In the typical financing arrangement, the vendor of equipment
acquires more than credit from the financing agency. He obtains
such services as credit appraisal and collection, legal advice and
assistance in the preparation of documents, engineering counsel, and
even general management advice. In some cases these ancillary serv-
ices appear to count for more than the credit itself in the estimation
of the borrower.

The market for instalment equipment loans is proximately de-
termined by the quantity of equipment passing into the hands of
businesses unable to finance its purchase with available equity or
open-line credit, and also by the propensity of manufacturers and
distributors of equipment to carry their own paper instead of utiliz-
ing their working capital for other purposes. Underlying determi-
nants of these variables are the rate of technological progress, the
amount of working capital possessed by enterprises selling and
purchasing equipment, and the terms on which additional working
capital can be obtained by alternative methods. In an expanding
economy, marked by increased mechanization of productive proc-
esses and a rapid rate of obsolescence of old equipment, the value
of new income-producing equipment annually passing into the
hands of business concerns is large. If such an economy is also one
that offers opportunities for new and small enterprises, many of
them may find it expedient to acquire equipment on instalment
terms. If, in addition, manufacturers and distributors of equipment
have ample alternative opportunities for employing their working
capital, and if they desire the specialized credit, collection, and other
services that equipment financing agencies can render, a large vol-
ume of instalment equipment loans might be made.

SIMILARITIES IN THE NEWER TYPES
OF BUSINESS LOANS

Twentieth century developments in the technique of supplying
credit to business have been based on a number of discoveries about
the relation of credit to business enterprise. In one form or another,
the four types of business loans just described involve applications
of these discoveries. They all conform to a common basic pattern.



TECHNIQUES OF SUPPLYING CREDIT 149

First, credit arrangements need to be fashioned according to the
special character of the production and merchandising processes of
the business being financed. Loan agreements so fashioned are not
only more satisfactory to the borrower but sounder from the point
of view of the lender. The formulation of such agreements requires
detailed knowledge of the industry to which the borrower belongs,
the position in that industry of the borrowing concern, and the gen-
eral underlying economic situation.

Second, much of the credit used by business is needed for more
than one year, and the amortization of such credit depends more on
a flow of income over time than on the conversion of short-term
trading assets into cash.

Third, the need of individual companies for short-term credit
is typically continuous. Demand is in part responsive to the sea-
sonal features of the industry involved, but it is not, as is sometimes
supposed, discontinuous in the sense that the need for short-term
credit is eliminated, or nearly so, for extended intervals.

Fourth, the credit needs of business are most nearly met by an
arrangement under which the amount of credit in use is automati-
cally adjusted to these changing needs.

Fifth, if credit extension is subjected to careful study and re-
search, a gradual reduction in costs may be achieved.

All the new types of loans explicitly recognize a fact which the
older forms ignored, i.e., that much of the credit used in business is
needed for more than one year. This recognition is explicit in the
term loan and in instalment equipment financing, but it also is pres-
ent in inventory or receivables financing, where both debtor and
creditor enter into an arrangement that contemplates a long-term
loan of fluctuating amount. The four types of loans do explicitly
what the traditional short-term loan did impliedly through the
practice of successive renewals. These types of lending necessarily
call for a more elaborate credit appraisal and forecast of the earning
power of the debtor business than was considered necessary under
the old forms.

Another thread in the new business credit pattern is the gearing
of loan amortization requirements closely to the power of the busi-
ness to make repayment. Term loans to oil producing businesses,
for example, have carried repayment schedules determined by the
net revenue from the probable flow of oil from producing proper-



150 BUSINESS FINANCE AND BANKING

ties after deducting out-of-pocket expenses. Instalment loans made
to finance the sale of Diesel-electric generating equipment have
frequently been repayable in a series of instalments, the amounts
of which have been equal to the periodic savings to the borrower re-
sulting from the installation.

A third bond between these newer types of loans is the close
adjustment of outstanding credit to the actual requirements of the
borrower for funds, and the basing of interest charges on the amount
of funds actually in use. These characteristics are quite apparent in
accounts receivable financing and in field warehouse receipt lending,
where the loan balance fluctuates from day to day, reflecting the
changing balance of either outgoing credit sales of the borrower
over incoming payments, or of inventory receipts over inventory
withdrawals, respectively. They are also present to a considerable
degree in term loans that permit the borrowing business to "take
down" only the amount of credit it requires, and to repay the loan
in instalments. The trade acceptance has this same virtue. In con-
trast, in the traditional loan a business borrows a definite amount
from its bank for a specified period of time and maintains a fluctuat-
ing deposit balance at the bank without automatic adjustment of the
outstanding loan balance and of interest charges.

Cooperation between banks in assuming and carrying loan risks
is another feature of modern business lending technique. Several
banks take participations in a loan for various reasons j for exam-
ple, the total amount of the loan may exceed the legal loan limit or
the self-imposed limit set by the policy of a bank, or the banks with
which the borrowing concern has continuing relationships may par-
ticipate at the instance of the borrower. Cooperation is most fre-
quent in term lending where the amounts of individual transac-
tions are large, but it also occurs in instalment equipment and field
warehouse receipt lending. The bank originating the loan is usually
assigned the task of supervising it, and may be paid a special fee
for its service. Extensive cooperation among American banks in
business lending emerged during the 1930*8, and this cooperation
may have provided a partial substitute for the economic functions
which commercial paper houses formerly performed in spreading
risks on large "open market" business loans and adding to the mo-
bility of unused bank lending power. 18

18 Sec Albert O. Greef , The Commercial Paper House in the United States (Cam-
bridge, Mass., 1938) Ch. XIV, for an appraisal of the economic function performed by



TECHNIQUES OF SUPPLYING CREDIT 151

"Mass financing" also is a common characteristic of the modern
business credit forms. It requires that bank examiners weigh the
competence of a bank for engaging in such credit operations as lend-
ing against accounts receivable, field warehouse receipts, and instal-
ment equipment paper, all of which may involve the handling
according to routine procedures of many relatively small items of
collateral, and for formulating new methods and standards of ap-
praising such collateral. Sampling methods are substituted for the
evaluation of every piece of collateral} and certain standards are
applied to the average performance of a large number of individual
small accounts rather than to the performance of every item of
paper.

Perhaps the most significant development of all is the fact that
modern types of business loans are applicable to the credit needs of
small and medium-sized business that is, the segment of the busi-
ness population which is widely believed to have suffered from
inadequate credit facilities and several of them are specially de-
signed to serve these needs.

commercial paper houses. It seems plausible that cooperative lending provided a means
whereby banks could discharge these functions by themselves, at least to a limited
extent.