounts, or by
the increase in such portfolios plus bank holdings of private cor-
porate securities. Compared with the periods that followed, this was
an era of relatively long and stable growth, marked by no apparent

UOO 'OS MO '15 '20 '25 '30 '35


change o basic importance in the general functional pattern of
banking or in the way the specific function of financing business was

1916-1922: Rapid Expansion and Contraction
of Bank Loans to Business

The second period is that of World War I and its immediate after-
math of accelerated price inflation and subsequent deflation. From
1916 to 1920 the commercial banking system grew rapidly, as war
production programs, inventory accumulation, and rising prices in-
creased business demands for bank credit. During these years busi-
ness loans of national banks rose on the average by $870 million
annually. Although price declines began in 1920 the deflation of
bank credit was not pronounced until 1921-22. These were years
of sharp contraction in business assets, yet the business loan increases
of the earlier years were not entirely lost. As far as the business
lending activity of commercial banks is concerned, the noteworthy
effect of the economic expansion of World War I was a volume of
business loans outstanding in 1922 nearly double that of 1915.
However, total bank assets had increased about proportionately and
the period ended with little over-all change in the relative impor-
tance of the business financing function of banks.

1925-1925: Period of Change in the Character
of Bank Financing of Business

An appraisal of the years 1923-28 depends on whether only the
growth of bank lending (still primarily short-term in character) is
considered, or whether changes in bank holdings of corporate se-
curities as well as changes in bank loans to business are taken into
account. From the former viewpoint the third period contrasts
sharply with the second} between 1923 and 1928 national bank
loans to business increased at an average annual rate of only $ 1 80
million, which was about one-half the 1916-22 average annual
increase. However, from the latter viewpoint, where business
loans are combined with bank holdings of corporate securities, the
rate of growth of bank holdings of business obligations was very
nearly the same in the years 1923-28 as in the earlier period. Con-
currently the amount of loans made on real estate and on the security
of stock exchange collateral increased substantially. While the pro-


portion of these loans which can be properly termed business loans
cannot be determined, it is clear that some were made explicitly as
such and that a good part of all credit thus extended had the effect
of lessening business demand for bank credit of conventional form.
There was a distinct shift away from the conventional short-term,
commercial type of lending and toward other, less direct, ways of
financing business. In view of these facts the years 1923-28 are
better characterized as ones in which significant changes occurred
in the ways in which commercial banks performed their business fi-
nancing functions than as years in which the conventional short-
term financing of business tended to decline.

7929-1955 and 1936-7940: Periods of Contraction and
Revival in Bank Lending to Business

In sharp contrast to earlier periods, when changes in the industrial
structure of the economy, in the asset structure of business, and in
the financial policies of business management were the primary
factors affecting the business credit market, the demand for bank
credit by business in the years 1929-35 was dominated by con-
traction of business assets, price declines, and general financial de-
flation. These circumstances were crucial in their effect on the
business financing function of commercial banks. While a moderate
increase in the business loan outstandings of banks began in 1936,
as business activity revived and the rate of business asset expansion
increased, the amount of bank credit in use by business in most years
in the period 1929-40 bore a definitely lower proportion to the
total value of goods and services produced in the economy than in
previous periods. Furthermore, drastic shifts occurred in the rela-
tive importance of the business financing function of commercial
banks and in the banks' competitive position.

As regards the former, the combined total of bank loans to busi-
ness and bank holdings of business securities fell from 43 per-
cent of total bank earning assets in 1930 to 30 percent in 1940.
During the period 1929-35 the change in relative importance re-
sulted from a shrinkage in the business loan assets of banks which
was more rapid than that experienced by total earning assets} in the
years 1936-40 the decline was due to a slower increase of business
loans than of bank earning assets as a whole.

As regards changes in the competitive framework within which


commercial banks functioned as business lending agencies, a useful
measure is the proportion of total business and consumer instalment
credit extended by commercial banks compared with that extended
by other agencies. For this comparison business and consumer in-
stalment credit are combined because of the substitutability of the
latter for the former, and the close competitive relationships be-
tween agencies functioning in these fields. While the total amount
of business plus consumer instalment credit in use in the business
system in 1940 differed little from that in use in 1930, the relative
importance of the various agencies serving this joint market was
very much altered between those two years. First, that part of
the combined market served by commercial banks fell from 73
percent to 45 percent. Second, the segment served by insurance
companies rose from 1 8 percent to 37 percent. Third, consumer in-
stalment credit, which comprised but 9 percent of the total business
plus consumer credit in 1930, accounted for 20 percent in 1940.
The commercial banks' share of the consumer instalment credit
market rose from 4 percent in 1930 to 27 percent in 1940. Finally,
in comparison with the shifts in the importance of the major agen-
cies serving the combined business and consumer credit market,
the growth in the importance of commercial finance companies and
of public lending agencies was of minor importance. The develop-
ment of these agencies doubtless affected certain segments of the
combined market with considerable force, but it did not substantially
change the relative positions of major agencies.

Shifts in the positions of various agencies in the combined busi-
ness and consumer credit market are, of course, the net result of
numerous forces and conditions, but they clearly reflect two major
developments of this period: first, the rise of consumption credit
relative to production credit, and, second, the growth of medium-
and long-term business credit, compared with the conventional
short-term type.


Primarily as a result of developments affecting business demands
for credit, significant adaptations were made in the business lending
policies and practices of commercial banks. During the years 1923-
28 the adaptations were mostly in the direction of increased holdings


of private corporate securities, larger holdings of loans secured by
real estate, and increased extensions of stock exchange collateral
loans. In 1929-35 adjustments were limited by the over-all con-
traction of credit demand, but during those years forces and condi-
tions developed which provided strong stimuli for change. By
1936, and in certain cases by 1934, significant adaptations were
being made which in a few years substantially altered the func-
tional character of the commercial banking system as a business
financing agency. The salient changes may be summarized briefly.

1 i) Banks greatly increased their participation in the consumer
instalment credit market. Since this market grew more than the
commercial banks' participation in it, the banks were able to hold
larger consumer debt outstandings without reducing their loans to
finance companies. However, since the acquisition of consumer re-
ceivables by business financing agencies placed nonfinancial business
concerns in possession of cash, bank participation in this market,
whether direct or indirect, was in varying degrees substitutive for
direct business lending.

(2) Banks were able to serve more effectively as suppliers of
credit to large concerns by extending serial repayment loans of
longer average term, a development caused primarily by changes in
the asset structure of nonfinancial businesses and in their business fi-
nancing policies.

(3) Banks showed increasing responsiveness to the credit needs
of small and medium-sized businesses, which provided the bulk of
demand for their credit at all times. Because enterprises of these
sizes fared badly during the thirties, the extension of credit to them
called increasingly for methods designed to provide greater se-
curity for the lending agency and to minimize risks of default and
loss. The adjustments which commercial banks made to meet these
credit needs more effectively were marked by a willingness to write
loans on terms more attractive to such borrowers (for example, term
loans with instalment amortization and revolving credits supplying
a reasonable guarantee of working capital facilities over periods
longer than customary), and by the use of a wider range of security
devices (such as the assignment of receivables, liens on income-
producing equipment, the trust receipt, and the field warehouse



During World War II business demand for bank credit was subject
to two opposing forces: the stimulative effects of the war pro-
duction program and the contractive effects of controls and limita-
tions over civilian production not essential to the prosecution of the
war. More specifically, expansive factors were the immense war
expenditures of the federal government, which rose from an an-
nual rate of $6 billion in the fiscal year 1941 to $90 billion during
the fiscal year 1945, and the vast increase in gross national product,
from $97 billion in 1940 to about $200 billion in 1944-45. As-
sociated with these forces was the greater volume of output and
of inventories, even though expansion of both these elements was
limited by contraction in certain lines of civilian goods. Contractive
factors were a net decline in the number of operating business con-
cerns, higher ratios of sales to inventory and to receivables, a
decline in the production of consumer durable goods between De-
cember 1941 and December 1942, and liquidation of consumer
credit outstandings, which greatly affected the borrowings of fi-
nance companies.

In general, wartime developments in the financial structure of
business were such as to forestall any substantial rise in the demand
for commercial bank credit. While net fixed assets appear to have
declined after 1941, because of rapid depreciation accruals, there
was a great expansion in the total plant operated by business, re-
flecting an increase in gross private plant and in government-owned
plant used by business. Between the end of 1939 and mid- 1945, an
expansion in current assets, owing in large measure to the postpone-
ment of replacement and maintenance expenditures and to the re-
tention of earnings, outstripped a rise in current liabilities to the
point where net working capital increased about $23 billion.

The principal effects of these developments on the business lend-
ing activities of commercial banks can be seen in the movement of
business loan outstandings and in the composition of the business
loans held by the banking system. Commercial and industrial loans
in December 1941 rose to a peak about 45 percent above the amount
of such loans at the end of 1939, then declined sharply through


mid- 1 943, and subsequently advanced again so that at the end of
June 1945 they were about 18 percent above the level at the close
of 1939. Factors associated with war production programs or with
wartime economic controls which served to keep the volume of
outstanding business loans only moderately above their 1939 level
were advances and prepayments to war contractors, a decline in
finance company borrowings which was caused by a reduction in
consumer instalment indebtedness, profitability of small and me-
dium-sized concerns which made it possible for them to finance a
large part of their asset expansion through the retention of earn-
ings, reduction of financing needs for agricultural crop movements,
which reflected transportation shortages, and a reduction in bor-
rowings by trade concerns following the liquidation of trade re-

More striking than the changes in the amount of business loan
outstandings during the war period was the change in the compo-
sition of the business loans held by banks. There was an enormous
flow of bank funds into war and out of nonwar uses, a rise in the
proportion of bank credit used by large concerns, which were most
active as producers of war goods, and sharp increases in bank credit
in districts, such as Chicago and San Francisco, where war produc-
tion activities grew most rapidly.

The other feature of wartime developments in banking that is
worthy of special attention is the greater role played by government
loan guarantees. When the special risks of the wartime financing
process appeared to slow the development of the war production
program, they were virtually eliminated by the guaranteed war
loan programs; on June 30, 1945 about 18 percent of the com-
mercial and industrial loans of all insured commercial banks were
held under at least partial government guarantee. In general,
World War II produced an extension of the principle of loan guar-
antees and caused considerable government activity in the area
of business financing through advances and prepayments on war


Postwar credit demands over the long run will be affected by the
same broad factors that have determined the magnitude of business


demands for credit in the past. These are the rate of business asset
expansion, the extent to which asset expansion is accomplished
through the retention of business earnings, and the decisions of
management as to the form in which externally acquired funds are
to be taken whether inequity or in debt, and if the latter whether
on a long-, medium-, or short-term basis. However, it is useful to
distinguish between those specific factors to which business credit
demands are subject over the long run and those of a short-run
nature. Over the short run, as the economy accomplishes postwar
transition, business credit demands are subject to both contractive
and expansive forces. Among the contractive forces are the high
wartime liquidity achieved by business} the payments due by
government on terminated war contracts} tax refunds and claims
and possible tax reductions; and funds recoverable on unamortized
emergency plant facilities. Expansive forces include needed recon-
version expenditures} expenditures for the expansion, relocation,
and improvement of productive facilities; the uneven capacity of
business concerns to finance activities from the liquidation of assets
and current earnings; credit demands of new businesses} and price
increases. The probable strength of these two sets of factors is ex-
tremely difficult to judge but, on balance, the factors of expansion
seem likely to predominate.

As the long-term factors indicated above make themselves felt
in the business credit market, the general environmental conditions
within which business financing is conducted will be changed, and
the position of commercial banks as business financing agencies will
depend in considerable part on their ability to adapt themselves to
the changing conditions. While adaptations can be expected, certain
factors tend to limit the flexibility of banks in making adjustments
to new conditions, notably the persisting environment of economic
instability in which all business financing agencies must operate,
lower ratios of bank capital to deposit liabilities, the short-term
nature of bank deposit liabilities, the risk quality of bank assets
other than business loans, regulations affecting bank investment
in business securities, examination procedures of bank supervisory
agencies, and the operation of legal and conventional conditions
affecting maximum loan charges.

Despite these limitations, commercial banks have made signifi-
cant and effective adaptations in their business lending policies and


practices adaptations which have been facilitated in some in-
stances by the action of public agencies. Prominent among these are
the formulation of specialized loan programs designed to meet the
needs of business concerns in all size classes, and a more specific
adaptation of the system of correspondent banking relationships to
the problems of business financing.

While the manner in which commercial banks function as busi-
ness financingagencies has undergone significant changes since 1900,
there is no evidence of a persisting tendency for the business lend-
ing function of commercial banks to decline. On the contrary, this
function of the commercial banking system has been expanding
since the mid-thirties. Further recovery and expansion will depend
upon the rate of growth of the assets of the business enterprise sys-
tem, the making of effective adaptations to changing conditions in
the field of business financing, and the existence of public laws and
regulations conducive to risk-taking.


PART I OF THIS STUDY PRESENTS a detailed analysis of the business
credit market around 1940 and of the position in that market of the
various agencies that serve the credit needs of business. The decision
to begin the study with this analysis was made mainly because an
understanding of the structure of the business credit market in a
selected recent year facilitates the analysis of changes in the rela-
tionship between business financing agencies and nonfinancial busi-
ness since 1900. The magnitude and significance of these changes
are more readily understood when related to conditions in a base
period. The year 1 940 was chosen for this comparison because of the
availability of necessary data and because conditions had not at
that time been much distorted by World War II.

Part II describes the major changes that occurred in the business
credit market over the years 1900-1940. Particular attention is
given to developments that affected the credit demands of nonfinan-
cial business, to changes in the relationships among various business
lending agencies, and to shifts in lending policies and practices.

In Part III, the analysis of relationships between financial insti-
tutions and business enterprises is extended through the years
1940-45 in order to show how these relationships were affected
by the war production program and war financing methods.

Finally, Part IV is concerned with the emerging role of commer-
cial banks as business financing agencies, viewed against the back-
ground of changing relationships between business finance and
banking since 1900.

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